Financial Landscape – June 2019

Global Macro Environment

Cloudy Global Economic Outlook
US GDP increased at an annual rate of 3.1% in the first quarter. Healthy spending, accelerating wages and a strong labor market all indicate the US consumer remains in good shape. Outside the US, the Chinese economy has yet to gain traction. The strong March PMI reading was short lived as April saw the measure fall back near the 50 boom/bust line. This doesn’t help Europe and emerging markets as both are significant trading partners. Tariff increases between the US and China cast a cloudy outlook on the global economy looking forward as global trade represents 25% of global GDP. It doesn’t appear the trade war narrative will be resolved anytime soon.

Fed Vigilant
At the end of May futures markets were pricing in rate cuts over the next 12 months (54bps) and 24 months (64bps). The most recent Federal Open Market Committee (FOMC) meeting minutes signaled that US monetary policy is appropriate and members pointed to solid economic growth, strong labor market and muted inflation pressures. However, they have since signaled their willingness to cut rates should the Trade War have a further negative impact on the economy

Geopolitical Risks
Recently, China released a government white paper blaming the US for the breakdown in trade talks and demanded that all existing tariffs must be removed for any deal to be signed. The US responded that China was at fault for the breakdown in talks which suggests that the two sides are still far apart. However, both have indicated that President Trump and President Xi Jinping could meet at the G‐20 Summit in Tokyo at the end of June. In a surprise announcement, President Trump announced plans to impose a 5% tariff on Mexican goods until the government acts to stop immigrants from entering the US illegally and threatened to increase the rate to 25% by October. Mexico’s exports to the US account for about 80% of total international sales, which equates to about 28% of GDP.

On May 24 U.K. Prime Minister Theresa May said she would resign as Prime Minister after failing repeatedly to win parliamentary backing for the Brexit agreement she negotiated with the European Union (EU). May said she would step down as Conservative leader on June 7, but stay as PM until her successor had been chosen. The next leader of the party will likely be won by a supporter of a sharper break from the EU The new leader will have until October 31 to push a deal through Parliament. All options, from delaying the deadline again, to whether to proceed with Brexit at all, to announcing a second referendum, are all on the table.

Market Observations

US Equities
Weakness in global growth and trade tensions took a toll on equities in May. The S&P 500 declined ‐6.4% bringing the YTD performance through May to +10.7%. As of May 31 US equities had seen six straight weeks of declines, the longest losing streak since 2011. The sector laggards for May were Energy (‐11.1%) and information technology (‐8.7%) as potential antitrust probes into major tech companies took a toll on the industry. Defensive sectors such as utilities (‐0.8%), health care (‐2.4%) and consumer staples (‐3.8%) held up well relative to other sectors.

International Equities
Australia was the shining star (+0.7%) in a tough month for developed international countries. Index provider MSCI upgraded Argentina from frontier market to emerging markets status sending a wave of passive flows into Argentine stocks. The country was up (+12.9%) for the month. Year-to-date performance through May is still positive for developed international (+7.6%) and emerging markets (+4.1%).

Fixed Income
Bond yields fell across the world in May and the US inverted yield curve may be signaling that the Fed is too tight. The 10‐year Treasury yield was 2.14% on May 31 down 69bps over the last year. Flows into municipal bond mutual funds this year have been the strongest since 1992.

Real Assets
Brent Crude has risen from $55.75/barrel at the end of 2018 to $61.99/barrel at the end of May. Oil markets remain relatively tight as we enter the peak summer demand season. Iran has escalated tensions in response to the US decision to let waivers expire on oil‐export sanctions. This is raising concerns over the oil supply in the Persian Gulf, which accounts for approximately 20% of global output. A bottom in China’s credit cycle would be a tailwind for industrial metals given the nation is by far the largest consumer (e.g., 40% of the global copper demand is consumed by China alone). Midstream energy (including MLPs) and global real estate continue to deliver strong relative performance.


This Financial Landscape represents the consensus of the Oxford Investment Fellows as of 6.12.19.
Statistical data is derived from third party sources believed to be reliable and has not been independently verified by Oxford.
The above commentary represents the opinions of the author as of 6.12.19 and are subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

The Adaptable Spousal Lifetime Access Trust

“All failure is failure to adapt, all success is successful adaptation.”
Max McKeown,Adaptability: The Art of Winning in an Age of Uncertainty.

This quote from the English writer and researcher of innovation strategy, Max McKeown, applies ironically well to modern day trust structures. While ‘innovative estate planning’ may seem like an oxymoron, a good estate plan should indeed be innovative and designed to adjust to a family’s evolving financial circumstances. Within an estate plan, a truly successful trust is one that will adapt.

A Spousal Lifetime Access Trust (SLAT) is such a trust. The SLAT is an ideal vehicle to embed flexibility into a family’s estate plan, while allowing for significant multi-generational estate tax savings.

Typically a SLAT is funded during life by one spouse for the benefit of the other spouse, as well as potentially children, grandchildren and even future descendants. The SLAT removes the assets from both the grantor’s and the beneficiary spouse’s estates, providing an estate ‘freeze’ because the gifted assets grow outside the taxable estate.

A key advantage of a SLAT is that the beneficiary spouse may still receive income and distributions from the trust, providing the couple with contingent access to trust assets during their lives. For SLATs structured properly and utilizing the laws of key ‘trust friendly’ states, an independent Trust Protector may later add additional contingent beneficiaries which may include the grantor as well.

As such, a SLAT is a good option for families who would like to make lifetime gifts to utilize at least one (or both) of their gift/estate and, perhaps, generation-skipping transfer (GST) tax exemptions, but are concerned about losing all access to the trust assets or depleting their current or future income.

Tax reform doubled the federal gift/estate and GST exsemptions to $11.4 million per person for 2019. This increased exemption, however, is due to expire December 31, 2025 and is also vulnerable to further tax law changes. A SLAT is ideal for families concerned they may lose the opportunity to make larger gifts should the exemption levels be reduced in the future.

As a general rule, a SLAT should be funded with assets that are expected to appreciate significantly over time, thereby enhancing the growth of wealth in the tax-advantaged SLAT and not in the taxable estate.

A SLAT is also an ideal vehicle to hold life insurance on the grantor’s life. During the grantor’s lifetime, the trustee can take a loan or cash withdrawals from the policy to provide the trust with liquidity for distributions to supplement income or to fund other financial goals.

Upon the grantor’s death, the death benefit and other SLAT assets continue to provide for the beneficiary spouse and family and are kept outside of the grantor’s taxable estate. Upon the beneficiary spouse’s passing, proceeds can enhance legacy wealth and provide for future generations, and can be used to lend money to the grantor’s estate to offset estate tax.

A SLAT can also be designed as a Dynasty Trust when created in a jurisdiction that allows trusts to extend in perpetuity. A Dynasty SLAT is designed to benefit the family as well as multiple future generations, providing an effective way to utilize the GST tax exemption.

With this type of trust, the couple captures the use of their GST tax exemptions along with all of the other advantages of a traditional SLAT.


  • Estate Tax Advantage: The SLAT is structured as an irrevocable trust. As such, upon funding (with assets held in the individual name of the grantor), the assets are removed from the grantor’s estate and are also not included in the spouse’s taxable estate. Note, the transfer of assets to a SLAT is a gift and will utilize the grantor’s gift/estate exemption. Also, spouses may not create ‘identical’ SLATs or assets will be taxed in their respective estates.
  • Spousal and Beneficiary Provisions: The spouse has a lifetime interest which can be designed as either required or discretionary income or income/principal distributions, or as unitrust payments. Children and grandchildren may also be named as current beneficiaries or their interest may begin at the spouse’s death as remainder beneficiaries.
  • Maximizing Tax Impact: Adding a power to substitute assets enables ‘basis planning’ to mitigate capital gain tax and also ensures that the most rapidly appreciating assets are held in the tax-advantaged SLAT, thereby maximizing the estate tax savings.
  • Flexibility Provisions: The beneficiary spouse can be given a limited power of appointment to redirect assets among a class of recipients, generally descendants, in order to create flexibility for unknown future circumstances.
  • Favorable Grantor Trust Status: The trust will be taxed as a grantor trust as long as the beneficiary spouse is living, thereby protecting the trust assets from being depleted by taxes and allowing the grantor to make tax payments on behalf of the trust without being considered a taxable gift. Certain provisions can be included to allow ongoing grantor trust status even if the beneficiary spouse predeceases the grantor.
  • Trustee: The grantor may not serve as Trustee but the spouse may, provided the power to make distributions to him or herself are restricted to an ascertainable standard, i.e. amounts needed for health, education, maintenance and support.
  • Divorce or Death of Spouse: To mitigate concerns, the SLAT can be drafted to include only a ‘current’ spouse and can be established in a jurisdiction that enables a Trust Protector to have the power to add beneficiaries, including a future spouse.

A SLAT provides families with an opportunity to take advantage of the current larger exemption amounts while leaving a window open for access to the trust assets to meet the income needs of the family. This adaptable tool in the planner’s toolbox requires the thoughtful input of the family’s entire team of advisors. Your Oxford advisor will work with your team to coordinate the optimal solution for your family.

The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

What’s Happening Across the Pond This Month?

As background, the European Union (“EU”) was formed shortly after WWII to create economic and political cohesion across the continent. The United Kingdom (“UK”) joined this organization in the 1970s. To advance its goals of reducing trade friction, integrating financial markets and creating a stronger presence for the EU in the global economy, the Euro was launched in 1999 as a shared currency. There were initially 11 countries which agreed to use the Euro. By doing so, they effectively relinquished their monetary policy (the ability to raise or lower interest rates) to the European Central Bank. The UK was concerned about giving up this level of control so it elected to retain its currency (Pound Sterling) but remain in the EU.

While there are a number of benefits to its membership in the EU (trade agreements, free-flow of labor from EU countries and being seen as the financial gateway to Europe) the UK gives up a degree of sovereignty. There had always been some concern amongst the UK population with this arrangement, but the 2011 to 2015 period saw growing frustration, particularly around the issue of migration from other parts of Europe and worries about domestic job losses. In 2015 the Conservative party unexpectedly won the election on a platform of leaving the EU. A public referendum was held in 2016 which narrowly (51.9%), and again unexpectedly, supported leaving the EU or “Brexit” (British exit). This outcome led to an 11% decline in the Pound Sterling and brought it to the lowest level in more than 30 years.

In March 2017, the UK invoked Article 50 of the Lisbon Treaty, which began a two-year timeline to negotiate the terms of the split. This period expires on March 29, 2019 – which is supposed to be the end of the story.

Over the past twenty three months, however, negotiations have not gone smoothly. There have been discussions of a “soft Brexit”, which would entail some degrees of continued reliance on EU policy and infrastructure, or a “hard Brexit” which would include a fully independent immigration policy and trade agreements would fall back underneath the WTO.

One significant issue, which has not generated as much media attention, relates to the fate of Northern Ireland. While the Republic of Ireland (the South) will remain in the EU, Northern Ireland remains part of the United Kingdom and is slated to leave. As such, any version of Brexit which requires a change in customs/immigration policy would necessitate a barrier between Ireland and Northern Ireland. While there has been relative peace since the 1998 Good Friday/Belfast Agreement, the decades prior were marked by protests, riots and violence. Fears of renewed tensions have been elevated in recent months, with a car bomb that was detonated outside a Northern Ireland courthouse in January 2019.

This bombing was just four days after UK Prime Minister Theresa May’s proposal to effect an exit was voted down by 230 votes (432 to 202). This was the largest ever defeat in the House of Commons. A subsequent vote on March 12 was also rejected, though by a lesser margin.

The uncertainty since 2017 has created significant stress and frictional costs on financial institutions and consumers. Banks and other institutions have moved thousands of jobs to the European mainland and in some cases developed redundant infrastructure to support a second regulatory regime. Manufacturing plants have begun stockpiling excess inventory amid worries of supply chain disruptions at the UK’s ports of entry, and some consumers have adopted a bunker mentality, purchasing canned goods and “Brexit Boxes” as the UK imports about 50% of its food.

The concern has been reflected in the economic data, as we’ve seen a slowdown in business investment in recent quarters.

GDP growth rates have also fallen on an absolute and relative basis. The UK had one of the highest growth rates in the G7 from 2013-2015, but has reported the lowest growth of this cohort over the past four quarters.

As things stand today (3/21/2019), the British Parliament has voted to seek a delay of Brexit beyond March 29 and Prime Minister May will be meeting with EU leaders to negotiate an extension. Interestingly, there is a straightforward (albeit politically painful) escape hatch given the European Court of Justice’s ruling that the UK could cancel the Brexit process without consent of the other EU members.

As difficult and challenging as globalization was to develop over the past 70 years, it will be equally challenging to unwind. Brexit and other populist/nationalist measures are at the fore, and we anticipate further trade friction and geopolitical disruption in the years ahead. This will create opportunities for our managers and our portfolios, as we closely watch the regime shifts within central banks and government houses. In any event, we can be assured the next 10 days will offer an interesting window into the fractures in Europe’s democratic systems.

The above commentary represents the opinions of the author as of 3.21.19 and are subject to change at any time due to market or economic conditions or other factors.

Wait and See…

Following a turbulent close to 2018, financial markets rebounded nicely in early 2019. The primary reason behind the reprieve in market volatility was the messaging by the Federal Reserve, which suggested the Federal Open Market Committee (FOMC) may hold off on further rate hikes for the time being and consider a slower pace of quantitative tightening. Thawing trade tensions with China and an end to the government shutdown also helped support asset prices.

It’s important to note, the Fed has been tightening monetary conditions for three years – since the FOMC first raised the fed funds rate in December 2015. The objective of tightening monetary policy, of course, has been to keep the economy from overheating. As economic growth reached full capacity and unemployment dropped to the lowest levels in nearly 40 years, it was quite reasonable for the Fed to take away some of the extraordinary stimulus which had been in place since the Great Recession. But in January we learned Fed officials are comfortable with current interest rate levels and the December 2018 hike may have been the last one for now.

Several factors may have contributed toward the change of direction by the Fed. Elevated volatility in financial markets and the slowdown in interest rate-sensitive sectors such as housing and autos suggested Fed rate hikes were beginning to take a bite. Rather than risking an excessive slowdown (e.g. a recession), Fed officials opted for a wait-and-see strategy. In other words, policy will change in either direction only as economic data deviates significantly from current levels.

Given this pause, the risk of a Fed-induced recession has diminished and investors can focus attention on economic and corporate fundamentals. On that front, the picture is mixed. Recent volatility has put a dent in consumer and corporate confidence indices. As stated earlier, interest rate-sensitive sectors of the economy have slowed in recent months. However, it’s too soon to call for a recession despite softer data.

This chart illustrates the fed funds rate alongside personal consumption expenditures (PCE), a measure of consumer inflation. Overall inflation expectations are well anchored around the Fed’s target levels although the recent employment report shows continued strength in labor markets. Despite recent healthy wage gains, labor costs don’t yet pose a major risk to corporate profits. Also, stable oil prices at lower levels will be supportive of consumer expenditures and capital investment.

The corporate sector remains resilient even after a record economic expansion. Although corporate confidence surveys weakened in recent months, they should stabilize now that the Fed has taken its foot off the brakes. A stable Fed policy should provide visibility for capital expenditures.

The big question, as has been the case lately, is whether political wrangling in Washington and abroad will remain contained. Negotiations around border security in the U.S. continue to pose headline risk and Brexit negotiations are running out of time. Also, trade tensions continue to erode confidence at home and abroad. Strong exporting countries such as China and Germany have seen slower economic activity and their officials have been unable to stem the tide.

Many of these issues are inherently unpredictable and should not alter the positioning in a long-term investment plan. Volatility in recent weeks reminds investors of the influence the Federal Reserve exerts on the markets. Despite the respite from Fed Funds rate hikes, volatility may continue as economic data alters the balance of risks.

The above commentary represents the opinions of the author as of 2.20.19 and are subject to change at any time due to market or economic conditions or other factors. The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

2018 Market Review: Taking the Punch Bowl Away

A combination of deteriorating news flow and a shift in economic policy contributed to an environment of rising volatility in 2018. In February, global equity markets suffered a price correction which proved to be the “shot over the bow” that presaged a spike in volatility late in the year.

Cash was the only place to hide as nearly all major market index returns were negative in 2018. Energy and financial sectors led US equities lower. Emerging markets equities held up relatively well during a tumultuous Q4, but declined nearly 15% during the year as a strong US dollar continued to be a headwind. Rising interest rates led to modest declines in most US bond markets, while a collapse in oil prices introduced renewed weakness within resource equities. Wild stock market gyrations in the last few weeks of 2018 left investors wondering, what caused this change in market dynamics?

Headline Risks
To be sure, there was no shortage of fear-inducing headlines during the year. The Mueller investigation into Russian election interference proceeded with relentless determination. Global trade tensions and nationalist policies advanced in the US and abroad. Tariffs imposed among major trading partners began to take a bite out of global economic activity. Concerns about intellectual property theft and currency manipulation created a growing rift with China. The announced US military withdrawal from Syria was welcomed by Russia even as a renewed threat of nuclear proliferation has heightened tensions with our old Cold War rival. To top it off, partisan bickering in Congress couldn’t avoid a partial government shutdown during the holidays, which continues today.

Although this dizzying news-flow may have affected sentiment on the margin, the real story affecting markets in 2018 was about tightening financial conditions.

Full Capacity
A strong economy has led the Federal Reserve to tap the breaks on accommodative monetary policy, causing yields to rise and financial conditions to tighten. The output gap has closed and the US economy is running at (or beyond) full capacity with an unemployment rate at multi-decade lows. In response, the Federal Open Market Committee (FOMC) raised the Fed Funds rate four times in 2018 and allowed its balance sheet to decline by $420 billion through bond maturity run-off. This interest rate normalization process has been a contributing factor to recent volatility for a market used to the extraordinary monetary policy enacted following the Great Recession.

Liquidity has also been declining abroad. The European Central Bank has signaled a shift in strategy by ending their quantitative easing program and possibly raising rates in late 2019. In addition, European policy is clouded by stress in the Italian financial system and complications in Brexit negotiations. Financial conditions in the emerging markets have also been tighter as a result of rising global yields, especially in countries with large amounts of foreign currency debt.

Tighter liquidity conditions, which reverberated through the financial system in the form of lower bond prices, also took a toll on equity valuations. The trailing 12-month price-earnings ratio for the S&P 500 declined by more than 20% to 17x in 2018.

During volatile times, it is important to keep a cool head and focus on long-term fundamentals. When we invest in stocks, we are buying their stream of future earnings. Of course the valuation at which we buy and eventually sell the earnings stream (the P/E ratio) matters a great deal, but more important for long term investors is the growth of those earnings during the period the stocks are held. And this is where we find some comfort.

The US economy is performing well and the probability of a recession in 2019 remains reasonably low. The unemployment rate is at the lowest level in 48 years and wages are rising just over 3% with core inflation around 2%. This should bode well for consumption, which represents more than two thirds of economic growth. In addition, the corporate sector remains healthy. Earnings growth will likely reach an impressive 20% year-over-year in Q4 and is likely to grow further in 2019, albeit at a slower pace. The Tax and Jobs Act of 2017 will continue to have a positive impact on capital investment, which in turn should grow our capital stock and boost productivity.

Looking abroad, emerging market equities (MSCI EM) trade at a meaningful valuation discount to US and international developed markets, as measured by trailing 12-month price-earnings ratios in the chart below. While valuations are not particularly useful as market timing tools, we believe this discount adequately compensates long-term investors that can look past current challenges and negative sentiment.

Source: Morningstar

If there is a silver lining from 2018, expected future returns are now higher than they were at the end of 2017. Higher yields increase returns for bond investors. Money market funds finally pay interest again. Equity market valuations offer a more attractive entry point. We also continue to utilize Niche Growth Strategies as a complement to traditional markets to potentially enhance risk-adjusted portfolio returns.

With the Presidential Twitter account fully active, a split Congress and other countries jockeying for position on the global stage, there is no doubt headline risk will continue in 2019. Smart investors should avoid overreacting to the noise and focus on the underlying economic factors. On this front, the data still suggests continued growth if only at a slower pace.

The above commentary represents the opinions of the author as of 1.7.19 and are subject to change at any time due to market or economic conditions or other factors.

This Season, Unwrap the Gift of Giving

Many taxpayers spend time in December trying to wrap up their charitable giving for the current year before the New Year’s Eve celebrations begin. The time spent is often hurried and lacking in a strategic approach.

This year, consider taking time to not only wrap up 2018 charitable giving, but also leverage this time with family to create the foundation for an enduring strategic charitable plan. By discussing key questions during the holidays when families are together, future charitable giving plans may feel more thoughtful and cohesive.


How Might the Entire Family be Involved in Charitable Giving?
Families are becoming more intentional about creating strategic charitable giving plans. They understand that philanthropy is a way to instill responsibility and stewardship. Families can utilize their resources to advance a cause, impact civic goals and further a legacy of giving. Philanthropy can also serve as a way to enhance family bonds creating cohesion around a shared generational mission of giving.

Along with identifying your family’s philanthropic goals, the structure for funding and maintaining these goals in the most tax-efficient manner is critical. Lost deductions, unsustainable entities or charitable structures and a lack of family governance will all undermine the endurance of your charitable plan. Several key questions follow in this respect.

How Can a Donor Advised Fund Enhance Your Philanthropic Structure?
A donor advised fund (DAF) is a separately identified fund or account set up by a donor through a sponsoring charitable organization. When a donor makes a contribution to a DAF, the donor maintains advisory privileges in making grants from the fund to various charities. The charitable sponsor has final authority over the grant recommendations of the donor.

DAFs can be utilized to engage multiple generations. The senior donor may ask their children and/or grandchildren to be responsible for recommending grants over a certain portion of the funds.

A DAF may also be utilized in conjunction with a Private Foundation. Families often choose to create private family foundations to meet their philanthropic and estate planning goals. However, over time, children and grandchildren may move to different locations, leading to disengagement. Younger generations can create their own DAFs to fund their personal philanthropic passions. By making these DAFs the recipients of a portion of the Private Foundation’s required annual 5% distribution, families can continue to honor their philanthropic mission but provide the flexibility to support new causes—regardless of where the family members live.

A DAF also aligns well with a recent income tax planning strategy known as charitable deduction bunching.

Are You Employing a Charitable Deduction Bunching Strategy?
Charitable deduction bunching refers to the strategy of combining charitable contributions that would normally be made over two or three years into one year, thereby maximizing the benefit of itemized deductions and the now higher standard deduction in alternating years. Donors itemize deductions in the year they make contributions. In the following year(s), they make no contributions and take the standard deduction. For example, if a donor traditionally gave $15,000 a year to charity, the donor could combine two years of gifts into one year and give $30,000 in that year. A DAF allows the donor to make a charitable contribution and receive an immediate tax benefit in the year of the gift, but distribute the funds to charities over multiple years.

Do You Have Appreciated Securities You Can Earmark for Charitable Giving (Rather Than Utilizing Cash?)
It is more beneficial to give long-term appreciated securities rather than cash. Securities that have appreciated in value are among the most tax-advantaged assets to contribute to charity because the capital gains tax liability is eliminated while a charitable deduction for the full fair market value is allowed. For example, if a donor gifts securities to a charity that were purchased 5 years ago for $10,000 and are now worth $20,000, the donor can deduct $20,000 as a charitable contribution; however, the donor will not be taxed on the $10,000 of capital gain. If the securities were sold first and the cash gifted, the donor would pay capital gains tax. In the above example, if the donor’s federal and state capital gains tax rate is 23.8%, the additional tax would be $2,380.

Can Required Minimum Distributions (RMDs) From Your IRA Be Used to Fund Your Philanthropy?
A Qualified Charitable Distribution is available if a taxpayer is 70½ or older and subject to required minimum distributions from his or her IRA. The taxpayer may use a Qualified Charitable Distribution to transfer funds (up to $100,000) directly from an IRA to a public charity. The amount transferred will count toward the taxpayer’s RMD but will not be considered taxable income. While there is no charitable deduction for making a Qualified Charitable Distribution, the charitable distribution reduces adjusted gross income which may keep the donor in a lower tax bracket and possibly reduce state income taxes. Funds from a Qualified Charitable Distribution must go directly to a public charity which, in this case, does not include a donor advised fund.

As future generations sprawl geographically and by growing family lines, a family’s philanthropic mission can be the ‘inter’ and ‘intra’ generational beacon that guides them home. Share your respective values, knowledge, wisdom and philanthropic passions. Begin to articulate your family’s mission statement for shared interests and values. As you devote this time to deepening your family connections, your Oxford team of advisors can work with your family to create the infrastructure for an enduring generational charitable plan.

The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.

Chairman Powell Is Not So Accommodating

The third quarter saw strong returns for US equity markets as measured by the S&P500 Index, which was up 7.7% for the quarter, bringing year-to-date results to positive 10.5%. This result was concurrent with robust consumer and business sentiment and continued strong earnings (Q2 S&P500 operating earnings were up more than 20% year over year). A “growth over value” regime also persisted as the Russell 1000 Growth Index outperformed its value counterpart during Q3 (9.2% vs. 5.7%) and by more than 13 percentage points during 2018 (17.1% vs. 3.9%).

As we reflect back on the US market we observe that while the vast majority of S&P500 companies beat earnings estimates in the first (76%) and second (80%) quarters, we are seeing a narrowness in market support with just three stocks: Amazon, Apple and Microsoft, accounting for more than 30% of the year-to-date return.

Another continuing theme for equity investors has been the weakness outside the US. Both developed (MSCI EAFE: +1.4%) and emerging (MSCI EM: -1.1%) markets generated muted returns in the third quarter. On a year-to-date basis through September 30, developed markets declined 1% and emerging markets were down 8% from weakness in Brazil (-12%), India (-10%) and fears of contagion from Turkey which declined more than 40% due to political turmoil.

A Strong US Economy & An Active Federal Reserve
The headline strength of the domestic economy continues to be significant. Second quarter GDP (+4.2% annualized) achieved its highest result in four years, although we believe some portion of this is related to one-time events like the 2017 tax cut and cross-border activity being pulled forward amid a growing trade war. The unemployment rate in September declined to 3.7%, which is the lowest level since the late 1960s. Down from a post-recession peak of 10% in 2009, it has been aided by Baby Boomers, whose retirements since that time have reduced the percentage of adults in the work force. Over the past several years the combination of slack in the labor market and the “gig economy” (project work via mobile apps or independent contractors as opposed to full-time employment) has restrained wage inflation, but we see growing data around enhanced benefits, bonuses and raises as employers struggle to find qualified workers. This is, of course, a good thing for workers, but in time may contribute to margin compression on corporate earnings.

Amid this economic strength Chairman Powell and the Federal Reserve has continued its path of raising rates. The third rate increase during 2018 occurred in September and a fourth hike is anticipated before year-end. A second order effect on interest rates comes from the Federal Reserve’s unwinding of its multi-trillion dollar balance sheet. During the depths of the financial crisis, and at critical points in this economic recovery, the Federal Reserve has purchased mortgage-backed securities to add liquidity to those markets, and long-dated Treasuries, in an effort to hold down long-term interest rates. Over the past year, the Fed has allowed the balance sheet to shrink, which now stands at $4.1 trillion and effective October 2018, will further shrink by $50 billion per month. Though we do not anticipate significant changes to the yield curve from this policy it does affirm the Fed’s commitment to removing some of its extraordinary support.

The corporate tax cuts announced last year are supporting increased business spending but a meaningful portion has been used to expand stock buyback programs. Thus far in 2018, over $700 billion in buybacks have been announced, as compared to less than $400 billion at the same time in 2017.

More Trade Turmoil
On the geopolitical front, more of the trade rhetoric has manifested into policy. The US expanded its tariffs on Chinese goods in late September with an additional $200 billion in annual goods/products being assessed a 10% tariff, which will rise to 25% in January 2019. Unlike the tariffs on steel and aluminum, which took effect earlier in 2018 and directly impacted US producers who may or may not have raised prices, about a quarter of these new tariffs are targeted at end consumer goods. While the exact impact on the economy won’t be known for some time, this type of trade friction has the potential to slow economic growth and increase inflation.

What Lies Ahead?
Lastly, while this issue of the Investment e.Perspective speaks specifically to the third quarter, the early weeks of Q4 have seen a notable change in market sentiment as equities, fixed income and energy declined. Notwithstanding these past few weeks, the diversification within our portfolios across traditional and private markets is a key tenet of our investment approach, and maintaining a disciplined effort is critical to helping our clients weather market turbulence and achieve their objectives.

The above commentary represents the opinions of the author as of 10.31.18 and are subject to change at any time due to market or economic conditions or other factors.

Second Quarter Review: The Trend is a Fickle Friend

In the second quarter, equity markets resumed a pattern which has become familiar throughout most of the nearly decade-long bull market. US Stocks, and growth stocks in particular, led the market while non-US Stocks and US bonds lagged behind. The 10-Year column in the chart below highlights the degree to which US equity has outperformed all other major asset classes in the current bull market. It’s natural for investors to question the merits of broader diversification after an extended period of underperformance. This is particularly true given the strong fundamentals currently driving domestic stocks. Recency bias is a cognitive bias which describes the tendency of people to assume recent trends will continue into the future. In investing, this can be dangerous, causing investors to buy high and sell low. Given such biases, we felt it appropriate to review the strategic case for diversification in fixed income and international equity…it remains strong.

Strong Earnings Growth Drives Domestic Equity
The domestic economy is firing on all cylinders. In the second quarter, sales and earnings per share for S&P 500 companies are poised to grow at nearly 9% and 20% respectively. The following factors are contributing to that growth:

  • The Tax Cuts and Jobs Act signed in late 2017 is providing a significant boost to corporate earnings.
  • Consumer spending is robust, fueled by an unemployment rate near 49-year lows and accelerating wage gains. Consumer confidence is at its highest level since the early 2000’s.
  • Corporations have increasingly utilized easy credit markets to expand their balance sheets and increase share buybacks.
  • The energy sector is experiencing a significant rebound in earnings, with the sector’s earnings expected to grow 145% in the second quarter.

There are, however, a number of risk factors for investors to consider when assessing the sustainability of domestic equity returns looking forward.

  • Slowing growth/recession: The US in the midst of its second longest expansion ever. The slope of the yield curve has historically been a good leading indicator of economic growth. An inverted yield curve has frequently preceded recessions. The yield curve is currently as flat as it’s been since 2007, suggesting caution is warranted.
  • Interest rates: Monetary policy is tightening. The Federal Reserve increased rates twice this year and reiterated its plans for two additional increases in 2018.
  • Leverage: Corporate leverage has reached record highs while the budget deficit is projected to approach 6% next year. In a rising interest rate environment, the debt service associated with increased leverage will weigh on growth.
  • Trade tensions: We continue to see escalating rhetoric around protectionist trade policy. A global trade war would have negative implications for growth. There are indications that corporate and consumer confidence have already been negatively impacted.

Fixed Income: Stability in Challenging Markets
The Bloomberg Barclay’s Aggregate Bond Index earned a negative return year-to-date as interest rates rose across the yield curve. The 10-year Treasury increased from 2.40% to 2.85%. With yields still depressed by historical standards and interest rates likely to rise, expected returns for fixed income remain modest.

That said, it’s important to remember the role of fixed income in a portfolio. Investors accept the lower long-term returns in fixed income for their volatility-reducing benefits. The chart below highlights the importance of an allocation to fixed income. In times of financial distress, risk assets tend to decline together. In each of the last three equity market corrections of 10% or more, fixed income has increased, mitigating overall portfolio volatility. An allocation to high quality bonds allows investors to rebalance and purchase risk assets at depressed levels.

International Equity: Stay the Course

International and emerging market countries account for nearly half of the global equity market cap and are projected to contribute 80% of global economic growth. As growth rates are a key component to our capital market assumptions, we do have higher return expectations for non-US markets.

Domestic equity returns have benefitted to a far greater degree from valuation expansion in recent years. Using the Shiller P/E ratio, the multiple on the S&P 500 has expanded from 13.3x at its trough in 2009 to 32.1x today. As the chart below highlights, US large cap and small cap stocks trade at well above average valuations.

Meanwhile, developed international stocks and emerging markets stocks trade at below average valuations.
Valuations are not a good predictor of short-term market movements, but are a very strong indicator of long-term returns. Current valuation disparities suggest International diversification will be much more beneficial to portfolios looking forward.


Timing recessions or market corrections is nearly impossible. Remembering that market cycles exist is critical. With domestic equity valuations near peak levels and the duration of the economic expansion approaching the longest in history, it is prudent for investors to confirm that their mix of safety and growth assets is consistent with their time horizon and risk tolerance.

A decade ago, many US investors, drawn to the strong trailing outperformance of emerging and international equities over domestic equities, increased their strategic allocation to foreign stocks. As tempting as it may be to do the opposite today, rebalancing to strategic targets will likely prove more rewarding.

The above commentary represent the opinions of the author as of 7.26.18 and are subject to change at any time due to market or economic conditions or other factors.

The Melting Effect of Rising Rates on Estate Planning

As Sir Winston Churchill observed, after every period of delay and procrastination comes a period of consequences.i While we are in this era of historically low interest rates, it is wise to consider the potential cost of delaying certain estate planning strategies.

The Freeze Before the Melt
An estate freezing strategy seeks to “freeze” the taxable value of a family’s estate, or certain assets, so that future appreciation avoids the 40% estate tax. Through freezing strategies, this appreciation grows outside of the taxable gross estate, allowing the family to retain 100% of their future wealth appreciation, rather than only 60% after netting out the estate tax.

The Tax Reform Act of 2017 essentially doubled the federal gift and estate tax exemption from $5.59 million per person to $11.18 million per person for 2018 (with future inflation adjustments). The estate value in excess of these amounts will be taxed at the rate of 40% if gifted during life or when passed to heirs at death.

Notably, the taxable ‘gross estate’ is a value defined by the Internal Revenue Code and it may be much greater than what is included on a family’s Financial Statement. For example, items such as Life Insurance proceeds and certain phantom wealth such as general powers of appointment over trust assets will be included in the taxable gross estate. Your team of wealth advisors should be engaged for an analysis of your family’s estate tax exposure.

A freezing strategy is appropriate when there is a current or potential estate tax liability. Rarely is a family’s wealth static, either in value or in asset composition. As assets appreciate or are monetized, reinvested, spent down or used for lifestyle purchases, the future value of the family’s estate will be impacted. Ideally, a freezing strategy should be implemented well ahead of rapid growth in asset values. Financial modeling of a family’s net worth and an estate tax projection can remove the guesswork from this analysis and provide the answers to ‘if and when’ a freezing strategy should be considered.

The Melting Effect of Rising Rates

Rising interest rates reduce the impact of freezing techniques, causing more wealth to flood back in to the taxable estate. The planner’s ability to hold back the flow of wealth from being taxed at the 40% estate tax rate becomes remarkably limited with each uptick in certain key interest rates.

Common freezing strategies include loans and installment sales to family members, Grantor Retained Annuity Trusts (GRATs), Sales to Intentionally Defective Grantor Trusts (SIDGTs), and Charitable Lead Annuity Trusts (CLATs). Each of these strategies must be structured with either annuity or installment payments back to the Grantor (or to a charity in the case of a CLAT) for a specified term. The nuances of a client’s situation or the underlying asset will determine which strategy is most appropriate at any given time.

The interest rate that determines the required payments back to the Grantor is referred to as the “hurdle rate”.ii The spread between the hurdle rate and the growth in asset values determines the “remainder interest”, which is the amount that will be paid outright or in trust to the Grantor’s heirs, free of estate tax. The higher the hurdle rate the greater the required payments back to the Grantor and the lower the estate tax free remainder interest for heirs. In other words, these strategies are at their maximum impact in a low interest rate environment. Unfortunately, the reverse is equally true.

To quantify the impact of rising rates on these estate planning strategies, we illustrate three hypothetical fact patterns using a GRAT strategy with identical terms, the only variable being an increase in the hurdle rate.iii

Specifically, we assume a 10 year GRAT funded with $10 million, with a zeroed-out gift tax.iv We assume 7% appreciation in the underlying assets and that the Grantor survives the term of the GRAT.v We also assume other prudent planning measures have been taken so that the GRAT assets are entitled to a 30% valuation

The Impact of Rising Rates

An increase in the hurdle rate from 3.2% to 4.2% results in the value of the remainder interest to beneficiaries declining from $7.87 million to $7.09 million, a drop of approximately 10%.

A increase in the hurdle rate to 5.2% would reduce the remainder interest to $6.27 million, which is a total reduction of approximately 20.5%.

The hurdle rates are determined by the IRS on a monthly basis and will follow general interest rate trends. Notably, the rising trend for these hurdle rates since 2017 has been fairly significant. The hurdle rate required for a GRAT strategy has risen from 2.2% in October, 2017, to 3.4% in June, 2018.

However, once a strategy is implemented, the hurdle rate will typically be fixed for the term of the strategy. For this reason, early implementation of a freezing strategy locks in the maximum freezing potential. While these rates remain low from a historical perspective, families still have the opportunity to maximize the impact of these popular and effective planning techniques. It is an excellent time to consult with your Oxford advisors as to whether a freezing strategy is appropriate for your situation.

i“The era of procrastination, of half-measures, of soothing and baffling expedients, of delays is coming to its close. In its place we are entering a period of consequences.” ― Sir Winston S. Churchill
iiThe amount of the hurdle rate is dictated by the IRS and will either be the IRC Section 7520 rate for any annuity payments or the Applicable Federal Rate (“AFR”) for loan or sale strategies. The Section 7520 rate is 120% of the midterm AFR.
iiiA GRAT is an irrevocable trust that provides Grantor with an annuity payment for a predetermined period of time. Appreciation in excess of the §7520 rate passes to remainder beneficiaries or in trust at the end of the GRAT term.
ivThe taxable value of a gift of property to a GRAT is reduced by the present value of the annuity payments back to Grantor, which can be structured to zero-out any gift tax. When the trust terms ends, the remaining assets pass to beneficiaries, outright or in trust, with no additional estate tax.
vThe Keys to Success for a GRAT ~ The growth in underlying assets must exceed the hurdle rate and the Grantor must survive the term of the GRAT.
viOften times, a portion of an entity interest may be structured as non-controlling, non-marketable and/or non-transferable. Provided the primary purpose of the entity is for a valid business purposes (a subject of extensive case law beyond the scope of this article), these restrictions may reduce the valuation of the interest, thereby utilizing less of the taxpayer’s lifetime federal estate tax exemption.

New Bond Disclosure Rules: A Win for Investors

Beginning May 14, amended rules from the Municipal Securities Rulemaking Board (“MSRB”) now require bond dealers to explicitly disclose their compensation, known as a “markup”, to retail clients for each municipal bond transaction. “Markups” are defined by MSRB as the difference between what a customer pays and the prevailing market price. This is a significant positive development for retail investors and it improves the transparency of bond trading costs within a broker-dealer relationship.

Unlike equity markets, where centralized trading exchanges help retail investors more easily understand prevailing market prices and transaction costs, the decentralized (“over-the-counter”) trading within the municipal bond market leads to an opaque price discovery process. In many cases, investors have been unaware of the specific markup they pay on a given trade. Or worse, some might not even know they were being charged at all.

According to a 2013 study by Standard & Poors1, markups on investment-grade municipal bond retail trades under $100,000 have averaged 1.21% historically. For comparable dealer-to-dealer trades, this transaction cost has averaged 0.49%. Why the difference? In at least some cases it is likely because bond dealers knew they could charge a higher markup when trading to a less informed retail investor.

Previously, confirmation statements contained only the total price paid for a bond (and resulting yield) with the markup buried in the price. Going forward, confirmation statements of trades will include the total dollar markup and total percentage markup relative to the prevailing market price as separate items.

For a fee-only firm like Oxford, this amendment has no impact on our business. Oxford does not receive any markups on bond transactions. The managers of municipal bond accounts we utilize on behalf of our clients do not receive markups. We are supportive of this amendment by the MSRB and believe it not only improves transparency for investors, but it lifts the veil on a conflicted business model.

1Gurtin Municipal Bond Management, Standard & Poors (“Unveiling the Hidden Costs of Retail Bond Buying & Selling”, January 2016)

The above commentary represent the opinions of the author as of 5.31.18 and are subject to change at any time due to market or economic conditions or other factors.