U.S. Treasuries are offering a lesson in supply and demand. Last week, the U.S. Treasury auctioned $258 billion in bonds. Treasury auctions are the way the United States government finances its debt. The Treasury sells short, intermediate, and long-term debt, known as bills, notes, and bonds. When investors and governments purchase bonds, they agree to lend money to the United States. In return, the United States agrees to pay an amount of interest over a certain period of time. At the end of that time, the government is expected to repay the money borrowed.
The price and interest paid on U.S. government debt is determined by supply and demand. When there are few bonds and a lot of demand, prices rise and interest rates fall. When there are a lot of bonds and little demand, prices fall and interest rates rise.
Last week, Barron’s reported, “The law of supply and demand meant that the glut of new Treasuries temporarily drove down prices and pushed up yields. The 10-year Treasury climbed during the week, reaching 2.95 percent, but ultimately ending the week at 2.87 percent.
The Treasury increased its debt issuance to fund tax reform and the two-year federal budget. Reuters reported, “…tax reform is expected to add as much as $1.5 trillion to the federal debt load over the next ten years, while the budget agreement would increase government spending by almost $300 billion over the next two years.”
A surplus of Treasury bonds, in tandem with decreased demand as the Federal Reserve reduces the holdings it accumulated during quantitative easing, could push Treasury rates higher. In addition, MarketWatch reported the Federal Reserve appears to be committed to gradually increasing the Fed funds rate to avoid an overheating economy and keep inflation down. Higher interest rates may be coming.
Key points for the week
- Stocks rose for the second week in a row.
- Relative performance trend remains intact despite the recent decline.
- Markets are at an interesting juncture.
On the surface, 2018 looks like a much different year from 2017. The sharp pullback in late January and early February was far more challenging than anything seen last year. However, 2017 and 2018 also have many similarities:
- Stocks are having a very good year. The S&P 500 is up 2.8 percent this year through February. If every two months produced that rate of return, the S&P would gain around 18 percent, not far from the 19.4 percent the S&P gained last year.
- United States and international stocks are performing at similar levels. In 2017, international stock markets, as represented by the MSCI ACWI ex USA rose 24.1 percent, about 5 percent better than the S&P 500. This year, the S&P 500 is ahead as international markets are up 1.4 percent.
- Large growth stocks continue to dominate, and small value continues to lag. In 2017, large growth stocks, based on the Morningstar U.S. Large Growth Index, climbed more than 31.2 percent, while small value lagged, rising only 8.4 percent. 2018 has seen more of the same: Large growth is up 8.4 percent, and small value has returned -2.7 percent.
- Technology was the top performing sector in 2017 and is back on top again. While the market was up significantly last year, cell phone data plans pushed telecommunications stocks lower. Even with higher volatility, technology stocks are up 7.6 percent this year and telecommunications are down 6.2 percent. Consumer staples, energy, and utilities stocks, which generally performed poorly last year, are lagging the market this year, too.
As investors enter the last few days of February, markets are at an interesting juncture. Investors seem focused on the market’s direction as they wrestle with the potential loss of momentum from the correction, but the rest of the 2017 playbook seems intact. United States and global stocks are producing attractive returns, and growth and technology stocks are leading the way.
We expect 2018 to veer from the 2017 playbook as the year goes on and encourage investors not to extrapolate current trends too far. Higher economic growth should expand the rally and reward a broader set of companies. Valuations will constrain some of these companies, and overall volatility is expected to remain higher.
IRS Clarifies Rules for Deducting Home Equity Loan Interest.
The Tax Cuts and Jobs Act of 2017, enacted Dec. 22, suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.
Under the new law, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements.
For anyone considering taking out a mortgage, the new law imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. Beginning in 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans. The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return. The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home.
The following examples illustrate these points.
- Example 1: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value of $800,000. In February 2018, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. Because the total amount of both loans does not exceed $750,000, all of the interest paid on the loans is deductible. However, if the taxpayer used the home equity loan proceeds for personal expenses, such as paying off student loans and credit cards, then the interest on the home equity loan would not be deductible.
- Example 2: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $250,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages does not exceed $750,000, all of the interest paid on both mortgages is deductible. However, if the taxpayer took out a $250,000 home equity loan on the main home to purchase the vacation home, then the interest on the home equity loan would not be deductible.
- Example 3: In January 2018, a taxpayer takes out a $500,000 mortgage to purchase a main home. The loan is secured by the main home. In February 2018, the taxpayer takes out a $500,000 loan to purchase a vacation home. The loan is secured by the vacation home. Because the total amount of both mortgages exceeds $750,000, not all of the interest paid on the mortgages is deductible. A percentage of the total interest paid is deductible.
Olympic Athletes Have to Pay the Bills, too.
Not every American Olympian and Paralympian is a household name. Money.com reported, “These athletes don’t have the same kind of lucrative sponsorship deals as Olympic standouts like snowboarder Shaun White or alpine skiing star Lindsey Vonn – so they have to make ends meet, which can often mean squeezing in extra shifts during the off season, heading to the gym early in the morning before work and moving from a full-time position to a part-time one with no replacement for those lost wages.”
So, how do lesser-known athletes pay the bills while training?
- Sled hockey player Josh Pauls is a sales account executive. His teammate Steve Cash is a personal banker.
- Pairs figure skater Chris Knierim works as an auto mechanic and wants to have his own auto shop someday.
- Biathlon competitor Lowell Bailey is a singer and songwriter who plays in bluegrass bands.
- Curling team member Nina Roth is a registered nurse. Her teammate Tabitha Peterson is a pharmacist.
- Snowboarder Jonathan Cheever is a licensed plumber.
- Luger Emily Sweeney is a member of the National Guard, and so is bobsledder Nick Cunningham.
- Short track speed skater Jessica Kooreman has a real estate license.
- Luger Justin Krewson is a firefighter.
- Snowboarder Mike Schultz designs and engineers prosthetics.
- Nordic skier Kendall Gretsch works in tech support.
There is a lot to admire about Olympic and Paralympic athletes.
Story of the week
The man who single-handedly altered the way consumers shop is taking an enduring approach to his next project, a giant clock that will last 10,000 years. Amazon CEO, Jeff Bezos, is creating the clock to demonstrate the power of long-term thinking. He has compared his project to building the Egyptian pyramids and has started a waiting list for visitors to view the clock when it is complete. Bezos is successful partly due to his long-term thinking and serves as a reminder to keep focused on our long-term objectives, particularly after this recent period of volatile markets.
Weekly Focus – Think About It
“There are only three ways to meet the unpaid bills of a nation. The first is taxation. The second is repudiation. The third is inflation.”
~ Herbert Hoover, 31st President of the United States
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RJFS and SPC do not offer or provide legal or tax advice. Tax services and analysis are provided by the related firm, S&M through a separate engagement letter with clients. Portions of this newsletter were prepared by Carson Group Coaching. Carson Group Coaching is not affiliated with RJFS, SPC or S&M. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This information is not intended as a solicitation of an offer to buy, hold or sell any security referred to herein. There is no assurance any of the trends mentioned will continue in the future. Any opinions are those of the author and not necessarily those of RJFS. Any expression of opinion is as of this date and are subject to change without notice.
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The MSCI ACWI (All Country World Index) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. As of June 2007 the MSCI ACWI consisted of 48 country indices comprising 23 developed and 25 emerging market country indices. The developed market country indices included are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States. The emerging market country indices included are: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. Hypothetical examples are for illustration purposes only and does not represent an actual investment. Actual investor results will vary.
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