Q1 2018 Returns By Asset Class

For the last few quarters, I’ve posted returns by asset class (by representative ETF), as well as year-to-date, last twelve months, and last five years. While there is still no predictive power in this data, I updated those charts as of the end of Q1 2018 for those of you that are interested (see below).  Note that there is no year-to-date chart in this quarter since year-to-date and last quarter are the same.

2018Q1 Asset Class Performance

A few callouts from the data:

  • Most asset classes finished Q1 down between 0.5% and 1.5%.  This is a far cry from “Markets In Turmoil”, as CNBC likes to call it whenever stocks move down for a few days in a row, but it is still the first down quarter in a long time.  The standouts on both sides of the flat line were Emerging Market Bonds (+~4%), Emerging Market Stocks (+~2.5%) and US Real Estate Investment Trusts (REITS) (-~8%).
  • All asset classes other than REITs remain positive over the last 12 months, led by Emerging Markets and Foreign Developed Markets.  As I’ve pointed out quite a few times in the last few years (and as can be seen on the 5-year chart), foreign stocks a have a lot of catching up to do vs. US stocks from a performance perspective.  Of course there’s no way to know whether they will catch up with the US or if there’s good reason for their underperformance.  At least over the last year, a bit of catch-up has occurred.
  • After smooth sailing in 2017, volatility returned for Q1 2018.  You’ll notice a lot more ups and downs on the 12-month chart over the last 3 months.  What feels like a bit of a roller coaster over the last few months is actually much more normal from a historical perspective than 2017 was.
  • Bonds (short and medium term) are still up slightly over the last 12 months despite another interest rate hike by the Fed.  The Fed Funds rate target is now 1.50-1.75%.  Futures markets are pricing in another two Fed rate hikes in 2018, with about a 30% chance of three more hikes.

Budget Deal Extends Some Expired Tax Provisions

The budget deal that was agreed upon in Congress and signed by the President early this morning includes “Tax Extenders”, which extend some previously expired tax provisions retroactively to 2017. These include the exclusion from gross income of discharge of qualified principal residence indebtedness, the ability to deduct mortgage insurance premiums, the deduction for college tuition and fees, and the credit for residential energy improvements (windows, etc.). See this summary (https://email.steptoecommunications.com/22/1412/uploads/summary-of-tax-extenders-agreement.pdf) for a full list. Make sure to consider these items when gathering inputs for your 2017 taxes.

Market Update (2/5/2018)

I had hesitated to send one of these out after the two-day pullback in the market because while it looks bad on a point basis (Dow, S&P, etc.), it’s far from exceptional on a % basis, which is what counts. After today’s fall, the S&P is down a little over 1% for the year. Some other assets classes are down a bit more, others are still up on the year. This is far from “Markets in Turmoil”, but that business news headline attracts attention, raises fears, and up go ratings. Because of that, I thought a quick note was warranted to both show there is not turmoil at this point and to give you my perspective on what’s going on. Here’s a quick look at year-to-date performance (including any dividends paid) by asset class (representative ETF) AFTER today’s “plunge”:

US Large Cap (SPY): -1.1%

US Small Cap (VB): -2.7%

Foreign Developed (VEA): -1.5%

Foreign Emerging (VWO): +1.7%

Real Estate Investment Trusts (VNQ): -9.9%

High-Yield Bonds (HYG): -1.3%

Aggregate Bonds (BND): -1.4%

Short-Term Investment Grade Credit Bonds: CSJ: -0.1%

Local Currency Emerging Market Bonds: +2.5%

Aggregate Commodities: +0.5%.

As you can see, with the exception of REITs, which are getting beaten up as interest rates rise, this is far from turmoil.

What happened today is concerning though. Stock markets behaved erratically. Futures liquidity dried up as this started to happen and liquidity in the S&P 500 futures contracts after-hours tonight are as low as they have been in a long time. That means it’s fairly easy to push the market around with relatively small orders, causing big moves in either direction. As a result, S&P futures have been moving 10+ points repeatedly over only a few minutes throughout the evening (this is the equivalent of the Dow moving in about 100 points per few minutes). The markets are down sharply overnight, with recent lows having Dow futures down another 1100 points from today’s close and S&P futures down a little over 100 points. This isn’t being caused by economic issues, bank liquidity issues, terrorism, recession, or anything that caused the last two major (-50%+) market falls. In my opinion, it’s being caused by large, leveraged bets on continuing low volatility which are unraveling in what should have been some mild profit-taking and re-pricing as interest rates moved a bit higher in January. Volatility has been running well below normal as I’ve pointed out in recent quarterly updates. Futures markets generally price in a return to normal volatility over time. Therefore, if one shorts future volatility in futures markets (or via multiple exotic ETFs and other financial products) and volatility remains low, money can be made over and over again very quickly. Hedge funds have been started that engage in this tactic and it has paid off massively over the past year as there has been virtually no volatility in the stock market. The longer the strategy pays off, the more money moves into it, chasing its success. People / funds begin to borrow money to invest in the strategy (leverage) because they can pay a few % of interest per year for their borrowing costs and make 10%+ per month if the strategy continues to do well. For all of history this has been a recipe for disaster and sure enough, it is beginning to unravel. An otherwise ordinary increase in volatility surrounding a few days of rising interest rates / declining stocks causes these bets on low future volatility to lose massive amounts of money very quickly. Fear that they won’t be able to pay back their loans causes margin calls which forces more selling of this strategy. Selling of short volatility funds is essentially buying volatility into a spike in volatility, which causes (of course) more volatility. Other hedge funds know this is happening and try to take advantage of the forced volatility buying (stock selling) causing even more. From there, it’s the same old vicious cycle that has fueled market drops like this in the past. Want proof that this is what’s going on? Today was the single biggest % increase in the VIX (the volatility index) in the history of the market on what wasn’t even in the top 100 down days on a % basis in the history of stocks. Want more proof? Here’s the after-hours chart of an exchanged traded note that tracks the inverse of the volatility index (I know that’s a mouth-full… it’s basically one of these short-future-volatility funds that is blowing up):

You’re reading that right… -86.04%, just since 4pm today! This is going to cause some hedge fund meltdowns. It’s going to cause some margin calls. It’s going to strain markets for a while. But I find it hard to believe an obscure greed-based strategy is going to bring down earnings growth, which is really starting to pick up around the world. That’s not to say there aren’t other factors playing a role here, but I think this short-volatility blow up is a big part of it. Another cue that this is probably a shorter-term event is that it’s not flowing through to currency markets at all (at least not yet). Despite futures being down 4% overnight, the dollar index, a normal flight to quality when there is a lot of fear in the market, is up only 0.1%.

Anything is possible, and as I’ve said many times, I’m certain that the stock market will eventually fall more than 50% again. We probably won’t see it coming in advance of that happening. But, if someone forced me to place a bet, I would bet that this will be a fairly short-term event that will allow the market to build again from whatever bottom that forms. To be clear, I’m not advising anyone to invest money they wouldn’t otherwise invest as a result of this. I’m not advising anyone to be more aggressive or conservative in their portfolio or to reposition assets in any way (other than usual rebalancing) as a result of this. Financial plans are designed to weather market moves, not predict them, and not time them. I know seeing your portfolio value fall hurts. For some of you, it makes you want to sell stocks. For others, it makes you want to aggressively buy stocks. But it is going to happen over and over again and is the price you pay for the kind of growth you’ve experienced over the past several years. Markets can’t only go up, despite what they’ve done in the past year. We’ll be rebalancing client portfolios on the way down (sell bonds, buy stocks), just as we rebalanced in the other direction (sell stocks, buy bonds) on the way up. And, it never hurts to have your planned contributions and 401k deposits go in at a lower level than they otherwise would have.

In short, expect that wild swings in either direction are possible over the next several days. I hope that with the explanation above, you’ll find what happens more interesting than traumatic. As always, if you’re reading this as a PWA client, feel free to contact me with any questions.

2018 Federal Withholding

In January, the IRS released new withholding tables for employers to begin using by the end of Feb 28. These new tables will take into account the new tax rates under the Tax Cuts & Jobs Act (“TCJA”) and will reduce the amount of tax withheld from your paycheck in most circumstances. However, your W-4 on file with your employer determines how many allowances are used as part of the withholding calculation and how much additional tax you elected to have withheld. Those allowances reflect a combination of your expected deductions that exceed the standard deduction (if you itemize), the number of members of your family (exemptions), the impact of multiple earners filing jointly (marriage penalty), and the impact of certain credits based on your total expected income and family size. Because the rules for many of those items have changed under the TCJA, it is very possible that the number of allowances that you are claiming is no longer correct, meaning that the withholding calculations will not be accurate.

The IRS is revising the W-4 form and their online withholding calculators to reflect the changes, but they’re not expected to complete that task for at least a few more weeks. Until then, once your employer starts using the new withholding tables, you should be aware that too little (or in some cases) too much tax will be withheld. This will accrue a refund or an amount owed in April 2019 when you file for 2018, which may result in a higher or lower refund or amount owed than you are used to seeing. Assuming the new W-4 is released by the time your 2017 taxes being prepared, you should work through the new withholding settings and file a new W-4 with your employer at that time. A month or two of inaccurate withholding will result in a smaller impact on your April 2019 tax refund / amount owed than multiple months will. I will be initiating this conversation with financial advising clients for whom I prepare taxes. If you’re preparing your taxes on your own or through another preparer, make sure to consider a W-4 revision if appropriate. Contact your financial advisor if you’re not sure what to do.

Q4 2017 Returns By Asset Class

For the last few quarters, I’ve posted returns by asset class (by representative ETF), as well as year-to-date, last twelve months, and last five years. While there is still no predictive power in this data, I updated those charts as of the end of Q4 2017 for those of you that are interested (see below).  Note that there is no year-to-date chart in this quarter since year-to-date and last twelve months are the same.  Instead, I just included one Full-Year 2017 chart.

2017Q4 Asset Class Performance

A few callouts from the data:

  • All asset classes displayed finished positive for 2017.  International markets led the way with emerging markets up 33% and developed foreign markets up 28%.  About 10% of this gain, is due strictly to currency fluctuations as the US Dollar finally took a breather vs. most foreign currencies in 2017.  That makes foreign holdings worth more in US dollars and juices returns a bit, offsetting some of the dollar gains / foreign losses in recent years.  Local currency emerging market bonds were up 15% for the year, due in part to the same currency impact.  As can be seen on the 5-year chart, foreign markets have a lot more catching up to do vs. the US, though there’s no way to know when that’s going to happen, or if the gap gets wider before it eventually starts to narrow.
  • US stocks continued their solid run with large caps up ~22% and small caps up ~17% on the year.  While those numbers aren’t extraordinary from a historical perspective, the lack of volatility was.  For the first time in the history of the S&P 500, all twelve months of the year had positive returns.  Don’t expect that to happen again, but if you think 20%+ returns usually means no chance of good returns the following year, you’d be mistaken.  The S&P 500 was up 20%+ 18 times since 1950 and in 16 of those times, the following year was higher (per LPL Research).
  • Bonds (short and medium term) had another positive year despite three more interest rate hikes by the Fed.  The Fed Funds rate target is now 1.25-1.50%.
  • Commodities (energy, metals, agricultural products) finished the year positive and are up substantially from their bottom in early 2016.  However, the oil crash really took its toll and as such, aggregate commodity funds are still down ~40% over the last 5 years.

IRS Statement Re: Prepaid Property Tax

Yesterday, the IRS issued this statement with regard to the tax deductibility of prepaid property tax.  In it, they state that the property tax must be both assessed and paid in 2017 in order to be deductible in 2017.  The statement is just a reminder/clarification, not a new rule.  It follows with what I wrote in my last post about prepaying property taxes…  “Be aware though that in most cases, if the county accepts the prepayment as a deposit placed in an escrow account, it is not considered “paid” for Federal tax purposes.  It has to be paid against a levied tax to be deductible.”  If there is no tax yet, then your county could just be putting your prepayment in a suspense or escrow account and that is definitely not deductible.  If your tax has not yet been assessed, then there is no tax bill to prepay and that means your situation is the same as the 2nd example in the IRS statement.  Clearly not deductible.  If the tax was already assessed and payment isn’t due until sometime in 2018, or if they are taking your payment, levying a tax to offset it, and applying the payment against a levied tax (with amount not finalized, but known to be at least as much as last year), then that should be deductible.  I highly doubt many counties are going through that level of trouble though.  Most likely, either the tax has already been assessed and you’ve been notified of it, in which case payment would be deductible if make by 12/31/2017, or the tax has not been assessed and is not deductible for 2017, regardless of when it is paid.

Pre-Paying Property Taxes

For those of you who are looking into making extra property tax payments in 2017 per this previous post in an attempt to make payments deductible in 2017 that would may not be deductible for 2018, I compiled a list of relevant (to my clients) states and their policies on prepayment.  In some states, even if the official property tax bill(s) for calendar year 2018 haven’t been published, they will accept pre-payment.  Be aware though that in most cases, if the county accepts the prepayment as a deposit placed in an escrow account, it is not considered “paid” for Federal tax purposes.  It has to be paid against a levied tax to be deductible.   This information is posted for reference only and is not a substitute for communicating directly with your tax collector and/or a CPA, EA, or tax attorney.  Use it as a guide to get started, not as the law.  Here’s what I’ve found so far:

California: taxes are managed at the county level but it appears that for all counties payment #2 for fiscal 2018 is due in early 2018 (payment #1 was due in late 2017).  These bills have been published and the amounts are known.  If you want to make a pre-payment, simply pay your 2nd payment prior to 1/1/2018.

Georgia:  taxes are managed at the county level.  For Dekalb and Cobb counties, there is no mention of prepayment of taxes for 2018 on their websites.  They just collected 2017 taxes in the Fall of 2017, so there is no assessment nor bill for 2018 yet.  However, they may still accept a payment for 2018.  Call the county tax office for details.  For Fulton county, due to issues I don’t fully understand, their 2017 tax bills were issued later than usual.  Residents in the City of Atlanta have a due date of Dec. 31, while residents in Fulton County have a due date of Jan. 15, 2018.  Pay by 12/31/2017 if you want the payment to count for 2017’s Federal taxes.  For 2018 pre-payments, again, call your county tax office.

Illinois: taxes are managed at the county level.  In Cook county, taxes are paid in arrears.  2016 taxes were paid in 2017.  2017 taxes are due 55% on 3/1/2018 and 45% on 8/1/18.  The county website indicates that they are now accepting prepayments for the 3/1/2018 portion, but makes no mention of the 8/1/2018 installment.  Call your tax collector for more detail if you’re interested in paying beyond the first installment.

Maryland – taxes are managed at the county level.  For Baltimore County, tax payments are divided into two installments.  The first installment is due on July 1 of the tax year and may be paid without interest on or before September 30 of the tax year. The second installment is due on December 1 of the tax year and may be paid without interest on or before December 31 of the tax year.  So, all tax bills for 2017 should be paid by end of calendar 2017.  I haven’t found any information about pre-paying 2018 taxes in Baltimore County, but Howard county just announced that it is accepting pre-payments for 2018 and will hold those payments in escrow until bills are generated.  I expect other counties to follow suit.  Contact your tax collector for more details.  Be aware though that in most cases, if the county accepts the prepayment as a deposit placed in an escrow account, it is not considered “paid” until they accept it against an levied tax, so you may still not get a deduction for it.

Michigan – taxes are managed at the county / city level.  For Detroit and the rest of Wayne county, tax bills are divided into two installments.  The first is due 8/15 and the second is due 1/15 of the following year.  You can make your 1/15 payment by 12/31 for it to count toward 2017 Federal taxes.  I haven’t found any information about pre-paying 2018 taxes so call your county tax collector to inquire.

Minnesota:  taxes are managed at the county level, but at least for Hennipen county, they are accepting prepayments based on the amount stated in your proposed property tax (Truth in taxation ) notice sent in November 2017.  Payments must be received (not postmarked) by the county by 12/29/17 to process for 2017 and they may be made in person or by mail.  Other counties probably have similar policies so check with your county tax collector if you want to pre-pay.  For Hennepin County, see their website for more info.

New Jersey: the annual property tax bill is due 25% each quarter on 2/1, 5/1, 8/1, and 11/1.  I believe you should already know the 2/1/18 and 5/1/18 payment amounts so those could easily be prepaid by 12/31/2017 if you want them to count for 2017 Federal tax.  I have no information about pre-paying beyond 5/1/18.  Call the county tax office for more info.

New York: there are two types of tax bills each year: 1) School and 2) Municipal and County.  School tax bills are typically mailed in Sep each year, with due date varying by district.  Municipal/County bills are typically mailed in Jan each year, with due date varying by locale.  If your School tax bill hasn’t been paid yet, you can definitely due that by 12/31/2017 if you want it to count toward 2017 Federal tax.  For the Municipal/County bill, call your tax office and ask if they can give you the amount that will be on the January 2018 bill and if you’re allowed to pay it by 12/31/2017.  There is no mention on state websites I looked at about pre-paying Municipal/County taxes for the following year.  That would be taxes not due until 2019 so I doubt that would be allowed, but check with your county tax office to inquire.

Update 12/23 – per Jeff Levine, CPA via Twitter: ” Interesting… NY’s Governor Cuomo has signed an executive order allowing the early payment of 2018 property in order to help New Yorkers impacted by the ‘s new SALT restrictions

North Carolina: taxes are managed at the county level.  I checked Mecklenberg and Union counties and both show due dates for 2017 tax of September 2017, but no interest will be due if paid by 1/5/2018.  If you want your 2017 tax payment to count for 2017 Federal tax, pay by 12/31/2017.  For 2018 prepayments, policy seems to vary by county but I was able to verify that both Mecklenburg and Union counties are accepting pre-payments by check with parcel number and “prepayment” noted on the check.  Incidentally, I’m writing this at 3pm on 12/21 and Mecklenburg County issued their policy at about 2:30pm on 12/21.

Pennsylvania – taxes are managed at the county / city level and the procedures vary greatly by municipality.  In Philadelphia tax bills are mailed in December for the following year and are due in March.  So you can definitely pay 2018 property tax bills in 2017 if you make payment by 12/31/2017.  In Delaware County, bills are mailed 2/1 and are payable at a slight discount through 4/1, full amount through 6/1, and with a 10% penalty through 12/31.  Call your tax collector to inquire about prepaying the following year’s taxes if you wish to do so.

South Dakota – Property tax bills are divided into two payments.  The first half of the property tax payments are accepted until April 30th without penalty. The second half of taxes will be accepted until October 31st without penalty.  So 2017 taxes have already been paid.  I haven’t found any information about pre-paying 2018 taxes so call your property tax collector to inquire.

Texas: 2017 property taxes are due 1/31/2018.  If you want them to count as a deduction for 2017 Federal tax, pay them by 12/31/2017.  There is no mention on state websites I looked at about pre-paying 2018 taxes.  That would be taxes not due until 2019 so I doubt that would be allowed, but check with your county tax office to inquire.

Virgina – taxes are managed at the county level.  Most counties seem to have tax due in two installments during the calendar year.  The counties I researched, including Fairfield County appear to be accepting prepayments of 2018 property taxes.  They need to be paid (not postmarked) by 12/26 to be credited as paid in calendar 2017.

Washington: 2017 tax bills have already been paid.  It is against state law for county tax collectors to accept payments for 2018 taxes during calendar 2017 per the Kings County website.

Calling your city/county tax collector and specifically asking if they will accept prepayment (and by what method) is the best way to get an accurate answer.  Many counties still appear to be figuring this out, so there’s a lot of changing / stale information out there.

Remember, if you’re in AMT for 2017 already, without the additional payment, then this will not help you.  But, the only way it hurts you is if the 2018 tax law changes again and would have made the payment deductible in 2018 (seems like a low probability), if your state/local income/property tax deductions would be less than $10k in 2018 (meaning you could have deducted the property taxes in 2018 instead), or if it’s tying up money you otherwise need for something else, leading you to take on debt or make other inefficient financial decisions.  So, if you can pre-pay your 2018 property taxes, unless you know for sure that it won’t help you to do so, you can consider doing it.