LPL’s Mid Year Outlook: 2017

An important shift has taken place in this economic cycle. The Federal Reserve (Fed) was finally able to start following through on its projected rate hike path, raising rates twice in just over a three-month period. By doing so, the Fed showed increasing trust that the economy has largely met its dual mandate of 2% inflation and full employment, that the economy is progressively able to stand on its own two feet, and that fiscal policy may now provide the backstop to the economy that monetary policy has provided throughout the expansion. The gauges say growth engines and market drivers may have changed: power down monetary policy, power up business fundamentals, and potentially take fiscal policy and economic growth off standby.

Thus far in 2017, the consistency of this new fiscal-led dynamic has been uneven, leading to shifting market leadership amidst low volatility and a narrow trading range for major market indexes. To be sure, in the post-election rally, the financial markets began to price in many of the pro-growth policies offered by the Trump administration. Yet, despite an initial flurry of activity, political momentum slowed, and investor sentiment dampened even as consumer and business confidence remained high. It is important for investors to appreciate that despite these developments, U.S. equity indexes managed to progress through the first half of 2017 either at, or very near, all-time highs. Moreover, signs of financial stress, based on interest rates, credit spreads, and market volatility, remained largely absent. Most importantly, even with fiscal policy on standby, the return to business fundamentals, such as renewed corporate earnings growth, can now act as a market catalyst. The Fed will still have its role to play, but monetary policy is powering down as the driver of financial market strength.

Despite the significant role of monetary policy as a market driver throughout this expansion, general investing principles have held true. The ability to form a good plan and stick to it, with judicious adaptation to the market environment, is the time-tested foundation of continued progress toward financial goals. If we are shifting to new market dynamics, including a greater role for corporate profits and fiscal policy, understanding the evolving opportunities will be important for diversified investors.

To read the entire LPL Mid-Year Outlook, please click on the link below:



IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. Economic forecasts set forth may not develop as predicted, and there can be no guarantee that strategies promoted will be successful. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Mortgage-backed securities are subject to credit, default, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment risk, market and interest rate risk. Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than shortterm debt and involve risk. Investing in MLPs involves additional risks as compared with the risks of investing in common stock, including risks related to cash flow, dilution, and voting rights. MLPs may trade less frequently than larger companies due to their smaller capitalizations, which may result in erratic price movement or difficulty in buying or selling. MLPs are subject to significant regulation and may be adversely affected by changes in the regulatory environment, including the risk that an MLP could lose its tax status as a partnership. Additional management fees and other expenses are associated with investing in MLP funds. INDEX

DEFINITIONS The U.S. Dollar Index (DXY) indicates the general international value of the U.S. dollar. The DXY Index does this by averaging the exchange rates between the U.S. dollar and six major world currencies. The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (agency and non-agency). The Bloomberg Barclays U.S. Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes U.S. dollar-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers. The Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the U.S. dollar-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded. The MSCI Emerging Markets Index is a free float-adjusted, market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI EAFE Index is a free float-adjusted, market-capitalization index that is designed to measure the equity market performance of developed markets, excluding the United States and Canada.


What a Fed Rate Hike Means for You

Earlier this month, The Federal Reserve raised its target short term interest rate benchmark by .25%, from .75% to 1.00%. As can be seen from the chart below, the hike can be viewed as a minuscule adjustment in comparison to past rate hiking cycles. But for a country that has been permanently in a low growth, low interest rate environment since The Great Recession, the psychological importance of a gradual rate hike is noteworthy. Per Fed Chair Janet Yellen “The simple message is – the economy is doing well. We have confidence in the robustness of the economy and its resilience to shocks.”

By historical standards, the new rate is still very low, and the projected increases are gradual. Wage growth, a dwindling supply of workers, and expectations of inflation growth are all factors with the gradual hike in rates. While many participants in this economy would dispute the improvement in wage growth and quality job opportunities, economists generally agree that a gradual increase in rates will help prevent an economy from “overheating” due to excessive business and consumer consumption.

Economic jargon aside, here’s how the rate increase can impact your everyday life, as well as some steps to take advantage:

Increases to Variable Rate Loans

Variable rate loans, mainly credit cards and HELOCs, will likely rise shortly following any hike in interest rates. Usually, within 3 months, you should see a corresponding bump in your rates on these types of loans.

What to do: Make sure you are aware of your interest rate % on your variable loans. Also, consider balance transfers and 0% introductory periods for your credit cards.

Mortgage Rates

For fixed rate mortgages, the lag for the interest rate hikes is not as clear cut. The Federal Reserve can only control the short end of the yield curve, meaning it cannot use its “toolbox” to materially impact longer term interest rates. Mortgage rates are usually more correlated to inflation expectations and demand for long term U.S. treasuries, and will not necessarily rise in tandem with a Federal Reserve rate hike.

With that said, mortgage rates do tend to rise if there is a sense of optimism about the economy. We have seen rates tick up modestly within the past year, based on the long-term outlook of the economy per the Fed.

What to do: Mortgage rates are still near historic lows. Explore refinancing or locking in a rate on a new home sooner rather than later.

*Average 30 yr Mortgage rate since 1972, per the St. Louis Federal Reserve. Gray bars indicate recessions.           

Savings Accounts

For the conservative investor, the idea of earning any interest in a savings account over the past few years has been wishful thinking. Unfortunately, a rise in rates does not automatically mean a rise in your savings rate. Banks typically use the hike in interest rates as an opportunity to raise their profit margins, and not necessarily pass on any benefit to the consumer. As a result, increases in savings rates tend to lag increases in rates to consumer financing.

What to do: Diligently shop for the best savings rate possible. Tying yourself to one bank will generally not result in the best possible rate. Some institutions utilize the rate hike as an opportunity to win business by sacrificing their margins for deposits. Make sure to check out online banks as well, as they can typically offer higher yields due to less overhead expenses.


*Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. 


Avoiding Higher Tax Brackets in Retirement with Partial Roth Conversions

As a retiree, it’s important to know and understand the basics when it comes to withdrawal order of your nest egg. Generally, conventional wisdom states that its best to spend down your cash and after-tax funds, while allowing your tax-advantaged investments to grow. But is this always the case, or can there be a such thing as “too much” tax deferral?

When accounting for all factors – including taxes, RMDs, and sources of retirement income – the answer often becomes more complicated.

Consider this example:

Mr. and Mrs. Smith, both aged 62, are recent retirees. Their combined income after deductions is $55,000, putting them squarely in the 15% tax bracket. They can live off this income, despite it being substantially lower than their working years, by tapping into their savings of $200k when needed. They are each eligible for social security income of $2,500 a month at full retirement age, and have managed to save $1.25M in their IRAs. Mrs. Smith will also begin receiving a private pension of $15,000 annually beginning at age 65.

In the case of Mr. and Mrs. Smith, continuing the tax deferral of their tax-advantaged accounts is likely not the best solution, and the couple should take advantage of their tax situation in their early 60’s. To do this without withdrawing the tax-advantaged funds, they can utilize a Partial Roth Conversion. In doing so, Mr. and Mrs. Smith can “fill up” the lower tax brackets by paying taxes on the IRA funds they convert to a Roth IRA. Mr. and Mrs. Smith will have access to tax free withdrawals in their later years, and will reduce their RMDs in the process.

Source: IRS.GOV

*If your nest egg is primarily tax-deferred investments, do your best to “fill up” the tax brackets in green in your early years of retirement

Reducing their RMDs, as well as having access to a stream of tax free funds in their later years, will be vital when their other sources of income kick in. Given that Mrs. Smith’s pension and 85% of the couple’s social security will be subject to tax, the Smith’s marginal tax rate will very easily jump to the higher, undesirable tax brackets. This will be doubly worse if the Smiths are forced to take RMDs that they don’t necessarily need to support their yearly expenses.

This example is a very common situation for recent retirees today, given that the primary source of retirement savings is through tax-deferred, employee sponsored 401k plans. Sometimes it’s important to challenge conventional wisdom when planning for retirement, and to recognize that seemingly crazy ideas, like paying tax now instead of later, may be something you should consider.


*This information is not intended as authoritative guidance or tax advice. You should consult with your tax advisor for guidance on your specific situation.