November 2018

November 2018 Market Update

Stock Market and Economic Update
October Is Over - FINALLY!

October certainly lived up to its reputation this year with the stock market down approximately 6%, and small company stocks down 10% during the month. The U.S. stock market is now up a mere 2-3% on a year-to-date basis after the recent October decline. On October 3, 2018 the Federal Reserve Board “FED” made it clear that it plans to raise interest rates for the rest of 2018 and into 2019 as it changed its monetary policy from “accommodating” to “neutral”. The stock market has been concerned for several months about trade tensions, especially between the U.S. and China, and then responded swiftly to the downside shortly after the FED announcement.

Why is the U.S. stock market not up 20% in 2018 in lockstep with corporate earnings? The stock market looks ahead as it did in 2017 when the market was up 19% and corporate earnings were up 12%. In 2017, investors were anticipating the positive earnings effects in 2018 of corporate tax reduction, a weaker dollar, and an economy gaining momentum. Currently, economists, strategists and analyst are estimating 8-10% earnings growth in 2019; And investors are becoming less certain about the earnings growth outlook.

Stock market valuation has declined since the beginning of 2018: A Good Thing! The most referenced stock market valuation metric is the price-to-earnings ratio “P/E”. The stock market is up 2-3% so far in 2018 while corporate earnings are up over 20%. As noted above, investors estimate 8-10% corporate earnings growth for 2019. The confluence of stock prices and earnings growth has brought down the P/E ratio from 18.2x at the beginning of 2018 to the current 15.4x, which is right in the middle of the 15x to 16x historical average.

The U.S. economy is performing well above trend; Real Gross Domestic Product “GDP” grew 3.5% in the September 2018 quarter, following a 4.2% growth rate in the June quarter. “Real’ GDP is a measure of economic growth, excluding the effects of inflation which is approximately 2%. So, if we add real GDP and inflation, final goods and services produced were up over 5% for the September 2018 quarter. Personal consumption, business investment, and government expenditures all added to economic growth in the quarter. The one concern is residential real estate which showed contraction in the quarter, very possibly due to interest rates rising. The job market could not be better for job seekers, with 250,000 additional jobs in October 2018, well above expectations and a steady 3.7% unemployment rate as more people joined the labor force. THE BIG NEWS: AVERAGE HOURLY WAGES ROSE 3.1%, FINALLY INCREASING AT A RATE HIGHER THAN INFLATION. In past cycles average hourly wages increased by 4.0% when the unemployment rate was at or below 4.0%. This bodes well for consumer sentiment as we enter the all-important year-end holiday shopping season.

Rich Lawrence, CFA
11.06.2018

Plan for the Long Term
Prepare for the Short Term

DISCLOSURE:
This market update includes data we believe to be accurate. However, Lawrence Wealth Management (LWM) does not warrant or guarantee its accuracy. Opinions about the future are not predictions, guarantees or forecasts. Investing in stock and bond markets have risk that could lead to investors losing money.

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Is Economic Growth On The Verge of Rising?

I ask if economic growth is on the verge of rising for a very specific reason. The stock market in 2016 is up 10% as measured by the S&P 500 Index, led by materials, industrials, financial and telecommunications stocks; and with health care and consumer staple stocks being the two worst performing sectors. In addition, gold and bond prices are on the decline. Please note: when bond prices decline interest rates are rising. This market behavior is classically associated with rising economic activity and certainly not indicative of the latter stage of an economic cycle.

1-2% Real GDP Growth

This market behavior may cause confusion to many, especially after nine years of economic expansion. Although the U.S. economy has been expanding, it has done so anemically with 1-2% real GDP growth. This compares to 6-8% annual GDP growth immediately after the deep recession of 1981 when the unemployment rate hit almost 10%. Then in the 1980s and 1990s GDP growth was 2-5% annually.

After eight years of so-so economic growth, corporate and consumer balance sheets are in good shape and not overextended as is usually the case when the economic cycle is nearing a peak. The U.S. government however continues to run deficits, and its share of GDP has expanded from 19 to 21%. Obviously our government has not had the will to curtail expenses, and its balance sheet poses risk to our economy and taxpayers.

A Republican President and a Republican Congress

What should we expect with a Republican President and a Republican Congress? The Trump campaign and policy initiatives were straight forward: reduce regulations; cut corporate taxes; increase infrastructure spending; renegotiate trade agreements, rebuild the military; and border control. These initiatives are pro-economic growth and the markets responded swiftly.
Some observers (pre-election) opined that the federal deficit would expand regardless of the election outcome. However Mitch McConnell (Senate Majority leader) stated last week that any corporate tax reduction must be matched with budget cuts to fully offset the revenue decline. So let the bargaining begin!

Higher Economic Activity

The stock market is an excellent economic predictor for six months, but that is about all. The market is expecting solid low-teen earnings growth in 2017, along with rising inflation and interest rates. If our government enacts policies of lower taxes and regulation the “animal spirits” of our country may finally be ignited resulting with capital investment and business formation. The result: higher economic activity.

Primary Market Risks

I envision two primary market risks as 2017 unfolds: saber rattling as we attempt to slow the transfer of U.S. wealth to China, and to a lesser extent a strengthening dollar.

As we all know we are in a $400 billion trade deficit annually with China. Why does this matter? Let’s “follow the money”. We sell China plenty of products, especially high technology and complex industrial products. China sells us a wide variety of products from low to high tech, most of which have a high labor content. There is a well know economic theory called comparative advantage that supports free trade. Essentially, comparative advantage stipulates that trading partners all win when each country produces that which they can produce most efficiently. And if trade balances are equal both trading partners win through sharing higher productivity.

Wealth Transfer to China

Our trading situation with China is far different. The regulatory environment of the U.S. and China could not be more different in term of labor laws, environment and market access. Our trade deficit with China has been running between $300 and $400 billion annually for the past few years, and is literally a wealth transfer to China. These deficits provide China with $300 to $400 billion of U.S. dollar currency which can be used to buy U.S. Treasury bonds, businesses or real estate around the globe including back here in the U.S. If this trade imbalance goes unchecked, we will see a slow but continued wealth transfer to China.

President-Elect Trump brought this issue to the fore and it is at the cornerstone of Trumps economic policy. I expect both countries will be pushing back against each other providing uncertainty and potentially stock market corrections. The good news is that both countries are economically dependent upon one another, so both economies will benefit greatly if trading activity remains brisk but moving back into balance.

Is economic growth on the verge of rising? Most indicators suggest our economy is gaining momentum. If you have questions about economic growth, financial planning, or would like to learn more about investment management advice offered on a fee-only basis, contact me Richard Lawrence at Lawrence Wealth Management LLC, a small, private investment firm. Phone 215-540-0896; email rich@lawrencewealthmanagement.com.

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What You Need to Know About a Health Savings Account Before January 1

Are health insurance premiums taking too big of a bite out of your budget? Do you wish you had better control over how you spend your health-care dollars? If so, you may be interested in an alternative to traditional health insurance called a Health Savings Account (HSA).

Most HSAs allow you to contribute through automatic transfers from a bank account or, if
You are employed, through an automatic payroll deduction plan.

How Does the HSA Option Work?

An HSA is a tax-advantaged account that’s paired with a high-deductible health plan (HDHP). Let’s look at how an HSA works with an HDHP to enable you to cover your current health-care costs and also save for your future needs. Before opening an HSA, you must first enroll in an HDHP, either on your own or through your employer. An HDHP is “catastrophic” health coverage that pays benefits only after you’ve satisfied a high annual deductible. (Some preventative care, such as routine physicals, may be covered without being subject to the deductible.) For 2016, the annual deductible for an HSA-qualified HDHP must be at least $1,300 for individual coverage and $2,600 for family coverage. However, your deductible may be higher, depending on the plan.

Once you’ve satisfied your deductible, the HDHP will provide comprehensive coverage for your medical expenses (though you may continue to owe co-payments or coinsurance costs until you reach your plan’s annual out-of-pocket limit). A qualifying HDHP must limit annual out-of-pocket expenses (including the deductible) to no more than $6,550 for individual coverage and $13,100 for family coverage for 2016. Once this limit is reached, the HDHP will cover 100% of your costs, as outlined in your policy.

Because you’re shouldering a greater portion of your health-care costs, you’ll usually pay a much lower premium for an HDHP than for traditional health insurance, allowing you to contribute the premium dollars you’re saving to your HSA. Your employer may also contribute to your HSA, or pay part of your HDHP premium. Then, when you need medical care, you can withdraw HSA funds to cover your expenses, or opt to pay your costs out-of-pocket if you want to save your account funds.

An HSA Can Be a Powerful Savings Tool.

Because there’s no “use it or lose it” provision, funds roll over from year to year. And the account is yours, so you can keep it even if you change employers or lose your job. If your health expenses are relatively low, you may be able to build up a significant balance in your HSA over time. You can even let your money grow until retirement, when your health expenses are likely to be substantial. However, HSAs aren’t foolproof. If you have relatively high health expenses (especially within the first year or two of opening your account, before you’ve built up a balance), you could deplete you could deplete your HSA or even face a shortfall.

How can an HSA help you save on taxes?

  • You may be able to make pretax contributions via payroll deduction through your employer, reducing your current income tax.
  • If you make contributions on your own using after-tax dollars, they’re deductible from your federal income tax (and perhaps from your state income tax) whether you itemize or not. You can also deduct contributions made on your behalf by family members.
  • Contributions to your HSA, and any interest or earnings, grow tax deferred.
  • Contributions and any earnings you withdraw will be tax free if they’re used to pay qualified medical expenses.
    Consult a tax professional if you have questions about the tax advantages offered by an HSA.

Can Anyone Open an HSA?

Any individual with qualifying HDHP coverage can open an HSA. However, you won’t be eligible to open an HSA if you’re already covered by another health plan (although some specialized health plans are exempt from this provision). You’re also out of luck if you’re 65 and enrolled in Medicare or if you can be claimed as a dependent on someone else’s tax return.

How Much Can You Contribute to an HSA?

For 2016, you can contribute up to $3,350 for individual coverage and $6,750 for family coverage. This annual limit applies to all contributions, whether they’re made by you, your employer, or your family members. You can make contributions up to April
15th of the following year (i.e., you can make 2016 contributions up to April 15, 2017). If you are 55 or older, you may also be eligible to make a $1,000 additional “catch-up” contribution to your HSA, but you cannot contribute anything once you reach age 65 and enroll in Medicare.

Note: You may be able to make a one-time tax-free rollover of funds to your HSA from a health flexible spending account (FSA), a health reimbursement arrangement (HRA), or a traditional IRA (certain limits apply).

Can You Invest Your HSA Funds?

HSAs typically offer several savings and investment options. These may include interest-earning savings, checking, and money market accounts, or investments such as stocks, bonds, and mutual funds that offer the potential to earn higher returns but carry more risk (including the risk of loss of principal). Make sure that you carefully consider the investment objectives, risks, charges, and expenses associated with each option before investing. A financial professional can help you decide which savings or investment options are appropriate.

How Can You Use Your HSA Funds?

You can use your HSA funds for many types of health-care expenses, including prescription drugs, eyeglasses, deductibles, and co-payments. Although you can’t use funds to pay regular health insurance premiums, you can withdraw money to pay for specialized types of insurance such as long-term care or disability insurance. IRS Publication 502 contains a list of allowable expenses.
There’s no rule against using your HSA funds for expenses that aren’t health-care related, but watch out–you’ll pay a 20% penalty if you withdraw money and use it for nonqualified expenses, and you’ll owe income taxes as well. Once you reach age 65, however, this penalty no longer applies, though you’ll owe income taxes on any money you withdraw that isn’t used for qualified medical expenses.

HSA Questions to Consider

  •  How much will you save on your health insurance premium by enrolling in an HDHP? If you’re currently paying a high premium for individual health insurance (perhaps because you’re self-employed), your savings will be greater than if you currently have group coverage and your employer is paying a substantial portion of the premium.
  • What will your annual out-of-pocket costs be under the HDHP you’re considering? Estimate these based on your current health expenses. The lower your costs, the easier it may be to accumulate HSA funds.
  • How much can you afford to contribute to your HSA every year? Contributing as much as you can on a regular basis is key to building up a cushion against future expenses.
  • Will your employer contribute to your HSA? Employer contributions can help offset the increased financial risk that you’re assuming by enrolling in an HDHP rather than traditional employer-sponsored health insurance.
  • Are you willing to take on more responsibility for your own health care? For example, to achieve the maximum cost savings, you may need to research costs and negotiate fees with health providers when paying out-of-pocket.
  • How does the coverage provided by the HDHP compare with your current health plan? Don’t sacrifice coverage to save money. Read all plan materials to make sure you understand benefits, exclusions, and all costs.
  • What tax savings might you expect? Tax savings will be greatest for individuals in higher income tax brackets. Ask your tax advisor or financial professional for help in determining how HSA contributions will impact your taxes.

If you need help with evaluating HSA options, financial planning, or investment management advice on a fee-only basis, contact me Richard Lawrence at Lawrence Wealth Management LLC, a small, private investment firm. Phone 215-540-0896; email rich@lawrencewealthmanagement.com.

Lawrence Wealth Mgmt is a Registered Investment Advisor (RIA) and provides financial planning and investment management services to our clients on a “fee-only” basis. We sell no investment products for compensation and are therefore “conflict-free.” Bond, stock and other capital market investments could lose value and are not guaranteed. Investors should consider investment risks before investing, and be aware that historical returns are not a guarantee of, or proxy for, future results. Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016