2017Q4 Quarterly Commentary

January 17, 2018

2017Q4 Newsletter

Market Recap

Despite massive natural disasters, political infighting in Washington and a tightening money policy, the US stock market continued its remarkable run. The S&P 500 posted gains of 6.6% for the quarter and 21.8% for the year. Over the fourth quarter, the Dow blew through 23,000, 24,000 and — a few days into 2018 — 25,000, each for the first time. Also of special note were emerging markets, which posted a whopping gain of 37.3% for the year.

As in recent quarters, underlying economic indicators were solid. In December, the Bureau of Economic Analysis announced that Real gross domestic product (GDP) increased at an annual rate of 3.2% in the third quarter. Likewise, the Institute for Supply Management reported that economic activity in the manufacturing and the non-manufacturing sectors each continued their multi-year growth trajectories.

Total nonfarm payroll employment increased by 228,000 in November, and the unemployment rate was unchanged at 4.1%. Employment continued to trend up in professional and business services, manufacturing, and health care.

Table 1

Key Index Returns

INDEX Q42017 2017
S&P500 (Large) 6.6% 21.8%
Russell 2000 (Small) 3.3% 14.7%
EAFE (International) 4.2% 25.0%
MSCI Emerging Markets 7.4% 37.3%
Barclays Agg (Taxable) 0.4% 3.5%
Barclays Muni (Tax-Free) 0.8% 5.5%
DJ-Real Estate 2.6% 9.8%
Bloomberg Commodity 4.7% 1.7%

In December, the Fed raised the federal funds rate 0.25% to 1.5% — a move that was widely expected. In support of the move, the Fed noted that “The labor market has continued to strengthen and. . .economic activity has been rising at a solid rate.” This is the fifth time the Fed has lifted interest rates since the 2008 financial crisis.Inflation remained subdued, as the CPI-U increased 0.4% seasonally adjusted; and 2.2% over the last 12 months, not seasonally adjusted. By far the biggest contributor to the increases was energy prices.

In other Fed-related news, President Trump nominated Jerome Power to take over as Fed Chairman when Janet Yellen’s term expires in early February. Powell is a current Fed governor and is expected to follow a centrist path similar to that of Yellen.

Ironically, the biggest threat to the US stock market — other than some prospective exogenous factor — may be elevated expectations. A university of Michigan survey in October showed that consumers saw a nearly 65% probability that stocks would rise in the next 12 months — the highest share on record.

Globally, economic growth is continuing among the world’s largest economies. The Organization for Economic Growth and development stated in a November report that:

The global economy is now growing at its fastest pace since 2010, with the upturn becoming increasingly synchronized across countries. This long awaited lift to global growth, supported by policy stimulus, is being accompanied by solid employment gains, a moderate upturn in investment and a pick-up in trade growth.


Did You Know?

As expected, the Tax Cuts and Jobs Act of 2017 (TCJA) was signed into law, and the IRS is now busy developing the supporting regulations. Here’s our take on nine key things to know about the law.

1. Compression of the marginal tax brackets, elimination of exemptions, increase in standard deduction and child tax credits.

Perhaps the most talked about changes are the slight decrease of the tax brackets, dropping the highest marginal rate from 39% to 37%. Additionally, exemptions go away starting in 2018 and the standard deduction increases to $12,000 for individuals / $24,000 for married couples up from the current $6,350 / $12,700. The child tax credit increases from $1,000 to $2,000 per child under the age of 17.
Most of these provisions are set to sunset and revert to current law in 2025 unless Congress steps in at some point and makes them permanent.

2. Elimination of the Obamacare mandate, the Pease Amendment and various itemized deductions.

The individual mandate for health insurance is repealed, but does not go into effect until 2019, thus the tax penalty theoretically could be imposed for both the 2017 and 2018 tax year.

The Pease Amendment that phased out itemized deductions for high-income earners ($261,500 for individuals / $318,800 for married couples) is eliminated.

Miscellaneous deductions subject to the 2% AGI floor are eliminated. For most people these deductions included tax preparation fees, financial advisory, and certain legal fees. The change in tax treatment of advisory fees means that we may begin debiting your fees from a different account, about which we encourage further discussion.

3. Dollar caps on itemized state & local property and income taxes as well mortgage interest deduction.

Under current law, persons who itemize can deduct property taxes for their home and a vacation home with no limit on the amount. Persons who pay state and local income taxes can also deduct these amounts without limitation if they itemize. The TCJA significantly curtails this deduction to a ceiling of only $10,000. This amount applies to the combined total of all property and income taxes, not $10,000 each.

Mortgage interest under current law is deductible on loan amounts up to $1,000,000, the TCJA drops this amount to $750,000, but applies this provision only to new loans that were issued after December 15, 2017.

Homeowner equity loans are no longer deductible after 2017 if the loan is not related to building, acquiring, or improving the primary residence.

4. New Qualified Business Income Deduction for Pass-through Entities

Pass-though entities such as LLCs, LPs, and S-Corps are allowed to deduct 20% of their income as a below-the-line deduction, separate from Schedule A itemization. This deduction is not available to service industry professionals like CPAs, attorneys, doctors’ offices, etc. and is not available on investment income. The rules and regulations supporting this provision are likely to be detailed and complex.

5. Estate and Gift Tax Exemption Amounts Doubled

The scheduled 2018-combined Estate and Gift Tax exemption of $5.6 million per person has been doubled to $11.2 million. All other relevant rules in this area have remained in place including the generation-skipping tax, the step-up in basis at death, and the 40% tax rate for taxable gifts and estates. This will likely push many families to consider unwinding certain tax planning strategies such as family limited partnerships, as they focus more on    stepping-up basis of family assets.

6. The Kiddie Tax subject to Trust Tax Rates

Under previous law, children were taxed at their parents’ tax rate on any unearned income (dividends, royalties, capital gains, interest, etc.) above $2,100. The TCJA instead taxes any unearned income above $2,100 at the trust tax rates, which after $12,500 of income are taxed at the highest marginal tax rate of 37%.

7. Backdoor Roth Still Available, but Re-characterization is Not

The ability to convert traditional IRA accounts to Roth accounts is still available; however, the ability to undo the conversion (previously known as re-characterization) is not.

8. Alternative Minimum Tax Exemption Increased

The AMT exemption increased to $70,300 for individuals and $109,400 for married couples, these amounts were previously $55,400 for and $86,200 respectively. Further, the phase-out thresholds of these exemptions are increased from $123,100 for individuals and $164,100 for married couples, up to a $500,000 for individuals and $1,000,000 for married couples, meaning few household will pay AMT going forward.

9. Alimony Treatment Reversed

Under previous law, alimony was deducible to the payer and reported as taxable income to the payee. Under the TCJA, alimony is not deductible or taxable. This provision will only apply to divorce agreements post-December 31, 2018.

Barnett Financial is monitoring events closely and reviewing analyses from leading tax experts. Most importantly, Laura and Brad will be working with you and your CPA in the coming months to make sure that we take full advantage of any tax planning opportunities that arise.

Outside Perspectives

To Bit or Not to Bit: What Should Investors Make of Bitcoin Mania?”

December 2017

Issue Brief

Dimensional Fund Advisors

Bitcoin and other cryptocurrencies are receiving intense media coverage, prompting many investors to wonder whether these new types of electronic money deserve a place in their portfolios.

Cryptocurrencies such as bitcoin emerged only in the past decade. Unlike traditional money, no paper notes or metal coins are involved. No central bank issues the currency, and no regulator or nation state stands behind it.

Instead, cryptocurrencies are a form of code made by computers and stored in a digital wallet. In the case of bitcoin, there is a finite supply of 21 million, of which more than 16 million are in circulation. Transactions are recorded on a public ledger called blockchain.

People can earn bitcoins in several ways, including buying them using traditional fiat currencies or by “mining” them—receiving newly created bitcoins for the service of using powerful computers to compile recent transactions into new blocks of the transaction chain through solving a highly complex mathematical puzzle.

For much of the past decade, cryptocurrencies were the preserve of digital enthusiasts and people who believe the age of fiat currencies is coming to an end. This niche appeal is reflected in their market value. For example, at a market value of $16,000 per bitcoin, the total value of bitcoin in circulation is less than one tenth of 1% of the aggregate value of global stocks and bonds. Despite this, the sharp rise in the market value of bitcoins over the past weeks and months have contributed to intense media attention.

What are investors to make of all this media attention? What place, if any, should bitcoin play in a diversified portfolio? Recently, the value of bitcoin has risen sharply, but that is the past. What about its future value?

You can approach these questions in several ways. A good place to begin is by examining the roles that stocks, bonds, and cash play in your portfolio.

Expected Returns

Companies often seek external sources of capital to finance projects they believe will generate profits in the future. When a company issues stock, it offers investors a residual claim on its future profits. When a company issues a bond, it offers investors a promised stream of future cash flows, including the repayment of principal when the bond matures. The price of a stock or bond reflects the return investors demand to exchange their cash today for an uncertain but greater amount of expected cash in the future. One important role these securities play in a portfolio is to provide positive expected returns by allowing investors to share in the future profits earned by corporations globally. By investing in stocks and bonds today, you expect to grow your wealth and enable greater consumption tomorrow.

Government bonds often provide a more certain repayment of promised cash flows than corporate bonds. Thus, besides the potential for providing positive expected returns, another reason to hold government bonds is to reduce the uncertainty of future wealth. And inflation-linked government bonds reduce the uncertainty of future inflation-adjusted wealth.

Holding cash does not provide an expected stream of future cash flow. One US dollar in your wallet today does not entitle you to more dollars in the future. The same logic applies to holding other fiat currencies — and holding bitcoins in a digital wallet. So we should not expect a positive return from holding cash in one or more currencies unless we can predict when one currency will appreciate or depreciate relative to others.

The academic literature overwhelmingly suggests that short-term currency movements are unpredictable, implying there is no reliable and systematic way to earn a positive return just by holding cash, regardless of its currency. So why should investors hold cash in one or more currencies? One reason is because it provides a store of value that can be used to manage near-term known expenditures in those currencies.

With this framework in mind, it might be argued that holding bitcoins is like holding cash; it can be used to pay for some goods and services. However, most goods and services are not priced in bitcoins.

A lot of volatility has occurred in the exchange rates between bitcoins and traditional currencies. That volatility implies uncertainty, even in the near term, in the amount of future goods and services your bitcoins can purchase. This uncertainty, combined with possibly high transaction costs to convert bitcoins into usable currency, suggests that the cryptocurrency currently falls short as a store of value to manage near-term known expenses. Of course, that may change in the future if it becomes common practice to pay for all goods and services using bitcoins.

If bitcoin is not currently practical as a substitute for cash, should we expect its value to appreciate?

Supply and Demand

The price of a bitcoin is tied to supply and demand. Although the supply of bitcoins is slowly rising, it may reach an upper limit, which might imply limited future supply. The future supply of cryptocurrencies, however, may be very flexible as new types are developed and innovation in technology makes many cryptocurrencies close substitutes for one another, implying the quantity of future supply might be unlimited.

Regarding future demand for bitcoins, there is a non-zero probability that nothing will come of it (no future demand) and a non-zero probability that it will be widely adopted (high future demand).

Future regulation adds to this uncertainty. While recent media attention has ensured bitcoin is more widely discussed today than in years past, it is still largely unused by most financial institutions. It has also been the subject of scrutiny by regulators. For example, in a note to investors in 2014, the US Securities and Exchange Commission warned that any new investment appearing to be exciting and cutting-edge has the potential to give rise to fraud and false “guarantees” of high investment returns. Other entities around the world have issued similar warnings. It is unclear what impact future laws and regulations may have on bitcoin’s future supply and demand (or even its existence). This uncertainty is common with young investments.

All of these factors suggest that future supply and demand are highly uncertain. But the probabilities of high or low future supply or demand are an input in the price of bitcoins today. That price is fair, in that investors willingly transact at that price. One investor does not have an unfair advantage over another in determining if the true probability of future demand will be different from what is reflected in bitcoin’s price today.

What to Expect

So, should we expect the value of bitcoins to appreciate? Maybe. But just as with traditional currencies, there is no reliable way to predict by how much and when that appreciation will occur. We know, however, that we should not expect to receive more bitcoins in the future just by holding one bitcoin today. They don’t entitle holders to an expected stream of future bitcoins, and they don’t entitle the holder to a residual claim on the future profits of global corporations.

None of this is to deny the exciting potential of the underlying blockchain technology that enables the trading of bitcoins. It is an open, distributed ledger that can record transactions efficiently and in a verifiable and permanent way, which has significant implications for banking and other industries, although these effects may take some years to emerge.

When it comes to designing a portfolio, a good place to begin is with one’s goals. This approach, combined with an understanding of the characteristics of each eligible security type, provides a good framework to decide which securities deserve a place in a portfolio. For the securities that make the cut, their weight in the total market of all investable securities provides a baseline for deciding how much of a portfolio should be allocated to that security.

Unlike stocks or corporate bonds, it is not clear that bitcoins offer investors positive expected returns. Unlike government bonds, they don’t provide clarity about future wealth. And, unlike holding cash in fiat currencies, they don’t provide the means to plan for a wide range of near-term known expenditures. Because bitcoin does not help achieve these investment goals, we believe that it does not warrant a place in a portfolio designed to meet one or more of such goals.

If, however, one has a goal not contemplated herein, and you believe bitcoin is well suited to meet that goal, keep in mind the final piece of our asset allocation framework: What percentage of all eligible investments do the value of all bitcoins represent? When compared to global stocks, bonds, and traditional currency, their market value is tiny. So, if for some reason an investor decides bitcoins are a good investment, we believe their weight in a well-diversified portfolio should generally be tiny.

Because bitcoin is being sold in some quarters as a paradigm shift in financial markets, this does not mean investors should rush to include it in their portfolios. When digesting the latest article on bitcoin, keep in mind that a goals-based approach based on stocks, bonds, and traditional currencies, as well as sensible and robust dimensions of expected returns, has been helping investors effectively pursue their goals for decades.


  1. Source: Bitcoin.org.
  2. As of December 14, 2017. Source: Coinmarketcap.com.
  3. A currency declared by a government to be legal tender.
  4. Per Bloomberg, the end-of-day market value of a bitcoin exceeded $16,000 USD for the first time on December 7, 2017.
  5. Describes an outcome that is possible (or not impossible) to occur.
  6. “Investor Alert: Bitcoin and Other Virtual Currency-Related Investments,” SEC, 7 May 2014.
  7. Investors should discuss the risks and other attributes of any security or currency with their advisor prior to making any investment.

Credit Reporting Initiative

As a reminder, please sign and return the Credit Reporting form included with this newsletter.

For those participating in the program, three times per year Barnett Financial will request one of the three nationwide credit reporting agencies (Equifax, Experian and Transunion; on a rotating basis) to mail you your credit report.

Each report will be sent directly to you by the credit reporting agency. Barnett Financial will have no responsibility for what is sent or for correcting any errors you may find.

To get started, simply sign the attached form and email it to Jessica at jessica@barnettfinancial.com. There is no cost to participate in this program. If you have any questions, please contact Jessica.

We hope you find that this program helps you effectively monitor your credit, and thereby helps you avoid identity theft!

2017 2018
Retirement Account Contribution Limits
401k/403b/457 $18,000 $18,500
401k/403b/457 Catch-up (50+) $6,000 $6,000
Traditional IRA / Roth IRA $5,500 $5,500
Traditional / Roth IRA Catch-up (50+) $1,000 $1,000
HSA Contribution Limits
Individual $3,400 $3,450
Family $6,750 $6,900
Catch-up (55+) $1,000 $1,000

At Barnett Financial

New Client Portal and Improved   Reporting

Over the next couple of months Barnett Financial will be implementing a new software infrastructure for our  reporting systems. We expect this change to result in some important benefits for you.

Probably the biggest change you will notice is that we will be launching a dynamic client portal that will deliver a more engaging client experience. Indeed the portal won the 2017 Wealth Management.com industry award for Best Client Portal.

Among other things, the portal will include the Probability of Success meter from your latest financial plan update. You’ll also be able to download a Barnett Financial app from your mobile app store. Stay tuned for details!

EOY Tax Loss Harvesting and Capital Gains Avoidance

Because the market was up so strongly and because there was so little volatility, there was little opportunity to harvest tax losses or to avoid capital gains this year. However, we continue to proactively look for such opportunities throughout the year — not just at year end.

Closing Thoughts

We hope you take the new portal as evidence of our desire to continually improve your client experience, stay in front of the technology curve, and “Take the Worry Out of Wealth.”

Let us know if there is anything on your mind or anything else we can do for you!