2017 Q4 Letter to Clients

January 10, 2018

Dear Clients,

In writing this letter, we reflect on the year and try to use this thinking to not only understand what occurred, but also help us shape our thinking for what lies ahead. These retrospectives conjure images, both positive and negative, about the path behind us and compel us to think what surprised us most.

Review of 2017

The most confounding event that occurred in 2017 must be the disconnect between the political discord and the rise in financial markets. Despite concerns that political acrimony and legislative uncertainty would bring increased market volatility, markets saw little downside activity and experienced a dramatic rise. The S&P 500 rose 6.1% and 19.4% for the fourth quarter and year, respectively.

Much of this climb was the continued momentum in corporate earnings growth, multi-year lows in unemployment, and steady GDP growth. A significant boost to these underlying fundamentals was the impending change in tax reform and ultimately, legislation. Starting in 2018, the US corporate tax rate will decline from 35% to 21%; this is a meaningful boost to earnings growth.

On the international front, news was fairly muted during the quarter. North Korea insists on a tactic of saber rattling but the market appears to take these threats with a grain of salt. During the year, BREXIT took centerstage. Since the referendum, talks have been ongoing between Britain and the EU. Currently, Britain is set to leave the EU in March of 2019 and issues of trade, immigration, and monetary settlement with EU have yet to be resolved. Given this, the MSCI EAFE, an index that measures the market across developed markets in Europe, Australia, and the Far East, increased 5.3% for the quarter and 12.2% for the year. Asia in general was a strong performer with the Nikkei growing 11.8% and 19.1%, for the quarter and year, respectively.

Fixed income markets continue to struggle to perform against the backdrop of rising rate environment. Despite this, the Bloomberg Barclays US Aggregate Bond index increased 0.4% and 3.5% for the quarter and year, respectively.

Crypto assets

One headline that became a recurring theme, especially during the fourth quarter, was the rise of crypto currencies. Given the fandom that this asset class has created, due in no small part to Bitcoin's meteoric rise in 2017, we thought it would be beneficial to provide our perspective as well as offer some technical insights.

Bitcoin started the year at about $1,000 and closed out 2017 over $13,000 (after having surpassed $19,000 in December). This rapid price increase is largely the extent of what people know about this emerging asset class. When an asset experiences this type price appreciation it can certainly feel like something one is missing out on, but before you rush in to buy, we would like to explain what it is and what it is not.

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Source: Coindesk / SVWA

Bitcoin is a digital asset. It is commonly referred to as currency, but that is not entirely correct as it lacks the backing of a government to be considered legal tender. We feel it is more comparable to a commodity. Some compare it to gold in that it possesses no intrinsic value but can act as a store of value. What makes trading in digital currencies more speculative is that 1) they are relatively new and not well understood, 2) there are dozens of competing assets trying to accomplish the same thing.

It certainly does not help clarify its legitimacy when some of the most well-respected leaders in the financial community cannot agree on the asset class. For example, In September Jamie Dimon, CEO of JP Morgan Chase offered his perspective on Bitcoin by saying it "is a fraud." On the other hand, wealthy investors like Mark Cuban are invested in the asset but quick to cite its speculative nature.

Adding to the confusion is the fact that, as of this writing, there are 1,386 crypto assets currently available according to the website coinmarketcap.com. This can make it even more challenging to know if what you are investing in is sustainable, or just a fad.

More important than the crypto assets themselves is the technology that is driving its capabilities. This technology, called blockchain is a foundational technology that could change the way transactions occur across the internet. It enables a seemingly incorruptible digital ledger of economic transactions that could make hacking a thing of the past. It will take decades for this technology to evolve and become mainstream.

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Source: blockgeeks.com

We see investments in crypto currency as extremely speculative, and we stop short of recommending that you add crypto assets as part of your diversified portfolio. We are excited about it, and continue to monitor the possible long-term ramifications for both crypto currencies, and for the underlying blockchain technology.

Taxes

Over 80% of Americans will get a tax cut next year, while just 5% of taxpayers are expected to pay more. In most cases, cuts are expected to be modest; however, much will depend on individual circumstances.

We encourage you to check with your tax advisor, but thought we wouldoffer a summary. Many experts are struggling with the details of the bill, and that is to be expected this early in the game.

This is by no means a detailed list - it is not all-inclusive and not a deep dive - but given that you may have several questions, we thought this would be a good start.

The 10% bracket remains unchanged, while the 15% bracket declines to 12%, the 25% to 22%, the 28% to 24%, the 33% to 32%, the 35% holds steady, and the 39.6% slips to 37%. The thresholds are modestly adjusted above the new 22% bracket.
The standard deduction nearly doubles to $12,000 for single filers and $24,000 for married filers, reducing the incentive to itemize and simplifying for some taxpayers.
The $4,150 personal exemption is eliminated, and the $1,000 child tax credit doubles to $2,000. In general, rules for charitable contributions remain unchanged.
By itself, the combination of points one, two, and three will provide modest tax relief for most families. But I must caution, it depends on your individual circumstances.
Those in high-tax states could see the biggest hit, as there will be a $10,000 cap on state, local and property tax deductions.
For investors, the preferential treatment for long-term capital gains and dividends remains intact.
One important change - the new law repeals rules that allow for recharacterizations of Roth conversions back into traditional IRAs. Once you convert into a Roth, there is no going back.
The 3.8% Medicare surtax on investment income for high-income taxpayers was retained.Since the levy entered the tax code, we have crafted strategies that reduce its bite; however, the tax survived tax reform and is likely to remain a permanent feature of the tax code going forward.
The AMT for individuals was not repealed, but exemptions have been widened.
The estate tax survived, with the exemption doubling from $5.6 million to $11.2 million for individuals, and $11.2 million to $22.4 million for couples with portability.
The new tax bill also repeals the Obamacare mandate that requires all individuals to obtain health insurance. It becomes effective 2019.
Finally, it is important to point out that many of the more popular changes in the tax code for individuals will sunset in 2025. While many may eventually be made permanent, as we saw with the Bush tax cuts of 2001 and 2003, there is no guarantee this will happen again.
And for businesses: Given that the 21% corporate tax rate applies only to C-corps, there will be a 20% deduction for pass-through entities, such as S-corps, partnerships, and LLCs. I believe this will be a welcome benefit for many business owners, but complex rules may limit the pass-through for some entities.

We expect that the rewrite of the tax code will produce unintended benefits and unexpected consequences.

From an economic standpoint, Congress and the president hope to unleash the "animal spirits" that have been lethargic for much of the economic expansion. They hope that changes, especially as they relate to business, will encourage firms to open new plants, expand in the U.S., and level the playing field with the global community.

Of course, the real question is - will it work? About 90% of economists surveyed by the Wall Street Journal expect a modest boost to growth in 2018 and 2019, but after that, opinions diverge. If tax incentives boost productivity, it could lift long-run GDP potential, which would yield a significant benefit. If the economic benefits end after a two-year sugar high, it will likely be deemed a failure.

Early anecdotal data offer some encouragement, as several large firms announced year-end bonuses or wage hikes tied to the lower corporate tax rate.

At a minimum, the lower tax rate increases longer-run after-tax earnings, which played a big role in the late-year stock market rally. It could also boost corporate stock buybacks and dividends going forward, which would create an added tailwind for stocks.

Summary

The question on the minds of many investors centers around the concern of an overheated market. So, does a sharp upward advance in one year set the stage for a pullback in the following year? Not if we use the historical data as our guide.

Since 1950, the S&P 500 has risen at least 20% in 24 separate years(including reinvested dividends, excluding 2017). In each subsequent year, the S&P 500 finished higher 19 times. Put another way, the S&P 500 rose 79.2% of the time in years that followed a 20% or greater advance, with an average gain of 18.1%. When the S&P 500 has declined following a 20%+ advance, the average drop has been 6.5%.

Based purely on the example above, last year's impressive advance has little predictive value, with one exception. It simply tells us that stocks have aninherent upward bias over the longer term.

What will impact shares next year?

Longer term, it is always about the fundamentals, i.e., economic growth and profit growth. Low inflation and low interest rates only sweetened the pot last year. The momentum generated by a growing U.S. and global economy is likely to carry over into the new year. While a 2018 recession cannot definitively be ruled out, leading indicators suggest the odds are low. That said, unexpected events can create short-term emotional responses in the market that are best avoided by long-term investors.

Last year's lack of volatility was simply remarkable. According to data from LPL Research and the St. Louis Federal Reserve, the biggest drop in the S&P 500 amounted to just 2.8%. It was the smallest intra-year decline since 1995. The average intra-year pullback for the S&P 500: 13.6%.

This is an excellent reminder that volatility is typically a part of the investment landscape. It can sometimes be unnerving, but it is incorporated into the investment plan we have implemented for you.

As always, we appreciate your confidence and welcome your questions.

Gratefully yours,

The Silicon Valley Wealth Advisors Team

Tracy Lasecke, CFP^®
Chris Duke, CFP^®
Scott Yang, CFP^®, CPA
Heidi Graham
Adam Gelhausen
Robert Lopez
Alison Lee
James Karel

References:

What We've Been Up To

Tracy and Roberta suffered through a bathroom remodel which of course took more time and money than anticipated. They are pleased with the results and are happy to have the project behind them.Compared with the prior quarter, with the excitement around the appendectomy in Switzerland, the end of the year was reasonably quiet.

Jim celebrated the advent of winter season by acquiring some boots and skis for the first time in 40 years. He then managed numerous slopes on Schweitzer Mountain in Idaho while skiing over New Years with kids.

Chris and his family had a relatively quiet holiday season, spent at home with family and friends. It was a great opportunity to reflect on the year - accomplishments, loss, and watching the kids thrive and grow, as well as to start setting big goals for 2018 and beyond.

Adam had a great holiday with the family, enjoying school Christmas plays, skiing, and spending time together. Plenty of snow and time leaves lots of time for more winter activities. Looking forward to a prosperous year!

Scott and family spent a quiet 2 weeks at the end of year with family and friends. The kids had basketball games so they needed to stay local. He is hoping for snow in the mountains soon.

Robert and his wife Shirley are looking forward to taking more trips in the new year. First will be a few days in Seattle with a large group of friends, and the second will be a weekend trip to Tahoe to enjoy the snow. Robert recently completed the final course of his Master's Degree in Personal Financial Planning, and is actively studying for the Certified Financial Planner (CFP^®) Exam.

Ali and Guy are really excited for all the new challenges that are coming their way in 2018. At the end of May, they will become a family of 3. Ali is only now starting to not hate pregnancy, and the excitement of getting to meet their daughter Penelope Leiora is helping her through. As the first grandchild in her family and the 14^th in Guys, there is a lot of excitement all around.

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