UNDER PRESSURE€¦ · July 2018 Pinnacleadvisory.com Page 1 6345 Woodside Court Suite 100...

July 2018

PINNACLEQUARTERLY

The Pinnacle Investment Team

Jake MasonAlice in Financeland

Michael Kitces

Alternative IRAInvestments AndThe IRS

Josh Rivers

How To Care For YourAging Parents

UNDERPRESSURE

Pinnacleadvisory.comJuly 2018

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July 2018

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Table of Contents

Alternative IRA InvestmentsAnd The IRSMichael Kitces

2

How To Care For YourAging ParentsJosh Rivers

5

Under Pressure: A PinnacleMarket ReviewRick Vollaro, Carl Noble, SeanDillon, Sauro Locatelli

10

Alice In FinancelandJake Mason

7


Alternative IRA InvestmentsAnd The IRS

To fulfill their intended purpose in supporting savingfor retirement, Congress grants the Individual Retire-ment Account (IRA) certain tax preferences, from tax-deductible contributions (as in the case of traditionalIRAs) to tax-freegrowth (for aRoth IRA).But to curtailpotential tax abuse, the Internal Revenue Code alsolimits the range of permissible investments in an IRA,and explicitly bans life insurance contracts and col-lectibles (andunderseparate rules, S corporationscan-not be owned in an IRA, either).

Furthermore, because an IRA is intended to be treatedas a separate retirement account from the other assetsof the IRAowner, the Internal RevenueCode also con-tains a series of “prohibited transaction” rules intend-ed to prevent the IRAowner fromusing the account toenrich themselves or their family members (withoutactually taking a taxable withdrawal).

Michael Kitces, CFP®,MSFS, MTAX, CLU®,

ChFC®, RHU®,REBC®, CASL®Director of Wealth

Management


Fortunately, in the past the IRS has been fairly lax inpursuing and attempting to enforce against IRA pro-hibited transactions. But with the rise of self-directedIRAsbuying real estateover thepastdecade, andmoregenerally the popularity of using self-directed IRAsfor alternative investments—which a recent GAOstudy estimates is now a $50Bmarketplace—there is agrowing risk that the IRSwill increase its enforcementon IRAprohibited transactions. Thatmeans it’s crucialfor IRAowners to takea lookathowthey’reusing theirIRA, especially for accounts that are not simply invest-ed in traditional publicly traded securities!

Permitted Investments For IRA Accounts

To ensure that retirement accounts are used appropri-ately for actual saving and long-term investing,though, the tax code places some limits on the types ofinvestments that can be held inside of an IRA. Thus,while most types of traditional (i.e., publicly traded)investments are permissible—like stocks and bonds,ormutual funds—tax code explicitly prohibits IRAas-sets from being invested into life insurance contracts,and any form of collectibles (including artwork, rugs,antiques, gems, stamps, and coins, but not includingcertain gold, silver, or platinum coins or bullion).

However, the reality is that there’s still a wide space ofpotential alternative investments that lie between theextremes of permitted traditional stocks and bonds (orfunds thathold them),andimpermissible life insuranceand collectibles (and S corporations). Other types of in-vestments thatmightbeheld inan IRA,butaren’t tradi-tional publicly traded securities, include limited part-nership investments, stock in a small (privately-held)business, or even a direct investment in real estate.

Yetwhile those investments aren’t specificallyprohib-ited frombeingowned inan IRA,additional complexi-ties arise, because of the limitations that exist betweenIRA owners and their individual retirement accounts.

The additional complications derive from the fact thatan IRA is technically a separate entity from its owner,who will ultimately use and benefit from the money.

And as a result, the tax code requires that the assets ofthe two remain separate, and not be used in a mannerwhere one indirectly enriches the other—also knownas a “prohibited transaction.”

Tax Consequences And Penalties For ASelf-Directed IRAProhibited Transaction

For those IRA owners (or other disqualified persons)who do engage in a prohibited transaction with anIRA, the tax consequences are severe.

The ‘standard’ rule is that if a prohibited transactionoccurs, there is a penalty tax of 15% of the amount in-volved in the transaction, imposedon anydisqualifiedperson engaged in the prohibited transaction. And ifthe prohibited transaction isn’t promptly unwound/correctedwithin the current tax year, the penalty tax isincreased to 100%(!) of the transaction amount.

In the case of IRAs, the consequences of a prohibitedtransaction are slightly different, but similarly harsh.When an IRA engages in a prohibited transaction, theentire account is disqualified, which means it loses itstax-deferred status, and is treated as though itwas ful-ly liquidated in a taxable distribution at the beginningof that year!

Common Prohibited Transactions WithSelf-Directed IRAs

Fortunately, the reality is that prohibited transactionswith IRAs are quite rare, due to the simple fact that theoverwhelmingmajority of IRAassets are invested intotraditional publicly traded securities, which doesn’traise prohibited transaction concerns in the first place.However, beyond traditional investments, prohibitedtransactions can sneak in surprisingly easily, especial-ly when it comes to directly owning real estate in anIRA. For instance, if an IRAowner invests directly intoa ‘fixer upper’, and then does repair work to it (e.g.,fixing up the property), a prohibited transaction hasoccurred, because the IRA owner rendered servicesto/foranassetof the IRA. (Instead, the IRAitselfneeds


to hire someone else to repair or otherwise provideservices to the property. And the IRA itself must payfor those services out of the IRA’s own cash, as the IRAowner paying for services on behalf of the IRA assetwould again be a prohibited transaction, or at leastdeemed a contribution.)

Other common prohibited transactionswith direct re-al estate in an IRA involve renting out the real estate tothe IRA owner or other members of his/her family(whoare alsodisqualifiedpersons), allowing family tostay for free in the real estate, orhiring familymembersto work on/in the real estate property. And of course,trying to transfer existing real estate the IRA owneralready owns into the IRA would be prohibited (be-cause even an arms’ length fair-market-value sale ofthe real estate from the IRA owner to the IRA is still aprohibited transaction, as the IRA owner is still a dis-qualified person).

The Rising Scrutiny Of IRA ProhibitedTransactions

The reality is that the prohibited transaction rules forIRAshave existed as long as IRAs themselves.And formost of their history, they were largely ignored, be-cause theywere largely irrelevant. After all, in aworldwhere most IRA custodians were investing in ‘tradi-tional’ publicly traded investment securities, it wasnearly impossible to create a prohibited transaction.

However,with theriseofnew‘self-directedIRAcusto-dian’ platforms like Pensco, Equity Trust, and EntrustGroup, there are more options for investors to pursue‘non-traditional’ alternative investments in retirementaccounts. Yet the rise of these types of self-directedretirement accounts has caused concern for the IRS.Withgood reason—there arenownearlyhalf amillionaccounts with $50B of collective value being investedin ‘unconventional’ assets in IRAs.

And the lack of consumer education on the issue isconcerning, given that avoiding ‘mistakes’ in an IRAthat could cause a prohibited transaction is still theresponsibility of the account owner. In fact, the GAOexpresses concern that some types of alternative in-vestments are sold into self-directed IRAs in amannerthat enriches the salesperson or promoter if the dealcloses,butdisownsany liability if the investment turnsout to be a prohibited transaction! Because in situa-tions where the self-directed IRA provider offers‘checkbook control’, it’s ultimately still up to the IRAowner to determine that each and every check is com-pliant with the prohibited transaction rules.

In other words, ignorance is no excuse when it comesto prohibited transactions in IRAs, which means it’stime to be more cognizant of the risks of prohibitedtransactions, and the situations that can trigger them.

If you have questions about the investments in yourIRA, speak with your qualified Wealth Manager, andthey can guide you through the rules.

Michael Kitces, CFP®, MSFS, MTAX, CLU®, ChFC®,RHU®, REBC®, CASL® is a Partner and Director ofWealth Management at Pinnacle Advisory Group.

Profile: pinnacleadvisory.com/team/mkitces/


How To Care For YourAging Parents

Over forty million families are acting as primary care-givers for their agingparents. This generation of adultsin their 40’s and 50’s is called the “sandwich genera-tion”becausetheyarecaringfor theirchildrenandtheiraging parents at the same time. The number of familycaregiverswill continue to riseasouragingpopulationgrows (there will be approximately 84 million peopleoverage65bytheyear2050).Sohowdoyouprepare forthe likelihood of caring for your parents?

You must be proactive and have a plan.

Josh Rivers, CFP®Wealth Manager


Where Will They Live?

Historically both gender and age have played apart indeciding who takes care of your parents when theyneed to be cared for. Instead of this antiquated way ofthinking, siblings should considerwho is the best fit interms of time, location, and finances. Before the familyis in crisis mode, you should sit down as a group andtalkaboutwhoandhowyouwill care foryourparents.Ideally you would want to have this discussion whenyour parents are in their late 60’s or early 70’s and arestill mentally and physically capable. Talk about thefinancial and geographical issues and who has thetime to help. Perhaps as important, find out how yourparents feel about their long-term care. For example,do they want to stay in their home, move in with oneof the siblings, or go to a facilitywhen the need arises?

Who Will Pay For It?

Caring for agingparents canbeveryexpensive. If yourparents have purchased long term care insurance, thatcan greatly defer the costs of the necessary care;unfortunately,most Americans do not have long termcare coverage. If your parents do not have that kind ofcoverage, you’ll need to have an understanding oftheir finances and what resources are available to payfor their care. Check what assets they have to providefor their care and what each sibling could potentiallycontribute. Talk to your advisor about your situation—you may be able to claim your parents asdependents if you are paying for more than half oftheir daily care.

Can Medicaid Help?

If financial resources are scarce from both yoursiblings and parents, you will want to make sure youunderstand the benefits Medicaid can provide. Manyassume incorrectly that Medicare will pay for longterm care. It does not. Medicaid finances 40% ofnursing home spending nationwide and isadministered by the states; it will cover care at home,in the community, or in a facility. MostMedicaid longterm care services assist those who struggle withactivities of daily living (e.g., bathing, dressing, usingthe toilet, eating). While having too much income orassets candisqualifyyou fromreceivingbenefits,moststates will allow you to spend down your excessincome on care. Families should look to see what theincome and asset limits are for their specific state.

One great web tool for information on state Medicaidrules is www.familyassets.com. Also, have a look atwww.agingcare.com for another great familyresource. This website can help you identify localprograms that provide information and services forolder adults.

Caring for aging parents can be very stressful. Planahead by having the discussionwith your parents andsiblings before a crisis arises. Know what assets areavailable to care for your parents or if they have longterm care insurancewhich candefray someof the cost.Research Medicaid eligibility and local options forcare if assets are scarce. Walking through this withyour parents may be hard, but it can also be one of thegreatest gifts you can give to the personwho cared foryou when you needed it the most.

Josh Rivers, CFP® is a Wealth Manager at PinnacleAdvisory Group.

Email: [email protected]: pinnacleadvisory.com/team/jrivers/


Alice In Financeland

My client, Alice, came in for her semi-annual reviewmeetingrecentlyandsaid (asmanyclientsdo), “Idon’tlike paying taxes.”

Good news: You only pay taxes when you’ve mademoney. But that does not mean you should not try tominimize your taxes as much as possible. In Alice’scase, shewas transitioning into retirement froma longcareer in the tech industry, and the retirement transi-tion planning would cover a wide range of issues. Wehad already figured out that she had enough money.Over time we would need to deal with how to do theactual retirement transition, the timing of claiming So-cial Security benefits, analyzing pension options, andhow to replace her paycheck and sustain her retire-ment spending. And we’d do all of this while balanc-ingherdesire tohelpher twodaughtersnowand leavea legacy for them when she was gone.

Jake Mason, CFP®Partner

Wealth Manager


In that day’s meeting, however, we focused on the ex-citingworldof the taxefficient liquidationofher invest-ment portfolio. (As she said, “I don’t like paying tax-es.”) Our primary focus was on coordinating the liqui-dationof theretirementaccounts (e.g., IRAs,401ks,andRoth IRAs) and her taxable brokerage account.

The rule of thumb is that taxable investment accountsshould be liquidated first allowing tax-deferred ac-counts to continue togrow. Itmakes sense, sinceother-wise you would be drawing on the IRA first, forcingyou to pay income taxes earlier than you otherwisewould.Thenyouwould start drawingonyourbroker-age account, but thatwouldnothavegrownasquicklybecauseof theannualdragof taxationon interest, divi-dends, and capital gains. If the retiree draws from thebrokerage account first, then they are not paying anyadditional taxes early, so the portfolio can maintainspending for a lot longer.

Rules of thumb often provide simple, easy to followmethods that generally work. They do not, however,necessarily offer the most effective approach. It is onething to delay paying taxes, but it is quite another tosimplypay less in taxes (nearanddear toAlice’sheart).By taking the blended approach of drawing from theIRA when you are in lower tax brackets, coordinatedwith the draws from the brokerage account to avoidadding toomuch incomeandendingup inahigher taxbracket, the portfolio can last even longer.

In addition, when many people with large IRAs turnage 70.5, they are forced to draw from them, suddenlymoving themintoahigher taxbracket.Byreducing theIRA amount at earlier ages, you potentially lower thetax bracket you will be in at age 70.5 and beyond.

This coordinated strategy still means that you are de-pleting a tax-deferred asset, so an even better optionmight be to convert IRA dollars when you are in a lowtax bracket to a Roth IRA. This couples the potentiallylower tax brackets pre and post age 70.5 with tax-freegrowth on the new Roth IRA dollars.

Since Alice was a good saver who lived within hermeans, she was happily retiring early at age 60. Thisgaveherat least 10years tocontrolher taxbracketsandimplement these strategies. But it is important to notethat this is anannualprocessofmanaging taxbrackets.

First of all, what tax bracket is “low” is dependent onone’s overall wealth and income. For some, they cantarget always trying to just fill up the current 12%bracket and try to avoid ever being in the 22%bracket.With Alice’s good fortune of having one of the fewremainingprivate pensions, shewould always be in atleast the22%bracket, soavoidingthe24%(andcertain-ly the 32%) brackets becomes ideal.

In addition, taking more income in a given year canhave consequences onother income—especially in thelowest taxbracketswhereotherwisenon-taxable long-term capital gains can suddenly become taxable at15%; or Social Security thatwouldnot havebeen taxedsuddenly is. Alternatively, yearswith very highmedi-cal costs or business losses could create opportunities

You only pay taxes when you’vemade money. But that does not mean

you should not try to minimize yourtaxes as much as possible.


Jake Mason, CFP® is a Partner and Wealth Managerat Pinnacle Advisory Group.

Email: [email protected]: pinnacleadvisory.com/team/jmason/

in very low tax brackets. It is critical to truly under-stand the tax rate on the dollars you convert or drawfrom the IRA to properly implement these strategies.

Alice could have followed the rule of thumb and justtakenher income fromher brokerage account first, butin reality you can actually be too good at deferring tax-es. The IRA can grow so large that it pushes you intohigher tax brackets. Instead, she is focused on main-taining the tax advantages of her retirement accountsinanoptimalapproachof fillingher lowestpossible taxbrackets earlyon,balancing taxablebrokerageaccountwithdrawals with annual partial Roth conversions,while being mindful of ancillary tax impacts.


In the second quarter volatilitywaned andperformance decou-pled as divergent backdrops created variances in returns forassets classes andmarkets across the globe. Thewinning tradesfor the second quarterwere in theU.S. energy sector, U.S. smallcompanies, and a select group of technology and consumer dis-cretionary stocks. Energy thrived on a rising oil price, smallcompanies on avoiding international earnings exposure, andtechnology/discretionaryon thebackof theirperceivedgrowthand safety prospects. While U.S. stocks rebounded throughoutthe quarter, internationalmarkets declined, and emergingmar-ketstockswereseverelypunishedonthebackofasoggierglobalgrowth backdrop combined with higher U.S. rates and astronger dollar. Commodities were amixed bag, with the ener-gy complex posting big positive returns resulting from favor-able supply fundamentals,while themetals andagriculture sec-tors appeared to succumb to a stronger dollar and other microfundamental concerns. In fixed income, bondswerevolatile butrange bound, and very short-termmaturities sawmoderate re-turns on the back of continued tightening by the Federal Re-serve.

Looking forward investors are challenged with decidingwhether thesedivergent trendswill persist, orwhethermarketsare set to recouple as policy burdens build across the globe.

Rick Vollaro

Chief Investment

Officer

Carl Noble

Senior Analyst

Sean Dillon

Technical Analyst

Sauro Locatelli

Quantitative Analyst

MARKET REVIEW


U.S.TugofWar&RisingGlobalPressures

Currently major U.S. stock indexes appear to betrapped in a trading rangedefinedby the January 26thhigh and the February 8th low, while international in-dexes have recently slipped to new lows on the year.The U.S. has been a relative source of market strengththis year and continues to enjoy the residual fruits ofthe prior tax cuts that are flowing through the econo-my. But outside the U.S., the overall message of themarkets seems to be that a variety of forces are perco-lating that may act to keep a ceiling on equity valua-tions for the time being. The combination of coolingglobalgrowth,monetary tightening,an increasingriskof a trade policy error, and a challenging seasonalbackdrop all appear to be conspiring to prevent stocksfrom making new highs in the short-term. This hascreatedanenvironment akin to a tugofwar in theU.S.,but risks seemtobebuildingandmaykeepworldmar-kets under pressure over the next quarter or so.

2018Surprise: LessSynchronizedGrowth

One of the surprises of 2018 has been the downshift inthe synchronized global growth story. The simultane-ous expansion in global economic growth and earn-ingswasamajordriver thathelpedpropelglobal stockprices higher in 2017. Coming into 2018, that storylooked promising to continue, but instead the globaleconomy has run into a soft patch. The U.S. economygot off to a sluggish start in the first quarter, but mostsigns pointed to a strong acceleration in the secondquarter. However, most global economies have expe-rienced recent setbacks, and theredoesn’t appear to beany catalysts on the horizon to give them a fresh boostin the near term.

China is the second largest economy in the world andhas been slowing, but policymakers there have beentaking it in stride, so it’s probably too early to expect a2015/2016 style fiscal intervention that would pumpupgrowthagain.Europeanand Japanesegrowth rateshave also beenweaker,with recent headwinds causedby their leverage to overall global growth rates, esca-

lating trade tensions, and the upcoming tapering ofbond purchases by European monetary authorities.

While the developed world seems soggy, it’s theemerging economies that are coming under consider-able pressure. The combination of rising U.S. interestrates andanunexpected rebound in theU.S. dollar hasled to a tightening of financial conditions and exposedunderlying weakness in some of the more fragile de-veloping economies. Stock prices have come underfire, and the currency markets are experiencing somenotable volatility, whichmay be awarning signal thatsomeof theweak links indevelopingmarketsarestart-ing to crack. The bottom line is that global growthlooks weaker than it did coming into the year, anddespite the U.S. doing its best to pull the rest of theworld along, it may not be able to do so without somesort of positive catalyst coming to the fore.

U.S. Fundamentals Currently Strong

In a world where global growth has softened, the U.S.continues to look fundamentally solid, and we agreewith consensus expectations for a material secondquarter bounce back in GDP growth after a somewhattepid first quarter performance. Presently, both con-sumer and business confidence is high, the labormar-kets are robust, leading indicators are still pointingup,and fiscal stimulus is still exertingupwardpressureonthe U.S. economy. Overall, the odds of a recession stillseem very low over coming quarters in the absence ofamajor shock from something like a spike in oil pricesor a full-blown tradewar. Earnings have also been ris-ing in tandem with the economy, and small businessconfidence has remained elevated, providing a solidbackdrop that shouldgivebusinesses thewherewithalto invest more and help keep the expansion going.Though theU.S. is likely in the late phase of the expan-sion, so far the economy has reaped the fruits of ahealthy labor market and higher incomes, along withinflationary pressures that have been developing at aslow enough pace to keep the positives outweighingthe negatives.


Risks To U.S. Rising

When it comes to the economy, stocks are currentlycaught in a bit of a pickle. One risk is that the U.S. isbeginning tooverheat as late cycle tax cuts collidewitha tight labormarket where demand appears to be out-stripping supply. The risk is that eventually the tight-ness in the labor market will stoke a material rise inwages.Higherwages are good for consumers’wallets,but if they accelerate too fast they become an inflation-ary input that crimps corporate earnings and putspressure on interest rates. From this perspective, goodeconomic news can actually be bad news for financialassets like stocks and bonds. So far wages have beenrising very slowly, which has allowed the Federal Re-serve to movemethodically in raising rates, but if thisdynamic changes it would likely be a game changerthat lures theFed intoamoreaggressive approach thateventually chokes off growth.

Anothermore deflationary risk is that the U.S. may beheaded towards an economic disappointment in com-ing quarters due to several factors that appear to bematerializing at the same time. The Fed is tighteningmonetary policy at the same time theworld appears tobe slowing, and financial conditions are starting totighten in the U.S. due to the mix of higher rates, astronger dollar, and increasing oil prices. The tax cutsshould continue to give the economy upward inertiafor a few more quarters, but the boost will graduallyfade, leaving the economy to deal with several head-winds that may start to dampen the recent forwardmomentum. The risks outlined above are also beingcompounded by the all-important wildcard comingout of Washington in the form of trade policy.

Elephant in the Room: Trade Policy Risk

Last quarter we wrote that the most significant risk toequities was a potential trade-related policy misstepcoming out of Washington. We’ve been monitoringthis risk closely for the last quarter and have not beenencouraged by the tone coming out of the WhiteHouse. The optimists on trade frictions still believe

that President Trump is either posturing for the bestpossible revised agreement, or that he will only pushthings so far if financial markets begin to riot, since hehasn’t been shy about using stock market gains as abarometer for success. We are not so sure if eitherchoice will have a positive impact. The idea that theU.S.hasbeendisadvantaged inour trade relationshipsseems to be a core belief of this administration, and asa result, they appear determined to pursue significantchanges to long-standing trade agreements.

There are a multitude of reasons to believe the risk ofa trade war is growing. First and foremost is the factthat the president and his team believe that makingmaterial changes to trade is the right thing to do, andthat a trade war will be easy to win because we havesucha significant tradedeficit. Thismaybeamiscalcu-lation in theeyesofmanyeconomists, but theadminis-tration seems to staunchly believe in the premise,which is importantwhen trying to discount future de-cision making. The president has assembled a teamaround him thatwill be tough on trade, and this is oneareaofpolicy thathehasunilateral authority tochangewithout the approval of Congress. To make mattersthornier, the president’s approval ratings have beenrising recently, so he will likely believe his recent ac-tions on trade to be winning support going into themid-term elections this fall. Why change strategywhen things appear to be working?

The current math on trade frictions may seem harm-less at first blush, but a closer look at the numbersshows that thisprotectionist behavior couldbeamate-rial headwind to the global economy.While some esti-mates of the first $250 billion in tariffs on China mayonly cost theU.S. less thanhalf of a percentagepoint inGDP growth, the real trouble will likely be felt in thesecondary effects of tariffs on supply chains across theglobe. This is because many goods exported throughChina are made in other Asian countries and sold toChina beforemaking theirway to theU.S. The result isthat amaterial reduction inChinese exports turns intoa problem for not only China, but also those countriesthat start the chain of production. One eye poppingstat from research firmCornerstoneMacro shows that


China plus other key Asian supply chain countriesmakeupapproximately 20%ofglobal growth. The ad-ministrationseemsvery focusedonchanging the traderelationshipwithChina, and if theykeeppushing thena large chunk of global GDP could be at risk.

OutsideofChina, theWhiteHouseseemsreadytopicka fight with any country, including some of our allieslike Canada and the European Union. Recently, autotariffs seem to be under serious consideration, andthere is a non-trivial risk to pulling the plug on theNorth American Free Trade Agreement and possiblyeven our membership in the World Trade Organiza-tion. The bottom line is that trade risks are escalatingandwill likelyweighonmarkets globally until there isenough political or market pressure to get the U.S.,China, and other countries to pull back from these ill-advised policies. This may eventually happen, butright now it seems like it may take some pain beforepolicymakers reverse course, particularly from theU.S. side.

Building Some Defense

We are beginning to lower portfolio volatility profilesdue towhat appears to be apoor risk/reward scenariothatmaybedevelopingover thenext quarter or so.Wewill be de-risking in an incremental fashion and look-ing to use upside volatility as an opportunity to getmore defensive on the rise. From a high level, portfo-lios will generally own less in equities, with less inter-national and cyclical exposure than in recent quarters.InU.S. and international sectors,weplan to rotate intomore defensive sectors of the equity market thatshould be less volatile than the overall market, shouldvolatility begin to rise. In fixed income we are alsobuilding back into high-quality treasury bonds as adefense against the faltering of global growth and the

risk of a trade war causing a deflationary shock. Wecontinue to hold some gold as a hedge as well, butprefer to own a variety of hedges in case the dollarkeeps rising and continues to weigh on the preciousmetal.We’ll also continue to ownmore cash-like secu-rities than the benchmark. In an environment whereshort-term rates are rising and there are seeminglyrisks to any asset class, cash just might be king for alittle while.

Conclusion

As we start the third quarter, we believe there are avariety of risks building inmarkets that have tilted therisk/reward balance into a place where global equityvolatility may be poised to increase in coming quar-ters. We don’t currently see the signs of an increasedrisk of a recession in the U.S., which should limit po-tential downside (though the trade frictions inprogress could potentially turn into a game changer ifpolicymakers continue to turn up the heat and tradefrictions turn into a full-blown trade war).

While we are pulling back towards neutral volatilitylevels on a tactical basis, we are also keeping an openmind for what develops from here. If volatility forcespolicymakers into a better place while the evidencestays firm, it may provide an opportunity to increaseexposure at better prices. On the other hand, if evi-dence deteriorates or policy keeps getting worse, itmight compel us to start defendingmore aggressivelyagainst the possibility of a cyclical bear market. Thelast few years have been great for growing investorwealth, but wemay be drawing closer to a timewhereweneed to focusonpreservingprincipal. This is a timeto bemore cautious, but also to remain flexible to reactto what unfolds over coming quarters.


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