Tax And Monetary Policy
Market Update
(all values as of 07.31.2020)

Stock Indices:

Dow Jones 26,428
S&P 500 3,271
Nasdaq 10,745

Bond Sector Yields:

2 Yr Treasury 0.11%
10 Yr Treasury 0.55%
10 Yr Municipal 0.64%
High Yield 5.44%

YTD Market Returns:

Dow Jones -7.39%
S&P 500 1.25%
Nasdaq 19.76%
MSCI-EAFE -10.64%
MSCI-Europe -10.86%
MSCI-Pacific -10.53%
MSCI-Emg Mkt -3.21%
US Agg Bond 7.72%
US Corp Bond 8.44%
US Gov’t Bond 9.35%

Commodity Prices:

Gold 1,992
Silver 24.54
Oil (WTI) 40.43


Dollar / Euro 1.17
Dollar / Pound 1.30
Yen / Dollar 105.01
Dollar / Canadian 0.74

The month of Thanksgiving ended with financial markets struggling to assess the level of real underlying economic activity in the absence of storm-related activity, tax reform, uncertainty in monetary policy, and a future regime change at the Fed under incoming Chairman Powell. Reports regarding the final enactment of the tax bill kept reform mania in play while recent commentary by Chair Yellen expressing concern on the trajectory of the U.S. debt and asset prices being sustainable gave caution to both fixed and equity markets.

In November, the Dow Jones Industrial Index climbed past 24,000 and the S&P 500 Index eclipsed the 2600 level as the likelihood of a tax reform passage became more apparent. Improvements in the economy and the labor markets materialized further as the unemployment rate dropped to 4.1%, below the estimated 4.2% in October, and the lowest rate since December 2000. Asset price inflation, historically high levels of debt and persistently low levels of inflation are lending new narrative about risk from Central Bankers globally. Although correlation is not causation, most investors have drawn the connection that raising rates and quantitatively tightening (known as the “normalization” of rates) will end the era of low cost liquidity and will, as such, impact markets much more to the downside.

The Market Update table shows the outsized double digit returns of equities relative to their more “normal” 10 year annual returns. The recent rise is best exemplified by the Dow’s year to date performance, wherein the top 5 companies contributed 50%+ to the Dow’s return. Boeing Co., who saw an 82.8% return in 2017 contributing to 20% of the Dow’s 29% return and Apple Inc., whose 49.5% return YTD contributed 8.5% to the Dow’s performance. The implication here is that markets are strongest when they are broadly based and weakest when they are narrowed to a handful of blue-chip names. Diversification is essential to sustaining long-term portfolio performance.


In November, the shape of the yield curve continued to flatten with yields from 3 months to 3 years rising by more than 10 basis points (bps). Meanwhile, the 10 year yield was lower by 6 bps and the 30 year yield was lower by 12 bps. During the month, the 10 Year Treasury yield traded in a tight range from 2.30% to 2.40%, while the 5-30 year yield spread tightened by 16 basis points from 86 to 70 basis points. In short, the 30 year treasury outperformed short treasuries significantly.

Portfolio durations were managed near their benchmark as we continue to prioritize preservation while accumulating capital gains going into year end. The persistently low volatility of the markets has brought about a level of complacency that can often move markets to the downside unexpectedly. With less than a month remaining, and shortened trading days in December, liquidity in the market could evaporate and cause market volatility to suddenly increase. As we move into December, we are increasing our allocation to an overweight position in high quality bonds across all sectors with a modest overweight in credit.

In our Agency Mortgage Backed Securities (MBS) strategy, we remain in an underweight position as the Fed’s tapering of their agency MBS reinvestments continue to add pressure to spreads and prices. Much of the outperformance in November can be attributed to the portfolio’s yield curve positioning and sector allocation.



In November, the municipal market was highly influenced by the uncertainty of tax reform and the impending ban on private activity bonds as well as advanced refundings.

Issuance during the month set a year-over-year record as November municipal bond volume, being the third largest this year, was up 10.6% compared to November 2016. With 11 months down and one to go, total volume for the year stands at $369.6 billion, down from $430.8 billion in the same period of 2016. However, December’s volume is expected to end up at near record levels of $50 billion with refunding issues comprising the majority of deals. Going forward, the elimination of state and local tax deductibility clearly increases the need for tax-free income with further potential for limiting offerings from the five largest states. So far this year, California has remained the state with most issuance ($58.9 billion), with New York coming in second ($41.4 billion), followed by Texas ($36 billion), Illinois ($17.8 billion), and Pennsylvania ($17 billion).

Ultimately, municipal bond investors will see supply benefits from the new tax bill as the value of their existing holdings and the potential shrinkage of future offerings (by approximately 20% or more) will add a scarcity premium. The negative impact from the tax reform bill will be felt more on the sale side of the market as we expect a distinct decline in underwriters, market makers, credit analysts, and sales people while the value add of their positions are reassessed.


Both gold and silver were positive for the month and they continue their positive performance year to date. The COMEX gold price is now up 11.3% YTD and the COMEX silver price is up 5.4%.

During these highly charged political times, fear complexity rises with debasement risks, default risks, and sovereign balance sheet risk, which increases the near term demand for “risk off” asset ownership.  Here in the U.S., the normalization of monetary policy and tax reform alongside a dollar in continuing decline, being addressed by an unknown and untested Federal Reserve Board, will dominate 2018. A year ago, it took $1.04 to purchase one euro and it took about $1.22 to purchase one British pound. Today, it takes over $1.19 to buy a euro and over $1.35 to purchase a pound. A need for a store of value remains important in portfolio construction.


As investors become swamped with Wall Street forecasts and projections for 2018, the lesson to be learned from 2017 is when everyone agrees that prices can only go in one direction, a contrarian view should be considered. We began 2017 with most of Wall Street being bullish about the prospects for the “reflation trade”, higher bond yields, dollar strength and higher inflation from rising wages. Our December 2016 monthly client review was headlined, “The Irrationality of the Trump Trade”. A year later, wage inflation hasn’t quite materialized to the market’s expectations but asset inflation certainly has. Benchmark 10 year treasury yields are down, not up; the dollar is also down, not up; and precious metals are up, not down. The current tax proposals by both houses of Congress, now in reconciliation, appear to be a mixed blessing. Apart from the potential delay in the corporate rate tax cut, almost all of the changes will take effect at the start of 2018. Our overall assessment of the fiscal stimulus has already played out in the equity markets. It would appear administratively, however, that the Fed is likely to operate on cruise control through the first half of next year as Governors Powell and Quarles and seven not-yet-nominated 2018 voting members go through the approval process and learn the policy ropes at the Fed.

As central banks globally are reducing liquidity with balance sheet roll offs, they are heightening volatility. The underlying tone of economic activity is revealing modest personal consumption level increases with the roll off of the post-hurricane, housing, and automobile bounce as well as the need for very early and deep discounting of retail sales. We remain cautiously optimistic heading into the end of the year as we emphasize relative value and quality as key strategic measures to enhancing performance and incorporating low-correlated assets to managing risk.

Disclaimer: This publication contains the current opinions of the manager and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Such opinions are subject to change without notice. This publication is distributed for education purposes only. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Forecasts are based on propriety research and should not be interpreted as an offer or solicitation, nor the purchase or sale of any financial instrument. No part of this publication may be reproduced in any form, or referred to in any publication, without the express written permission of Smith Affiliated Capital Corp.