MAY 28, 2018
Geopolitical uncertainty didn’t dent U.S. stocks last week.
Geopolitics is the intersection of geography, economics, and politics. Last week, there were some fine examples of the ways geopolitical events can create uncertainty. Barron’s reported:
“President Donald Trump began the week suggesting that a trade war with China was on hold, before later ordering his administration to explore penalties on imported automobiles. The president also canceled talks with North Korea. Italy’s bond market melted down following the emergence of a Euroskeptic government, while Turkey’s lira tumbled over concerns that President Tayyip Erdogan would take control of its central bank, raising concerns about emerging markets.”
Uncertainty caused major indices across Europe to finish lower last week. A majority of Asian-Pacific indices moved south, too, as did Canadian and Mexican indices. Despite pessimism elsewhere, investors in the United States remained unfazed and major U.S. stock market indices finished the week higher. The Standard & Poor’s (S&P) 500 Index was up 0.3 percent. Oil prices dropped after an extended rally on concerns Russia and OPEC’s supply reduction efforts will wane as prices rise.
The strong performance of U.S. markets last week was remarkable because the S&P 500 moved higher on news that would seem to inspire uncertainty. It was also remarkable because U.S. stocks gained less when S&P 500 companies reported
First quarter’s earnings season – when companies report how profitable they were during the first quarter – is almost over. A majority of S&P 500 companies did better than expected, according to FactSet. However, companies with stronger than expected earnings saw share prices increase 0.2 percent on average, less than share prices increased last week.
During the past five years, companies with higher-than-expected profits have realized share price gains of 1.1 percent.
Looking at U.S. monetary policy, The Federal Reserve’s latest minutes confirmed expectations the Fed will continue to raise interest rates gradually and members see no reason to deviate from their plan.
According to Vanguard’s growth and value indices, growth stocks have outperformed value stocks by more than 6 percent so far in 2018. This has been the theme for much of the last decade, but we believe that theme will change as investors begin to examine opportunities in value stocks.
Value stocks are generally solid companies in slower growing industries. Investors often pay too much for fast growth and ignore the ability of solid businesses to adapt. While value stocks are present in every sector, financial and energy companies are often classified as value stocks.
Fundamentals are currently improving for value stocks. Financials are likely to benefit from improved margins and increased demand for loans. Even with the recent rally, energy stocks are cheap relative to oil. We also see the potential for mergers and acquisitions to increase as some industries consolidate. The recent changes in the corporate tax code will help value stocks, too.
Source: Carson Group and Morningstar Direct
In spite of all this good news, value stocks are cheaper than normal compared to growth stocks. The above chart shows the percentage of value’s price-to-earnings ratio to growth’s when comparing stocks in the S&P 500. The continued support of growth stocks, whether markets are calm or turbulent, has widened this ratio to the widest levels seen in the last 10 years. We expect the cheap valuations and improved profit outlook to allow value stocks to narrow the gap with growth over the rest of the year.
Key points for the week
- The Federal Reserve affirmed its outlook for a gradual increase in rates.
- Oil prices and bond yields fell.
- Value companies look attractive after a long period of outperformance by growth stocks.
IRS to Propose Rules for Limit on State and Local Tax Deductions.
For tax years 2018–2025, a taxpayer's itemized deduction for state and local taxes is limited to $10,000 ($5,000 if married filing separately) per year. In response to this, some states are considering or have adopted legislation that allows taxpayers to make transfers to state-established charitable funds in exchange for credits against their state and local taxes.
In a recent Notice, the IRS has announced it will propose regulations on the federal income tax treatment of these payments. The proposed regulations will specify that federal tax law, which includes substance-over-form principles, governs the proper characterization of these payments for federal income tax purposes. In other words, a state's classification of the payment is irrelevant.
Also, the proposed regulations will assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new state and local tax deduction limit. Notice 2018-54, 2018-24 IRB.
What are we reading?
Below are some articles we paid particularly close attention to this week. We encourage our readers to follow the links.
History was made on May 20,
Working Out the Bugs.
There was a lot of news about new inventions last week. Some devices appear to have potential while others have been delivering unexpected results. Take a look at recent innovation news:
- Droning on. Remember the vehicles Galactic storm troopers rode into battle against the Ewoks in Star Wars? They’re now available on Earth.
Hover bikeslook a lot like a super-sized drone that can carry a person. They can travel up to 13 miles or 20 minutes, at speeds up to 43 miles an hour, before recharging is needed.
- Shhh. It’s listening. Smart speakers made the news last week after it was widely reported that one had recorded a family’s conversation and sent it to someone on their contact list. A writer for MIT Technology Review investigated further, checking her smart speaker history. She found:
“…in the past several months it has also tuned in, frequently several times a day, for no obvious reason. It’s heard me complain to my dad about something work-related, chide my toddler about eating dinner, and talk to my husband – the kinds of normal, everyday things you say at home when you think no one else is listening.”
- Diagnosed by math. There’s a new algorithm in town. The U.S. Food and Drug Administration (FDA) just gave the thumbs-up to artificial intelligence that helps surgeons detect wrist fractures, reported MIT Technology Review. In fact, the FDA is “writing new rules to speed up approvals for AI-based devices and tools.”
- Folding wingtips. It seems like poor design, but some planes’ wingspans are too wide for standard airport gates. Instead of asking airports to build special gates, the Federal Aviation Administration approved folding wingtips on Friday.
We know change is constant. Adapting to change is the challenge.
“Our flag does not fly because the wind moves it. It flies with the last breath of each soldier who died
"It has been my philosophy of life that difficulties vanish when faced boldly."
~Isaac Asimov, Author
"Wisdom is knowing what to do; virtue is doing it."
~ David Jordan, Scientist
"There is no sadder sight than a young pessimist."
~Mark Twain, Author
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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 is subject to change without notice.
Opinions expressed are not intended as investment advice or to predict future performance. Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Past performance does not guarantee future results. Investing involves risk, including loss of principal. Consult your financial professional before making any investment decision. Stock investing involves risk including loss of principal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock companies maintained and reviewed by the editors of the Wall Street Journal. Please note direct investment in
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