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Quarterly Letter to Clients

January, 2018

Indices at quarter-end (December 31, 2017):

Dow Jones Industrials: 24,719.22 4Q'17 +10.33% YTD +25.08%

Standard & Poor's 500: 2,673.61 4Q'17 +6.12% YTD +19.42%

John Templeton, founder of the Templeton Funds, once said, “…bull markets are born in pessimism, grow in skepticism, mature in optimism, and die in euphoria.” Another way to phrase this is that they start at the bottom and finish at the top, but that is not nearly as entertaining as Templeton’s phrasing. Or as descriptive. My suspicion is that we are in the middle of the optimism phase, edging toward euphoria.

The stock market has powered to all-time highs this past year, as measured by the Dow Jones Industrials and the S&P 500. But it has been a polarized move, with a limited number of stocks doing all of the heavy lifting. During most of the year the number of stocks declining actually exceeded the number of those advancing.

If you were in those “heavy lifting” stocks this year, you did swimmingly well. I guess my selections were last year’s stocks, as my equity accounts lagged the indices. We did much better on the bond side, as rates remained low in the face of only minimal upward pressure from the Fed.

There were two items related to finance that were on many minds this year: the new tax bill, and Bitcoin. As for the former, it remains to be seen how it will work out in the real world, but my suspicion is that the masses will see no benefit and will be left waiting for the trickle that is hoped to drip down from the real beneficiaries, which is to say, major corporations. I have said previously that I fail to see why a large corporation should have a lower tax rate than I do, and I have not changed my opinion on that.

Theoretically, lowering corporate tax levels is being done to make our businesses more competitive on the global stage. Unfortunately, the rest of the world is also lowering corporate taxes, so any advantage is illusory and temporary at best.

Remember that there can be no real tax cut without a reduction in spending. If you do not reduce spending, all you have is a tax deferral. Proposed policy not only does not reduce spending, it increases it. Debt levels will rise and I would expect inflation to rise as well. The rise in our federal debt is but one factor that will dent the value of our currency, but it is a large one. Our national debt load is a problem that no one wants to confront.

Growth, due to lower taxes, is supposed to be the panacea, the thing that makes the economy keep chugging along, the thing that cures the debt problem. How, exactly, lower taxes will increase growth is yet to be shown. Of course, lower corporate taxes will result in higher corporate earnings, but this is not real growth. It is simply a swollen bottom line due to a lower expense.

Then there is the expectation of higher wages because corporations will have lower taxes. The stage may be a large one, but this is not a stand-up routine, comical as it is. If wages go up, it won’t be because of lower taxes. A handful of companies have announced bonuses for their employees, but I suspect that action to be no more than a tax ploy, one that will not continue.

I recognize that all of the hoopla around the new tax bill is political posturing, phrases and constructs designed to allay the populace so that political ends can be reached. In the end, there is not likely to be much change to the ordinary American’s life.

Nevertheless, one can posit that the lower tax on corporations will lead—has led—to higher stock valuations; it is precisely that opinion that accounts for the ebullient stock market of 2017. While a good bit of fear leads me to be carrying higher cash balances than normal in my equity accounts, still I hope that the rise can continue into the New Year, as seems likely. We all love a bull market, even if it makes us nervous.

As for Bitcoin, and the multitude of other “cryptocurrencies,” my opinion is that we will be best served by simply observing. I don’t know if we are witnessing something like the tulip mania of the early 17^th century, or a seismic shift in currency and banking, but it is undeniably a very dangerous place to be. Money comes too hard to gamble away. But the show should be a good one. I suggest we watch from the comfort and safety of the sidelines.

I wish you a happy, healthy and prosperous New Year.

Jim Pappas