Bob’s Journal for 11/25/21

House Approves ‘Build Back Better’ Bill With Retirement, Tax Changes

The House of Representatives finally approved the much-discussed $2+ trillion-dollar spending package last week.

Before you take any action, however, remember that the bill must be approved by the Senate. The Senate is likely to make changes. After that, either the House must approve the Senate version, or a conference committee has to approve a compromise version.

Most media coverage emphasizes the new money that would be spent under the law. But the drafters sought to have tax increases and other revenue-raising provisions that equal all the spending.

Here are some items in the Build Back Better (BBB) bill you might not have read about.

The BBB would limit the value of IRAs for higher-income taxpayers.

No contributions would be allowed to a Roth or traditional IRA during a taxable year if, at the end of the previous taxable year, the total value of the owner’s IRAs, 401(k)s, and similar accounts exceeded $10 million. This limit would apply to single taxpayers with incomes over $400,000 and married couples filing jointly with incomes over $450,000.

In a related provision, a required minimum distribution would be imposed during a year when, at the end of the previous year, the individual’s combined balances for all IRAs, 401(k)s, and similar plans exceeded $10 million. This provision would apply to taxpayers with the same income levels as discussed above, regardless of the taxpayer’s age.

The minimum distribution would be 50% of the amount by which the total balances exceeded $10 million. A higher distribution would be required when the aggregate balances exceeded $20 million.

These provisions wouldn’t be effective until 2029.

In addition, custodians of defined contribution plans, such as IRAs and 401(k)s, would have to report to the IRS and the plan participant any aggregate account balances exceeding $2.5 million.

The BBB bill also would eliminate the back door Roth IRA and mega back door Roth IRA strategies. This would be done by prohibiting all after-tax contributions in a 401(k) plan or traditional IRA from being converted to a Roth IRA. This prohibition would apply to taxpayers at all income levels and would be effective after 2021.

Another provision would prohibit conversions of traditional IRAs or 401(k)s to Roth IRAs for single taxpayers with taxable incomes above $400,000 and married couples filing jointly with taxable incomes above $450,000. This prohibition wouldn’t be effective until 2032.

The BBB also would limit IRA investments by stating that an IRA owner always is a “disqualified person.” That means the IRA can’t engage in any transactions such as investing in a small business or buying an asset in which the IRA owner has any financial or ownership interest.

A little-known provision in BBB is a “methane fee” that taxes natural gas production. The American Gas Association estimates an average family’s natural gas bill would increase by 17% under this provision.

Remember, none of these provisions is law yet. Final action on the BBB likely won’t be taken before mid-December and changes are probable.

Beware of Some ‘Proven’ Investment Strategies

Some years ago, after I wrote an article about investment strategies that were proven to beat the indexes, a colleague asked where I found the ideas.

The strategies all were published in academic financial journals over the years. Sometimes such research is a good source of ideas that can have practical applications.

But it’s important to approach all research with skepticism. A lot of it can be influenced or biased by the incentives of the authors.

We already know from other studies that a large majority of published science and social science research can’t be replicated by other researchers. That puts the conclusions of the initial research in doubt.

This year, Campbell Harvey, a well-respected finance professor at Duke University, published a paper arguing that most academic finance research is distorted. He also argued that research published by financial firms is distorted but perhaps less so, because unlike academics, the financial firms have to generate results for their clients over time.

For both academics and financial professionals, there are incentives for research to conclude that a strategy produces index-beating returns. People won’t pay much attention to research that concludes a strategy doesn’t work. As a result, Harvey estimates that according to the published literature there are more than 400 ways to beat the stock indexes.

Harvey also points to research that shows specialized indexes tend to have market-beating performance for a period of years. But after exchange-traded funds (ETFs) are launched to capture those excess returns, on average, the excess returns disappear. A few ETFs deliver the outperformance found in the research, but most don’t.

There are a number of ways researchers can distort or manipulate the numbers to get the results they want, and Harvey discusses them in his paper. He recommends that investors be skeptical of finance research, whether it is published by academics or financial firms.

But Cliff Asness and his colleagues at investment manager AQR say Harvey overstates the problem.

They say research consistently shows that four factors can be used to deliver above-average, long-term results, especially in stocks. These factors are value, momentum, quality and low-risk or volatility. They also argued that most finance research can be successfully replicated.

Asness says there aren’t more than 400 published strategies to beat the indexes. Most of the strategies are variations of the same themes, such as different ways to measure or use value investing.

But like Harvey, Asness says investors shouldn’t blindly rely on published research and especially not on media summaries of the research.

Investors also need to realize there are obstacles and frictions that make it difficult to replicate research results precisely in live markets. Before relying on a published strategy, read the articles I linked to here and the related papers that also have links.

How Will Zillow’s Failure Affect Home Prices?

Two weeks ago, I reported that housing data firm Zillow Group closed its home-flipping business.

My focus two weeks ago addressed the limits of using algorithms to invest. Zillow developed an algorithm to tell it how much to pay for a house. The price was supposed to enable Zillow to profit by doing some improvements to the home and selling it quickly.

The algorithm was not able to meet the goals in the real-world housing market.

But before realizing that, Zillow purchased thousands of homes using the algorithm. Also, in several markets, it was paying significantly more for homes than other prospective buyers and even than the algorithm said it should.

The issue now for homeowners and buyers is how much Zillow influenced the market.

Was Zillow a large enough buyer that it helped cause the imbalance between the supply of homes for sale and demand for them? Were its high purchase prices a significant factor in 2021’s national home price increases? Now that Zillow isn’t buying thousands of homes around the country, will price increases slow or prices decline?

I don’t have answers to these questions. But people considering bidding for homes or looking to receive a certain amount for their homes should be cautious. We don’t know how much Zillow might have distorted housing markets around the country.

The Data

New unemployment claims declined below 200,000 for the first time since the pandemic began. New unemployment claims were only 199,000 in the latest week, the lowest level since November 15, 1969, and a decrease of 71,000 from the previous week.

The decline might have been exaggerated by the effects of the Veterans’ Day holiday during the week.

Continuing claims also established a new pandemic low, declining by 60,000 to 2.05 million.

New orders for durable goods declined by 0.5% in October, a little lower than September’s 0.4% dip.

But after excluding transportation, durable goods orders increased 0.5% in October. And September’s rise was revised higher to 0.7% from 0.4%.

Core capital goods orders, which are considered a good measure of business investment, increased 0.5% in October. September’s jump was adjusted higher to 1.3% from the 0.8% reported initially.

The Philadelphia Fed Manufacturing Index for November increased to 39 from 23.8 in October. Within the index, there were sharp increases in employment, prices paid and prices received.

The Kansas City Fed Manufacturing Index for November declined to 24 from 31 in October. The November level still indicates strong growth.

The Richmond Fed Manufacturing Index for November declined slightly to 11 from 12 in October.

Economic growth slowed a little in November, according to the PMI Composite Index.

The Manufacturing Index increased to 59.1 from 58.6 in October. But the Services Index declined to 57.0 from 59.0 in October. The result was the Composite Index declined to 56.5 in November from 57.8 in October.

The Leading Economic Indicators Index from The Conference Board rose 0.9% in October, but September’s increase was revised down to 0.1% from 0.2%.

Existing home sales increased by 0.8% in October. This was the highest monthly increase since January.

But sales declined 5.8% over 12 months. This was the third month in 2020 in which sales were lower than 12 months earlier. That is likely to be the case for the rest of 2021’s reports.

The 12-month numbers are distorted by several factors. The pandemic delayed the traditional buying season to later than usual in 2020, so sales late in 2020 were inflated by delayed buying.

In addition, sales in 2020 were spurred by record-low mortgage interest rates, a surge in second-home buying, a lot of people moving because of the pandemic, and a strong stock market improving household finances.

The second estimate of third-quarter gross domestic product (GDP) was little changed from the initial estimate. The economy was estimated to grow at an annual rate of 2.1% in the third quarter, up from the 2.0% initial estimate.

The Markets

The S&P 500 lost 0.23% for the week ended with Tuesday’s close. The Dow Jones Industrial Average declined 0.89%. The Russell 2000 fell 3.21%. The All-Country World Index (excluding U.S. stocks) decreased 1.92%. Emerging market equities are 2.77% lower.

Long-term treasuries lost 0.42% for the week. Investment-grade bonds fell 0.58%. Treasury Inflation-Protected Securities (TIPS) declined 1.11%. High-yield bonds decreased 0.78%.

In the currency arena, the dollar rose 0.51%.

Energy-based commodities increased 0.28%. Broader-based commodities rose 0.30%, while gold lost 3.24%.

Bob’s News & Updates

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