February Market Commentary

Over the next few months, the production and distribution of COVID-19 vaccinations is expected to ramp up significantly. Late in February, the FDA approved Johnson & Johnson’s single-shot COVID-19 vaccine for emergency use. The President recently announced that he projects there will be enough doses of the coronavirus vaccine available for the entire adult population in the U.S. by the end of May. Based on these positive developments, investors rewarded stocks in February with solid gains, demonstrating optimism regarding economic recovery and falling COVID-19 infections. With spring and warmer months ahead, the opportunity to spend more time outdoors will not only be refreshing, but it will also provide businesses the opportunity to reopen and begin to recover from the pandemic.

With most Standard & Poor’s 500 (S&P 500) companies reporting fourth quarter financial results, we are seeing Corporate America heal and show signs of recovery. With that said, there are significant divergences in segments of the economy performing well and those yet to see improvement. While S&P 500 corporate profits gained only 1.8% in the fourth quarter, these results are 14.7% above expectations. This is the third consecutive quarter of the highest level of earnings surprises we have witnessed in the past twenty years. In addition, while economists expect a robust recovery in GDP for 2021, approaching a level not seen since 1984, S&P 500 corporate profits are expected to surge over 24% this year! This expected robust recovery has contributed to some of the highest market valuations not seen since 2000. In addition, improving economic conditions are contributing to rising interest rates and inflation. While this is not necessarily a bad thing, the pace of the recent rise in interest rates is concerning to some investors.  

You can look no further than the bond market to find the downside to rising interest rates. Bond prices move inversely with interest rates. When interest rates fall, bond prices rise. When interest rates rise, bond prices fall. Interest rates have increased in 2021 and bond prices have declined, leading to moderate losses in the bond market. While this is normal in an improving economy, it may be unsettling for bond investors seeking a safe haven for a portion of their assets from the vagaries of stock market volatility. However, attempting to predict interest rates has been an exercise in futility over the past decade, as interest rates plunged to all-time lows. We believe it remains prudent to maintain some diversified bond exposure in portfolios to mitigate stock market risk. Therefore, we focus on structuring high quality bond portfolios with below average maturities to dampen the negative effects of stock market declines.  

We see the direction of the financial markets increasingly dependent on interest rates, economic data, and future corporate earnings. We continue to see evidence of strong economic recovery in the second half of 2021 and into 2022. However, the global pandemic continues, with new variants of the virus spreading. This may contribute to unexpected surges in cases from time to time and renewed economic restrictions. Therefore, pullbacks in the stock market are normal and should be expected as the pandemic persists and global economies recover. We view these pullbacks in the stock market as opportunities to make portfolio adjustments within a long-term investment time horizon. 

The one-year anniversary of the novel coronavirus (COVID-19) outbreak being declared a global pandemic is March 11th. We extend our most heartfelt sympathies to our friends and families who have lost a loved one during this difficult year. As we strive to provide our best financial and investment advice to you during these unprecedented times, we humbly reflect on the challenges faced by many of you and appreciate your trust and loyalty. We wish you and your family health and wellness in the coming spring season. As always, please feel free to contact us at 513.791.9258 (Blue Ash) or 513.863.4015 (Hamilton) or inquire about arranging a video call!

Taxes – What Does the Future Have in Store?

Now that the Biden administration has been sworn in and the Democrats have taken control of both the House and the Senate, many are concerned about potential tax increases. Even if nothing is done, the current tax rates that were reduced starting in 2018, will sunset on December 31, 2025. That means that the highest tax rate will revert back to 39.6% from the current 37%. Even aside from the top rate, some taxpayers in the 24% bracket will see an increase to the previous 33% bracket. Since the 2018 tax law impacted virtually every taxpayer, a sunsetting of many key provisions will once again impact virtually everyone. The question is whether Congress will let that happen or will changes occur before that?

During the election, the Biden team posted information about what their intentions were with tax policy. While much remains unknown as to what will actually pass and when taxes will become a focal point of the administration, one of the key messages was that taxpayers with income of $400,000 or less would NOT see an increase in taxes. Below we highlight areas of the tax law that are being considered. Increasing the top individual tax rate from 37% to 39.6% which, as noted above, will be the rate in effect for 2026 if no action is taken by Congress. With Biden’s plan, it is unclear how other rates will be affected given the over-arching theme of no new taxes for those making $400,000 or less.

  • Increasing the top corporate tax rate from 21% to 28%.
  • Eliminating the pass through “QBI” deduction for those making over $400,000.
  • Eliminate Section 1031 exchanges for real estate transactions.
  • Cap itemized tax deductions at an effective 28% rate.  Obviously those taxpayers in the current 32%, 35%, and 37% brackets would be affected.
  • Increase child and dependent care tax credits.
  • Implement new tax credits for caregivers and long-term care insurance.
  • Increase tax rates on long term capital gains and qualified dividends. This would only apply to those making over $1M.
  • Keep the surtax on net investment income which is above and beyond the 39.6% ordinary income and capital gains tax rates discussed above. 
  • Increase Social Security FICA taxes on those making over $400,000.
  • Convert retirement plan contribution deductions into tax credits based on a flat 26% benefit regardless of your tax bracket. This would benefit lower income taxpayers while negatively impacting higher income taxpayers.

Do you see a common theme? Obviously, it’s increasing taxes on those making over $400,000. The question is ultimately how to do that. There are also significant changes being considered to estate and gift tax rules including a sizeable reduction in the lifetime exemption levels. We will discuss this in greater detail in a subsequent article. Separate from what the Biden administration has proposed, there is additional legislation being discussed as a follow up to the SECURE Act passed in 2020. While there are many aspects of this “SECURE Act 2.0,” one item that would affect many people is the raising of the Required Minimum Distribution (RMD) age to 75. It was raised from 70 ½ to 72 as part of the original SECURE Act and now there is discussion of raising it even higher. Additionally, SECURE Act 2.0 would eliminate RMDs for taxpayers with less than $100,000 of assets that typically would require RMDs (IRA, 401k, 403b, etc.). While we will continue to monitor proposals, our advice is not to over-react to proposals as who knows what provisions actually make it into law. However, it’s clear what the intentions are – to raise taxes on higher income taxpayers. Thus, it is critical that you begin to plan for a general increase in taxes which may mean planning strategies that are opposite of the tried and true ways of the past. For example, instead of deferring income and accelerating deductions, you may want to consider accelerating income and deferring deductions before the laws change! 

As with any tax planning, one strategy does not fit all. Each of you have unique situations that require a thorough analysis of options. Please contact your financial advisor at 9258 Wealth Management if you have questions or wish to further discuss.