As we approach the summer, we need to remind ourselves of our timeframe for our investments as well as our goals are for our portfolios. We spent most of April calibrating our portfolios to provide a stable foundation if the markets should become volatile favoring the downside. As we initiate new positions and close out older positions, we continue to ask ourselves where we believe the investments will be over the next year or two in the event of a market correction. While we maintain a level of cautious optimism for the short‐term domestic economy, we have concerns that there is a discrepancy between where the markets are currently and the economy.
As we have observed in previous monthly letters, markets are overvalued compared to the size of the economy. For the last two to three years, markets have enjoyed growth rates exceeding much of the rest of the economy. Historically, this has proven unsustainable over the long term. Even if growth in the domestic economy rose up to four percent, markets would still be overvalued by about another ten percent.
We believe that the Trump administration will attempt to introduce policies that will foster higher economic growth rates and provide a short‐term boost to markets. The impact this may have to markets and the economy a year or two later remains uncertain, however. Moreover, whether or how such forthcoming policies will make it through Capitol Hill and be implemented also is unclear. As we saw a little over a month ago, Health Care reform proved far more difficult and complicated than administration officials may have expected.
The health care bill is significant here as it raises the question brings us to the elephant in the room; will the Administration produce a comprehensive tax reform package good enough for the stock market, who is expecting a good, favorable plan. As details of the plan get released during the month of May, there are going to be certain guidelines that we are going to look for:
- What will the corporate tax rate be? Perhaps more importantly, will the tax code be simplified and loopholes eliminated? We believe most business owners would like to see a simplified version that is more fair for all businesses, not just those able to use loopholes to pay a lower tax rate.
- As a way to increase tax receipts, will the Administration eliminate tax deductions into retirement accounts (like 401ks)? Will the administration seek to tax gains up to 15% annually in those accounts? We believe this would a profound hardship for most investors as they often rely on the tax deductions to adjust their taxable income down. This also discourages investment in retirement which will place additional strain on the government’s social programs in the future.
- How will tax breaks be divided among the different earning demographics? Retail sales have
largely flattened or fallen in recent months. Many consumers are struggling to pay for standard
household goods and are using credit to meet their daily expenditures. Simply put, if consumers increasingly need to borrow money to buy goods because they do not generate enough net income, a market correction is a possibility.
In conclusion, as we approach what is probably going to be a tough summer for the stock market (historically the stock market is much weaker during the summer), we will continue to be proactive in protecting capital from impairment. Over the last two months, we have been researching and initiating positions in less risky investments such as short term corporate bonds. This will be an area of focus for us in the short term as we work to create a solid footing to weather a possible storm. After this storm passes, we want to be prepared with ready capital to take advantage of valuable price discounts.