We hope you enjoyed the holidays and are looking for a bright 2018. By my estimation, investors should be optimistic for the new year.
A good showing for 2018 would be a continuation of a prosperous 2017. On the heels of the Tax Cuts and Jobs Act of 2017 passage, the New Year is also coupled with the prospects of deregulation and infrastructure spending.
Aggressive investors were rewarded in 2017 by taking on the following uncertainty and risks:
- An ambitious policy agenda from a new administration
- A flattening yield curve – which many times is a precursor to an economic recession
- North Korean arms escalation
- The continuing Brexit saga
- Record period of stock market gains without at least a 3% drop
As I have said many times in the past, markets do not like uncertainty, and 2017 was choked full of them. It was unusual in that the financial markets embraced the proposed policy changes and didn’t flinch from the political bickering across party isles and within the Republican Party. The relief from uncertainty was never more prominent than immediately following the last presidential election. With cause or not, within hours of the Trump victory there was an attitude and expectation of renewed faith in the economy, which continues to persist.
Globally, whether one likes or dislikes the heads of state they collectively were able to blaze a believable expansionary path in which investors bid up asset prices on the belief of future reward.
During the fourth quarter of 2017, the S&P 500 Index gained 6.1%, the NASDAQ Index gained 6.3%, while the iShares Barclays 7-10 yr. Treasury Bond ETF (IEF) lost 0.9%.
Tax Cuts and Jobs Act of 2017
Many have asked if the recently passed tax cut bill is good. The answer depends on who is asking about the $1.5 trillion proposal.
The overall theme of the tax cut is that the savings will generate economic growth by creating more jobs and raising wages, which will in turn provide future tax revenue in excess of the tax cut. The following is a partial snapshot of some winners and losers of the tax cut.
Winners:
- Corporate America: It permanently cuts the corporate tax rate from 35 percent to 21 percent to bring it closer to that of countries like Canada, which has a 15 percent corporate tax rate, or Ireland, which has a 12.5 percent rate.
- Individual Taxpayers: It lowers the individual tax rates and increases the standard deduction. A single filer’s deduction increases from $6,350 to $12,000. The deduction for Married and Joint Filers increases from $12,700 to $24,000.
- Owners of pass-through companies, like LLCs, partnerships, sole proprietorships, and S corporations: It now gives pass-through businesses a 20 percent deduction, in addition to cutting the top individual tax rate.
Losers:
- Homeowners with high real estate taxes: It places a $10,000 cap on the state and local income and property tax deduction. The bill also changes the mortgage interest deduction, lowering the cap for newly issued loans to $750,000 from the current $1 million threshold.
- Individual Taxpayers: The tax cut for individuals will slowly decrease over time — and end altogether in 2025.
- Future generations: Could be burdened with $1.5 trillion being added to the national debt if the offsetting gains don’t materialize.
Ultimately, the economy should continue to expand as corporate tax savings are in turn used for capital expenditures, but the stock market may have a bumpy ride through the year as it navigates the following risks:
- The magnitude of the change in interest rates and inflation could surprise investors and scale back projections of future earnings growth.
- China and Japan, our two largest creditors besides the Federal Reserve, reduce U.S. Treasury purchases causing an increase in U.S. debt expense.
- Mid-Term election results create political gridlock which cap or reverses growth initiatives.
- North Korean tensions escalate
- The stock market as measured by the S&P 500 is experiencing its longest run without a 3% drop which may indicate that investors are bidding up prices without properly considering risk.
Bitcoin Fever
Next on the agenda for topics to be explored is our old friend Bitcoin and the other nascent offerings of cryptocurrencies (digital money). In my opinion there are three reasons why investors gravitate towards Bitcoin. None of which I believe at this point in time is worthy of my hardearned investment dollars.
Proponents of Bitcoin say that Bitcoin is a currency that stores value and can be freely exchanged for goods and services and other currencies. In the past year, Bitcoin has more than once dropped 40% within a short period of time. This is not a good store of value. The U.S. government has yet to make a clear statement about Bitcoin being a currency, but Japan and South Korea have. Japanese Finance Minister Taro Aso commented that bitcoin has not been proven as a credible currency, and South Korea’s Financial Supervisory Service has declared it does not consider bitcoin and other cryptocurrencies to be currencies of any kind.
Secondly, advocates argue that cryptocurrencies are a new asset class such as stocks, bonds, real estate and precious metals, to name a few. This may happen in the future, but it would only be after institutions such as banks and insurance companies embrace and include them in their portfolios. Today, institutional activity revolves around Bitcoins as a transactional commodity, not an asset. Their focus is on making money through transactions, such as futures trading, or from fees generated by creating investment pools, such as ETFs. Just because something — again let me reiterate, “something”, – has a futures contract or is ETF based does not mean it’s viable for general investing. The Chicago Mercantile Exchange (CME) will trade anything if they can make money on the transactions. For instance, did you know that there is a futures contracts on frost? It’s designed as a hedge for orange growers and speculators. Likewise, there is an ETF marketed as a Faith Shared Christian value investment. Both are not a comment on their viability but only an indication of investor appetite for a certain investment vehicle, however brief it may or may not be.
My next issue with Bitcoin is that it is a fad. One definition of a fad is that it is an intense and widely shared enthusiasm for something, especially one that is short-lived and without basis in the object’s qualities; a craze. Fads are many times unexplainable but develop for one reason or another and then disappear. One such memorable fad was the Cabbage Patch doll. The last thought to ponder on this subject of fads is: How did AOL, the one-time king of the internet and media with a 1999 peak market value of $222 billion, perform for investors in the end? As a shell of its former glory it was sold to Verizon for a paltry $4.4 billion.
Making money from a fad sometimes comes from looking deeper into the underlying components of it. This is how we at Torii Asset Management focus on making money for our clients over time instead of just chasing the popular headline investment themes like Bitcoin. While bitcoin could be a fad, it’s peripheral technology is where the true potential may be found. Cryptocurrencies are based on blockchain technology, an incorruptible digital accounting of transactions. In this example, the science of blockchain is not where the money is easily made; it is in its alternative uses and computers, networks and other infrastructure requirements to support blockchain.
What makes blockchain technology so brilliant is that it provides each network member an identical encrypted copy of an accounting list of every transaction, so all parties can review previous entries and record new ones. The rapid development of blockchain technology opens up a far-reaching list of exciting investment possibilities. For example, big data bureaus such as Equifax hold personal identifiable information like your social security number, the model of your first car, or the name of your first pet in a centralized location that can be targeted by hackers. Blockchain technology could decentralize this encrypted information across many computers all over the world making it virtually impossible to access the entire chain of information.
Other possible uses of blockchain technology includes the efficient handling of digital medical records and vote-counting systems. Due to blockchain technology, financial regulation may lead to increased spending on KYC (Know Your Customer) and AML (Anti-Money Laundering) compliance. Power companies may benefit from the need to improve the energy grid due to
cryptology’s massive energy consumption in computing requirements to run a blockchain. Even in today’s environment, the ever-expanding racks of processors used by miners already consume as much electricity as a small city. Cloud computing and data center businesses may continue to see demand rise for their technology as the amount of information increases across the Blockchain.
Yet as good as it sounds, blockchain as a technology is still in its infancy. Many of its uses are in the trial stage and still not mainstream, but we will be keeping a close eye on its progress, and will be poised to invest your hard-earned dollars when the right opportunity appears.
During the current quarter, in addition to monitoring and adjusting for the previously mentioned risks, we will be seeking out companies that demonstrate they are providing the goods and services which we believe will continue to prosper in the current economic environment and stock market.
To our existing clients, I extend my sincere thanks for your business. You have our continued commitment to your success. To prospective clients, I invite you to come and grow with us.
Very truly yours,
Martin L. Yokosawa