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Severe Blue

by M. Burke Koonce, III

I went to dinner last week with a friend who was on his way to New York to see one of the last performances of Bruce Springsteen’s run at the St. James Theater on Broadway. I was jealous. I haven’t been to New York City since before COVID-19, and seeing “The Boss” in such a small venue would be amazing. All week I’ve been thinking about New York and hearing Springsteen’s voice in my head. And finally, this morning, it was here. The 20th anniversary of 9/11.

One of the cruel legacies of the terrorist attacks of that day is that it was such an unusually beautiful day. I remember walking to the subway that morning and gazing up at the sky that was a color that pilots refer to as “severe blue,” associated with strong high pressure, bright sunshine, and just a touch of wind. So for the last 20 years, on the first truly beautiful day in September, I have thought at least for a few moments of something truly terrible.

I was just 30 years old, closer to my children’s ages today than my own, working as an analyst at Merrill Lynch on Vesey Street, one block from the World Trade Center. I had walked through the North Tower at about 8:15 AM, about half an hour before the first plane hit and a little more than two hours before the building collapsed. I don’t believe my own life was ever in real danger; after evacuating my building, I had made my way several blocks up the West Side Highway before the towers fell. But I watched the North Tower fall and it was only then, when I saw nothing behind it, that I realized the South Tower was already gone.

At this point, there’s not much I can say that most people don’t already know about September 11, 2001. Of course, we were paralyzed by shock and fear for days, frightened about what new terrors might emerge. Men with machine guns guarded street corners, fighter planes patrolled the skies, and the acrid odor of burnt metal hung in the air all over the city. But what’s interesting to me now is that my most vivid memories of the weeks that followed the existential threat of 9/11 are not of horror but joy. Every gathering, every dinner with friends, was a full-on reunion. Every opportunity to be together was a treasured experience. That autumn in New York, as we shuddered at every low flying plane and struggled to navigate the city without the Twin Towers, was one of the happiest periods of my life.

That’s the great irony of suffering—its gift is the gift of empathy, of shared human experience. Few of us would choose to endure something like a terrorist attack, or a global pandemic, but to experience it is to come into possession of something valuable.

As we saw in the case of 9/11 and later in the COVID-19 free-fall in March 2020, these episodes of extreme fear tend to be fleeting. Why? Because of what drives us as humans. It’s easy to forget that when we talk about markets and economies that what we are really describing are human beings. We have become so accustomed to the extraordinary resiliency and power of a market economy in a free society that it’s difficult to observe on a daily basis. However, when we are faced with true trauma, that power is on full display. The economy adjusts, markets reset, and free people around the world to rediscover joy in their lives. This is made possible by the universal motivation of millions of people around the globe to live their lives and grow their families and pursue their dreams. In the early hours, it looks like hope, and eventually, it even resembles greed. But the truth is it’s just the human spirit.

After 9/11 markets fell sharply, with the Dow Jones down 14 percent for the week after the market finally opened again on September 17. However, by early October, markets had fully recovered. Last year, markets collapsed as COVID-19 fears spread, but if you blinked you might have missed the shortest bear market in U.S. history.

Since 9/11, the S&P 500 has advanced 4.3x. The Dow is also up almost 4x. The tech-heavy NASDAQ, juiced by collapsing interest rates, is officially a 10-bagger. Similarly, since the low in March 2020, the broad market has effectively doubled. The markets have come a long way, to be sure, but naysayers still abound. The VIX Index, which measures volatility or “fear” in the financial markets, has been creeping steadily higher, fueled by factors such as the Delta variant. This fear is to be welcomed by investors. Historically, it does not last.

There has been a lot of virtual ink spilled this week about how after 9/11 nothing was ever quite the same. There may be some truth to that as it relates to certain aspects of our lives that were forcibly modified by circumstances. I certainly feel like it was a turning point in my own life. Over the next two years, I lost my father, became one, and left New York. But the events of 9/11 didn’t directly cause any of these things; it’s just what I remember about my life before I could tell it was changing.

The fact is, our lives are always changing; they were changing on September 10, 2001, and they were changing on March 22, 2020. As individuals, we are not equipped to see this. Humans, unlike markets, are spectacularly inefficient. Only in the fullness of time, in the collective wisdom of human experience, as expressed in markets and other public forums, can we trace our progress. Individual humans change, but the human experience, not so much. There are thousands of 30-year-olds working in Lower Manhattan today—certainly more now than there were in 2001. They’re just different 30-year-olds, doing what 30-year-olds did in 2001 and 1901, and 1801.

This country is an extraordinary wealth creation machine. It’s far from perfect and it’s certainly not fair. And in the future, there will be hideous terrorist attacks and terrible diseases and tragedies we cannot even contemplate. But these episodes do nothing more than increase the efforts of people who want to improve their lives and build better futures for themselves and their families, people who yearn to breathe free. The way to bet is with them. With us.

“I believe that man will not merely endure: he will prevail. He is immortal, not because he alone among creatures has an inexhaustible voice, but because he has a soul, a spirit capable of compassion and sacrifice and endurance.”  — William Faulkner

Burke is the firm’s Investment Strategist. Based in the Raleigh office, Burke works closely with the firm’s Chief Investment Officer helping develop investment strategy and communicating with clients.

The Great Charlie Watts

by M. Burke Koonce, III

News of the death of Rolling Stones drummer Charlie Watts upended the music world this week. Tributes poured in from fellow occupants of the rock and roll pantheon—Sir Paul McCartney, Ringo Starr, Sir Elton John to name a few—as perhaps this was the most significant rock and roll death since George Harrison was lost to cancer almost 20 years ago. When guitar great Eddie Van Halen died last year, I was surprised and pleased the New York Times ran an obituary. For Charlie Watts, it would have been unthinkable if there had not been one. Charlie Watts was a Stone.

That’s why for me this has been more than a mere upending. I loved Van Halen just about as much as anyone my age, but I am a Stones freak. This has been like the passing of an old friend because, even without knowing him personally, he was one.

He was the most relatable of the Stones, by far. One could dream about being able to move like Mick Jagger, party like Keith Richards or play guitar like Ron Wood or Mick Taylor, but only in the same way one can dream of dunking a basketball like Michael Jordan (for me, an impossibility). It was a little easier to dream about being a seemingly normal person like Charlie seemed to be on stage with the Glimmer Twins—a well-dressed guy playing repurposed jazz while all hell broke loose around him. In virtually every Stones concert I attended, and there were many, there was a moment in which Jagger would do or say something so preposterous that Watts would just shake his head and grin. And in every single Stones show, when Mick introduced him as “Mister Chaaarlie Wattssssss!” the crowd responded with thunderous applause, offering up thanks for being the adult in the room, above the madness, keeping the time, and really, keeping the train on the track. It wasn’t so much that he was above it all, it was that his presence, his cool, allowed it all to happen.

He was the son of a truck driver and a homemaker, born in war-torn London in 1941. First trained as a graphic artist, he came under the spell of Charlie Parker and jazz and became a sought-after drummer in the London rhythm and blues club scene in the early 1960s. When Stones founders Jagger, Richards and Brian Jones finally scraped enough money together to pay him, he joined the band and moved into a flat with them.  Can one imagine what living in that place must have been like? Not just playing but living with The Rolling Stones? I don’t think there are too many people that could have done that and not gone insane, no matter how much fun it might have been.

My other favorite Charlie, Charlie Munger of Berkshire Hathaway fame, is fond of saying that temperament is more important than intelligence when it comes to investing. Maybe the same is true for rock and roll? I wonder what kind of investor Charlie Watts might have been. Well, actually, one doesn’t have to wonder—the man did pretty well for himself.

In addition to being one of three members of the Stones who appeared on every one of 30 albums (10 #1s) across 58 years, he also collected fine automobiles (although he did not drive), drum kits, and was a well-known breeder of Arabian horses. He also remained married to the same woman, Shirley Ann Shepherd, from 1964 until his death. While great timing can make both a drummer and an investor look good, perhaps it’s patience that counts even more.

There’s a great interview with Watts in the 1990 Stones documentary 25 x 5, in which he is asked about being in The Rolling Stones for 25 years. “It’s absurd,” he said with a wry smile. “Work five years and 20 years hanging around.”

He also once said he didn’t expect the Stones would last more than three weeks, which became three months, which became three years, which is when he stopped counting. Paul Tudor Jones might have said it this way: let your winners win.

If that’s not the life of an investor, I don’t know what is. Being prepared, showing up and paying attention are all part of the job, but what really counts is the way one performs perhaps one in every five years. Every once in a while, the world will appear to veer off its axis, and the way an investor responds to the world during these episodes will be the difference between success and failure.

Charlie did this through his natural temperament but also through his attention to his craft and his continued curiosity about it. Multiple tributes this week mentioned his childlike awe of the work of not just his jazz heroes Parker and Duke Ellington but of his open-mindedness. He didn’t even like rock until Keith Richards made him listen to Elvis Presley again, and he spent decades reaching out to musicians in cities he was touring. He also knew what he was good at—jazz and swing rhythms—and made his band better by being himself instead of pretending to be John Bonham or Keith Moon (both of whom he happened to outlive by 48 years). Charlie wasn’t perfect; ironically, after his rowdy bandmates had begun to calm down in their forties, he began to develop his own problems with drugs and alcohol, but after an intervention by Keith Richards (I mean, really?) he went cold turkey. He had the self-awareness to see he had made a mistake and the discipline to correct it.

He also did it with style. While Mick and Keith paraded around in boas, Charlie sported Saville Row suits. Reportedly, he owned hundreds of them.

I have no idea if Charlie Watts ever bought a single share of stock in his life but based on the evidence, he was a man of great patience and of near-imperturbable temperament, who took a long-term view and tended toward quality. He was capable of recognizing great talent and willing to put his skills to work in a way that would benefit the group, though he insisted on getting paid and once knocked his famous lead singer out when he was annoyed. He probably would have been successful at a lot of things but being a pretty good investor doesn’t sound like a stretch.

When Van Halen died, there was an element of sadness about a life cut relatively short. Watts was 80 and had lived an extraordinary life. In this case, I suppose I just mourn the passing of time. I miss the cassettes on which I first heard the Stones. I miss the lazy afternoons and sometimes raucous evenings listening to him hammer away on Gimme Shelter and Midnight Rambler. It makes me sad to think I’ll never hear him play live again. But when I think about how much he enriched my life through his music, it makes me smile. Like Red said in The Shawshank Redemption, “I guess I just miss my friend.”

RIP Charlie. Watts that is.

Burke is the firm’s Investment Strategist. Based in the Raleigh office, Burke works closely with the firm’s Chief Investment Officer helping develop investment strategy and communicating with clients.

Planning Before the End of 2020

by Westray Veasey, J.D.

The Tax Cuts and Jobs Act of 2017 (“TCJA”), signed into law at the end of 2017, was based on tax reform advocated by Congressional Republicans and the Trump administration and resulted in the highest federal gift and estate tax exemption ever available under the current transfer tax system, currently $11.58MM per person. A couple can leave just over $23MM to their beneficiaries before incurring a 40% tax on the excess. This high exemption is scheduled to return to pre-TCJA levels, or $5MM per person indexed for inflation back to 2010, in 2026. If Joe Biden is elected President in the November election, and the Democrats regain control of the Senate and keep control of the House, a government looking to raise revenue for stimulus spending and to address wealth inequality could seek to implement tax changes that could negatively impact estate planning. Changes anticipated include reducing exemption amounts before 2026 and possibly to amounts lower than pre-TCJA levels, raising the gift and estate tax rate above 40%, and curtailing effective estate planning techniques such as valuation discounts. Any such changes could be effective as soon as January 1, 2021 if Congress passes legislation having retroactive effect.

Bottom line: If you were considering implementing estate planning strategies before 2026 to take advantage of the high TCJA exemptions, you may want to do that now. Recall that in 2012 there was much anticipation that the exemption could drop from $5MM to $1MM. As a result, there was a flurry of activity at the end of 2012, and many who rushed to make large gifts to lock in the higher exemption were later unhappy with the plans they made when the exemption did not, in fact, go way down. The lessons to be learned from 2012 are (1) plan ahead: go ahead and contact your advisory team to run projections, discuss strategies, get appraisals and have documents prepared, and (2) whatever you decide to do, make sure you will be comfortable with your decision even if the laws do not change after the election.

It is important to keep in mind that the exemption is used from the bottom up, meaning that if you want to use the “bonus” part of the current exemption that is scheduled to sunset in 2026 (or next year, worst case), you have to make a gift in excess of what the exemption will be in the future when it is reduced. Example: You make a gift of $6MM today and the exemption is $10MM. If the exemption is reduced to $5MM on January 1, 2021, on that date you will have $0 exemption left and $4MM of the $5MM “bonus” exemption you had in 2020 will have been wasted.

What strategies might you implement to take advantage of the record high exemptions before tax mitigation techniques are curtailed, exemptions are reduced, and taxes are increased? It depends, of course. If you are wealthy enough to use your full exemption without having to access any assets you give away, you could simply make a gift outright or in trust for your beneficiaries up to the amount of the current exemption. Many wealthy people, however, do have not sufficient assets to use all of their exemptions and not be able to access those assets should they need to.

If you are in that category, a spousal lifetime access trust (or “SLAT”) is a strategy that can take advantage of high exemption amounts without eliminating access to your assets in the future. With a SLAT, one spouse makes a gift in trust for the benefit of the other spouse (and others if desired). This uses the donor spouse’s exemption, and if the spouses later need funds, the trustee can make distributions from the trust to the beneficiary spouse. If you have sufficient assets, it is possible for each spouse to set up a SLAT for the other spouse and use all $23MM of their combined exemptions. If you don’t have sufficient assets, one spouse should set up a SLAT using as much of his or her bonus exemption as possible, preserving the full base exemption of the other spouse for future planning.

There are obvious complexities to designing and implementing a SLAT. For example, what assets should fund the trust, who should serve as trustee, and how you may be able to protect against the possibility of divorce or the beneficiary spouse predeceasing. Consultation with your advisory team is critical to the viability and success of the strategy.

In addition to record high exemptions, wealthy individuals should also take advantage of the economic impact of COVID-19, namely pandemic-depressed asset values and record low interest rates. One such strategy is a Grantor Retained Annuity Trust (or “GRAT”). With a GRAT, you can transfer assets to a trust and retain an annuity interest in the trust for a term of years. At the end of your retained term, any amount remaining in the trust passes to your beneficiaries. A gift is made equal to the value of the property contributed to the trust less the present value of your retained interest. (Note that if the annuity is sizeable enough, the gift can be virtually zero, which is a way to implement additional planning to take advantage of low rates even if you have already used your exemption.) If the assets in the trust appreciate in excess of a government rate called the Section 7520 rate, that appreciation will pass to the remainder beneficiary without making any additional gift. The Section 7520 rate for October 2020 is 0.4%, so it is quite likely that a GRAT could pass significant value to the trust’s remainder beneficiaries without a gift tax cost, especially if assets contributed to the GRAT are currently at depressed values and are expected to appreciate post-pandemic.

An intra-family loan is a simple and low cost technique that works best in low interest rate environments. If the interest rate on a loan to a beneficiary is at the applicable federal rate (“AFR”), which for long-term loans made in October 2020 is 1.12%, the loan will not be treated as a gift. Assuming the beneficiary can use the loan proceeds to pay down higher rate debt or make investments that will yield more than the AFR, assets are passing to the beneficiary without any gift or estate tax.

There is a window of opportunity to take advantage of these and several other estate planning strategies before the impact of the November election hits and the economy recovers from the pandemic. Anyone with net worth in excess of the reduced exemption levels that may be in effect as early as January 2021 should engage their advisory team to explore these planning opportunities while there is still time.