Uncertainty All Around

Here at First State Trust Company, we utilize a variety of market commentary from our partners to keep our investment committee up to date on market trends and overall investor sentiment. Over the recent quarter, I have noticed an overwhelming lack of consensus of where the markets might be headed and what the optimal portfolio allocation should be based on the same information. Two partner commentaries I rely on most, Northern Trust & Morgan Stanley, will highlight this conundrum.

Both partners predict multiple interest rate cuts by the Federal Reserve over the next year yet differ on the how it will impact the markets and how to weight portfolios accordingly. Northern Trust believes a further reduction in rates will continue to drive investors towards the higher dividend yields offered by equities. A corresponding overweighting to equities with a US tilt is Northern’s recommendation. Morgan Stanley states the rate cuts at this juncture in the market is “policy capitulation” and continues to prop up US equity markets. They refer to US equities as the “least dirty shirt in the laundry” and believe the odds of an economic recession are accelerating. Their relative weighting is contrarian with underweighting of US equities to International and Emerging Markets.

The differing opinions continue in the fixed income space. Northern takes a long duration stance due to foreign investors valuing the US market due to lower rates overseas and negative yielding bonds representing almost 30% of the of total debt issuance. Morgan favors shorter duration and inflation-protected securities due to concerns about pricing of credit spreads and the significant amount of leverage on corporate balance sheets.

Two areas of agreement are real assets and executive actions by the President. Northern and Morgan agree dividend hungry investors will continue to flock to MLP’s and real estate due to higher yields and inflation protection provided. Both question whether continued dividend growth in these spaces are sustainable in the long term. Executive actions (Executive Power Play & Trump Put at Northern & Morgan, respectively) remain at the forefront of uncertainty for both partners. Both believe President Trump will leverage financial markets as an indicator of economic strength heading into the 2020 election. They believe this will limit the effects of a continued trade dispute with China in the coming year. Although, they disagree on the relative sturdiness of US economy if a trade dispute continues with China. Northern argues the US can continue to withstand trade conflict assuming it doesn’t spread to countries outside of China. Morgan states the trade disputes have meaningfully contributed to the accelerating recessionary indicators and one is most likely on the horizon.

Even though Northern Trust and Morgan Stanley are offering different outlooks on the same macro data, both have been offering the same solution: stay patient and watch the data moving forward. It speaks to the uncertainty within the broader market and the unpredictability of the next twelve months. I agree, uncertainty abounds.

Les Eisel, MBA, Assistant Vice President & Investment Officer

The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only.

Delaware Trust Act 2019

Changes to Delaware trust laws were passed by both houses and approved by Governor Carney on June 19, 2019.  The amendments concern (1) a fiduciaries ability to appoint agents and assign fiduciary duties to such agents, (2) the power to appoint successor trustees and additional trustees, and (3) the power of trustees to reimburse trustors for income tax liability that is attributable to the trust’s income.

  • Section 3322 allows a trustee to appoint an agent similarly to the way a trustee appoints a power of attorney.  The trustee has the same standard of care for liability, hiring and firing of agents as normal.
  • Section 3325 which gives a trustee a reason to divide a trust along family lines.
  • Section 3342 allows trustees to appoint multiple successor trustees, additional trustees and allocate trustee powers.  If a trustee is excluded from a power then it has no liability concerning that power.
  • Section 3344 clarifies that a trust can reimburse grantors for income tax consequences on a grantor trust.
  • Section 3528 clarifies that decanting powers exist if the first trust gives authority to invade principal to make distributions.
  • Section 3544 clarifies that a successor trustee has no obligation to confirm validity of modifications or alterations made by former trustee.

The specific updates listed above are the items that as a Trust Officer are interesting and helpful regarding performing the roles and responsibilities of my job.  These are welcoming changes, and all add clarity to each section of the act.  This is helpful when we encounter complex situations that require creative solutions for our clients.  The updates further strengthen consideration to utilizing Delaware law and or making a change and potentially moving their trust to Delaware.

Christopher Carr, Vice President and Trust Officer

ccarr@fs-trust.com

The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only.

August 6, 2019

After experiencing the worst quarterly performance since the financial crisis to end 2018, the S&P 500 has rebounded sharply posting positive returns in 5 of the first 6 months of the year and returning over 20% through the end of July.  Returns were bolstered by better than expected earnings and GDP growth in Q1, and also by the Federal Reserve’s pivot to end their rate hiking cycle in December and just recently opting to cut rates by 0.25%.

The Fed’s quick change in stance came as a surprise to economists, many of whom were projecting 2-3 additional rate hikes in 2019.  Their decision is definitely curious when you look at the data around two of the Fed’s primary mandates: controlling inflation and promoting maximum employment. Inflation has been at or below the Fed’s stated target of 2%, and unemployment has dropped to a 50-year low of 3.7%.  Additionally, there have been other positive signs in the economy including strong corporate earnings (77% of S&P 500 companies that have reported Q2 earnings through the end of July had a positive EPS surprise according to Factset) and consumer spending rose at an annual rate of 4.3% in the 2nd quarter, or the highest since 2017. 

So why did the Fed decide to cut rates despite all this positive economic data?  One rationale is that it was a proactive measure to lessen the risk of a recession in the US given the economic slowdown that has affected other developed nations around world.  While market performance and current economic data has been positive, the Fed’s actions are based on their forecasts and future projections on the direction of the economy.  Based on their comments those forecasts have been showing some potential headwinds for the US economy including the slowing growth abroad in areas like China and Europe.  Another reason for the rate cut is that many Fed members place particular importance on the term structure of the treasury yield curve, and believe that maintaining an upward sloping curve is critical for ensuring economic stability.  As you can see in the chart below, the 3-, 5-, and 7-year treasury yields were below both the 3-month and 1-year yields as of June 30, 2019.

 

Chart 1

 

While portions of the yield curve have inverted, the measure that many economists watch closest and tout as a recession indicator, the spread between the 10- & 2-year treasury yields, has yet to invert.  It’s a focus because that particular spread has inverted prior to the last four economic recessions.  If you’re a believer in that measure as a leading indicator for recessions, then there is good reason to believe there is a low risk of a recession in the US over the next 12 months.  The chart below demonstrates the timing from when those yields have inverted and the US enters a recession, which on average has been 14 months.  As of writing this, that spread has narrowed to +0.11% and the 10-year treasury is at its lowest level since 2016, so it will be something to watch.

Chart 2

While there certainly are risks facing the global economy that could have a negative impact on US equities, there are also cases to be made for further upside.  It’s true that this has been one of the longest expansions in history, the S&P 500 has more than tripled since the financial crisis, and equity valuations are slightly higher than their historical averages (fwd PE was 16.74x at 6/30/2019 vs the 25-yr average of 16.19x).  But environments like the one we are in currently with low inflation, low interest rates, and low treasury yields support even higher valuations and make equities more attractive.  It’s important to remember that the overall economy and markets are linked, but it’s the market participants which drive asset prices.  For those investors charged with the decision on where to allocate capital for themselves and their clients, traditional alternatives to equities look much worse than they have in other periods.  For example, the 10-year treasury yield is now well below 2%, and prior to the financial crisis that yield was over 4%.  The same can be said for corporate bond yields as well with the BC Aggregate Bond index only yielding around 2.4%. 

It will be important to watch the various risks that are present: slowing GDP and earnings growth, continued trade tensions with China, political instability in the US and abroad, and a slowdown in aggregate demand globally.  Thus, amongst these risks and uncertainty, it’s more important than ever to remain diversified and be prepared for the range of possible scenarios that may play out in both markets and the global economy. 

 

Andrew Gibson, CFA

 


The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only.

 

ARP’s Get a Level Playing Field

PLANSPONSOR just reported on: The Department of Labor (DOL) has issued a final rule to help more employers offer retirement savings benefits through ‘Association Retirement Plans’ (ARPs).

The rule, which will go into effect on September 30, will permit employers to connect with associations of employers in a city, county, state, or a multi-state metropolitan area, or in a particular industry nationwide to provide retirement plans for their employees. The DOL says the rule will allow small and midsized plan sponsors to offer competitive benefits packages similar to those of larger organizations, a resource usually unattainable for smaller businesses due to high costs and overwhelming paperwork.

“Less than a year ago, President Donald J. Trump signed an Executive Order focused on expanding quality, affordable workplace retirement plan options for America’s small businesses and their employees,” said Acting Secretary of Labor Patrick Pizzella. “Many small businesses would like to offer retirement benefits to their employees but are discouraged by the cost and complexity of running their own plans. Association Retirement Plans offer valuable retirement security to small businesses’ employees through their retirement years.”

According to the DOL under the rule, retirement plans may also be sponsored through professional employer organizations (PEOs), third-party human resources providers offering services to small and midsized plan sponsors. The DOL adds that the rule creates a safe harbor for PEOs, which offers clarity in administering retirement plans and in their role as PEOs. This includes “recruiting, hiring and firing workers of its client-employers that adopt the MEP [multiple employer plan],” and assuming “responsibility for and has substantial control over the functions and activities of any employee benefits which the service contract may require the PEO to provide”.

With ARPs, businesses can join retirement plans without sorting through the filing and administration burdens, as the association handles this on behalf of small plans.

First State Trust Company is a directed trustee, custodian and paying agent for both traditional Defined Benefit Plans as well as Multiple Employer Plans. For more information, please feel free to contact us.

David Draper, Chief Operating Officer

The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only.

End of the IRA Trust?

Recently the SECURE Act (Setting Every Community Up for Retirement Act of 2019) passed the House but the Act is currently stalled in the Senate.  It is expected to pass once a few provisions are ironed out.  One of the provisions in the bill does away with the ability to stretch your IRA after death over the lifetime of a designated beneficiary.  The “stretch” IRA is eliminated and is replaced with a requirement to pay out the IRA over a 10 year period - with a few exceptions.  RMD also gets bumped from age 70.5 to 72.

This severely hampers the benefits of IRA Trusts. The conduit trust is effectively eliminated and the discretionary trust becomes much less efficient.

There are still some options to help clients especially if they have a Roth IRA (no RMD requirements) or can convert to a Roth, want to set up a charitable trust or can qualify for life insurance.

Likely, more to come on this topic, especially if the SECURE Act is passed.  Regardless, FSTC will be able to help navigate the options.

Please reach out to our Business Development Officers for details.

Jim Okamura, President FSTC

The posts expressed are views of FSTC and are not intended as advice or recommendations. For informational purposes only.