We Always Bring Something to the Table
By Kathy Thompson, J.D.
A table has several different meanings. It can refer to a set of facts and figures displayed in rows and columns. It can also indicate postponing consideration of something, as in, “Let’s table this discussion for another time.” But frequently the first image that comes to mind when hearing the word “table” is a piece of furniture that can be used for such purposes as eating, writing, or working. Gathering around a table is conducive to discussion, problem-solving, and teamwork. For us, the table symbolizes this team-oriented, synergistic approach to wealth management that makes our collaborative method so effective. We call our experienced and knowledgeable professionals our Table of Experts and we’re pleased to announce that it’s growing! We’ve added three new place settings, and they all bring something valuable to the table. ♦
Laura George, CTFA, CFP®
With more than 20 years of extensive experience in wealth management with several major regional banks and asset management firms, Laura concentrates her efforts on the planning and administration of personal and institutional trust accounts and estates. After receiving her Bachelor of Science from the University of Kentucky, she earned a master’s degree at Bellarmine University and is a Certified Trust and Financial Advisor and certified financial planner® professional.
(502) 625-9132 Laura.George@syb.com
Stephen Turner II
Stephen provides professional investment advice for the successful accumulation, distribution, and transfer of wealth across generations. Prior to joining Stock Yards Bank & Trust, he worked for a large, regional brokerage and money management firm, and holds various professional licenses in the investment and brokerage industry. Stephen received his Bachelor of Science in Finance from Murray State University, and his MBA from Southern Illinois University Carbondale.
(502) 625-1010 Stephen.Turner@syb.com
Maria Tipton, JD
Building relationships and working collaboratively with clients to achieve their goals and protect their financial future, Maria is responsible for the administration of personal trust accounts and client relationship management. After receiving her Bachlor of Arts degree magna cum laude from the University of Louisville, Maria earned her Juris Doctor magna cum laude from the Louis D. Brandeis School of Law at the University of Louisville.
(502) 625-9904 Maria.Tipton@syb.com
Economic Update Q4: 2018
Oct. 5, 2018
The stock market as measured by the Standard & Poor 500 turned in a quiet but very positive return in the third quarter gaining 7.7% for the three months ending September 30th. Year to date the domestic market has provided investors with a return of 10.6%. Bond investors were not as fortunate. The return from the Barclays U. S. Aggregate Bond Index was +0.02 and -1.6% for the quarter and first nine months respectively.
The United States domestic economy continues to build momentum. The latest revision to second quarter Gross Domestic Product estimates came in at a 4.2% rate. The increase in economic activity has surprised many economists and strategists. This has been one of the longest periods of economic expansion in post-World War II history. Generally, growth tends to slow as an economic expansion ages. Accelerating growth in an economy that has been expanding this long is a rarity. Because of the duration and slow pace of the recovery, market strategists and economists have been worried that the recovery could end abruptly. This economy has gotten very little respect. However, the pace of economic growth continues to accelerate. What happened to cause this growth? Two primary factors were responsible for the increase in growth.
- Consumer and business confidence is soaring resulting in increased spending and consumption. This is primarily the result of the recent tax law changes that lowered corporate and individual tax rates and reduced regulation which lowered some key barriers to investment in the United States. Giving businesses and consumers more money to save, invest, and spend has always been a positive for economic growth.
- The unemployment rate has dropped dramatically. Most economists consider our current level of unemployment to be full employment because a small portion of the labor market is either between jobs or temporarily or permanently unemployed at any given point in time. A high employment rate is very positive for economic activity. People receiving paychecks are much more likely to spend money, and consumption accounts for over two thirds of our economy.
We expect economic growth to continue to improve in 2018 from the anemic 2% growth we have experienced for the last ten years to something north of 3% both this year and next.
What does this mean for the capital markets the remainder of this year and next? Addressing the stock market first, we believe that we are in a secular bull market for stocks. What does that mean? It means that the general trend of the stock market is up with higher highs and higher lows for an extended period of time. It does not mean we will not have corrections or volatility. What is driving our positive outlook for stocks? The corporate profit picture is the main reason we are positive about the stock market. Earnings are the fuel that drive stock prices higher. The impact of faster economic growth and lower taxes will have a positive impact on corporate earnings in 2018 and beyond. In fact the growth in corporate profits has exceeded the growth in the market for the last three years. This has reduced valuation levels to much more reasonable ranges. The combination of lower valuations and higher profit growth have historically given us very good long term returns from stocks.
The fixed income markets may not be so fortunate. The bond market had a negative total rate of return in the first nine months of this year. We expect fixed income returns to be meager for the next eighteen months or so for several reasons. Generally, faster economic growth increases the demand for capital which results in higher interest rates. In addition, the Federal Reserve has promised that it will continue to increase short term rates and unwind its quantitative easing program. The Fed will shrink its balance sheet by not reinvesting the income or proceeds from maturing bonds and by beginning to sell bond holdings outright. This reduction in demand and increase in supply is generally not good for bond prices. Lastly, wage pressure appears to be increasing as the economy operates at full employment. Wage pressure has been a precursor to inflationary pressure in the past. Bond prices are negatively impacted by inflation as investors demand higher rates of interest to compensate for the loss of purchasing power that inflation creates.
What could blow this up and make us change our economic and capital markets outlook? The first problem is the Federal Reserve and rising interest rates. The Fed could normalize interest rates too quickly which would undo many of the positive economic initiatives. The high debt level in the United States will leverage any increases in rates by immediately increasing the cost of servicing that debt. This could disrupt economic growth. If the Fed moves too slowly to unwind the quantitative easing they could create inflationary pressures especially in a full employment environment. We are already seeing some wage pressure because of the increasing demand for workers. This has been an early sign of increasing inflation in past economic cycles. The second problem is tariffs. Tariffs are essentially taxes placed by countries on imported goods. These taxes are imposed to make the cost of locally produced goods more attractive and to punish low cost producing countries. However, countries seldom sit idly by and allow their exports to be taxed. They retaliate with tariffs of their own which can escalate to the extent that global trade is diminished and world economic growth is negatively impacted. Some of you will remember from history that this was one of the reasons for the severity and length of the Great Depression in the 1930’s. Finally, the shape of the yield curve is flashing a warning signal. The yield curve graphically represents the yields available from fixed income investments at different maturities. It is traditionally upward sloping meaning that shorter term fixed income investments yield less than longer term investments. When the reverse is true, short term rates yield more than long term rates or the yield curve becomes inverted, it has been a very good indicator of a recession on the horizon. Right now the yield curve is very flat. If the Federal Reserve increases short term interest rates one more time this year and all other yields remain the same we will have an inverted yield curve. The yield curve has inverted anywhere from ten months to two years before each of the last five recessions.
What could go right over the next year to six months that may not be factored into the markets? What economic or political factors could provide a catalyst for higher stock prices for the remainder of this year and into 2019? I want to mention a few possible scenarios because they are things you will probably not see or hear in the financial press or on the nightly news telecasts.
- The Federal Reserve signals an end to rate hikes after the December increase in the Fed Funds Rate calling a time out on future rate hikes. They could do this for several reasons. The need to unwind the quantitative easing bond purchases on their balance sheet while interest rates remain relatively low would be the first reason. Secondly, the Fed is also very much aware of the dilemma they have placed themselves in. The last thing they would want to do is disrupt the economic growth that we are currently experiencing by increasing interest rates too quickly or to disrupt the supply and demand equation for bonds.
- Trade negotiations could end positively with renegotiated agreements and no trade war. This would be very positive for consumer and business confidence and global growth. Right now the headlines could not be any worse. Economists here and overseas are expecting a trade war that will slow global growth and lead to the next recession. We have said all along that this might just be an art of the deal strategy to coerce our trading partners back to the table. What if the unconventional methods used by the President result in continued successes like the recently announced USMCA that replaced NAFTA with positive results for Canada, Mexico, and the United States? That is certainly not priced into the current stock markets here at home or abroad.
- The economy and corporate profits could continue to expand. This economy has been suspect because of the length of the economic expansion with few strategists expecting the recovery to last let alone accelerate. What if the tax cuts continue to boost economic growth that translates into better earnings and cash flows for corporations for the next several years? What if the economic expansion goes on through 2020? A larger than expected earnings surprise resulting from faster and/or longer economic growth would be very positive for the stock market.
- Investors might also come to realize that we may have already had our correction. Market volatility has become more intense since January. We have talked a lot about how normal a 10% correction is in a secular bull market. Federated Investments recently noted that an astounding 83% of the stocks in the Standard & Poor 500 have had a correction of 10% or more year to date; just not all at the same time. Does it matter that the market has not had the 10% correction when most stocks seem to have already experienced one?
The combination of lower valuation and faster corporate profit growth will eventually kick start the market. The combination of faster profit growth and reasonable valuations has historically been a prescription for above average stock market returns. If any one of the above unanticipated events happens, it could provide the catalyst for a much better second half and positive stock market returns in 2019.
Thank you again for the confidence you have placed in the Wealth Management and Trust team at Stock Yards Bank & Trust. Please contact us at any time to discuss our outlook in more detail. ♦
Source: FactSet, FRB, Robert Shiller, Standard & Poor’s, Thomson Reuters, J.P. Morgan Asset Management. Price to earnings is price divided by consensus analyst estimates of earnings per share for the next 12 months as provided by IBES since December 1989, and FactSet for June 30, 2018. Average P/E and standard deviations are calculated using 25 years of FactSet history. Shiller’s P/E uses trailing 10-years of inflation-adjusted earnings as reported by companies. Dividend yield is calculated as the next 12-month consensus dividend divided by most recent price. Price to book ratio is the price divided by book value per share. Price to cash flow is price divided by NTM cash flow. EY minus Baa yield is the forward earnings yield (consensus analyst estimates of EPS over the next 12 months divided by price) minus the Moody’sBaa seasoned corporate bond yield. Std. dev. over-/under-valued is calculated using the average and standard deviation over 25 years for each measure. *P/CF is a 20-year average due to cash flow data availability.Guide to the Markets –U.S.Data are as of June 30, 2018.
Paving the Road to Retirement: “Prudent” Spending Matters
One of the milestones on the road to retirement is reaching an understanding that you will be able to achieve the lifestyle and legacy you want with the assets and income you will have. Developing dependable and/or varied sources of income gives strength to part of the retirement equation. The other part of achieving one’s retirement dreams lies in understanding how much you will personally need and working toward that goal through “prudent” spending.
The financial media provides a plentitude of recommended savings rates based on age and income level. We have also been educated that our current national savings rate hovering just above 3% will not adequately prepare most families for this special time of their lives. Rules of thumb like saving 10-15% of your annual income are less relevant to those nearing retirement since they are based on starting young and having a longer time horizon to “fill the bucket” through contributions and compounding. Those beginning to develop a savings plan later in life will likely find they need to accumulate even more to maintain their current lifestyle, especially higher income individuals for whom Social Security will replace less of their income.
Understanding how much of your current income needs to be replaced is best achieved by breaking down what you will actually need in retirement. Rather than throwing a dart and accepting an arbitrary 60-80% income replacement guideline which may not be accurate for you, it is far better to undergo a simple assessment and understand the inputs to your personal retirement budget.
One way to consider what will be needed is to break retirement life down into spending categories-an easy mental walk with your favorite drink in hand or relaxing in your favorite space. Do what you need to do in order to make this process a rewarding one, but let your imagination take you to a place where every day you can choose how you spend your time and how robust your activity level will be.
Remembering that most of us will be in retirement for around 20 years, lean back, relax, and consider these categories:
Food and Dining Out: What is your preference on eating in or dining out? Do you enjoy cooking, and for reduced numbers of people? If you dine out, how often and at what average cost?
Digital Services: What subscriptions or information access do you currently have personally or through your employer? Will you have the same needs/desires for access at retirement? What change in costs, if any, will be related to your needs for news, online, courses, or any retirement activity to supplement your income?
Recharge: What personal or recreational services do you wish to have in retirement? Are hard copy or audiobooks, trips to the spa, mani-and-pedicures part of your vision? Are you planning to join or continue your country club membership?
Travel: Do your retirement plans include travel to places yet unseen? How frequently do you plan to get away, and how far will you travel by air or another vehicle? Will you purchase or continue to maintain a vacation home?
Entertainment: What sort of sports activities, fine arts events, or classes do you like to attend? Will you continue these or add to/subtract from the list during your retirement years? Do you enjoy these activities with friends and will they continue into your twilight years?
Shopping and Gifts: Do you like to shop and give gifts to friends and family? Are you charitably inclined? How much change to your current spending on clothing and household goods do you imagine?
Basic Needs: What essential spending needs to occur to bring you happiness? Utilities, and replacement appliances are not exciting, but are a necessary part of life. Housing and transportation are likely the two biggest parts of your current budget. Do you plan to create more or less space for you and your family in retirement? Will you splurge on the luxury car you have worked hard to enjoy? How much will your healthcare costs change with age and when any employer subsidies are gone?
As you can see, there are many inputs to formulating an accurate retirement budget, and often handing the answers to these questions over to a professional can be a very rewarding experience. Quality financial advisors are trained to be your partner in constructing an easy-to-understand plan which includes tax implications and investment return projections. There is also no replacement for an objective opinion which highlights issues that can throw you off track, like assessing excessively high risk in your portfolio needed to achieve unrealistic goals.
Once you have worked the puzzle of what expenses you will have in retirement, it is an easy bridge to understand how much your current asset mix will support and any shortfall of income which needs attention between now and the time you retire. For the average family, greater headway toward building the proper sized nest egg will be achieved by placing the focus on controlling “prudent” spending rather than attempting to target an arbitrary savings rate.
Examination of consumer spending for U.S. households clearly shows that transportation and housing monopolize the largest shares of overall spending. It is highly probable these categories also consume the largest portion of your personal household budget as well. Focusing your efforts on prudent spending in categories with the highest potential to increase savings for retirement clearly makes sense. Will reducing home expenses over the long term get you closer to your retirement dreams than eliminating your occasional stop at the coffee shop? It sounds all too simple. But what does it really mean to “live within your means”?
Distinguishing between “saving what is left over” and “prudently controlling flexible spending” to achieve your long-term goals is important. How often do any of us have something left over with no added attention given to our spending habits? If we are being good stewards of our resources and paying attention to high impact items, there are opportunities to make headway toward long-term goals as fixed expenses change from time to time. Focusing on prudent spending decisions even during periods when fixed expenses are lower provides greater positive results than curbing expenses with less budget impact. Although we sometimes feel hit with one outlay after another, indeed there are many expense decisions we can control and holding ourselves accountable for making those with a long-term mindset is key to making your retirement dreams a reality.
Given your new understanding of exactly what will be needed in retirement from the exercise above, there is no need to accept that simply being within acceptable debt ratios will keep your spending at the proper levels. In fact, consumer debt ratios are set by lenders to satisfy a different set of criteria, not to help average families select a level of debt in line with their long-term family goals. Prudent spending is actually the key driver to controlling what you can and reducing the risk of missing your retirement target. Let us help you create a baseline plan and talk through the obstacles you see to reaching your ideal retirement. With a quality conversation about a prudent spending plan, you may be closer than you think! ♦
Wealth Management & Trust
KATHY THOMPSON, Senior Executive Vice President, (502) 625-2291
E. GORDON MAYNARD, Managing Director of Trust, (502) 625-0814
MARK HOLLOWAY, Chief Investment Officer, (502) 625-9124
SHANNON BUDNICK, Managing Director of Investment Advisors, (502) 625-2513
REBECCA HOWARD, Managing Director of Wealth Advisors, (502) 625-0855
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We provide the information in this newsletter for general guidance only. It does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, investment, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, expressed or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.