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.
Most Read IRIS Articles of the Week: July 17-21
Here’s a look at the Top 11 Most Viewed Articles of the Week on IRIS.xyz, July 17-21 2017
Click the headline to read the full article. Enjoy!
The fee debate raging across mutual funds has long since seeped into hedge funds. Certainly the direction of travel on hedge fund fees was already downward, as strong industry competition and underwhelming performance have taken their toll. — Yazann Romahi
Equity markets continued their strong run in the second quarter of 2017, thanks to the global economy hitting its stride and registering the fastest level of growth in six years. For the first time since 2011, the U.S. is no longer the only shining star as economic momentum picked up across the globe. — Sonu Varghese
What’s powerful about Smart Beta is that it allows investors to target very specific factors to create an ideal portfolio based on a given asset allocation. — Salvatore Bruno
At almost every financial and insurance conference we’ve attended in the past year, sessions to discuss the Department of Labor (DOL) Fiduciary Rule have been among the most popular. — Merriah Harkins
In researching high growth professional services firms we made an eye-opening discovery. Those firms that did systematic business research on their target client group grew faster and were more profitable. — Michael Kay
We live in a noisy world where wisdom is hard to discern. Here are a dozen financial truths honed from more than three decades of observation. — James E. Wilson
If you keep getting the same actions or responses from your interactions, it is most likely you that is the problem. Stop blaming others for your issues. — Matthew Halloran
Being influential through your verbal and non-verbal communication Monday to Monday® requires deliberate practice. You can’t read how-to’s in a book or rely on your title and comfort level to be influential. — Stacey Hanke
We all search for the least chaotic place to work and think. However, your location could hurt your productivity. Here’s why…. — Jennifer Goldman
You’re supposed to have a single burning passion, right? To feel this incredible drive to do this thing that you love. — Alli Polin
Real innovation, and real disruption, will be concepts and methods which “do new things that make the old things obsolete”. — Tony Vidler
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