Equity Overview – Global Stock Update

Global markets accelerated throughout 2017, marking new highs and sending broader market indices higher. The election prompted rally in domestic stocks continued on in 2017 as optimism and expectations that growth oriented policies and tax cuts would fuel earnings appreciation.

International markets excelled in 2017 as both developing and emerging stocks were boosted by expanding economies throughout Europe and Asia.

The new tax law imposes a repatriation tax on cash held overseas by U.S. corporations. A tax of 15.5% on liquid assets will affect various sectors and numerous companies that are estimated to have amassed over $2 trillion overseas. The new rate is considerably lower than the previous rate of 35%, incentivizing companies to bring cash back to the U.S.

Of the several sectors encompassing the equity markets, technology and healthcare companies hold the most cash overseas, placing them at the forefront of bringing billions of dollars back to the U.S. at the preferable tax rate. (Sources: Bloomberg, Reuters, www.congress.gov/bill/115th-congress/house-bill/1)

KCG has experienced excellent performance in our choice of International and Emerging Market mutual funds.  As long as they out-perform the MSCI EAFE index, we will continue to hold more mutual funds than indexed ETFs.  In 4Q17, we saw a trend with our International funds to underperform EAFE because their allocations diverge from the index Japan holdings.  The fund managers intend to maintain this posture.  If the index continues to outperform, we expect we will continue to hold both, but rebalance to outperform as needed.

IMF Revises Global Growth Upward – International

Revisions to the initial World Economic Outlook were released in October, revealing stronger than expected estimates for the remainder of 2017 and all of 2018. Growth estimates now are 3.6% for 2017 and 3.7% for 2018, an acceleration from the 3.2% growth that occurred in 2016.

The IMF report states that a global cyclical upswing that began in the middle of 2016 is still intact and gradually gaining momentum. Financial conditions remain buoyant in the U.S. and internationally regardless of any monetary stimulus efforts discontinued by global central banks.

The IMF did attest that the global economy has achieved a level of momentum during a short term that has not occurred for many years. The identified growth is also broad based, more so than any other time over the past decade. Global growth is expected to be the strongest this year since 2014, with the majority of developed economies strengthening. (Source: IMF; World Economic Outlook Report revised October 2017)

Short Term Rates Heading Higher – Bond Market Overview

The Federal Reserve raised a key short-term rate as expected by the markets and made fairly optimistic comments about economic growth projections for 2018. The federal funds rate rose to a target range of 1.25 – 1.50%. The increase is a strategy of tightening and also meant to alleviate inflationary pressures. Concurrently, the Fed is also shrinking its $4.4 trillion balance sheet, a dual monetary policy effect expected to curtail inflation and reduce stimulus. Members of the Federal Reserve indirectly expressed concern about the labor market, suggesting that improvements in the job market were expected to ease. The Fed committee also maintained a conservative growth estimate for 2018 of 1.8%, hinting that the new tax plan may not yet produce economic benefits in 2018. The yield curve flattened throughout 2017, with a rise in short term rates and a drop in longer-term rates. The yield on the 2-year Treasury Note had its largest annual increase in over 10 years, ending the year at 1.89%, up from 1.22% at the beginning of January 2017. The benchmark 10-year Treasury bond yield saw almost no change in 2017, falling to 2.40% at year end from 2.45% in the beginning of January. The current Chair of the Fed, Janet Yellen, is scheduled to chair her last Fed meeting on January 30^th & 31^st, with Jerome Powell assuming the post in February. (Sources: Federal Reserve, U.S. Treasury, Bloomberg)

The New Tax Bill – Fiscal Policy Review

Both individual taxpayers and companies will see broad changes for deductions and tax rates. The emphasis of the tax bill, known formally as the Tax Cuts & Jobs Act, is to stimulate economic activity via new and higher paying jobs. This is why many of the changes directly benefit large and small businesses in order to encourage hiring.

Some of the tax provisions enacted by the new tax act will be temporary, while others permanent. The cost of reduced tax revenue brought about by tax cuts may only be viable for a certain period, thus producing more immediate benefits from tax cuts rather than later.

Affecting essentially every taxpayer is the increase in the standard deduction, which is meant to simplify the tax preparation process by replacing itemized deductions with a larger standard deduction.

The IRS estimates that about 95% of the businesses in the United States are pass-through entities, such as sole proprietors, S-Corps, LLCs, and partnerships. These entities are called pass-throughs because the profits generated are passed directly through the business to the owners, which are taxed at the owners’ individual income tax rates. The new tax law allows for a 20% deduction of that income, thus reducing overall taxable income. According to the Tax Foundation, pass-through businesses account for over 55% of all private sector employment, representing over 65.5 million workers nationwide. (Sources: IRS, www.congress.gov/bill/115th-congress/house-bill/1)