The Tax Cut and Jobs Act of 2017, together with rising interest rates have changed the calculus in determining whether to pay down your mortgage or let it ride. Let's examine the pros and cons.

 

Over the last 10 years, as interest rates fell to almost zero, it made total sense to pay off your high-interest mortgage. At the very least, one could re-finance and save on monthly payments. This was especially true if your mortgage was in the last stages of a 30- or 15-year life.

 

At that point, the interest portion of the payment, (which is tax deductible) was minimal, while the principal payments represented the lion's share of the monthly bill. For those with new mortgages, or who refinanced at record-low interest rates, the interest banks charged composed most of the payment (and thus a larger tax deduction), so these buyers had fewer reasons to prepay.

 

All this changed with the new tax act. There is now a cap on how much of a mortgage interest deduction one can claim. Worse still, if you are unlucky enough to live in a state with an income tax, the cap on the mortgage deduction is combined with a cap on state income tax and property taxes deductions. In short, the higher the interest payment on your mortgage, the less tax incentive you have to carry a mortgage.

 

However, there are some positives to this mortgage equation. Interest rates have already begun to rise, although not by much. If rates continue to rise, at some point, some homeowners will have lower mortgage rates than the interest rates they could obtain in the prevailing market. They would have borrowed "cheap" money at a fixed rate for an extended period. Of course, all bets are off if you have an adjustable rate mortgage or home equity loan. In these loans, your payments rise along with interest rates.

 

However, for some Americans, an aversion to debt can be an overriding factor in holding a mortgage. We are a nation of debtors overall. But as we grow older, many retirees facing a decline in their income, realize that paying down their debt raises their chances of a satisfying, worry-free retirement. There are others who just hate owing money or resent paying that "pound of flesh" the lending institution demands for the loan.

 

Putting those emotional issues aside, the key question to ask as a financial planner will always be what is the best use of capital? Can I make more by paying off my loan or keeping it and investing my extra money elsewhere in something that is yielding even more than my mortgage rate.

 

Given the lower tax incentives for owning a mortgage, why hold a mortgage at all?

 

Let's take an example. Pretend you are 65 years old, have no debt, except a 30-year fixed, 3.5 percent mortgage.  As a retiree, if you are going to pay off your 3.5 percent mortgage, you want a safe, guaranteed return on your money that is higher than that. Certificates of Deposits, therefore, make the most sense. Right now, the best three-year CD rate is around 3.1 percent.  So, you would still be making more by using any extra cash in prepaying your higher rate mortgage than putting your money in a CD, but not by much.

 

As rates move higher, your fixed-rate mortgage looks better and better. Fast forward a year, and now CDs are yielding 4 percent. In which case, it would make more sense to invest your extra cash in that higher-yielding CDs than paying off your mortgage. In a sense, you are borrowing cheap 3.5 percent money and investing it in an investment returning 4 percent.

 

Given that you will still be receiving some reduced mortgage interest tax benefits under the new tax rules, this example needs to be adjusted for that tax benefit depending on your state of residence. Remember too, that in retirement, you may need cash when you least expect it. Medical emergencies, a new car, home repairs—all seem to crop up when you least expect them. As such, liquidity will be an important variable in your financial line-up. As such, prepaying your mortgage will usually require a severe decline in your available cash. 

 

I guess the good news is that after a decade of low-interest rates and high tax mortgage deductions, the worm has turned. This opportunity may provide conservative investors with alternative investments to at least think about and monitor in the future.

 

Bill Schmick is registered as an investment adviser representative and portfolio manager with Berkshire Money Management (BMM), managing over $400 million for investors in the Berkshires.  Bill's forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquiries to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.

There was a time, back in the late Nineties, that publicly-traded stocks were the envy of all companies, great and small. But times have changed, and since then the number of public companies have fallen by 50 percent.

 

You might have missed that trend, however. That's because the market capitalization of equities has been increasing for a decade. This year the market cap of the U.S. stock market hit a record $32.2 trillion. Globally, the World Bank estimates stock market capitalization is above $80 trillion. The largest contributor to this trend has been the large increases in stock prices.

 

Bottom line: investors are simply bidding up the prices of existing stocks in an incredibly shrinking market.

 

The peak year for publicly-traded companies was 1996 when there were over 8,000 companies listed. Since then the number has gradually decreased until today, where only 4,336 companies remain in the public sphere. The same trend has been identified in developed markets around the world. European and Canadian stock market trends mirror our own with listed companies falling by anywhere from 20 to 60 percent overseas.

 

There are several reasons why listing your company on an exchange has lost much of its luster.

Most companies complain of an increasingly complex and expensive mountain of governmental and industrial rules and regulations they are required to obey. Despite the Trump administration's effort to reduce this onerous burden, few companies are planning to reduce their law departments any time soon.

 

Then there is the media and an increasingly active shareholder base. Every move, every action by management is scrutinized, analyzed and sometimes reported inaccurately by the financial media. Shareholders, both active and passive, respond to the news in a vicious circle of give and take. Short-term activists demand change to "increase shareholder value." Often, these same activists are only interested in goosing the stock price for their own benefit over the short-term.

 

That's because public companies are increasingly judged by their short-term results. Quarterly earnings performance is a do-or-die event for managements. Wall Street analysts demand guidance on sales and profit numbers that better come in on the nose or else. And more and more of top management's time is spent appeasing these analysts, shareholders and the media. All of which takes time and effort that could be better spent on running their company.

 

The nature of the stock market has also changed. Back in the day, when a company needed to expand, it went to the stock market to raise that capital. The public market also provided a means for the owners and employees of private companies to "cash out" their sweat equity. But today, there are other means to accomplish the same ends.

 

More and more large private companies do not need to be listed to raise capital or reward employees. Venture capitalists and other well-heeled investors are only too happy to provide the money in exchange for ownership in the future growth of these private companies. As a result, more and more companies are waiting to go public, enjoying more of the fruits of their labor and sharing less of it with public shareholders.

 

Leveraged buyouts (LBOs) have also come into vogue. Managements, fed up with the demands of their public companies, have chosen to take their company private by enlisting outside investors to take the company private through purchase of their stocks. These LBOs come in all colors and stripes and have played a big role in the ever-shrinking number of public companies.

 

Given the nature of the stock market and its participants today, staying or going private may be the right decision for many companies. The downside is that we, their potential shareholders, are being shut out of the opportunity of participating in the lion's share of profits and growth of these future Apples or Googles. Instead, we are simply forced to pay more and more for the same old lineup of public companies.

 

Tariffs on $34 billion in Chinese imports were imposed, as expected, last week. China responded with $34 billion of their own tariffs on American imports. So far, this has been a zero-sum game. The question that investors are asking is whether or not the trade war will escalate.

 

I could say that this entire trade spat has been "much ado about nothing." The total amount of trade tariffs and counter tariffs don't add up to much given that China is a multitrillion-dollar economy. The war of words and threats between our once-allies, our antagonists, and the president, amount to much more.

 

Right now, Trump's statements would indicate he is ready to impose $500 billion on Chinese imports alone. If the Chinese (as they have promised) respond by levying a like amount on U.S. goods, we could see $1 trillion or more in additional tariffs. That would hurt the U.S. every bit as much as it would hurt China. If we also consider Trump's trade war on other fronts — Europe, Asia, emerging markets — then, look out below.

 

We also need to consider how this tariff issue will impact consumer and business confidence. If the tariff threat escalates, it will damage confidence, which, in turn, will reduce the potential for spending and capital investment. That would lead to an abrupt and sudden decline in economic expansion and the end to the bull market in stocks.

 

How likely is that? Not very, in my opinion; at least for now. In the meantime, the president and his men have managed to turn our allies into antagonists, while giving the Chinese an opening to fill the vacuum we are creating in U.S. international trade. America's attitude toward this development is predictably smug.

 

"The world needs our goods, especially technology," say the protectionists, "so what do we care that the Chinese will gain market share at our expense?"

 

As someone who has spent half my career investing in foreign markets, I can tell you that attitude is naïve at best. The global marketplace is extremely competitive. Companies respond to protectionism by moving jobs, plant and equipment to the areas that offer them the highest competitive advantage while down-sizing in those areas that don't.

 

This is already happening here at home: "Capital spending had been scaled back or postponed as a result of uncertainty over trade policy," wrote the Federal Reserve Bank in its latest meeting minutes. U.S. companies "expressed concern about the possible adverse effects of tariffs and other proposed trade restriction, both domestically and abroad, on future investment activity."

 

Consumer spending also slowed in this year's first quarter, registering the weakest growth in five years. The jury is still out on that front, however. We will need to see the second quarter numbers before we make a judgment call on spending.

 

Another unrealized impact of tariffs will be their contribution to the inflation rate. Tariffs do one thing: increase prices. While most investors worry about a tariff war's impact on overall trade, much of world trade will continue, but at higher prices. Tariffs are simply price increases levied by governments and paid for by consumers and business.

 

The markets are expecting a gradual increase in interest rates as the U.S. central bank works to normalize interest rates after years of easy monetary policy. What they fear most is a spike in inflation. They are already concerned that U.S. labor shortages are reaching a critical point. As companies compete for workers, wage growth will rise and with it the inflation rate.

 

The last thing the economy needs right now is a trade war, but it seems the president, in his wisdom, believes the opposite. Let's hope he knows something that we don't.

 

What's up with the dollar? The greenback is strengthening and is having its best quarter since 2016 against an array of foreign currencies. Is this an accident, or is it something far more dangerous?

 

Economists will tell you that the Trump tariff crusade is responsible. New trade barriers, which the president is suggesting, would usually lead to higher prices at home, according to economic doctrine. Products we import would cost more, whether we are talking about steel, automobiles, or baseball caps.

 

As prices increase, so should the U.S. inflation rate. As inflation rises, bondholders will demand higher interest rates to keep up with inflation. In turn, higher interest rates would normally lead to a stronger dollar. In the real world, this explanation is not so cut and dried.

 

There could be any number of macro scenarios that I could spin, which could alter the dollar's rise. For example, the Fed (which controls U.S. interest rates) could decide not to raise interest rates for other reasons. The impact of tariffs might also end up being so minor that prices barely budge. In other cases, breakthroughs in technology (such as oil and gas fracking) or in a manufacturing process could lower the cost of certain products even while others are going up due to the tariffs.

 

The dollar's strength or weakness will also depend on what is happening overseas. The economic conditions of other nations will impact their own currencies relative to ours.  In many countries, the exchange rate is not determined by market forces, as is the greenback. In many cases, currencies are controlled by a central government. A currency could be "pegged" to the U.S. dollar, or to a basket of currencies. It could rise and fall in a pre-set range pre-determined by the government's central bank. Governments can also control how much of any currency their citizens may own.  

 

In a trade war, like Donald Trump appears to be waging, a country can use its currency to countervail the price impact of tariffs on their exports. Let's say you are a Chinese manufacturer of Major League baseball caps. You compete with one of two American companies. They may make a better product, but also charge more for it, let's say 10 percent.

 

So, being a great patriot and baseball fan, the president decides to slap a 10 percent tariff on all baseball caps imported from China. Now, the Chinese manufacturer has neither a price or quality advantage. His sales suffer and America "wins." However, the Chinese government could alleviate the situation by allowing their currency to devalue by that 10 percent. In this case, the cost to the American importer of Chinese baseball hats remains the same, because it now costs him 10 percent less (in U.S. dollars) to buy the hats. 

 

Fast forward to today. The latest salvo in Trump's trade war is to threaten to raise the amount of Chinese goods taxed by the U.S. to $450 billion. That would mean that tariffs would be applied to nearly all the $505 billion in goods that China exported to the U.S. last year. That would be a real blow to the Chinese economy. To soften that blow, China could decide to let their currency, the yuan, weaken to the point that the impact of tariffs would be erased.

 

In the past two weeks, the yuan has fallen three percent against the dollar. It is still up about 5 percent against the greenback over the last year, but that can easily change. Is the Chinese government deliberately causing the decline?

 

If they are, you can't prove it. Going back to the economic models, one could argue that the tariffs Trump is planning to impose would damage the Chinese economy, slow growth, and weaken their currency. The recent decline could only reflect that fear among currency traders.

 

Whatever the case, China is not the only player that may be tempted to play this game. All of Europe and Asia will be hurt by American tariffs. It makes economic and political sense for nations to protect their own fortunes and those of their people in the event of a trade war. Some would argue that it is their duty to do so. 

 

Since all is fair in love and war, deliberately weakening a nation's currency in relation to the dollar in response to tariffs could be a smart move. Some might even argue it is the patriotic thing to do.

 

Bill Schmick is registered as an investment adviser representative and portfolio manager with Berkshire Money Management (BMM), managing over $400 million for investors in the Berkshires.  Bill's forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquiries to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.

Over half the economists on Wall Street believe that by the end of 2020, we will experience our first economic downturn in years. If so, when might you begin to prepare for a rocky two-year period for all of us?

 

The good news is that we still have another year or so of stock market gains, job growth and more importantly, wage growth. As it stands, the U.S. is currently enjoying its second-longest economic expansion in history with an unemployment rate that hasn't been this low in decades. Wage growth, after languishing for years, is expected to top 3 percent by the end of 2018, while GDP could achieve greater than 3 percent this year and a further 2.5 percent next year.

 

So how does an economy go from blue skies to dark clouds in so short a time? This economic expansion is now entering its final stage, according to economists. As the good times grow, investors and consumers tend to overborrow and overspend. That's human nature, but it almost always leads to inflation rising, which touches off a rise in interest rates that ultimately slows the economy.

 

By that time, consumers are back in debt and paying more interest on that debt, while corporations are stuck with an overabundance of goods produced that no one wants. So, everyone pulls back, causing the economy to slow, and the rest is history.

 

Normally, a recession will span a year or two before the economy recalibrates. In the meantime, the stock market falls anywhere from 15-30 percent and the mood is somber. I have seen it repeatedly in my career. And yet, for some reasons, investors always act as if this is some new startling new development.

 

The timing of a recession can always be called into question. Any number of things could prove to be a tipping point in ushering in a recession sooner than expected. In 1991, skyrocketing oil prices proved the culprit. In 2001, the dot-com bubble caused a year or two of declines, in 2007, it was a housing bubble. This time around there are several "what ifs" that could hasten our demise.

 

Right now, a global trade war, instigated by Donald Trump, could tip the economy (both here and abroad) into recession. Trump's latest threat: levying tariffs on almost $200 billion in Chinese imports, would certainly elicit a like response from the Chinese. Tariffs on goods of that proportion would drive both economies into recession.

 

A crisis in Europe could also hit us hard. Italy is none too stable right now. Populists forces might set in motion their exit from the European Community. That would cause a great deal of instability among European nations, the Euro, and their economies. That, too, could tip our country, as well as their own, into recession.

 

Oil prices might prove to be our downfall once again if geopolitical events among countries in the Middle East (Iran, Syria and Saudi Arabia) come to blows. An escalating conflict there would surely send oil prices back over $100/barrel with negative consequences for the U.S., as well as other global economies. 

 

Finally, U.S. interest rates could move higher in direct response to our president's actions towards our global allies and enemies. In the last two months, foreigners have reduced their U.S. Treasury holdings by about $10 billion. Russia has reduced their holdings by half. That is a relatively small amount, but as more and more governments realize that "Making America Great Again" will be at their expense, why should they hold our bonds?

 

China, for example, in response to Trump's tariff threats, could respond by dumping our treasury bonds. That would cause interest rates here at home to spike higher. That would cause even more panic among foreign holders, who would be happy to sell more of our bonds. I could see a nasty chain reaction, a sort of dot. com-like bond sell-off, which could spread throughout the economy and the stock market.

 

Barring any of these worries, however, we still have some clear sailing ahead for our economy. The stock market usually begins to discount a recession 6-9 month ahead of time, so it won't be for a year or more before we need to prepare for the inevitable, which would be just in time for the next election.