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Growth for Whom?

This week, President Trump was forced to back off on his aggressive trade war, defend himself against recorded audio discussing a payoff to a Playboy model, and fret over the Trump Organization financial chief, Allen Weisselberg, testifying before a federal grand jury. Understandably, Trump has seized on relatively good news that U.S. economic growth hit 4.1% in the second quarter of 2018. Nevertheless, 40 million Americans live in poverty, and remain without healthcare coverage¹. It begs the question, "Who is the growth benefiting?"

The apparently good numbers come in the wake of a massive tax cut from 35% down to 21% that Trump gave corporations at the beginning of the year. Although previous administrations have used economic stimulus in order to avoid recessions, Trump's gift came at a bullish period of economic expansion, falling unemployment and rising home values. Maya MacGuineas, president of the nonpartisan Committee for a Responsible Federal Budget, calls it a "temporary sugar-high" that has long-term negative consequences because it pushes the federal deficit to over $1 trillion.² 

The biggest beneficiaries of this largesse have been corporate executives. Corporate profits after taxes are at the highest level ever seen in this country.² Earlier this year, the United Nations Human Rights Council reported that the top 1% of the U.S. population owns 38.6% of the total wealth in the country, and that "the U.S. already leads the developed world in income and wealth inequality." ³

Only a trickle has gone towards employee raises or bonuses. $800 billion is going towards stock buybacks to boost share prices and dividends. Stock shareholders have benefited, but 84% of all stocks are owned by the wealthiest 10% of households. 40% of Americans (125 million people) have hardly any investments at all.⁴

Trump’s trade war has also created an artificial spike in growth. In anticipation of U.S. tariffs and retaliatory tariffs being implemented, foreign companies have been stockpiling goods and raw materials in order to buy before prices jump. This has temporarily boosted U.S. exports.

A 10% tariff on $400 billion of imports is $40 billion that goes into the U.S. Treasury, a welcome pay increase for the government. But who pays for the trade tariffs? For American consumers, the trade war is a new financial hit, because it raises prices. The import tax on automobiles would raise the cost of a Toyota Corolla, Honda CRV or Ford F150 by about $1,000 due to the tariffs on car parts manufactured outside the U.S. It would add about $5,000 to the cost of imported cars.⁵

In addition, General Motors estimates that because of the proposed tariffs, they would have to eliminate 195,000 jobs over the next three years. With retaliatory tariffs, these job losses could increase to 624,000.⁶

It appears that “growth” means even more wealth to a small number of already-wealthy Americans. For the vast majority of the population, it means paying more for food, housing, clothing and healthcare, including the possibility of losing their jobs.

Although Trump characterizes the quarterly number as “an economic turnaround of HISTORIC proportions,” it is actually more modest and fleeting. During the Obama administration, the economy exceeded 4.1% four times.⁷ And because of the unusual confluence of events that created last quarter’s surge, it’s likely the economy will soon return to the average 2 to 2.5% rate that we’ve experienced since 2009.

 

¹ Bloomberg 4/3/2018

² New York Times 7/25/2018

³ Los Angeles Times 6/6/2018

⁴ CNN Money, 2/16/2018

⁵ CBS News 7/2/2018

⁶ CNBC 7/3/2018

⁷ New York Times 7/27/2018

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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U.S. Stock Market Improves in Second Quarter

The first half of this year was shaky, and made some people wonder if the positive, bull market was coming to an end. Thankfully, the market stabilized in the second quarter, and made back much of the losses. The U.S. equity markets are back on the positive side.

The broadest measure of the U.S. market is the Wilshire 5000 Total Market index. For this last quarter, it finished up 3.83%. For the first half of the year, it was up 3.04%.¹

There are two closely-followed indices for the U.S. large company market: the Wilshire U.S. Large Cap index, and the Standard and Poors 500 index of large company stocks. The Wilshire index was up 3.41% in the last quarter, and up 2.62 from the beginning of the year.¹ The S&P 500 index was up 2.93% in the last quarter, and up 1.67% for the year.² The generous tax cut that Trump gave these companies, from 35% all the way down to 21%, took awhile to kick in, which is one reason why the second quarter performance was better than the first. 

Over a longer period of time, small companies tend to grow faster than large companies. This makes sense, because it's easier to double in size if you're a small company, compared to doubling in size as a mega-company. Small U.S. companies are starting to have their day in the sun. The Wilshire U.S. Small Cap index rose 7.87% in the last three months, and is up 7.08% for the year. ¹ A comparable index is the Russell 2000 Small Cap index. It is up 7.66% since the beginning of the year.³

International stocks have been hit badly by the Trump trade tariffs. Because the U.S. economy is the strongest in the world, it's like the 800-pound gorilla. Trump is likely betting that in an all-out trade war, weaker global economies will feel the pain more than the U.S., and so far this is happening. The EAFE (Europe, Australasia and Far East) index, which represents companies in developed foreign markets, lost 2.34% in the last quarter. The performance for the year is even worse, down 4.49%. Europe by itself has a loss of 2.74% over the last three months, and an overall loss of 5.23% for the year.

Emerging markets indices represent small, less-developed but quickly-growing economies, like China, India, Brazil and Russia. These suffered most of all from the trade war in the last quarter. The Shanghai Composite is already in a bear market, down more than 20% from its 52-week high. MSCI's EM index is down 8.66% for the quarter, with a loss of 7.68% for the year.⁴

Trade tariffs act like an extra tax on the people. When the U.S. slaps tariffs on goods coming into the U.S., it doesn't go into our pockets -- it goes into the U.S. Treasury as extra revenue. Because domestic producers are not forced to reduce their prices from increased competition, U.S. consumers are left paying higher prices as a result. In a round-about way, the tariffs are helping the government pay for the tax cut to corporations, and Americans are paying the price at the cash register.

Jerome Powell, the chairman of the Federal Reserve Bank, has raised interest rates a couple of times already this year. He also announced possible further interest rate increases for September, December, next March, and next June. This has a direct impact on the bond market. Typically, when interest rates go up, bond values go down, with long-term bonds affected the most. When bond values go down, the coupon rate (which is relative to the lower value) goes up. Consequently, the coupon rate on 10-year Treasury bonds has risen to 2.86%, and for 30-year Treasuries, 2.99%.⁵

You'll notice that the coupon rate between 10-year and 30-year Treasuries is not that different. This is called a "flattening yield curve," and is a concern to economists because it's an indication that the current bull market, which started in March of 2009, is running out of steam.

The stimulus given to corporations in the recent Tax Law gave an artificial boost of adrenalin to the U.S. market and economy. The benefits could be short-lived, but the long-term impact of the additional $1 trillion deficit can have dire consequences, especially if the Trump administration attempts to take it out of Medicare, Social Security and other programs that benefit everyone.

¹ www.wilshire.com/indexes/calculator

² www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf-p-us-1

³ www.ftse.com/products/indices/russell-us

⁴ www.msci.com/end-of-day-data-search

⁵ www.bloomberg.com/markets/rates-bonds/government-bonds/us

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

 

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Strong Dollar and Trade Tariffs Play Chicken

The Dow Jones Industrial Average got an awakening this last week when two consecutive days of losses wiped out the year's gains. Down by 1.8% for 2018, it marked the worst half-year performance for the index since 2010.

Ironically, the losses were due to the strong U.S. economy and dollar, and the sluggish performance of overseas markets. More than half of the 30 companies that make up the DJIA receive 50% of more of their revenue from outside the U.S. By comparison, only 30% of the 500 companies that make up the Standard & Poors Index receive significant overseas revenue. The S&P 500 is still positive for 2018.¹

Since March 2009, when the U.S. pulled out from the bottom of the Great Recession, the domestic market benefited from one of the strongest rallies in history. The strength of the dollar increased in tandem. In order to thwart rampant inflation, the Federal Reserve Bank steadily raised interest rates. Chairman Jerome Powell recently raised interest rates for the second time this year, and indicated his intention to raise them two more times before the end of the year. Consequently, the dollar's value is at its highest since June 2017, compared to other global currencies -- up 5.5% against the Euro, and up 4.2% against the Japanese yen.¹

The dollar gained even more steam when mega-corporations were granted a "tax holiday" on profits held overseas in the latest tax law. $175 billion in profits were repatriated in the first quarter of 2018. Economists estimate that eventually, $450 billion will return to the U.S.¹

Emerging market countries, like Brazil, India, and Russia have been hammered by the strong dollar because in past years, they borrowed heavily in dollars to service their debt. Now, they have to repay the debt with dollars that cost even more. The Brazilian real is down 14% in value, the Indian rupee is down 7%, and the Russian ruble is down 9%.²

The firm dollar may be one of the reasons that Trump has decided to spark a trade war. Because the U.S. is in a stronger position than its global rivals, it may be hurt less than China or Europe, and can afford to "play chicken." The administration is even drafting a bill to exit from the World Trade Organization so it can impose tariffs with a freer hand, and without the consent of Congress.³

The tariffs have crippled markets outside the U.S. The Shanghai composite is in a bear market, down more than 20% from its 52-week high. The German DAX index is down 9% since January. The European market is down 6%, and Europe-focused funds lost $25 billion in assets in just the second quarter of the year. By comparison, U.S.-focused equity funds gained $3.2 billion in inflows in Q2. Of global investment portfolios, U.S. stocks and bonds now have a 60% share, the highest allocation since early 2017.⁴

U.S. Treasury bonds have also benefited from the turmoil. In a "flight to safety," investors have been drawn to the security of government bonds. The higher interest rates have made them even more attractive.

What does this mean for your personal investments? The money pouring into the U.S. market seems like a vote of confidence for strong, future growth. Because stocks are currently a little cheaper, this may be a buying opportunity. Volatility (the ups and downs of the market) may increase in the short-term because of the upcoming mid-term elections, and the continued uncertainty over how the trade war will play itself out. However, if you are investing to support 25 to 30 years of retirement, short-term volatility may be inconsequential to you.

The bottom line is, don't panic. This level of volatility is normal for the market, and is one of the reasons why the market holds out the potential for returns that are better than stashing money in a bank account. A strategy of broad, global diversification can be an effective way to reduce volatility, by spreading your risk. That way, no matter which of the many global markets is doing the best, your investment can benefit from it.

 

¹ Wall Street Journal, 7/2/2018

² Reuters 6/29/2018

³ Marketwatch 7/2/2018

⁴ Institute of International Finance 7/2/2018

 

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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U.N. Study Exposes American Poverty

In his "campaign rallies," and in Twitter, Trump often credits his economic approach for creating "the greatest economy in the HISTORY of America." However, on June 21, U.N. investigator, Philip Alston, presented a report to the U.N. Human Rights Council that told a very different story --

* 40 million Americans live in poverty. 5.3 million Americans live in "Third World conditions of absolute poverty."

* Among Organization of Economic Cooperation and Development countries, the U.S. has the highest youth poverty rate, and the highest infant mortality rate.

* Four out of ten Americans cannot cover an emergency expense of $400 without borrowing money or selling possessions.

* The top 1% of the U.S. population owns 38.6% of the total wealth.

Alston's study, carried out last December, included Skid Row in Los Angeles, African American communities in Alabama, the hard-hit coal country in West Virginia, and hurricane-racked Puerto Rico. He described, "people who have lost all of their teeth because adult dental care is not covered in programs for the poor," and Puerto Ricans living next to mountains of toxic coal ash. In Alabama, he found cesspools of sewage that have led to a resurgence of hookworm, which thrives in conditions of poor sanitation. A recent study found that more than one-third of people surveyed in Alabama tested positive for hookworm.

Alston found that, "the U.S. already leads the developed world in income and wealth inequality, and is now moving full steam ahead to make itself even more unequal," citing the $1.5 trillion in tax cuts that Trump passed in December of 2017, which "overwhelmingly benefited the wealthy and worsened inequality." Simultaneously, Trump cut a third of the food stamp program, and proposed to triple the base rent for federally subsidized housing. Alston said, "It's a very deliberate attempt to remove basic protections from the poorest, punish the unemployed, and make even basic health care into a privilege to be earned rather than a right of citizenship." He concluded that the U.S. is "building a society where wealth and privilege will dominate everything. The persistence of extreme poverty is a political choice made by those in power, amounting to a violation of civil and political rights."

In an interview with the Los Angeles Times,¹ Alston elaborated -- "There's been a systematic effort by conservatives to promote the notion that anyone who is receiving money from the government is shameful and offensive. Yet the rich receive vastly more money from the government, and that's not considered shameful." He pointed out "caricatured narratives" that hold up the rich as drivers of economic progress, while slamming the poor as "wasters, losers and scammers."

The report takes special note that the inequalities "affect African Americans in particular, where they just come out worse on every possible indicator, and policies are clearly designed to hit them harder." On the flip side, it cautions that "the equality of opportunity, which is so prized in theory, is in practice a myth, especially for minorities and women, but also for many middle-class White workers." Nobel prize-winning economist, Joseph Stiglitz added, "Can you believe a country where the life expectancy is already in decline, particularly among those whose income is limited, giving tax breaks to billionaires and corporations while leaving millions of Americans without health insurance?" Stiglitz warned that Trump's assault, "bodes ill for society as a whole. The proposed slashing of social protection benefits will affect the middle class every bit as much as the poor."²

"The American dream is rapidly becoming the American illusion," is the scathing message that the report delivered to the U.N. Human Rights Council. That message was scorned and dismissed by the Trump administration. Republican Party leaders like House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell and the Republican committee chairs have declined to comment. Rather than addressing the contents of the report, Trump's U.N. Ambassador, Nikki Haley, chose instead to criticize the U.N. Human Rights Council.

¹ Los Angeles Times 6/6/2018

² The Guardian 6/1/2018

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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Charitable Gifts and the New Tax Law

One of the unexpected consequences of the new tax law is that charitable organizations are going to be struggling. Under the new tax law, charitable contributions are expected to drop by about half.¹

This is because the Standard Deduction has nearly doubled, from $13,000 to $24,000. At first blush, this would appear to be good news, but this is how it pans out for some taxpayers --

Let's say we're back in 2017, when the Standard Deduction for a married couple was $13,000. Your mortgage is paid off, and your only itemized deduction is $10,000 for state and local taxes.

It would make sense to make a $10,000 charitable contribution, because your tax deductions would total $20,000, $7,000 greater than the Standard Deduction.

However, for 2018, you would probably want to take the Standard Deduction of $24,000, because it's higher. Consequently, you might not do a gift to charity because there would be no tax benefit to you. In the past, roughly 30% of taxpayers were itemizers. That number is expected to drop to 10% by the time we start filing this year's taxes.² It's a tough decision, because you may still want to support your favorite church, temple or charitable organization, and help preserve the community.

There is still a way to support the community, take advantage of the higher Standard Deduction, and also receive additional tax deductions -- it's a strategy called "bunching," and it uses the unique advantages of the Donor-Advised Fund.

A Donor-Advised Fund is a fund in your name created inside a public charity. You receive an immediate federal (and sometimes state) tax deduction for the full value of your donation. Then, you can decide which charities, how much, and when to make distributions from the account later on.

In "bunching," (continuing the example above), instead of gifting $10,000 each year, you do $20,000 every other year. That gets your Itemized Deductions above the level of the Standard Deduction, but you have full control over when to make grants from the fund.

Because the investments continue to grow inside the fund, you could give away only the earnings each year, and preserve the principal. Or you could give away some or all of the principal. You can even wait several years, letting the money in your account grow before making grants. The main restriction is that the charities must be IRS-approved.

It gets even better. Suppose you donate stock that you bought at $10 a share, and now it's worth $50 a share. If you sold it yourself, you would have to pay capital gains taxes on the $40 per share gain. However, when you donate the appreciated stock to a Donor-Advised Fund, you escape paying the capital gains taxes. Nevertheless, you still receive a tax deduction based on the full $50 a share, as long as you’ve held the stock for at least a year. In this example, because of the tax savings, it would only cost you about $9,000 to make a $20,000 gift to your favorite community organization. 

You don't need to be a millionaire to consider Donor-Advised Funds. Minimum initial donations are typically in the $5,000 to $10,000 range.  Subsequent contributions can be much smaller. Donor-Advised Funds can accept any one of a variety of assets as a charitable contribution --  cash, wire transfers, stocks, mutual fund shares and bonds all are acceptable. 

When choosing a Donor-Advised Fund, you should carefully examine management fees, donation restrictions and investment choices.  A Certified Financial PlannerTM or CPA who is involved in the community can provide advice on the local needs of your community as well as a feature comparison of Donor-Advised Funds.

¹  http://cct.org/2018/02/giving-after-the-tax-cuts-jobs-act-a-charitable-conversation-guide/

² https://www.aefonline.org/blog/new-tax-law-bundling-gifts-donor-advised-funds

 

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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