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Strategic Insights

Volume 6, Edition 32 | August 21 - August 25, 2017

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Ringside Seats

Doug_Walters Doug Walters | Articles

Read Time: 5:30 min

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The S&P 500 rebounded this week, breaking the downward trend that had cast a shadow over the previous two weeks. Investors are hoping that the growing hype over the battle for tax reform (and Saturday’s Mayweather-McGregor bout), live up to expectations.

Market Review

Contributed by Doug Walters

Tax reform took center stage this week, as Trump’s top economic advisor, Gary Cohn, made it clear he is not going anywhere until progress is made on reducing the corporate tax burden. U.S. stocks ended the week up over 0.7%, putting an end to the negative returns of the previous two weeks. Corporate earnings remained robust, with the 2nd quarter reporting season nearly complete.

No Waffling for Cohn

There were concerns that National Economics Council Director, Gary Cohn, might exit the Trump administration over the President’s handling of the events in Charlottesville. Cohn is seen as a key advocate for corporate tax reform. This week he made clear that, despite his differences with the administration over their messaging, he is committed to seeing through tax reform. In defiance of the pressure he has received to resign, Cohn stated, “As a Jewish American, I will not allow neo-Nazis ranting ‘Jews will not replace us’ to cause this Jew to leave his job.” Cohn sees tax reform happening before the end of the year, with a big push by Trump expected to begin next week. We see successful tax reform as an important factor in justifying current equity valuations.

Earning Their Keep

Tax reform overshadowed the end of a bountiful 2nd quarter corporate earnings season. With 98% of the S&P 500 having reported, the overall results are encouraging. Sales for the quarter were up 5.5% as compared to the same period last year, while earnings were up 10.4%. Both results were materially above expectations. With equity valuations above their long-term average, it is important for investors to see earnings grow. The Federal Reserve continues to do its part. Fed Chairwoman, Janet Yellen, spoke this week at the Economic Policy Symposium in Jackson. There were some fears that she would strike a more hawkish tone. However, there was no indication of this, leaving investors wondering if we will see another rate rise this year at all.

Economic Commentary

Contributed by Mark Abdalla

Billion Dollar Bout

Odd makers have Floyd Mayweather as the heavy favorite against Connor McGregor in the boxing match this Saturday. While no one knows for sure who will win the fight, what is certain is that both fighters will have a big pay day.

Two years ago, over four million people signed up for pay-per-view to see Mayweather fight Manny Pacquiao. While the fight itself may have been disappointing, the $400 million revenue it brought in was record breaking. Ticket sales generated another $73 million, and sponsorships brought in $13 million. Mayweather took in $240 million that day.

This weekend’s fight may generate even more money as there is crossover interest in the fight from MMA fans and international viewers. Mayweather’s last fight against Andre Berto improved his record to 49-0 and his career earnings to $700 million. This next fight may increase his cumulative income to over $1 billion. There are only two other athletes that made over a billion dollars over their careers:

  • Michael Jordan, who made $1.5 billion with the help of his Nike sponsorship, and
  • Tiger Woods, who made $1.4 billion, also with Nike that paid him over $1 billion.

Mayweather has made his money the more traditional way, mostly from pay-per-view revenue rather than from brand sponsors. When asked why he is fighting McGregor in a recent interview, he responded, “If I can put myself in a position to make nine figures, why not?” Let’s hope he has a good financial advisor to keep him from throwing it all away as many of his predecessors have.

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Week Ahead

Contributed by Max Berkovich

A HUGE Week in Economic Data Next Week

Housing data including Case-Shiller Home Price Index, MBA Mortgage Applications data, and Pending Home Sales numbers are on the docket.

  • After the previous week’s weak housing data (i.e., highest home prices since the housing bubble, the largest jump in inventory since 2009 and below expectations new home sales numbers), positive data points are needed to assure investors that the housing market is not cooling.

Unemployment picture will be painted when the Non-Farm Payroll figures are released on Friday.

  • The current consensus of 185,000 jobs created would be a decline from July’s 209,000, but no change in hours worked, or hourly wages is expected.

Gross Domestic Product (GDP) for the 2nd quarter is due out Wednesday.

  • Annualized growth of the domestic economy is expected to come in at 2.7%.

Economic data focusing on consumer and inflation will come rolling through this week.

  • Highlights of expected reports include: Personal Consumption Expenditures Index (PCE) a preferred inflation measure of the Federal Reserve Chairwoman Yellen, Institute of Supply Management (ISM) prices paid index and The University of Michigan Consumer Sentiment Index.

Strategy Updates

Contributed by Max Berkovich

STRATEGIC ASSET ALLOCATION

A Taxing Situation

With Federal tax reform the next big focus in Washington (see our Market Review), we would like to highlight some items for clients to take into consideration.

Tax-exempt bonds or Municipal bonds will likely be the most impacted investment vehicle from any tax reform. Investors have historically steered their fixed income allocation to tax-exempt bonds to avoid paying Federal taxes, and in some case state and local taxes as well.

  • We caution investors not in the highest tax brackets to look at the after-tax returns (also called the tax equivalent yield). Currently, the yield on a 5-year AAA General Obligation Bond index’s yield is 1.27% on a tax equivalent basis. That yield would be 1.76% assuming a 28% tax rate. The yield on a 5-year U.S. Treasury is 1.78%, meaning there is better yield on a Treasury than a tax-exempt bond for investors whose marginal tax bracket is at or below 28%.
  • It is important to work your financial advisor to understand the implications of your tax situation, particularly if it has recently changed.

Capital Gains will be running on the high side as we are in the 10th year of a post-recession stock market run-up. A luxury problem of course, but tax-loss harvesting opportunities are few and far between after the equities market’s stellar run.

  • We are particularly concerned with mutual fund distributions in 2018 as they face a structural problem that may elevate capital gains distributions. The transition of investor capital from Mutual Funds and into Exchange Traded Funds (ETFs) forces mutual funds to sell securities to meet declining asset bases, but leaves the tax liability that those sales produced to the remaining investors.
  • A cautionary story is the Columbia Acorn Fund (LACAX) which paid out a 23.07% capital gain in 2013, 17.94% in 2014, 42.21% in 2015, 23.94% in 2016 and already 3.84% so far this year. The fund had an annualized return of 8.99% from 2013-2016, trailing the Russell 2,000 Index’s annual return of 13.88% for that period.
  • If you have concerns about mutual fund capital gains, your Strategic advisor can help you understand the implications for your unique situation.

STRATEGIC GROWTH

Growing Like Trees

Consumer Staples came unstapled thanks to Amazon’s (AMZN) announcement of price cuts at Whole Foods that it just acquired. The Health Care sector was the leading sector thanks to Biotechnology. Consumer Discretionary could have easily been either the leader or the laggard thanks to earnings of…

  • DollarTree, Inc. (DLTR) reported consensus topping earnings. The owner of Dollar Tree and Family Dollar stores showed growing sales, with Dollar Tree stores reporting a same-store sales expansion of 3.9% in the quarter.  The sales increase put at ease concerns of potential weakness. Even better, the company guided for full-year 2017 sales of over $22 Billion, topping Wall Street expectations of $20.7 Billion.
  • Ulta Beauty, Inc. (ULTA) didn’t miss a beat and topped guidance, but failed to match the sky-high investor expectations. A close look at the results illuminated an impressive 72.3% increase in online sales. But online sales amounted to only $96.3 Million versus total sales of $1.29 Billion.

STRATEGIC Equity Income

No nightmare on West Elm Street

Telecom and REITs topped Consumer Discretionary for top billing, while Consumer Staples felt the heat from Amazon’s entrance into the supermarket business. In other strategy news…

  • William-Sonoma Inc. (WSM), the home furnishings retailer, rebounded from extreme negativity by proving the naysayers wrong. The company beat expectations and despite fears to the contrary, reported sales growth. The West Elm chain was heavily responsible, as sales expanded by over 10% year-over-year.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets over $1 billion.

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