Subscribe to receive our latest insights

Subscribers receive our thoughts on the markets, retirement planning, estate planning, tax law, and more. 
December 17, 2017
Please read the important disclaimers at the bottom of this post. Past performance is not indicative of future results. Not a recommendation to buy or sell securities. Nothing in this presentation is intended to be construed as investment advice.

A Gut-Punch Averted: The most recent tax reform proposal from Republican leaders in Congress removed the proposed mandate for first-in-first-out (FIFO) accounting of stock transactions. The FIFO mandate, projected to add only $2-3 billion in revenue over 10 years in a bill that would add hundreds of billions to the deficit, would have disproportionately hurt long-term investors and those that add to their investments over time. We had been concerned that passage of such a mandate could cause temporary selling pressure in equity markets, as long-term owners of stock could seek to trim holdings under a more flexible tax structure.

November Market Recap: The S&P 500 posted its 13th consecutive monthly gain with a 3.1% return in November. The 13-month streak is now the longest on record, surpassing 12 months of consecutive gains in 1935-1936. Positive reports to start the holiday shopping season sent retail stocks higher, and financial stocks continue to benefit from the rising rate environment. Fixed income indices posted modest losses, and the US Treasury yield curve continued its flattening trend. A late November meeting between OPEC and Russia caused speculation for further oil output restrictions, sending WTI Crude Oil higher by nearly $3/bbl. to $57.42.

A Gut-Punch Averted

In recent weeks, we prepared to deliver a full-throated warning about a lesser-known provision in the Senate tax reform proposal: the FIFO mandate. However, before we could publish the commentary, the most recent proposal removed the FIFO mandate from its plan. Under current law, investors can choose its specific shares to sell, which helps them manage their tax liability. The bill would have forced investors to use First-In-First-Out (FIFO) accounting for stock transactions.

Despite the many problems still left in the final tax reform proposal, in removing the FIFO provision the GOP got this one right. Many of us were taught from an early age to save as much as possible to begin investing early and to add to our holdings over time, a technique known as dollar-cost-averaging. A FIFO mandate would disproportionately punish long-term investors, particularly those that add to their holdings over time. Including a FIFO mandate would have only raised approximately $2-3 billion in revenue over 10 years. This is a relatively small sum by Washington’s standards, in a bill that is projected to add over $1 trillion cumulatively to the deficit. Perhaps even more egregiously, Congress was prepared to give mutual funds an exemption for trades made inside the fund after the industry successfully lobbied against the mandate.

Assuming an investor doesn’t purchase the entirety of his or her shares at once, for example using dollar-cost-averaging, the investor accumulates shares in lots that each correspond to a specific date, time, and price the shares were purchased. Upon selling some of these shares, investors have the freedom to choose which of the lots they would like to sell. If the investor had only one lot, there is no choice to make. However, if the investor had made more than one purchase and is not closing out the entire position, the investor can choose which lot(s) to sell. The investor must use one of three methods to choose: Last-In-First-Out, in which the latest purchase is liquidated, First-In-First-Out, in which the earliest purchase is liquidated, or specific identification. Mutual fund owners have the average-cost method instead of Last-In-First-Out.

Each of these methods will have a different effect on the investor’s short-term and long-term capital gains taxes. Each investor is different, so there is no single accounting method which can be applied to all investors to minimize their taxes. In a rising market, investors forced to sell will typically choose to sell the highest-cost lots to avoid incurring larger capital gains taxes (usually LIFO). Unless, of course, those lots are less than a year old and the investor has lots that are more than a year old, in which case the investor would choose to sell those lots so they will be taxed at the lower long-term capital gains rate. The investor could use FIFO or specific identification in this case. An investor may want to capture losses in a security, but would want to do so at his or her marginal rate. To do this, the investor would need to use LIFO or specific identification.

Congress’ previously proposed FIFO mandate makes selling a tricky endeavor, particularly for long-term holders/dollar-cost-averagers during a market drawdown. As a thought experiment, we simulated a dollar-cost-averaging strategy that purchased $500/month of the S&P 500 ETF (SPY), from its inception in 1993 until today. Over the period, the hypothetical investor would have acquired approximately 1,444 shares of the ETF, worth $384,900 today, for $150,000. If that investor attempted to sell 100 shares today, which would generate $26,665 in proceeds, a FIFO mandate would cause the investor to generate over $22,000 of taxable gains. A last-in-first-out (LIFO) approach would result in only around $5,000 in taxable gain. Although the tax rate on the $22,000 would be 15%-20% vs the investor’s presumably larger marginal tax rate (25%-39.6%), there is still a much larger amount paid in either case if FIFO were used.

In a large drawdown, the results are even more pronounced. If the hypothetical investor attempted to sell 100 shares not today but at the trough of the great financial crisis in February 2009 (when that investor probably needs the cash the most), a FIFO mandate would have caused an approximately $3,900 capital gain on less than $7,400 in proceeds, while a LIFO approach actually generates a nearly $5,000 capital loss – a paper loss needed at tax time, as it surely was not a good time to owe money.

Before the FIFO provision in the bill was removed, we were concerned that the tax consequences could actually cause some short-term selling pressure for equities, as long-term holders might rush to trim their holdings with a more flexible tax structure before the tax bill took effect. If tax policy is designed to not only raise revenue but also incent certain behaviors from the citizenry and promote economic growth, a FIFO mandate certainly misses the mark, and we are glad to see it go.


Domestic stock indices rallied once again in November, continuing a historic run of positive returns, as investors weigh the prospects of comprehensive tax reform out of Washington and rising interest rates from the Federal Reserve. US Large Cap stocks, as measured by the S&P 500 Index, gained 3.1% for the month to bring year-to-date returns to 20.5%. The November gain was the index’s 13th consecutive monthly gain, surpassing a 12-month streak in 1935-1936 as the longest on record. Small cap stocks, measured by the Russell 2000 index, continued to underperform large cap with a 2.9% gain in November to bring year-to-date returns to 15.1%. The MSCI EAFE Index, an index of international developed stocks, gained 1.1%, while the MSCI Emerging Markets Index rallied a modest 0.2% for the month, though emerging markets continue to outperform on a year-to-date basis [+32.9%].

At the sector level, consumer stocks led the market higher, as consumer confidence continues to trend higher and several retailers gave positive reports about the start of the holiday shopping season. In November, the S&P 500 Consumer Discretionary sector index gained 5.1% while the Consumer Staples sector index gained 5.7%, as several grocers delivered strong third quarter earnings reports. The rising interest rate environment benefitted the Financials sector, which gained 3.5% on the month. Market volatility, as measured by the CBOE Market Volatility Index (VIX), trended higher in the first two weeks of the month, peaking at 13.13 on November 15th, though the index finished the month at 11.28, only modestly higher than the 10.18 October close.

Fixed Income markets delivered modest losses in November, as short-term interest rates continue to rise in the United States. The Bloomberg Barclays US Aggregate Bond index returned -0.1% for the month to bring year-to-date returns to 3.1%. The US Treasury curve maintained its trend of flattening, as short-term rates have risen meaningfully in recent months with the Federal Reserve committed to tightening. In November, the 2-year Treasury rose 19 bps to 1.79%, the 10-year Treasury rose 4 bps to 2.42%, and the 30-year Treasury fell 5 bps to 2.83%. High yield credit spreads, as measured by the BofA Merrill Lynch US High Yield Option-Adjusted Spread, spiked 46 bps to 3.97% in the first two weeks of November, as large outflows in the high yield fund complex caused some selling pressure; in the week ending November 15th, high yield funds saw $5.1 billion in outflows, the largest withdrawal since August 2014. Ultimately, high yield spreads fell in the second half of the month to close the month at 3.61%, only 10 bps higher than October’s 3.51% close.

The S&P GSCI Total Return Index gained 1.4% in November, bringing the index into positive territory for 2017; year-to-date, the index is up 1.3%. The Energy sub-index led the commodities complex for a second straight month with a 3.4% gain in November. West Texas Intermediate (WTI) Crude Oil trended higher throughout the month, closing November at $57.42/bbl. after closing October at $54.64/bbl. The rally was fueled by speculation that the November 30th meeting between OPEC and Russia would result in agreement on maintaining supply cuts. After leading crude prices in October, the price gains of refined products lagged in November, with Gasoline gaining only 1% for the month. The Industrial Metals sub-index fell 3.2% in November, though it still leads the market with a 19.5% return on a year-to-date basis. The US Dollar Index trended lower throughout the month to close November at 93.047. The Index, which measures the US Dollar’s value against a basket of 6 foreign currencies, fell after FOMC minutes showed many committee members were concerned with the low level of inflation as the Fed pursues monetary tightening.

We’re thankful for your continued interest and feedback. We also wish you and your families a joyous holiday season! Charlie and family will be enjoying their first Christmas with new son Grant, and Artie is heading south to hometown Key West. As always, please feel free to contact us with questions or comments.

Thank you to everyone for your feedback. Please feel free to reach out at any time with questions or comments.


Arthur Grizzle & Charles Culver
Managing Partners
Martello Investments

important disclaimers

The information contained in this presentation is qualified in its entirety by the following disclosures which must be read in conjunction with the presentation. The presentation is intended for sophisticated investors for informational purposes only and is not intended to constitute investment advice or recommendations by any party. Unless otherwise indicated, information, data, strategies and opinions included in the presentation are provided as of the byline date and are subject to change without notice. In accordance with relevant SEC advertising regulations, a full list of trades and investment recommendations is available upon request. Past performance is not a guarantee or a reliable indicator of future results. The views and strategies described herein may not be suitable for all investors. You should consult your financial advisor regarding such matters. The material contains the current opinions of the author, and such opinions are subject to change without notice. Forecasts, estimates, and certain information contained herein are based on proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. This material contains information that has been prepared from original sources and data believed to be reliable. However, no representations are made to the accuracy or completeness thereof. Investing involves a variety of risks and may be only appropriate for sophisticated persons who can afford a loss of all or a substantial portion of their investment. No part of this material may, without advance written consent, be copied or duplicated in any form by any means. There can be no assurance that any client’s investment objective will be achieved or that a client will not lose a portion or all of its investment account. The investment return and principal value of any investment will fluctuate over time. No chart, graph, or other figure provided should be used to determine which investment strategies to use or which securities to buy or sell. No figure above should be taken as a recommendation or endorsement of a specific security, sector, or strategy. References to market or composite indexes, benchmarks or other measures of relative market performance over a specified period of time are provided for information only and do not imply that any client account will achieve similar returns, volatility or other results. The composition of an index may not reflect the manner in which a client’s portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which may change over time. An index’s performance does not reflect the deduction of transaction costs, management fees, or other costs which would reduce returns. You cannot invest directly in an index.

Subscribe to receive our latest insights

Subscribers receive our thoughts on the markets, retirement planning, estate planning, tax law, and more.