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Monthly Insights | 2019.11

A wise owl
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Market Recap

The Fed lowered rates late last month, in line with market expectations. Market response was muted. The labor market remains strong, confounding most experts. The stock market has remained cautious, being rather range-bound for the last several weeks until a quick jump on trade-related optimism.

The repo market continued to distort liquidity at a very fundamental level, but the Fed’s quick and continued intervention staved off a worse crises for now. The culprit seems to be interactions of regulatory restrictions (Dodd Frank + Basel III) and abnormally low interest rates everywhere.

Thankfully the Fed has shown that they will react quickly, so we have some time to fix the regulations before it gets worse. Note the key lesson – the Fed is trying to fix a market distortion caused by legislation by….distorting the market. Yes, we’re deep in the plumbing of the economy, but when plumbing doesn’t work, nobody is happy. An ugly workaround is better than the alternative.

The EU is closer to recession, with certain parts technically in recession. Germany’s manufacturing is down considerably, and probably will remain that way for the foreseeable future. Brexit got delayed yet again (until January), despite the best efforts of Boris Johnson. We believe there is a good chance this saga continues, but that bet is only 50/50 that this is the final extension. Germany PMI data here – (any reading below 50 indicates contraction).

Market Outlook

We downgraded our outlook to “guarded”, as despite the quick jump in the market, the increase has been concentrated among only a few companies. As one example, Apple has grown over 65% this year, and is now bigger than the entire US energy sector

Key drivers going forward:

  1. The Fed. Right now, the Fed is supplying the Repo market with over 50 billion dollars per day of liquidity. Our forecast is “guarded” because a simple policy error at this level could easily drop the markets 10% in a few days. The end of month/quarter/year are the worst times for liquidity, so December is the time when any error would be magnified.
  2. Trade. Will we or won’t we have a trade deal is the first big question; the second is will it be of any significance? Both questions will affect business leaders investment decisions, and therefore growth. Our belief is that the US and China are at odds over fundamental pieces. A deal might be possible, but the hype will probably be larger than any benefits. Indeed, recent comments about just being near a deal (as opposed to an announcement of a signed deal) have driven the market higher. Smoke or mirrors, we’re not sure.
  3. Impeachment. This process is looking to get very partisan, but we believe the likelihood of an actual impeachment conviction to be less than 50%.
  4. Rising civil unrest. Hong Kong may be the most obvious, but Chile, Catalonia, the mideast and others are affected by high food prices and frustrated populations with high unemployment. These situations can and do negatively impact global growth. Interestingly, it is believed that HK University is a huge battleground because over90% of HK internet traffic flows through its switches.

The market’s movie analogy this month (and perhaps for the entire year) is Dr. Jekyll & Mr. Hyde. Investors weigh their options with all the noise (not to mention next year’s election), and FOMO competes with recession fears.

Quick Tip

529 Plans, formally called “Education Savings Plans” are a great way to save money for college. They have numerous benefits, including non-taxed gains if use for qualified” education expenses.  One question we get often is “what is a qualified education expense?”

Fortunately, the SEC defines it here as “Includes tuition; room and board; mandatory fees; and, books, computers, and software (if required).” Further, up to $10,000 per year can be spent on tuition for secondary schools.

In short, here are the best uses of your 529 funds to not incur federal income tax on the gains are:

  • Tuition and fees
  • Books, supplies, and equipment (only those required for enrollment)
  • Room & board (must be enrolled at least half-time)
  • Purchase of computer, software, & peripherals (for use primarily by the student)

Even though you can use up to $10,000 of it for “Qualified Elementary and Secondary Education Expenses”, we find this option to be less economical due to the shorter time for your funds to grow. If needed, use it, but your tax break is likely to be smaller than if you wait to use it for college.

Much more information can be found on this IRS Page, starting on page 51.

Words of Wisdom

“Beliefs formed on insufficient evidence seem tough to move,” 

― Justin Rao, Microsoft Research
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