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.
Why Lasting Change Is Hard
Before we had any children, my wife and I lived in the heart of Dallas. One day, on our way back to our house, we were driving down Skillman Avenue when we were caught in a sudden torrential downpour.
The rain was coming down incredibly hard, which wouldn’t have been a problem if the storm drains were equipped to handle that much water. Instead, the road itself filled with water faster than we could have anticipated. Quickly, the water rose up the side of our car. Trying not to panic, we realized that we could not continue and would need to turn around and get to higher ground.
Water rising up the side of your car door is the kind of roadblock you might not expect to encounter, but when you do, it’s formidable. We couldn’t drive through it or even around it. We had to deal with it quickly or face serious consequences.
When we’re trying to implement change in our own lives, it’s important to identify and plan for common roadblocks to lasting change.
The first and, in my opinion, most important roadblock to lasting change is not addressing the real issue.
Let’s say you wake up in the middle of the night with a sore throat. You’re annoyed by feeling sick but your throat really hurts, so you get up and spray a little Chloraseptic in your mouth and drift off to sleep. When you wake up the next day, you still have a sore throat, so you pop in a cough drop and go about your day.
The change you’re making – using a numbing agent – might work if you’ve only got a cold, but if it’s strep throat, you’re not addressing the real problem. Only an antibiotic will cure what ails you, even if Chloraseptic will keep the pain at bay for a while.
Just like how more information is needed to diagnose your sore throat than one feeling, problems you encounter in your life or business require diagnostics, too. Figuring out the real problem – not just your most apparent needs – requires some introspection and a little bit of time.
Here are eight questions to ask when you need to discover the root cause, courtesy of MindTools.com:
- What do you see happening?
- What are the specific symptoms?
- What proof do you have that the problem exists?
- How long has the problem existed?
- What is the impact of the problem?
- What sequence of events leads to the problem?
- What conditions allow the problem to occur?
- What other problems surround the occurrence of the central problem?
Once you have your answers to these key questions, you can’t stop there. Your vantage point is skewed from your own perspective. You’re going to want to ask someone else to evaluate the problem at hand with the same questions and then compare your answers.
If you and all of the partners at your firm have similar answers, you’ll know you’re on the right track. If you wind up with wildly different ideas, I suggest seeking the advice of someone outside your organization. Fresh eyes can make all the difference in understanding a problem.
I often talk about being ‘too close’ to understand. You’ve probably heard the illustration about a group of people standing by an elephant with blindfolds on, trying to describe what they’re experiencing. Depending on what part of the elephant you’re next to, you’re going to have different observations.
But someone outside of that elephant’s cage can clearly identify the elephant.
The first key to making a lasting change is to make sure you’ve addressed the real problem and are looking for authentic change.
Next time, we’ll address the second major roadblock to creating last change.
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