Covenant Weekly Market Synopsis as of April 7, 2017

April 10, 2017

Risk assets kicked off the second quarter on a modestly soft note, as domestic equities declined less than 0.5% for the week (following flattish domestic equity performance in March).  Small capitalization stocks (which were a major beneficiary of President Trump’s election) were an exception, falling 1.5% (as measured by the Russell 2000).  International developed markets moved lower as well as the Europe, Australasia and Far East (“EAFE”) Index declining 0.6%.  Emerging and Frontier market equity indices, however, were a relatively bright spot rising 0.6% and 1.7% respectively, and remain amongst the best performers year-to-date.  The yield curve continued to flatten, with the yield on 2-year bonds rising 0.03% while the yield on 30-year bond ended the week basically unchanged.  Precious metals were mixed (Gold +0.4%, Silver -1.3%). Despite a strengthening US dollar (+0.8%), WTI Crude moved higher by 3.3% to end the week at $52.29 per barrel.

For a detailed view of weekly, month-to-date and year-to-date asset class performance please click here.

 

Tax Time – Tax season tends to produce feelings of frustration, if not outright anger, at the IRS and government for scraping off a healthy portion of our annual income. Of course, most people understand that some level of taxation is necessary to provide funds for federal, state and local governments to provide defense, education, and social support – government programs associated with advanced societies. Nevertheless, a lot of people feel they are paying away too much of their income for these services. Yet, as a nation, U.S. citizens bear lower taxes than any industrial country, except for Ireland. In fact, U.S. taxes and social security contributions are more than 10% lower than the average of 21 other industrial countries and have remained relatively stable between 25% – 28% of GDP since 1990. [Sources:  BCA Research and the Organization for Economic Co-operation and Development (OECD), an intergovernmental economic organization founded in 1960 with 35 member countries.]

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Source: BCA Research

 

It is also worth noting that the form of U.S. taxes is different than in other OECD member countries. The U.S. relies heavily on taxing income and business profits to fund government services as opposed to consumption-based taxes (i.e. a value add tax or “VAT”) employed by other OECD members. In fact, the U.S. is the only industrial country without a VAT. Indeed, taxes on goods and services in the U.S. account for only 18% of government tax revenues vs. the 33% average for other OECD countries.

So, if U.S. citizens pay less into the system than other developed countries, why do so many our friends, and family members feel overtaxed? The answer likely lies in how corporate and personal income taxes are applied. For purposes of brevity, I will focus only on personal income taxes (though there are notable distortions in corporate taxes as well). The following data points are based on data from 2014, the most recent year in which detailed personal income tax data is available.

 

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Sources: IRS, BCA Research, Covenant Investment Research

As the graphic indicates, 55% of tax filers paid 100% of IRS tax receipts in 2014. As reportable earnings increased, so did the tax burden such that 4.2% of the nation’s taxable citizens paid 62.8% of total income taxes in 2014.

On average U.S. citizens bear a relatively low tax burden compared to our industrial counterparts, yet distortions in the way income taxes are applied skews the burden to high earners which is why so many people feel over-taxed. BCA Research suggests one possible solution is to begin employing a consumption-based tax and using the proceeds to reduce the marginal tax rate on high earners. The regressive nature of a VAT (i.e. disproportionately penalizing low income households) could be addressed by excluding certain items such as food, energy and children’s clothing. This may not reduce the overall tax burden of high earners (as they tend to choose to consume more), but it would more evenly spread government program funding amongst the populace.

Syria – President Trump’s decisive move Thursday night to respond to Syria President Bashar al-Assad’s use of a lethal nerve gas on its citizens was widely lauded by both political parties in the U.S. and many of our international allies. Saying that the situation in Syria is complex, is an understatement. If you are interested in gaining a better understanding of the major players within and outside of Syria’s border, I highly recommend this short, five-minute video: https://www.youtube.com/watch?v=NKb9GVU8bHE

 

Be well,

Jp.