Long-Term Trends

January 7th, 2018

by Steve Stofka

This week I’ll look at a few long-term trends in the marketplace for goods and labor.  Millennials born between approximately 1982 – 2002 are now the largest generation alive. Their tastes will dominate the marketplace for the next twenty years at least.  In the first eighteen years of the new century, change has been a dominant theme.

Some businesses drowned in the rush of change. A former member of the Dow Jones Industrial Average, the film giant Eastman Kodak is a shadow of its former self after it emerged from bankruptcy in 2013.

Some in the music business complain that the younger generations don’t want to pay for music. Much of YouTube music is pirated material and yes, Google, the site’s owner, does remove content in response to complaints. There’s just so much of it. Album sales revenue in the U.S., both digital and physical, fell 40% in the five years from 2011 to 2016. Globally, the entire music business has lost 40% in revenues since the millennium and is just now starting to grow again (More).

Some in the porn industry make the same complaint as those in the music business. As online demand for porn grew, the industry helped pioneer digital payment security. Now there is too much free porn on the internet. Producers and distributors pirate each other’s content. Who wants to invest in good production values only to see their work ripped off? (Atlantic article/interview on the porn industry) Will the lack of quality reduce demand? ROFL!

An ever-diminishing number of city newspapers struggle to survive. Some complain that people don’t want to pay for local news. Local reporters have long been the bloodhounds who sniff out the corruption in city halls and state capitols around the country. There are fewer of them now.  Think that corruption has been reduced?  ROFL!

Surviving bookstores glance over their shoulders at Amazon’s growing physical presence in the marketplace. This year Amazon became the 4th largest chain of physical bookstores. The large book publishing houses try to preserve their hegemony as readers turn to a greater variety of alternatively published books.

As online sales grow, brick and mortar stores struggle to produce enough revenue growth to sustain the costs of a physical store.  During the past three years, an ETF basket of retail sector stocks (XRT) is down almost 10%.

Hip-hop music was a fad of the ‘80s and ’90 until It wasn’t. Rock ‘n Roll was a fad that has lasted sixty years. In the early 60s, the Beatles were told to make it rich while they could, and they worked hard to capitalize on their success before it fizzled. Never happened.

How are we going to predict the future if it is so unpredictable? Some standards fade while some fads become standards. We face the past, not the future, as the future sneaks up on us from behind.



A few notes on what was the weakest employment report of the past year. Job gains were only 150K as reported to government surveyors but the percentage of businesses responding to the survey was particularly low. Expect the BLS to revise those job gains higher next month when more of the survey forms come in. I have long used an average of the BLS numbers and ADP’s estimate of private job gains. That average was 200K – a healthy number indicative of a growing economy.

The long-term trend remains positive. The annual growth of total employment should be at 1.5% or above. We are currently holding that threshold despite the loss of jobs to automation and the growing number of Boomers retiring.  Growth in construction jobs  remains at or above the growth in total employment – another healthy sign.


The employment market faces a long-term challenge as the largest generation of workers in history is retiring. In January 2000, 69 million adults were out of the labor force. That figure now stands at 95 million. As a ratio, there were 53 adults not in the labor force for every 100 adults with a job. Now there are 65 adults for each 100 workers.


Although growth in hourly wages is at 2.5%, weekly paychecks have grown 3% as part-time workers get more hours or find full-time jobs. Look for inflation to approach that growth in paychecks.


When inflation rises above paycheck growth, workers struggle more than usual to balance their income with spending.  I’ll use that same chart to highlight some stress points during the past decade.


As the economy continues to improve, the Fed is expected to continue increasing interest rates either two or three times in the coming year.  After a decade of zero interest rates (ZIRP), those with savings accounts may have noticed that their bank is paying 1% or more in interest.  It is still a far cry from the 4% to 5% rates paid on CDs in the ’90s and 2000s.  This past decade has been particularly worrisome for older folks trying to live off their savings.

Years Past

December 31, 2017

by Steve Stofka

This past week, I found a July 2008 Wall St. Journal used as shelf liner. On the eve of 2018, a look back has some useful reminders for a casual investor.


Most of us remember the financial crisis that erupted in September 2008. What we may not remember is that the first half of that year was very volatile. In reporting about the first half, there were “warnings of the collapse of the global financial system.”

In the first six months of 2008, 703,000 jobs had been lost. The job losses continued until March of 2010 and totaled a staggering 8 million. In early July 2008, the stock market had lost 16% from its high mark in October 2007 but a balanced portfolio of 60% stocks and 40% bonds had lost only 8%. To prepare for a difficult second half of 2008, investors were cautioned to:
1) Balance
2) Diversity
3) Spend less and invest more
4) Don’t pay high investment fees
5) Don’t get greedy and chase get rich investments

The advice is timeless.


Tax Reform

In a holiday week, thousands of residents in coastal states lined up at their local tax assessor in order to pre-pay 2018 property taxes in 2017.  Most of these residents have annual property taxes that exceed the $10,000 cap on all state and local taxes that can be deducted on 2018 Federal taxes.

The IRS said that they would not allow deductions for prepaid taxes unless the local district had assessed the tax by December 31, 2017.  We may see lawsuits over the definition of the word “assess.” When is a homeowner assessed a property tax?  When they receive a bill?  When the district announces the rate for the following year?

In their battle against the IRS, Republicans have cut the agency’s funding so much that the IRS does not have the resources to perform audits on several hundred thousand to determine the status of assessment.  The courts will likely weigh in on the question.  Come next November, voters will register their opinions.

The New York Times featured a several question calculator  to estimate the effect of the tax bill on your 2018 taxes.



Economists have noted the decades long decline in inflation-adjusted wages.  Since 1973, the share of national income going to wages and salaries has declined by 14%.


Employee benefits as a percent of gross domestic income have grown by a third since the 1970s. Of course, a person cannot spend benefits.


Even after the increase in benefits, total income is down. In 1973, 50% of Gross Domestic Income (GDI) went to wages and salaries + 7.5% to benefits for a total of 57.5%. In 2016, 42% went to wages + 10% to benefits = 52%.  Total compensation is down 10%.

As the wealth of the affluent continues to grow, the ratio of net wealth to disposable income has reached an all-time high.

It is inevitable that extreme imbalances must revert to mean.  The last two peaks preceded severe asset repricings.

Taxes, Bitcoin, and Housing

December 24, 2017

by Steve Stofka

Merry Christmas! Because of the holidays, I’ll keep it short. A few notes on the tax bill passed this week and some odds and ends I’ve collected.

In the final version of the tax bill, the state and local tax (SALT) deduction was limited to $10,000.  This limitation will hurt those in the coastal “blue” states.  As a group, these states already pay more in Federal taxes than they receive in various Federal programs.  The limit on the SALT deduction will take even more money from blue states and give it to red states. There is a second transfer taking place intra-state.

There are several components to SALT: income, sales and property taxes. According to the Census Bureau’s American Community Survey, almost 50 million households own a home with a mortgage.  Under current tax law, they get to deduct whatever mortgage interest they pay. Rich homeowners take the bulk of the mortgage interest deduction on their million-dollar homes.  50 million households rent. They get to deduct zilch.

For decades, homeowners have been in a protected class and able to deduct their property taxes. Renters have enjoyed no such deduction.  The owner of the building gets the deduction.  Think the owner is sharing that tax largesse by lowering rents?  No. For years, renters have effectively subsidized the tax deduction for their homeowning neighbors. The new tax bill transfers some of that tax burden from renters back to homeowners, putting both types of households on a more even level.

The density of coastal populations requires more infrastructure supplied by states, cities and towns.  Unless there is a natural resource like oil that can be taxed, local jurisdictions need higher taxes to pay for the added infrastructure. Secondly, the population density leads to more competition for land and housing, which causes higher property prices.  Even if New Jersey and Colorado charged the same property tax rate, the higher home prices in New Jersey would result in higher taxes.  But the two states don’t charge the same rate.  New Jersey averages almost twice the property tax rate charged by counties and towns in Colorado.

If you would like to compare property taxes in your state, county, or zip code with others, you can click here (https://smartasset.com/taxes/new-jersey-property-tax-calculator)

Democrats have long championed a graduated income tax, and the more graduated the better. The limit on the SALT deduction effectively levies more tax on those with higher incomes. That is the core principle of a graduated tax. Isn’t that what Democrats want?


Bitcoin Bumps

After surging more than 2000% this year, bitcoin has fallen 40% this week, but is still up more than 1400% for the year. 80% of the trading volume this year has come from Asia. Japanese men have turned from leveraged forex trading to bitcoin and other digital currencies. (WSJ article)

As an exchange of value, currencies should be stable. When they are not, they have failed, and it is invariably due to a failure of government policy. Venezuela is a current example. From 2007-2009 Zimbabwe’s currency failed, and even today, they use the U.S. dollar. Germany in the 1920s is probably the most egregious example of a failed currency.

Bitcoin is not a currency. Bitcoin is an asset but barely that. Buyers of bitcoin and other digital “currencies” are buying a share in the “greater fool” theory. Yes, the concept is brilliant. Ledger transaction chains solve many problems in international exchange. But digital transactions take too much energy to serve as a currency. In the time that it takes to validate the transfer of one bitcoin, hundreds of credit card transactions take place.

Bitcoin is not secure. A South Korean bitcoin exchange went bankrupt this month when it was hacked, and its reserves stolen. (CNN article) . Mt. Gox is the most well-known bitcoin hack victim, but there are others (Top 5 Bitcoin Hacks ).


Housing Prices to Income Ratio

New home sales in October were 10% above estimates. The average price of a new home hit an all-time high of $400K. The median price is $316K, more than five times the median household income. Here’s a graph of that housing price/income ratio for the past thirty years.


The ratio first broke above 4 in 1987 and steadied for the next 13 years. During the housing bubble in the 2000s, the ratio rose swiftly and crossed above 5. As the bubble popped in 2007 and millions of people defaulted on their loans, the ratio fell as fast as it rose. Since the Financial Crisis, low interest rates have helped fuel another bubble.

The recent Case-Shiller housing index was higher than expected. Home prices are going up 6% per year, twice the rate of increase in incomes.


I’ll have more next week on long-term trends in income and inflation. Have a merry and take care of year ending stuff this week! Those with high SALT deductions might consider paying 2018 property taxes in 2017 but there is some question whether the IRS will allow the deduction. See this L.A. Times article.

Tax Reform Is Calling

by Steve Stofka

December 17, 2016

On our journey on the sea of life, we sometimes hear the siren call of politicians who promise simple taxes. “File your taxes on a postcard” their voices echo across the waters as they invite us to their island. Our journey is long and treacherous, so we are drawn to the prospect of simple tax filing.

Some taxpayer boats weave through the sharp rocks that lay just off the sandy shores of the simple tax island. They are greeted by the politicians who give them postcards to celebrate their arrival. Many boats are caught in the turbulent waters and are swallowed up by the tax monsters lurking in the sea.  “Alas!” they wail as they curse themselves for their attraction to the politicians’ call.

So the story goes with the tax bill that Republicans hope to pass next week. I didn’t think that the bill would get this far.

Many paycheck employees will find the new tax rule simpler. Student loan interest will continue to be an “above the line” deduction from income. The child tax credit will be doubled to $2000. To satisfy Republican Sen. Marco Rubio’s demands, more of this credit will be refundable to those taxpayers who pay little or no income tax.

Those in high tax states will suffer under the new tax bill, which allows only $10,000 in combined deductions for state, local and property taxes (SALT). Deductible mortgage interest will be capped as well. Tax policy has long subsidized homeowners over renters and favored those in coastal states (NY Times article).

Many taxpayers will find it more advantageous to take the newly doubled standard deduction of $24,000.  Under the new law, 529-college funds can now be used for K-12 tuition and qualified expenses.

Caught in the rocks and turbulent waters are professionals and business owners, who have adopted “pass-through” ownership structures to legally minimize taxes under current law. This group accounts for 30% of all business income. As this Journal of Accountancy article notes, court rulings and IRS guidance can be complex and contradictory. The new tax bill only complicates the familiarity of the existing complexity.

These non-paycheck earners receive all or part of their business income through a Sub-S corporation, an LLC, or partnership. Unlike a conventional C-corporation, these businesses “pass through” their profits to the owner/partners who pay at a personal tax rate. Under the new tax bill, some of that income may be subject to a 20% exclusion from taxes.

Under the new tax bill, the tax rate for C-corps will be reduced to 21%. Depending on individual circumstances, some owner groups may find it advantageous to adopt a C-corp ownership structure.

25 million sole proprietors  account for 11% of non-farm business income. Many are low-profit or part-time businesses which will remain sole proprietors. Higher volume businesses may want to revisit their ownership strategies with their accountants.

Corporations will benefit from the reduced tax rate but the accountants for publicly held corporations are dreading the prospect that the new tax law will be signed before the new year. Under GAAP accounting rules, those corporations must estimate the effect of the tax changes and present those estimates at the next earnings announcement which are scheduled for late January or February. Number crunchers can cancel that Cabo vacation during Christmas week.

The rich benefit because they pay an outsize portion of income taxes. According to the IRS (2016 tax stats on this page) , taxpayers with adjusted gross incomes (AGI) above $500K were only .8% of the 150 million individual returns. Their AGI was 19.4% of the $10 trillion in income reported, but they paid 36.5% of the $1.4 trillion in Federal income taxes.


These high incomes will get a reduction in taxes from 39.6% to 37%. The very rich – those with an AGI above $10 million – get half of their income from capital gains, which are not affected by the new tax law. Despite promising to do so, lawmakers did not reduce or repeal the 3.8% Obamacare tax on investment income for high income taxpayers. Based on 2016 tax data, they probably could not forgo the tax revenue and keep the ten-year cost of the bill under $1.5 trillion.

In short, the new bill will create two classes of taxpayers – the postcard and non-postcard payers. Some tax preparers and accountants may worry that the new law will reduce their business. Rest assured – Congress does not know how to write tax laws that are not complex. Thank God for politics!

Trump To The Rescue

by Steve Stofka

December 10, 2017

This blog post goes to what may be a dark place for some readers. The election of Donald J. Trump may have stopped a year-long slide into recession. I didn’t start out with that conclusion. I meant to point out some interesting correlations in the velocity of money. Yeh, yawn. By the time I was done, not yawn.

If I mention the change in the velocity of money, do you groan at the prospect of a wonky economics topic? Take heart. Anyone who has slowed down from 65 MPH on a highway to 15 MPH in rush hour traffic is familiar with a change in velocity.

The velocity of money measures the amount of time that money stays in our pockets. It signals the willingness of buyers and sellers to make transactions. When buyers and sellers can’t agree on price, transactions fall and the change in velocity goes negative. In the chart below, the change in the velocity of money (blue line) often has a similar pattern to the change in real GDP (red line).


Both recent recessions were preceded by declines in GDP growth and the speed of money. Following the financial crisis, the Fed began to inflate the money supply in a series of policies dubbed “QE,” or Quantitative Easing. In 2011, after two rounds of QE, the Fed worried that the recovery might stall out.

Let’s turn to the green square in the chart labelled Operation Twist. Obama and a do-nothing Republican Congress were at odds so there was little chance of Congress enacting any fiscal policy to come to the economic rescue. That task was left – once again – to the Federal Reserve to use its monetary tools.

In Congressional hearings, then Fed Chairman Ben Bernanke advised the Senate Finance Committee that the short term interest rate was already zero and the Fed was out of monetary tools. The Congress should step in with a stimulative fiscal policy. The Committee members somberly hung their heads. We are incompetent, they said, so the Federal Reserve will have to rescue the country.

If it expanded the money supply further, the Fed was concerned that they would spark inflation. In hindsight, that fear was unfounded, but none of us has the luxury of making decisions while looking in the rearview mirror. Economic identities like M*V = P*Q (notes at end) are just that – looking in the rearview mirror.

The Fed resurrected a monetary tool from the 1960s dubbed Operation Twist, after the dance craze the Twist (Fed paper).  Early Boomers will remember Chubby Checker. The Fed began selling the short-term Treasuries they owned and buying long term Treasuries. By increasing the demand for long term Treasuries, the Fed drove down long-term interest rates as an inducement for businesses and consumers to borrow. Despite the low rates, consumers continued to shed debt for another year. How effective was Operation Twist – maybe a little bit (Survey).

As the price of oil declined in late 2014 and the Fed ended yet another round of QE (QE3), there was a real danger of moving into a recession. Notice the decline in GDP growth (red) and money velocity (blue).

The downward trend barely reversed itself in the 3rd quarter of 2016, just before the election, but not by much.


The election of Donald J. Trump and a single party controlling both houses of Congress kindled hope of a looser regulatory environment and tax reform. Only then did the speed of money turn consistently upward. But we are not out of the woods yet. A year later, in late 2017, money velocity is still negative. As I said earlier, buyers and sellers still cannot agree on price. There is a mismatch in confidence and expectations. Until that blue line turns positive, GDP growth will remain tepid or turn negative.


M*V = P*Q is an identity that equates money supply (M) and demand (V) to inflation (P) and output (Q).




by Steve Stofka

December 3, 2017

What can I expect from my portfolio mix? Portfolio Visualizer has a free tool  to analyze an asset mix. We can also get a quick approximation by looking at a fund with that mix.
An investor with a 40/60 stock/bond mix might go to the performance page of Vanguard’s Wellesley Income fund VWINX. It’s 50-year return is close to 10% but that includes the heady days of the 1970s and early 1980s when both interest rates and inflation were high. The ten-year performance of this fund includes the financial crisis and is close to 7%.

An investor with a slightly aggressive 65/35 stock bond mix could look to Vanguard’s Wellington Fund VWELX, which has a similar weighting. It’s 90-year return is 8.3% but that includes the Great Depression and WW2. It’s 10-year return is – wait for it – close to 7%.

Two funds – a conservative 40/60 and a slightly aggressive 65/35 – both had the same ten-year returns. All it took was one bad year in the stock market – 2008 – to even up the returns between these two very different allocations. On a year-by-year comparison of the two funds we see a trend. During the two negative years of this fifteen period, I charted the absolute value to better show that trend. Also, compare the absolute values of the returns in 2008 and 2009. The collapse and bounce back was about the same level.


During this fifteen year period, the cautious mix earned 88 cents to the $1 earned by the slightly aggressive mix. Looking back thirty years, cautious made only 75 cents. In the past fifteen years, the difference between positive and negative years was important. In good years, cautious earned 20 cents less. But in negative years, like 2002 and 2008, cautious made 73 cents more by losing that much less.


Personal Saving Rate

The savings rate is near all-time lows. We’ve seen a similar lack of caution in 2000 and 2006. As housing and equities rise, families may count those gains in their mental piggy bank. Asset gains are not savings. Asset prices, particularly equities, will decline during a recession. Jobs are lost. Without an adequate financial cushion, families struggle to weather the downturn. The rise in bankruptcies and foreclosures further exacerbates the downturn.



A good explanation of the various types of annuities.  The graphics that the author presents might help some readers understand the role of annuities, and the advantages of deferred vs. immediate annuitues.  I have also posted this on the Tools page for future reference.


The Bubble of Average

November 26, 2017

by Steve Stofka

December is the 10-year anniversary of the start of the recession that culminated in the Financial Crisis of 2008. Four years later, an investor finally broke even.

Since that breakeven point in early 2012, the total return of the SP500 has more than doubled.  The rising market and historically low volatility sparks predictions of a bubble and a crash. The Shiller CAPE ratio, an inflation adjusted measure of price-earnings, is not as high as the ratio of the dot-com boom but it is very high.  Stocks are expensive.

Let’s turn to some long-term returns for a different perspective. The 10-year annual return is only 8.13%, almost 2% less than the average for the past 90 years. The 20-year return is even worse – just 7%.

From July 2000 to August 2006 an investor made nothing. As a rule of thumb, savings needed in the next five years should not be invested in the stock market. Both downturns are good examples. The 2000-2006 downturn lasted six years. The 2007-2012 lasted more than four years.

Let’s turn to a 30-year period, 1988 to 2017. The period begins just after the October 1987 meltdown. All the froth has been taken out of the market. The 1990s included the historic run up of the dot-com boom. The 30-year return is above average but not by much – .6%.

The most disturbing truth about these averages is the average or below average returns of these periods.  Investor surveys regularly show that people disregard averages and overestimate future returns.  That fantasy is the true bubble.


Corporate Taxes

Next week the Senate will attempt to pass a tax cut bill. As I noted last week, both the Senate and House bills cut the corporate income tax to 20%. The administration and Republican lawmakers state that this tax cut will help working families the most. They must be too busy to read the analysis of their own Treasury department.

The Department periodically analyzes the distribution of the tax burden on various types of taxpayers. In their latest analysis, they estimate that labor income bears only 19% of the costs of corporate income taxes. Steve Mnuchin, the head of the department, claims that workers bear 2/3rds of the cost of the corporate tax. He uses this fantasy number to support a corporate tax cut.

Who will benefit most from a cut in the corporate income tax? The report states “the top 10 percent of families bears 72.5 percent of the burden” and will be the winners.

Over the decades, through Republican and Democratic administrations, the cost burden of labor has changed only slightly. Economists might argue the finer points, but the distribution is well understood. Mnuchin’s job is to sell the boss’s tax cuts. Facts be damned and full steam ahead.

Rocky Tax Road

November 19, 2017

The House passed a tax cut bill this week as the Senate Finance Committee passed a separate version that must still go to the full Senate for a vote. There’s a hard road ahead for this bill to reach the President’s desk.

The Process…

The full Senate will take up the bill after Thanksgiving. If the Senate passes the bill, there are still more steps. Bills submitted by Congress must have identical language from both the House and Senate.

The House passed its tax bill first, so the Senate could adopt the House version and approve it. Highly unlikely. If the Senate passes a bill, both bills will likely go to a House-Senate conference committee to resolve differences in the two bills and produce a unified bill. The Republicans will hold a majority on that committee and do not need Democratic votes.

If the committee can produce a unified bill, it will be sent to the House and Senate for a vote. If either body rejects the bill, it can be sent back to the joint committee, but that rarely happens. The bill would be effectively dead.

Republican leaders regard passage of the bill as critical to the 2018 Senate races. After the Republican majority failed to pass a health care bill earlier this year, big dollar donors have advised party leaders that they are closing their wallets if the party cannot pass a tax bill. Fundraising for the 2018 campaigns kicks off in a month.

The Provisions…for business

Both bills cut the corporate income tax to 20%. Both bills will tax pass-through and passive income at 25% or 32%.

Pass-through income consists of profits earned by businesses that flow to the business owner as personal income. Half of all pass-through income goes to the top 1% of incomes.

Passive income can be the profits from rental property, or dividends paid by an REIT (Real Estate Investment Trust). Under current law, such income is taxed at personal rates as high as 40%.

Republican Senator Ron Johnson opposes the bill as it came out of the Finance Committee. The bill gives an estimated $1.3 trillion in tax cuts to corporations, more than three times the $362 billion in tax cuts to taxpayers with pass-through income. Each sector currently pays half of the taxes on business profits. Small businesses and farmers get 25 cents of the tax cut dollar, while big corporations get 75 cents.

With only a two-person majority, Senate Republicans cannot afford to lose more than two votes and pass this bill. Susan Collins from Maine, a state dominated by small businesses, has echoed Johnson’s objections. Rand Paul from Kentucky says he will not vote for a bill that increases the deficit, which this bill does. Unless there are some key changes made to the Senate bill during the Thanksgiving break, the bill is unlikely to pass.

Both bills keep the 1031 exchange clause which allows real estate owners to avoid capital gains taxes on the sale of a property when they reinvest the gains in a similar class property. Owners of equities do not enjoy this tax subsidy. An investor who sells a stock, mutual fund, or ETF must pay any capital gains even if the investor buys another equity with the gains.

The Provision…for individuals

The House bill promises to save a median income family $1182 in taxes. Not about $1200. $1182. The precision of that number indicates that it is more a selling tool than a reality. The Senate version will likely tout something similar.

Half of taxpayers will notice little change in either bill because they pay almost no income taxes. Both bills retain the Earned Income Tax Credit (EITC). Lower income taxpayers will see no relief from the bite of FICA taxes.

The standard deduction is doubled but personal exemptions are eliminated and the child tax credit is increased by $600 per child but only for five years. Have you got that? Paul Ryan, the House Majority Leader, assured us that the tax bill would be simpler. Sound simple to you?

The Senate bill includes a repeal of Obamacare penalties for not having health insurance. Oddly enough, this saves the government $332 billion over ten years. Wait, how does that happen? The Congressional Budget Office (CBO) estimates that many younger people who would be eligible for subsidies under Obamacare will simply forgo insurance if the penalty is eliminated. Republican leaders get two birds with one tax stone. Senators can register their disapproval of the most hated part of Obamacare and the savings enable the Senate bill to meet the deficit requirements under reconciliation rules.  These rules allow the Senate to pass legislation with a simple majority.

As I noted two weeks ago, both bills eliminate or reduce the current deduction for state and local taxes (SALT). High tax states like California, New York, New Jersey, Connecticut and Massachusetts have no Republican Senators. If Republican leaders lose the votes of Johnson, Collins and Paul, they would have to reinstate a full SALT deduction to have any hope of gaining one or two Democratic votes.

The Senate eliminates the SALT deduction entirely and uses the tax money to continue the deductions for medical expenses, student loans, mortgage interest and charitable donations. The House bill eliminated these deductions but allowed some SALT deduction in order to appease Republican House members from high tax states.

The House bill simplifies the tax brackets from the current seven to four. The Senate version has seven brackets.

The Conclusion…

Imagine a rough dirt road after a lot of rain. The tax bill has just turned off the paved highway and onto the dirt road. Expect a lot of muttered cursing, pushing and digging to move a tax bill to its final destination, the desk of President Trump.


Phillips Curve

November 12, 2017

For the past 16 decades, there has been a least one recession per decade. Given that this bull market is eight years old without a recession, some investors may be concerned that their portfolio mix is a bit on the risky side. Here’s something that can help investors map the road ahead.

For several decades, the Federal Reserve has used the Phillips Curve to help guide monetary policy. The curve is an inverse relationship between inflation and unemployment. Picture a see saw. When unemployment is low, demand for labor and inflation are high. When unemployment is high, demand for labor and inflation are low (See wonky notes at end).

The monetary economist Milton Friedman said the relationship of the Phillips curve was weak, and economists continue to debate the validity of the curve. As we’ll see, the curve is valid until it’s not. The breakdown of the relationship between employment and inflation signals the onset of a recession.

Let’s compare the annual change in employment, the inverse of unemployment, and inflation. We should see these two series move in lockstep. As these series diverge, the onset of a recession draws near.

In a divergence, one series goes up while one series goes down.  The difference, or spread, between the two grows larger. Spread is a term usually associated with interest rates, so I’ll call this difference the GAP.

In the chart below, I have marked fully developed divergences with an arrow marked “PC”. Each is a recession. I’ll show both series first, so you can see the divergences develop. I’ll show a graph of the GAP at the end.


As you can see to the right of the graph, no divergences have formed since the financial crisis.

Shown in the chart below are the beginnings of divergences, marked with an orange square. I’ve also included a few convergences, when the series move toward each other. These usually precede a drop in the stock market but no recession.


Here’s a graph of the difference, or GAP, between the two series in the last 11 years.


Fundamental economic indicators like this one can help an investor avoid longer term meltdowns. Can investors avoid all the bear markets? No. Financial, not economic, causes lay behind the sharp downturns of the 1987 October meltdown and 1998 Asian financial crisis.

What about the 2008 financial crisis? A year earlier, in October 2007, this indicator had already signaled trouble ahead based on the high and steadily growing GAP.

What about the dot com crash? In February 2001, several months after the market’s height, the growing GAP warned of a rocky road ahead. A recession began a month later. The downturn in the market would last another two years.

Readers who want to check on this indicator themselves can follow this link.


Wonky Stuff

In Econ101, students become familiar with a graph of this curve. Readers who want to dive deeper can see this article from Dr. Econ at the Federal Reserve. There is also a Khan Academy video .

Numbers and Feelings

November 5, 2017

How do numbers feel to us? Numbers are hard like rocks. Feelings are squishy. Numbers are left-brained. Feelings are right-brained. Deep in the vaults of our brains, tiny elves translate one into another. Here’s an example.

This past week, House Republicans released an initial proposal of tax reform. A feature of the plan is the limitation of state and local tax deductions (SALT) to $10,000. Under current tax law, taxpayers have been able to deduct state and local taxes without limit.

This will hurt taxpayers in high-tax blue states which are overwhelmingly Democratic. Wisconsin, a purple state, is the lone exception among the top ten states (Forbes ranking of state tax burden).

Expecting no votes from Democrats in passing a tax reform/cut bill, Republicans included few provisions in the bill that would pacify voters in Blue Democratic states. Republican congresspersons in those states are faced with a dilemma. One Republican congressperson in New Jersey, one of the top high tax states, claimed that the average SALT deduction in his district was $21,000, more than double the allowance in the tax reform proposal.

Knowing that the SALT limitation will hurt their constituents, do Republican House members vote with their party or in the interests of their constituents? Numbers can make politicians anxious.

For some taxpayers in those states, the feeling is anger. “I don’t want to pay taxes on my taxes,” one New Jersey resident growled.

That same N.J. congressperson claimed that incomes less than $200,000 were middle-class. According to this calculator based on the Census Bureau’s Current Population Survey, an income of $200K is in the 97th percentile of all incomes. Less than 3% of households have incomes greater than $200K. Hardly middle-class.

What is middle class? Some studies use the 25th – 75th percentile. Some use the 30th – 80th percentile. Using the latter definition, 2016 incomes from $24,000 to $75,000 were considered middle-class. These classifications use national data. Many coastal states have far higher incomes and living costs.

People living in some east and west coastal states feel middle class even though the income numbers do not classify them as such. Take for example, a household in Silicon Valley, where the median household income is almost $100K,  $40K more than the national median. They are rich, right?

Not so fast. The median price of a home in Santa Clara County (San Jose) is almost $1.2 million (See here ). Spending $40,000 annually for housing on an income of $95,000 feels middle class. The percentage of housing cost to income, 42%, is far higher than the 30% HUD guideline, and is more typical of poor working-class families.

Californians have counties with the highest incomes in the U.S. – and some of the poorest. The state has a median household income that is 12% higher than the national average.


But that’s not how it feels. That extra income is eaten up by higher housing costs, high car insurance premiums, and higher taxes at all levels. California sends about 12% more taxes to Washington than it gets back in various national programs. The additional federal taxes paid by higher income coastal states helps pay for benefits to those in lower income states, particularly those in southern states. Blue states subsidize Red states.

The Red states control the national agenda in Washington. The Republican tax proposal in its current form takes tax pebbles from the Red scale and puts them on the Blue scale. That feels spiteful.  Voters in those Blue states feel angry.

Interest groups around the country feel angry. The National Association of Home Builders claims that the SALT limit will lower home valuations, particularly in coastal states. They have promised a considerable effort and expense to defeat this version of the tax proposal.

When I recalculated my family’s 2016 taxes using the new proposal, we saved $752, a bit less than the $1200 average savings for a family of four. The monthly tax savings – the numbers – are relatively small. I feel neither angry or joyful. Those of us who are little affected by the proposal are unlikely to raise our voices in protest or support.

Angry people act. They call, they shout, they organize.

Joyful people – the CEOs of large corporations who will benefit greatly from this proposal – are not shouting. They calmly make claims that lower taxes will create more jobs, although the evidence is rather weak. They are organizing. They are calling talk shows. But most of all they are donating.

Political donations can speak more loudly than the shouts of angry people. In the political game of Rock, Scissors, Paper, cash covers a rock thrown in anger. Angry people must take up the more precise and patient tool of the scissors if they hope to best cash in a contest.

Lastly, this tax proposal further divides earners into groups. Income earners above the median will learn that this $1 is not the same as that $1 to the taxman.  According to an analysis done for the Wall St. Journal,
The $1 earned in wages and salary will be taxed more than
The $1 earned by the small manufacturer, which will be taxed more than
The $1 earned by the real estate investor, which will be taxed more than
The $1 earned by a stock or bond investor, which will be taxed more than
The $1 paid to an inheritor, who will pay $0.

Republicans criticize the identity politics practiced by Democrats. With this tax proposal, Republicans have stamped identities on the very $$$$ we earn. Those numbers don’t feel good.