Windsor Brief for November 2020
This edition of the WindsorBrief examines the impact of White House policies on various asset classes and sectors. Although Presidential policies can influence future returns in specific industries or asset classes, longer term the market is driven by the economy, earnings, and interest rates. As we look forward, we are always looking at all the pieces of the puzzle and how each new piece will help shape the long-term investment mosaic we are piecing together.
In addition, to investment commentary, we also examine possible changes to the Federal estate tax laws, which will sunset in 2025. In the Planning feature below, we provide an overview of what potential changes may be coming for estate tax law. Year end is an appropriate time to revisit estate tax planning and with changes on the horizon, it may be very timely for those impacted by changes in the estate tax. Contact us if you would like to talk over your current estate plan.
Investing: The impact of presidential policy and investment opportunities
The 2020 Presidential election, as of this writing, is just a day away. While everyone is focused on voting and discussing who will be the President for the next 4 years, we remain focused on investment opportunities for the next 4 years and beyond.
The primary driver of both the stock and bond market will always be the overall economy. The economy is driven by economic data, company earnings, interest rates and inflation. However, these factors can be influenced by policies coming out of the White House. Below, we will look at how the market could be influenced by policy platforms of each candidate.
Based on history, who occupies the White House is not as relevant to investments outcomes as some may believe. History shows the stock market is typically in positive territory 6 and 12 months out from a Presidential election, regardless of the outcome. Likewise, the market is typically down slightly the first month or so post-election as the uncertainty of policy that will be shaped becomes clearer.
S&P 500 Performance, 12 Months Following Presidential Race
Specific policies can be one factor to consider and can impact on how investors will view a specific asset class. For instance, one potential investment shift could be between domestic and international equities. A weaker dollar would benefit non-US stocks, US companies with high foreign revenue exposure, and US industries that are impacted by the dollar such as energy. Historically, a weaker dollar occurs if an opposing party wins an election, as shown below.
Post-Election US Dollar Average Performance
Based on history and announced policy choices, a weaker dollar going forward would be the most likely outcome of a Biden presidency, therefore making those types of investments mentioned above potentially more appealing.
Under a continuation of a Trump administration, the market would expect to see a continuing opportunity in small cap stocks. This is based on evidence that small cap stocks tend to outperform in periods of lower capital gains taxes. Based on the current capital gains tax rate, and even more so with the proposed cut to 15% laid out in August of this year, small cap stocks should benefit. As shown in the chart below, a lower capital gains tax rate typically leads to small cap stocks outperforming large cap stocks, while higher capital gains tax benefits large cap stocks.
Small Caps Relative to Large Caps & Capital Gains Tax Rates
While both parties talk of a large infrastructure bill, it is expected Democrats would pass a larger scale package. A bill passed by either party would be positive for industrial stocks overall. However, highway, rail, water, green energy and 5G spending would most likely disproportionably benefit under the Democrats’ Moving Forward Act of June 2020.
Turning to the regulatory environment, under a Trump second term, we would expect to see continued deregulation across multiple industries. The largest beneficiary has been and would continue to be the financial services industry. Under a Trump Presidency, financials could be a prime beneficiary of continued deregulation, though there are still other forces at work, such as low interest rates, that are hampering financials currently. Materials and energy are two other sectors that would benefit from deregulation going forward.
Finally, we take a look at real assets, such as gold. As shown below, gold is highly correlated with government spending. As both parties will most likely look to pass, at a minimum, some sort of stimulus package and an infrastructure package, we would expect fiscal spending to continue its upward trajectory.
Federal Government Spending & Gold Price
Markets are continually discounting uncertain outcomes, and what the market ultimately wants is certainty. Once the election results are decided, markets will reward different sectors and asset classes based on valuations and fundamentals. Those factors are influenced by policy, but even more so by the overall direction of the global economy which is likely to be in recovery mode in 2021. That is why investing in the context of each client’s specific portfolio allocation is the key to success. Many aspects of elections, especially heightened political rhetoric, are noise from a financial perspective. We remain focused on analyzing policies, which are just one aspect that impact fundamentals and valuations in a portfolio allocation. Again, it’s important to remember that the markets themselves are complex and hard to predict. Adhering to a target investment allocation based on financial objectives and your risk comfort zone is the wisest approach.
Planning: Potential impact on the federal estate tax
The 2020 estate tax exclusion amount is $11,580,000 per person - this is the amount that is not subject to federal estate taxes. Estates in excess of this amount are currently taxed at the 40% estate tax rate. The exclusion amount could also be used for lifetime gifts and reduce the amount remaining for the estate. This exclusion amount is scheduled to sunset after 2025 and automatically reduce to an inflation adjusted $5,000,000. Presidential candidate Biden has proposed to reduce the exclusion amount back to “historical norms” (estimated between $3.5 – 5 million per person). The chart below shows the historical exclusion amounts over the years. Regardless of who wins this November, at some point it is likely that the exclusion amount will be reduced from its current level based on the current law.
Federal Estate Tax & Top Tax Rate
When considering methods to reduce potential estate taxes, the strategies can start out simple and range to complex. Below are some strategies that Windsor can help you evaluate based on your financial goals:
- Annual gifting program – each individual donor can gift up to $15,000 per donee each calendar year (this is referred to as the annual gift tax exclusion amount). This gift could be made outright or to a trust. College funding 529 plans have a special rule that allow 5 years of annual gifts to be made at one time.
- Direct medical expense or educational tuition payments – there is no annual limit on payments made directly to medical providers or educational institutions (tuition only). Direct payments do not count against the annual gift tax exclusion limit.
- Utilizing your estate tax exclusion amount in your Will or Revocable Trust by setting up an exclusion trust for your beneficiaries. The exclusion amount will be based upon the rules in existence at death.
- Lifetime planning could also involve the following:
- Large Outright Gift – Utilize your estate tax exclusion amount now for an outright gift made during your lifetime. The future growth on the assets are removed from your taxable estate.
- Limited Liability Company or Family Limited Partnership – transfer funds to the LLC/FLP and gift nonvoting interest to family members. The lifetime gift amount is discounted based on lack of control and lack of marketability. In addition, the future growth in the gifted interests occurs outside of the original owner’s estate.
- Spousal Lifetime Access Trust (SLAT) – gift funds to an irrevocable trust for the benefit of your spouse. The SLAT can provide for the spouse’s needs but cannot provide any benefit back to you. At spouse’s death, remaining funds go to named beneficiaries and are not included in spouse’s taxable estate. This strategy could lock in the current large exclusion amount.
- Grantor Retained Annuity Trust (GRAT) or Intentionally Defective Grantor Trust (IDGR) – both strategies are designed to remove future growth from your taxable estate.
For charitably inclined individuals, there are many options that can be used to redirect funds that would otherwise be subject to estate taxes. These charitable gifts can be made either during lifetime or through estate distribution documents.
- Outright Charitable Gifts – made during lifetime could include gifts of highly appreciated securities or through an IRA Qualified Charitable Distribution if over 70 ½.
- Donor Advised Fund or Private Foundation – a large tax-deductible contribution can be made upfront to the DAF or PF and then funds can be distributed annually to charities. The chosen structure will depend upon the desired level of control and charitable intent.
- Charitable Remainder Trust (CRT) or Charitable Lead Trust (CLT) – a CRT will pay the income beneficiary an annual payment for a set number of years or for their lifetime. Upon the end of the term or the income beneficiary’s death, the remaining property is distributed to the charity. A CLT makes annual distributions to the charity for a set number of years and then the remaining principal is distributed to the remainder beneficiary.
While we have been having conversation with clients who will be exposed to lower federal estate tax threshold, we encourage further conversations after election results are decided.
Thank you for allowing the Windsor Wealth Management Team to continue to earn your trust and confidence in the services offered to you. We appreciate your loyalty and always welcome feedback from you.