Fiduciary Trust International


Third Quarter 2013 Perspective

September 2013

Markets Have Been Focused on Worries, But We Expect Unease to Pass

Since we last wrote in late May, global markets have gone nowhere. While US stocks were off -1.6%, non-US stocks were generally off more, -4.0% by the MSCI All-Country World (Ex US) Index. European equities fell -1.4% and emerging markets lost -7.9% (CHART 1).1


Was it Syria, oil prices rising by +16.9%,2 tepid second quarter earnings, the looming and likely acrimonious debate over raising the US debt ceiling, who will succeed Ben Bernanke, rising volatility among emerging markets or the prospect of another claim on US workers’ wages with the second round of federally mandated healthcare premiums? Or, as we suspect, all of these surfacing as the Federal Reserve debates—quite publically—ratcheting back QE?


The Federal Open Market Committee (FOMC) wound up its third 2013 meeting on May 1, coinciding with the 10-year Treasury bond trading at a low yield for the year of 1.66%. The yield began to rise the next day, reaching 2.78% on August 30. This sharp +67% climb affected car loans, mortgages and thousands of private transactions. The rate for a conventional 30-year fixed mortgage rose from 3.40% on May 1 to 4.46% at month end, an increase of +31%.3


Gasoline also rose, +8.6%, in the three months.4 With more expensive mortgages and gasoline, it is not surprising the CEO of Wal-Mart US recently complained that “the consumer remains challenged…”5 More broadly these higher prices, especially of energy, come when the US consumer is vulnerable. US consumers face the “unhappy combination of high energy prices and declining median incomes in real terms.”6 As a result, spending on energy as a percentage of personal income in the US is now nearly 40% higher than the 1999 low (CHART 2).



It is not a stretch to conclude that the equity markets’ weakness over the past three months is based on the confluence of these worries, especially coming after a +141% rally from the March 2009 recession low, and more recently, the +20.5% rally from an interim low last November 14.7 Second quarter earnings certainly were no boost to confidence: sales +1.4% and earnings +3.3%, versus second quarter 2012. Without the financial sector that is finally showing strong recovery as housing revives, the year-over-year growth was truly uninspiring: sales +0.6%, earnings -1.9%. Analysts, however, are sticking to more rosy estimates for the next four quarters. If companies actually deliver, we expect the current jitters will pass (CHART 3).8



The strong four-and-a-half-year rally and tepid earnings growth have elevated valuations beyond their long-term averages. This suggests to us that earnings growth must at least remain in the recent range, around 3+% to 5+%, or trouble may lie ahead. An acceleration to meet the higher growth the analysts foresee would be best. The S&P 500’s price-to-earnings (P/E) ratio over the past three years to August shows how strongly the multiple of earnings has recovered from the ratio’s low of 11.8x in early October 2011 to 15.7x today (CHART 4).



There is no absolute rule that equities cannot trade at higher valuations. They certainly have before. The course of inflation over the next several quarters will be a key thermometer of the economy’s and likely the market’s health—not too hot and not too cold—and therefore a support (or not) to confidence and a higher valuation. Any material deviation away from Goldilocks’s judgment would indeed spell trouble.

Today there is little expectation that inflation will veer from the current benign path. The Cleveland Fed’s work suggests the expectations for inflation itself for the next ten years are muted. Further, the bank’s estimate of the inflation risk premium over the coming decade is also steady at approximately 0.5%, suggesting that inflation will not vary much from the current level.


The Fed’s much discussed prospective policy change has certainly upset some emerging markets, especially where the country is dependent on foreign capital to fund hefty current account and budget deficits. India is the recent poster child, and Indonesia the runner-up. The Fed’s debate appears to have pricked a profitable carry trade bubble, where one could borrow at US low rates and buy higher yielding emerging market securities. When US rates rise, the profit in this trade evaporates, especially as the currency inevitably weakens. Indeed in recent weeks, the Indian rupee has been hit hard, falling more than -16% since April 30.9 It is no coincidence that the FOMC meeting ended on May 1.

India’s travails do not suggest to us that the enormous opportunity among the emerging markets is over. The core growing appetite for all sorts of goods and services by people at last able to afford a better life is not reversing. Exercising some patience as the markets adjust to higher rates will be rewarding.

The emerging market carry trade has indeed been a bubble, and the weeks ahead will no doubt reveal others where repressed interest rates have animated speculation. These also may not be far from home. For instance, the Chicago Fed tracks farmland prices in its district. In Iowa, the year-over-year increase has been +22%, +28% and +20% in 2010, 2011, and 2012!10 We do not, however, think developed market equities and particularly US stocks, despite their heady rally from March 2009, qualify.


With all these accumulating worries, where is it wise to invest? The effects of the recession of 2007-2009 are still with us. Consumers’ debts are still being brought to tolerable levels consistent with expectations for incomes. Job growth, although hardly robust, is steady. The Fed has few levers to use to accelerate the growth rate of this prolonged, slow recovery.

The answer, as before, remains well-chosen, high quality equities. The managements of high quality companies are best able to confront the transition back to interest rates set by market demand replacing Fed policy. Bonds may be less volatile than equities, but have limited probability of holding value in the face of upward trending rates. This is not to say bonds should be completely eliminated from portfolios. Their relative stability and predictable flow of income has value in an uncertain world. On balance, however, as long as we can be completely confident that earnings will continue to trend higher over the next several years and do so in a low-inflation climate, our view is equities should do well.

A Strong Bias Toward Equities



  • Our equity allocation recommendation remains overweight, reflecting our positive long-term view for global recovery.
  • Despite a current confluence of uncertainties and higher US equity valuations, we believe the risk/reward balance is to the upside, and expect volatility may offer up appealing opportunities.
  • Although emerging market valuations are attractive, we are maintaining a neutral weighting until we become confident that global rates and currencies have adjusted to the Fed’s outlook.


  • We are maintaining an underweight fixed income allocation while continuing to monitor the evolving impact of the upward move in rates.
  • In the current environment, municipal bonds represent particularly attractive values on a pre- and after-tax basis relative to other fixed income sectors.
  • We are seeking opportunities to increase the income profile of our portfolios by investing in new higher coupon issues.


  • We are recommending that portfolios be fully invested, with cash positions at no more than 5%.





Elisa Shevlin Rizzo
Managing Director and Trust Counsel

Don’t Underestimate State Estate Taxes

The generous federal estate tax exemption implemented as part of the American Taxpayer Relief Act this year has been a welcome resolution for many. However, families residing in any of the 19 states and the District of Columbia that levy state estate or inheritance tax should not be complacent. Our Fiduciary Trust Forum examines the potential impact of state estate taxes on an inheritance.

Q. What is the difference between federal and state estate and gift taxes?

Elisa: While there has been a lot of discussion about federal estate taxes over the past 10 years, state estate taxes have often fallen under the radar. At the federal level, each of us may transfer—either during lifetime or at death—up to $5.25 million (adjusted annually for inflation) free from federal gift and/or estate tax. Any amount over the federal exemption is taxed at a maximum 40% federal estate tax rate.

Many states impose separate state estate, gift and/or inheritance taxes on assets transferred during lifetime or at death. Until 2005, most states simply received a share of the federal estate tax in the form of an estate tax credit (also called a “pick-up tax”), so no additional burden was felt by most families. However, under the 2001 tax act, the state estate tax credit was slowly phased out and was replaced with a less valuable estate tax deduction. As a result, many states lost an important revenue source. In response, a number of states “decoupled” from the federal system and enacted their own separate transfer tax systems. Today, 19 states including New York, New Jersey, Connecticut, Maine and Rhode Island plus the District of Columbia levy state estate taxes, and the rates can be as high as 20%.

Q. What impact can state estate taxes have on an inheritance?

Elisa: State estate taxes can have a meaningful impact on an inheritance, particularly when the family expects that no tax will be due at the death of the first spouse. While the federal exemption is quite high, states will often tax much smaller estates. For example, New Jersey only exempts the first $675,000 from state estate and inheritance tax. Other state estate tax exemptions range from $910,725 in Rhode Island to $4 million in Illinois—with the majority of states, including New York, exempting only up to $1 million. Any assets over the state exemption, even if that amount is less than the federal exemption, will be subject to state estate tax.

To put this into dollar terms, consider that a New Yorker who dies in 2013 with a $5.25 million estate will owe no federal estate tax, but will owe $420,800 in New York state estate tax. Residents of Maryland, Massachusetts, Minnesota and Washington, D.C. face similar costs.

Q. Can families living in states without estate tax be affected?

Elisa: Absolutely. Residents of states that do not impose a state estate tax should not be complacent. First, if an individual owns property in a state with an estate tax, such as a vacation home, the family may be subject to a non-resident estate tax.

Second, tax laws can and do change. Within the last few years, some states including Illinois, Delaware and Hawaii have re-enacted or made permanent their separate state estate tax laws. Other states have modified their existing laws, either by increasing (Rhode Island) or reducing (Connecticut) the amount that can pass free from state estate taxes. Rates may also change—for example, Washington recently raised the top four estate tax rates by 1%, bringing the highest marginal rate to 20% on amounts transferred in excess of $9 million.

Q. Since state and federal estate tax exemption levels differ, how can families best make use of both exemptions?

Elisa: For many families, maximizing the use of the federal exemption through the use of a credit shelter trust funded with the then-available federal exemption amount remains a priority, even if such a plan would require that a state estate tax be paid at the death of the first spouse.

Others may wish to avoid or minimize state estate taxes at the first spouse’s death. In that case, there are several planning options which may involve the use of qualified disclaimers, limiting the credit shelter trust to the state estate exemption, planning for the “gap” amount between the state and federal estate tax exemptions with the use of marital trusts and/or maximizing the use of any state Qualified Terminable Interest Property “QTIP” elections. We recommend that our clients speak with their Fiduciary Trust advisor or estate planning attorney to determine the most appropriate strategy for their particular situation.

Q. Can married couples combine their individual exemption amounts?

Elisa: Yes and no. Federal law allows for “portability” of federal estate and gift tax exemptions between spouses. In simple terms, if an individual dies without having used his or her full federal estate tax exemption, the unused exemption can be used at a later date by his or her surviving spouse, provided certain elections are made on the decedent’s estate tax return.

That said, portability does not apply to state estate, gift or inheritance taxes, nor does it apply to the federal Generation Skipping Transfer tax exemption. While portability may simplify estate planning at the federal level, it may result in a substantially higher state estate tax bill at the first spouse’s death plus additional taxes on distributions to grandchildren at a later date if one’s GST tax exemption is not preserved.

Q. Can lifetime gifts help to reduce state estate taxes?

Elisa: Yes, lifetime gifting is a great option for individuals seeking to reduce their overall estate tax bill. Since only two states—Connecticut and Minnesota—impose a state gift tax, most people can reduce their state estate tax bill by making lifetime gifts. In most cases, assets transferred during life will not incur a state level gift tax and will not be subject to state estate tax at the donor’s death. Of course, we recommend that our clients consult with their attorney or other advisors before making substantial lifetime gifts. 

1. Bloomberg. S&P 500, MSCI All Country World Index (Ex US), MSCI Europe Index, MSCI Emerging Markets Index.
2. Bloomberg, WTI Crude Future Oct 13; 5/31/13-8/30/13.
3. Bloomberg. US home mortgage 30-year fixed national average.
4. Bloomberg. Generic 1st XB gasoline future.
5. Wal-Mart stores, second quarter fiscal year 2014 earnings call, August 15, 2013.
6. GaveKal Research, daily comment, 8/28/13, “Syria and the US Consumer.”
7. S&P 500 3/9/09-8/30/13 and 11/14/12-8/30/13, respectively.
8. Bloomberg, Fiduciary Trust. As of 8/31/13.
9. Bloomberg. The Indian rupee Fx was 53.815/USD on 4/30/13; on 8/30/13 the Fx was 65.7057/USD.
10. Federal Reserve Bank of Chicago 7th District Iowa farmland values, year-over-year


This communication is intended solely to provide general information. The information and opinions stated are as of September 1, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods. IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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Our Author

Pulsifer_Mackin.jpgMackin Pulsifer
Vice Chairman and
Chief Investment Officer

Panel Member

E Rizzo.JPGElisa Rizzo
Managing Director and
Trust Counsel

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