Is the Trump Bump an Example of Irrational Exuberance?
The stock market continues to soar. The natural question is: How long can this go on?
The market’s behavior reflects high expectations of the Trump administration, particularly with regard to cutting corporate tax rates and scaling back business regulation. So far there has been more talk than action, but that should not be surprising. The biggest changes will need to run through Congress and, in many cases, require some degree of bipartisan support.
The relatively moderate tone of President Trump’s recent speech to a joint session of Congress suggests that he understands that he needs some Congressional support to advance his agenda. Sweeping executive orders get a lot of publicity, but can only accomplish so much.
President Trump still has hundreds of politically-appointed key jobs to fill in the executive branch—the people who are needed to execute the change in direction he is trying to bring about. The main cabinet secretary positions are getting filled, but there is still a long way to go. So, for the time being, we are waiting to see how things play out in Washington.
And as always, we’re paying close attention to interest rates and moves by the Federal Reserve. Fed Governor Jerome Powell of the Federal Reserve, in a recent speech, sounded very optimistic about the economic outlook for the U.S. He explained how Fed policymakers evaluate alternative policy paths using a Taylor-type rule. Unless you understand advanced statistical modeling and forecasting, it may strain your vision.
Meanwhile, minutes of the latest FOMC meeting indicate the Fed plans to raise rates “fairly soon,” if the economy cooperates. Whereas the prospect of rising rates used to spook markets, today the markets view it more positively. Why? The focus has shifted from worries that rising rates will slow down economic activity, to the view that if the Fed is preparing to raise the discount rate, it must be expecting a serious and sustained uptick in the economy (and thus inflationary pressures that the Fed wants to moderate).
So, our basic stance is: Enjoy the market’s advance while it lasts, but don’t expect the run to keep up at its current pace indefinitely. Continue to maintain an appropriately balanced asset allocation profile across multiple asset classes.
The Role of Muni Bonds
One asset class we have favored lately and continue to do so is municipal bonds–even though, as with any other kind of bond, their market values will slide as interest rates rise. We’re attracted to the ability to lock in some attractive after-tax yields, for those investors who are focusing more on income than capital gains opportunities.
As Barron’s recently pointed out, a ten-year high-quality municipal bond is now yielding around 2.45%. A year ago it was 1.9%. You’d need more than a 4% yield on a taxable bond to give you that 2.45% yield on an after-tax basis, depending on your tax bracket.
In case you want to do the math for yourself, here’s how you do the calculation. To determine what a muni yield equates to on a before-tax taxable bond yield, you divide the tax-free yield by your “after-tax factor.”
You get that figure by taking the number 1, subtracting your marginal tax rate (include both state and federal taxes, unless the muni bond was issued in your state) from it (like 1 minus 40%, or 1 minus .40 = .60), then take the decimal and divide it into the tax free return. That examples assumes you’re in the 40% tax bracket. So, if you have a 3% tax free return, you would divide 3 by .6, and voila, the result is 5, meaning that you’d need a 5% yield on a taxable bond to equal the after-tax yield you’d get on a muni yielding 3%.
Today the yield on a 10-year U.S. bond is close to 2.5%–about half the yield on a 10-year taxable corporate bond, so munis blow away Treasury bonds on an after-tax basis. (A slight complication in the calculation is that U.S. bonds aren’t subject to state income tax, which makes their after-tax yield slightly more attractive than a corporate bond with the same yield. But you’re not likely to find a corporate bond with a yield close to as low as a U.S. bond.)
Naturally, credit risk is another important consideration when buying bonds. But highly rated municipal bonds have a default rate only slightly higher than the government rate–which of course is zero.
Advisors Will Be Extinct in 5 Years Unless…
I’ve had financial advisors for more than 40 years. Not once in those years have I called my advisor to find out what stock/funds I should buy or sell. But I have called to find out where I should get my first mortgage, when to sell my house, or how much income I could get in retirement.
In short -- and I think I’m pretty typical – I was looking for financial advice, as it relates to my life.
Here’s the disconnect, what most advisors do is simply manage their clients’ assets. They determine what to buy, and what to sell, they think about risk management, about growing their practice by finding new clients and about getting paid.
Historically that has been the business model. But as more women take control over financial assets, they, like me, will be looking for a different experience. And unless the financial community is willing to change ….. advisors, as they are today will be extinct in five years.
Advisors who want to survive will have to do a lot more than just manage money – they will have to provide genuine “advice”. That means doing what’s right for the client, not pushing product and pretending it’s advice.
Women especially, but all investors generally, are becoming more and more cynical. They says, “If I want advice about reducing my debt, that’s what I want and not ‘here’s more debt’ because that’s what my advisor gets paid for! And if saving taxes is what I want then saving taxes should take precedent over selling me a product.”
You may be thinking that spending your time providing advice isn’t lucrative but the reality is that in the long run – it pays off in spades. The advisors who take the time to build real relationships with clients, who provide advice as it relates to their clients’ lives, even when there is no immediate financial benefit to themselves, those who don’t simply push product – are the ones who over time have the most successful practices.
Generally women understand and value service, but they will say, “If I’m paying, I want to know what I’m paying for: Is it for returns? Is it for advice? Is it for administration? I want to know. Then I can make up my mind what’s worth it and what isn’t.”
Investing is becoming a commoditized business and technology is replacing research that no one else can find. Today the average advisor is hard pressed to consistently beat the markets, and with women emerging as the client of the future, unless they start providing real advice, their jobs will likely be extinct in five years.
- 1 of 1143