What's Your Forecast for the Stock Market?

My brother asked me what my forecast for the stock market was. Here is what I wrote to him:

"Well, I’ve been surprised how weak it has been recently, particularly in December, which you may have heard is so far the worst December in US stock markets since 1931. December is a seasonally strong month as is January. The US economy has been strong though house prices have been falling in many places, presumably due to the Fed raising interest rates and this seems to have been the main reason why the market is down. House prices have been falling in Sydney and Melbourne without any increase in interest rates here. Some indicators though show that the global economy could already be in recession, but I don’t know how reliable that is. The reason I was a bit surprised was it has been very predictable that before recessions the yield curve would invert (short term interest rates higher than long term). This hasn’t happened yet in the US. However, the Fed is signalling that they are going to raise interest rates by another 0.5% in 2019 which would reach an inversion probably. Stock markets tend to be leading indicators and so looks like this time it is more leading than usual. The US economic expansion is the 2nd longest in history and so presumably would come to an end some time soon (Australia hasn’t had a recession since the early 90s though…). Now we can say that the bull market ended as stocks have fallen 20%. If we look at the last two recessions and stock market crashes in the US, the stock market bottomed near the end or after the actual recession – in March 2003 and 2009. At that point the Fed will have slashed interest rates dramatically and unemployment will be high. OTOH in the 1990s the US market bottomed in October 1990, which was when the recession was only just getting underway. The Gulf War turned that around.

I did reduce my exposure to the stock market in early October, but not by enough. So, I’d probably use rallies in the market to reduce exposure more at this point. I was planning to use trading as a hedge, but I stopped trading soon after that as backtests weren’t good and I got ill and didn’t have time to work on it.

Of course, I could be completely wrong about all of this. In the last cycle I got out too early and got back in too early. Probably this time I’ll be late :)

I’m not planning on buying Australian Dollars in a hurry either, even though the current price is quite good. I’ll buy them gradually."

No Interest on More Than $2 Million Deposit?

My brother and I have between us more than USD 2 million in cash in an account at UBS – most of the money we inherited – that we have been jumping through hoops to get out of there. In the meantime the bank seems to be paying no interest on the money and in the last two weeks it actually the account went down by USD 800 for no clear reason – online I can't find any info on fees the bank has charged. How is that possible?

Looks like we have everything in place now to close the account but have been told it'll take about 2 weeks still given the coming holidays etc. However, the client manager told my brother that she could transfer the majority of the money to us right away, while keeping some for unspecified fees and sending us the remainder not spent on fees later. My brother told her that he was happy to wait to get the money in one lump when they close the account. I was shocked and told him to accept her offer. It's hard for me to imagine that the extra fees for a second transfer could be more than the interest we could potentially earn on the money in two weeks (c. USD 2,000 if investing in US Treasury bills).

Update: We missed the client manager leaving for the Christmas break, so likely won't be till mid-January that we'll get the money out...
Another update: Actually, we now got about 90% of the money transferred to us. Why they need to hang on to a 1/4 million dollars, I don't know...

Will Listed Investment Companies Restructure if Labor Eliminates Refundability of Franking Credits?

As you probably know if you live in Australia, Labor plans to abolish the refundability of franking credits - the tax credits attached to dividends for company tax already paid. This will affect taxpayers with low marginal tax rates including self managed superfunds that are paying out a pension, which is tax free if they have less than AUD 1.6 million in assets for that member. This could significantly cut the retirement income of self-funded retirees who have a lot of Australian shares. OTOH, this was the policy prior to 2000 and most other offsets, like foreign tax credits, aren't refundable either.

I already plan to have relatively small amounts of Australian shares when I start an SMSF - this makes sense as I have lots of investments outside super and so it makes sense to put the least tax efficient investments like managed futures into super.

Listed investment companies (LICs) are closed-end funds that pay tax on their earnings and then distribute franked dividends to shareholders. I own shares in several of these like Platinum Capital, Cadence Capital, Hearts and Minds, and Tribeca Global Resources. Both Geoff Wilson and Cadence Capital's Karl Siegling have suggested that they will reorganize their funds if this happens. There are a couple of ways this could happen. One I had thought about, is to delist and turn the fund into a unlisted managed fund (mutual fund). For funds that trade at a premium to NAV, like several of Wilson's funds, this would cause investors to lose a lot of money as now their holdings would only be worth the NAV. For funds trading at a discount to NAV it could be attractive, as shareholders would gain wealth (but see below). To the extent that the funds receive franked dividends from companies, they would still have to distribute franking credits, but capital gains would no longer create franking credits.

Another option I didn't know about, is that they could instead convert to a listed investment trust like an ETF that doesn't pay taxes. This solves the problem of wealth destruction for funds trading at a premium to NAV.

But the article I linked says that this would result in realization of the portfolio for tax purposes. This could be a huge tax bill for companies like Argo that do little trading. The funds will need to pay out a massive special dividend to distribute the associated franking credit. According to Argo's website they will need to pay 72 cents in tax for liquidating the portfolio. That means they would have to pay a $1.68 cash dividend and so actually sell 23% of the portfolio to pay the dividend out. Some other funds have undistributed franking credits and so would also need to sell shares to generate the cash for such a dividend. They will need to do this soon, as there will probably be an election next May. So, I am a bit skeptical that many will.

Was It a Good Decision to Switch to Defined Contribution Superannuation?

Back in 2009 when I started with my current employer, I carried out a cost-benefit analysis to see whether it made sense to stay in the default defined benefit scheme or to switch to the defined contribution scheme. As a result of the analysis I switched to defined contribution.

Was that a good decision. Using the info in the Unisuper PDS and my data I compute that if I retired at the end of this month I would get a lump sum of AUD 213k. My actual Unisuper account is at AUD 284k. So, so far it's been a good decision.

For context, in Britain, there have been strikes and demonstrations against the plan to switch academics from  defined benefit to defined contribution. But I see defined benefit as a regressive form of socialism where people who are promoted near the end of their career suck the benefits from the system. This is because the lump sum benefit is proportional to the members salary in the last 5 years. I've seem quite a few people promoted to professor in their last few years and of course, deans and other senior administrators benefit heavily from the scheme. This is at the expense of successful researchers who are promoted early and stay in research at a more or less constant salary.