Sage Advisory, Author at Sage Advisory

Feeling Insecure about the SECURE Act?

Posted on August 1, 2019August 2, 2019 by Sage Advisory

by Andy Poreda, Research Analyst at Sage Advisory

After the SECURE Act passed quickly through the House of Representatives on May 23 with near-unanimous support, it has unfortunately stalled in the Senate. All signs point to Senator Ted Cruz (R-Texas) as the likely culprit. Cruz has voiced frustration over certain provisions that were removed, such as allowing individuals to use tax-advantaged savings in 529 college accounts to pay for home-schooling expenses, apprenticeships, and other educational programs. However, these provisions were stealthily removed at the last minute from the final bill, causing outrage among certain politicians, including Senator Cruz. Another group that has voiced disapproval, and in some cases – extreme frustration, has been the financial services community.

One area of contention is the safe harbor component of the SECURE Act, which was designed to increase the availability of annuities for retirees. Currently, when a retirement plan sponsor selects an insurer to offer annuities to its retirees, the plan sponsor is on the hook for any liabilities associated with an insurer’s inability to make guaranteed payments. Hence, many plan sponsors are reluctant to offer annuities at all, with only 12% providing annuities as a distribution option, according to a Callan 2019 Defined Contribution Trends Study. The SECURE Act’s safe harbor rule essentially frees plan sponsors of this liability if they select insurers that meet certain guidelines. Many critics have argued this rule essentially grants insurers a license to run away with people’s money. In their minds, annuity products are far too complex and costly, and therefore any benefit from the potential utility they could provide is completely eroded.

While we at Sage can understand this sentiment, we believe it’s important to provide retirees with annuity options, especially deferred fixed income products such as a Qualified Longevity Annuity Contract. A recent Transamerica survey discovered that the average 60-year-old has only $172,000 saved in various retirement accounts. In today’s low-interest-rate environment, $172,000 may not be enough to purchase an annuity that would provide a significant income stream, as $172,000 provides a 60-year-old female about $800 monthly in a single-life-only annuity policy. However, if that same woman withdrew the money from her 401(k) plan, she would likely run out of money sometime in her 80s, depending on the portfolio’s allocation and returns. The Society of Actuaries predicts that men have a 20% chance of reaching age 90, while women have a 32% chance. Therefore, we must enable individuals to pool life longevity risk, and as it stands now, annuities are the only viable option to hedge against a longer life. Limiting them would be a huge mistake.

The other big topic that has negatively swayed public opinion on the SECURE Act is the elimination of the “stretch IRA” provision. Current estate planning laws allow for individuals to pass down IRA accounts to their beneficiaries, who can then continue to accrue tax-deferred returns while being required to take out only minor distributions over their lifetime. The SECURE Act forces non-spouse beneficiaries to withdraw all funds within a 10-year period (though minor beneficiaries get 10 years after turning 18). The SECURE Act’s treatment of stretch IRAs would have resulted in a windfall of tax revenue that was intended to fund other SECURE Act measures; conversely, it would also adversely affect the wealthy – so it is no surprise that it is on the chopping block. President Obama unsuccessfully tried for years during his tenure to kill the policy, viewing it as a tax-break for the wealthy and their heirs. It’s likely that many individuals have factored in the provision when making their estate-planning decisions, and no one likes it when someone changes the rules midway through a game.

Aside from the fairness issue, the retirement situation in the United States is so disastrous for millions of people that we need to find ways to set up the average American for financial success in retirement. Since 73% of inheritance gifts total less than $50,000 (with only 2% being greater than $1 million, according to the Federal Reserve Board’s Survey of Consumer Finance), and because IRA accounts represent only a portion of inheritances, it is likely very few individuals will be severely impacted.

As might be expected, the bottom half of households ranked by wealth are only getting 3% of total inheritance transfers. These families represent those that are least set up for success financially in retirement, not the ones that are receiving large inheritances. Congress must attempt to be revenue-neutral on this bill and not add further to the national debt, so the IRA stretch provision ultimately seems like a reasonable casualty. Financial advisors will likely be able to help their clients adapt anyway, as there are other products readily available in estate planning. Life insurance products and charitable remainder trusts are also tax-deferred investments and may make more sense in the future depending on the situation. Changes in estate planning tactics will likely lead to Congress not fully realizing the anticipated $15.7 billion in tax revenue from elimination of the stretch IRA, but that will be an issue for them to figure out later when the dust settles.

According to the U.S. Government Accountability Office, 48% of Americans aged 55 and older have nothing saved for retirement. We are witnessing a crisis, and we need to act now. The SECURE Act may not be a panacea, but the myriad of benefits certainly outweighs the perceived negative effects. Hopefully the select few who still oppose the bill will try to instead focus on the positives, such as removing barriers for multi-employer 401(k) plans, implementing tax credits for small businesses to encourage 401(k) plan creation, and eliminating age limits on contributions to 401(k) accounts. The longer we wait, the more dire America’s retirement picture will become.

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

July Fixed Income Outlook in 5 Charts

Posted on July 16, 2019July 16, 2019 by Sage Advisory

1. Slowing U.S. data and risks abroad, particularly trade, give the Fed the green light to cut rates. The market has priced in this expectation, with 4 cuts expected in the next 12 months.

Source: Bloomberg

2. The demand for U.S. fixed income is supported by the lack of high-quality yield globally.

Source: Bloomberg

3. Central bank support and fixed income demand should result in stable credit spreads and positive yield carry. Given that spreads are at historic low levels and we’re in the late stage of the business cycle, our strategy is to earn yield carry rather than position for a major spread compression.

Source: Bloomberg

4. Both declining rates and tighter credit spreads have made yield more difficult to find. While the MBS sector has absorbed the brunt of the rally in rates, it still looks attractive from a carry perspective.

Source: Bloomberg

5. Within non-core fixed income, preferred stocks and high yield have the best yield-to-volatility ratio, or risk/reward profile, in our view.

Source: Bloomberg

For Sage’s Equities Outlook in 5 Charts, click here.

July Equities Outlook in 5 Charts

Posted on July 16, 2019July 16, 2019 by Sage Advisory

1. Manufacturing activity, which is a leading indicator for economic growth, has slowed down in nearly every major economy, especially Europe and Japan. The U.S. remains relatively healthy, but how much will the slowdown overseas seep into the U.S. economy?

Source: Bloomberg

2. Slowing U.S. data and risks abroad, particularly trade, give the Fed the green light to cut rates. The market has priced in this expectation, with 4 cuts expected in the next 12 months.

Source: Bloomberg

3. Relative to fixed income, global equity valuations look attractive given the positive yield gap, and equities should benefit from continued monetary policy support.

Source: Bloomberg

4. Cyclical sectors (e.g., technology and materials) are favorable, as they are still lagging defensive sectors – even with the huge equity market rebound this year.

Source: Goldman Sachs

5. Central bank policy has become supportive again, which should underpin equities even as trade and other geopolitical risks increase volatility. Given strong returns, weaker overseas data, and rising trade concerns, attractive segments include U.S. large-caps, and the quality, value, and high-dividend markets.

Source: Bloomberg

For Sage’s Fixed Income Outlook in 5 Charts, click here.

4 Reasons “Going to Cash” is Not the Best Strategy During Market Volatility

Posted on June 26, 2019February 8, 2021 by Sage Advisory

by Rob Williams, Director of Research

At Sage, we are tactical managers that make adjustments to our portfolios as the market environment changes. What does this mean? We believe there is always a beneficial market segment to be in; we believe in staying invested. While we have the flexibility to hold some cash in our portfolios, it’s a route we would reserve only for large market draw-downs (think the 2008 financial crisis). For us, choosing the right market segments is more important than repeatedly trying to time short-term market pullbacks.

The following are four reasons why “going to cash” during market corrections is not the best strategy:

1. “Going to Cash” is not an active risk management tactic.

Cash is a guess on near-term market direction. It is often not the best defense in a down market and sets up the potential to miss the upside when the market rebounds.

2. Most corrections are short-lived and rebound relatively quickly.

Major downturns happen only every 5 to 10 years, the corrections range between 5% and 20%, and they only last a few months. Since 2010, we have seen four corrections, and they have all followed this pattern.

3. Being “tactical” in asset allocation is about portfolio risk, not individual position risk.

Mitigating portfolio risk can be done with other tools besides cash. The following scenario takes place during the 2011 correction and rebound. Allocation B outperforms because it participated in the upside of the recovery; and, importantly, because overall portfolio risk was similar, it protected just as well during the draw-down.

Both portfolios have similar total risk to market (.5 and .6 beta)

Beta = volatility or risk of allocation to market, .5 = roughly 50% of downside risk

4. Being tactical means smoothing the ride.

We do this by limiting the potential negative outcomes. Consider the 2011 correction and rebound. The broad U.S. market recovered quickly, with a six-month window from peak to trough and back to peak. Perfect timing of a 50% cash allocation would lead to strong gains; however, considering the risk of mistiming, the range of outcomes is between -4% to +16%, a 21% difference from best to worst. Alternatively, a 50% tilt to more defensive equities had half that spread, with a +1% to +12% range of outcomes, limiting the size of the potential miss and creating a smoother ride for clients.

Hold the Door – Policy Optimism Could Provide a Good Exit Point

Posted on June 24, 2019June 25, 2019 by Sage Advisory

by Rob Williams, Director of Research

Policy Pivot and Markets

The Fed and the other major central banks have turned decidedly dovish in the face of trade concerns and a more obviously weakening global economy. This has bolstered risk markets and sent global rates falling. We believe this trend is likely to continue in the near-term, as the policy shift has been dramatic and central bank dialogue has highlighted the commitment to easing and stimulus as needed.

Bad is Good Again

We appear to be entering a period we have become all too familiar with in this recovery; one where bad data equals good returns – all due to policy expectations. As shown below, economic data has been surprising to the downside while the S&P 500 keeps climbing. This suggests staying risk-on in the near-term. Unfortunately for investors, the difficult questions have yet to be answered. Namely, is this policy shift a temporary boost that will reverse the economic slowdown, or the beginning of a long easing cycle to manage us through a recession?

Pivot vs. Precursor to Recession

Only time and the evolution of data will give us the true answer, but we can look back and see some historical precedence as to when the Fed paused or eased temporarily between tightening regimes. Over the last 40 years we have had three easing cycles, which were all associated with recession. We have also seen the Fed pivot four times in response to market and economic stress.

Good for Bonds Either Way, but Risk Asset Outcomes Diverge

Examining historical returns of these two types of easing periods highlights the fact that bonds benefit from easing, no matter the outcome. But the fate of risk assets is ultimately tied to the ability policy has to affect the actual data.

Conclusion – Hold the Door

While we would not be hitting the exit button with respect to risk assets at this time, given policy support, we would keep the door cracked open and ready for an exit. Although we expect easing policy to affect asset prices, we are skeptical that it will have any meaningful impact on actual growth. Global rates are already low, and shaving even 100 basis points off rates over 12 months is unlikely to be a game changer. If risk markets continue to push higher on policy optimism in the face of poor global growth momentum, we would view this as a good opportunity to lower risk.

*Source on all charts is Bloomberg

China Gets Serious – Tightening the Screws on Rare Earth Elements

Posted on June 3, 2019June 3, 2019 by Sage Advisory

by Komson Silapachai

As tensions between China and the United States escalate beyond trade, both sides are gearing up for a protracted economic conflict. One sign of that escalation lies in an esoteric part of the periodic table – rare earth elements (REEs).

We’ve written about rare earth elements before, most recently in August 2018. Rare earth elements are small but critical parts of many technological applications, including defense, mobile phones, energy, and automobiles. China controls upwards of 80% of U.S. imports of rare earths, and media reports have hinted that China could restrict supply to the U.S., which would threaten to disrupt the supply chains of many of the United States’ largest companies.

This move by China is a significant escalation in the trade war, as this is one of the areas of high leverage for China due to its dominant position as a producer and the reliance on REEs by the U.S. manufacturing sector in consumer, medical, defense, and energy-related applications. China’s proposal threatens a critical area of U.S. manufacturing and technology with comparatively low level of economic fallout that would harm China itself. This escalation of trade tensions bolsters our base case scenario of negotiations stretching into at least 2020, subjecting financial markets to episodes of large swings both negatively and positively as negotiations are playing out in headlines and social media.

What are Rare Earths?

Rare earth elements are a group of 17 chemical elements on the periodic table that tend to occur together in nature. These metals have many similar properties, and they are often found together in geologic formations, such as coal seams and deposits. They were named “rare earth elements” because most were identified by scientists during the 18th and 19th centuries as “earths,” which were defined originally as materials that could not be changed further by heat and were thus considered to be rare in nature. Contrary to historical findings, REEs are moderately abundant but difficult to extract from surrounding matter because of the way in which they bond freely with one another in minerals and clays. As a result, these natural properties make for a difficult extraction effort involving significant capital investment, time, and adverse environmental chemical processes.

China is the world’s leading producer of rare earth elements, having started production from its coal deposits within inner Mongolia in the early 1980s. Today, China controls over 37% of the estimated worldwide reserves of REEs and currently over 89% of reported global production. As a result, China wields significant power over this critical global supply chain and continues to gain market share. Politics in other countries are also contributing to China’s strength in this area. Recently, Lynas Corporation, an Australian rare earth mining company, is facing the closure of its Malaysia-based Advanced Materials Plant by the Malaysian government. Given that the plant produces 10% of the world’s output in rare earth oxides (REOs), the potential closure of this plant means the second largest REO producer could potentially shut down, thus augmenting China’s power position in this strategic group of industrial commodities.

Recent Developments and Implications for Our View

China has the “strong hand” in terms of rare earths and has used it as an economic weapon in the trade war. After the U.S. imposed additional tariffs on Chinese imports on May 10, China responded in kind, but one of the targets of the retaliatory tariffs was interesting. According to Bloomberg, China targeted shipments of rare earth elements used in electric cars from the only U.S. rare earth producer – MP Materials, based in California. China is the world’s largest producer of electric vehicles, and the tariffs will constrict MP Materials’ margins and skew the competitive landscape in rare earth production in favor of China. On May 29, media reports out of China continue to hint at the prospect of a rare earth export restriction against the U.S. in response to the United States’ blacklisting of Huawei Technologies and depriving its supply chain of crucial components from U.S. suppliers. Two days later, on May 31, Bloomberg reported that Chinese officials have readied a plan to restrict REE exports, conditional on a further dispute.

Our base case for trade tensions is a protracted negotiation period stretching into at least 2020. This view is predicated on the fact that the structural issues at play – the United States’ desire to protect its status as the world’s technology hub and China’s need to transition its economy into a value-added producer from a low-cost manufacturer are fundamentally at odds. A restriction on REEs is a significant escalation by China given it’s an area that cuts to a key vulnerability for the U.S. manufacturing and technology sectors and doesn’t have much of a negative effect on the Chinese economy in isolation. We think concerns over sales of Treasuries by China are less likely in the near term, as a disruption in Treasuries could impair the value of China’s USD reserves.

Tail risks abound. The probability of no deal in the form of an indefinite cessation of talks is higher given recent rapid escalation, and financial markets are not priced for a scenario in which that happens. Trade negotiations between the U.S. and China are moving from the realm of diplomacy into an economic war.

All eyes now move to Presidents Trump and Xi’s scheduled face to face at the G20 summit on June 28^th, as the stakes continue to march higher.

Landmark Retirement Reform Legislation May Finally Become a Reality

Posted on May 24, 2019June 6, 2019 by Sage Advisory

by Andy Poreda

On Thursday morning, the House of Representatives took a big step toward sweeping retirement reform. A bipartisan legislation package was near-unanimously approved by the House 417-3 (no thanks to dissenting GOP Reps. Justin Amash (R-MI), Thomas Massie (R-KY), and Chip Roy (R-TX)). Although there was some last-minute frustration by Republicans over the removal of a provision that would have allowed 529 plan funds to be used for K-12 private education and homeschooling, we believe the primary focus of the legislation was a no-brainer for the country.

The Setting Every Community up for Retirement (SECURE) Act of 2019 is a multi-faceted set of provisions aimed to enhance the ability for Americans to save for retirement, providing the first major set of updates to retirement plans since 2006. The estimated $16 billion landmark bill would ease the multi-employer plan rules (MEPs) to allow two or more unrelated employers to join a pooled employer plan (PEP) through a designated pooled plan provider.

Other key provisions of the legislation include:

Increasing the auto enrollment safe harbor cap for existing plans
Simplifying safe harbor 401(k) rules
Increasing the tax credit for small employer plan start-up costs
Providing portability of lifetime income options
Allowing long-term part-time workers to participate in 401(k) plans
Allowing plans adopting by the filing due date to be treated as in effect as of close of year
Providing a fiduciary safe harbor for selection of lifetime income provider
Modifying the treatment of custodial accounts on termination of section 403(b) plans
Requiring disclosures regarding lifetime income
Modifying the nondiscrimination rules to protect longer service participants

Source: American Society of Pension Professionals & Actuaries

According to a recently released Federal Reserve report, a quarter of American adults have no money saved for retirement. A likely culprit is the fact that over half of American workers do not have access to an employer-based retirement plan, according to a 2018 Stanford study; exacerbating the situation, life expectancy is on the rise and future Social Security benefits remain tenuous at best. Meaningful legislation that provides opportunities for Americans to start saving for the future while also lessening the blow of an impending retirement epidemic must be hailed as a monumental success.

Our hope is that the SECURE Act is the start of a bigger reform movement, as future bills are already being pushed. The similarly focused Retirement Enhancement and Savings (RESA) Act still needs to pass through the Senate and is currently stuck at the committee level. A few key differences need to be sorted out, as the Senate version has included no provisions for part-time employees or increasing the required minimum distribution age; however, all signs point to Senate and House Leadership working them out. The bipartisan team of Senator Portman (R-OH) and Senator Cardin (D-MD) are encouraging a bill that would enhance the saver’s credit for low-income individuals and increase catch-up contribution, among other improvements to current rules.

Only time will tell, but these current changes are all a step in the right direction. Here at Sage, our team of professionals build dynamic liability and cash-flow oriented investment strategies for pension and cash balance plans, in addition to providing asset allocation strategies for 401(k) plans. For more information, visit: https://www.sageadvisory.com/retirement-plans/.

The U.S. Economy – Signs of A Sneaky Slowdown

Posted on May 21, 2019May 21, 2019 by Sage Advisory

By Komson Silapachai

We are in the longest U.S. economic expansion in modern history.

Barring a black swan of epic proportions this month, the U.S. economy will break the record in June for the longest expansion since 1854. The current leader, which is soon to be surpassed, is the 1990’s economic expansion, which lasted for 10 years. Is this a cause for a celebration, or is the economy due for a downturn?

Economic expansions don’t die of old age. Just because the expansion has lasted this long doesn’t mean it should end. In fact, there are many positive indicators of why this expansion should continue. Private-sector balance sheets remain strong, as financial assets and home prices are near all-time highs. The labor market is solid – the U.S. unemployment rate stands at 3.6%, just 0.2% from its all-time low. Inflation remains subdued and serves as a tailwind to the economy, as the Federal Reserve has not moved to tighten conditions.

An additional positive indicator, the Chicago Fed’s National Financial Conditions Index, which indicates conditions in debt, equity, and “shadow” banking systems, illustrates that financial conditions are at their easiest levels post-crisis.

However, we’re starting to see initial signs that the economy could be softening. While we don’t believe these indicators point to an imminent recession, the economy is experiencing a material slowdown that warrants observation for the remainder of the year.

1. Business Loan Activity

The Federal Reserve’s Senior Loan Officer Survey’s measure of business loan activities points to moderation in business investment. The percentage of loan officers reporting stronger demand are the lowest in the post-crisis period, while loan standards have moved tighter since the second half of 2018.

2. Transport Volume

Key transportation indicators have turned negative. The Association of American Railroads has reported a slowing in U.S. rail traffic volumes, with total volumes falling in the first 17 out of 19 weeks in 2019.

3. Industrial Output

Capacity Utilization, which measures the percentage of realized potential industrial output and economic slack, has been declining since its peak in October 2018 and is at a 14-month low.

4. Manufacturing Demand

The widely followed ISM Manufacturing Purchasing Manager’s Index (PMI), which surveys purchasing managers at over 300 manufacturing firms, has moved sharply lower in recent months. A PMI index above 50 indicates an expanding economy, and a move below 50 indicates a contraction. While the indicator stands in expansionary territory at 52.5, it has declined from its peak in August 2018 of 60.8. A sustained move below 50 would signal a serious slowdown, if not a recession; however, we are not there yet.

5. Economic Activity

The Chicago Fed’s National Activity Index, which is a composite of 85 indicators of national economic activity, has turned lower and points to below-trend growth in recent months.

As the U.S. economy moves into its longest expansion in modern history, we are seeing signs of a slowdown bubbling under the sanguine labor market and easy financial conditions. Whether the dip is transitory, as it was in 2016, or a herald of a larger slowdown remains to be seen. It all depends on the outlook for monetary and fiscal policy, as well as a potential fallout from slowing global trade.