Friday, October 26, 2012

Weekly unemployment claims

The finance blog Calculated Risk puts the recent decline in initial unemployment claims in historic context.

(Clicking on the chart shows that the current unemployment situation shows similarites to the 1982 recession.)

only 5 matter

The Dow is up 885 points year to date. While there are 30 stocks in the Index, only five really matter to this 7.3% advance on the year. They are Home Depot (NYSE: HD) (164 points), Wal-Mart (NYSE: WMT) (107 points), Disney (NYSE: DIS) (103 points), Travelers (100 points) and JP Morgan Chase (NYSE: JPM) (58 points) ...

These five stocks represent 60% of the Dow's gain this year. The other 25 names are the remaining 40%, but these are the stocks that have the outsized returns (24 to 47% YTD) and sufficiently large stock price to push the Dow Jones Industrial Average higher. Bank of America (NYSE: BAC) is up 68% on the year, but because it is a low-priced stock at $9, its influence on the Dow is just 45 points.

Monday, October 22, 2012

U.S. stocks on top for first time since 1995

U.S. stocks are beating every major asset class for the first time in 17 years even as economic growth weakens and profits rise at the slowest rate since 2009.

The Standard & Poor’s 500 Index has rallied 14 percent in 2012, beating Treasuries, corporate bonds, commodities, the dollar and equities in Asia and Europe, data compiled by Bloomberg show. The last time that happened, in 1995, the S&P 500 was posting the biggest annual advance of the last five decades. With a price-earnings ratio close to today’s level, the index gained another 93 percent in the next 2 1/2 years.

For all the concern about unemployment and manufacturing growth, the best assets this year remain American companies after unprecedented steps by the Federal Reserve to support growth. Forecasts for a rebound in the U.S. economy and the central bank’s pledge to keep interest rates near zero for years convinced bulls the S&P 500 will extend gains. Bears say political gridlock will drag down prices after monetary stimulus wears off.

The bull market will last another year as individuals regain confidence and return to equities after withdrawing money since 2007, according to Laszlo Birinyi, the president of Birinyi Associates Inc. in Westport, Connecticut. Investors have pulled about $100 billion from U.S. stock funds this year and added $250 billion to bond funds, according to data from the Investment Company Institute in Washington.

“I don’t think you’ve seen the signs of a frothy, toppy market,” Birinyi, who traded equities at Salomon Brothers Inc. in the 1980s, said in an Oct. 17 phone interview. “People are realizing that the stock market is not all that bad. It’s been telling us that the economy and companies are in better shape than people think.”

Wall Street strategists tracked by Bloomberg predict the S&P 500 may surpass its all-time high next year. The benchmark may end 2013 at 1,585, according to the median forecast of five analysts polled by Bloomberg News, 1.3 percent higher than a record in October 2007.

Sunday, October 21, 2012

do tax cuts help the economy?

A new study by Ernst & Young concludes that increasing taxes on higher-income Americans will hurt economic growth and lead to 710,000 fewer jobs being created.

The study was commissioned by four business groups that are opposed to this tax increase, which will go into effect Jan. 1 under current law.

This study should give these groups more ammunition in their fight to ward off this tax hike. They have an uphill battle as far as public opinion is concerned: A new Pew Research Center poll found that 44 percent of Americans think raising taxes on households with more than $250,000 in income would help the economy, while only 22 percent said it would hurt the economy.

Most small businesses are flow-through entities, where profits are taxed at the individual owner. The study found that taxpayers in the top two brackets earn more than $576 billion in flow-through business income, through S corporations, partnerships, limited liability companies and sole proprietorships.
Subjecting this business income to higher taxes is a bad idea if we want to encourage economic growth, business groups argue.

***

The one idea that is almost certain not to jump-start this economy is a tax cut.

Why can we be sure of this? Because that is what we have done for the past three years. For those who think President Obama’s policies have done little to produce growth, keep in mind that the single largest piece of his policies — in dollar terms — has been tax cuts. They actually began before Obama, with the tax cut passed under the George W. Bush administration in response to the financial crisis in 2008. Then came the stimulus bill, of which tax cuts were the largest chunk by far — one-third of the total. The Department of Transportation, by contrast, got 6 percent of the total to fix infrastructure.

That wasn’t the end of it. There was the payroll tax cut, the small business tax cut, the extension of the payroll tax cut, and so on. The president’s Twitter feed boasted: “President Obama has signed 21 tax cuts to support middle class families.” And how has that worked out?

In the wake of a financial crisis caused by excessive debt, tax cuts are highly unlikely to lead to increased economic activity. People use the money to pay down their debts rather than shop for cars, houses and appliances.

- Fareed Zakaria, MidWeek, 6/13/12

***

One of the most pernicious economic falsehoods you'll hear during the next seven months of political campaigning is there's a necessary tradeoff between fairness and growth. By this view, if we raise taxes on the wealthy the economy can't grow as fast.

Wrong. Taxes were far higher on top incomes in the three decades after World War II than they've been since. And the distribution of income was far more equal. Yet the American economy grew faster in those years than it's grown since tax rates were slashed in 1981.

This wasn't a post-war aberration. Bill Clinton raised taxes on the wealthy in the 1990s, and the economy produced faster job growth and higher wages than it did after George W. Bush slashed taxes on the rich in his first term.

If you need more evidence, consider modern Germany, where taxes on the wealthy are much higher than they are here and the distribution of income is far more equal. But Germany's average annual growth has been faster than that in the United States.

You see, higher taxes on the wealthy can finance more investments in infrastructure and education, which are vital for growth and the economic prospects of the middle class.

Higher taxes on the wealthy also allow for lower taxes on the middle -- potentially restoring enough middle class purchasing power to keep the economy going.

As we've seen in recent years, when disposable income is concentrated at the top, the middle class doesn't have enough money to boost the economy.

What we should have learned over the last half century is that growth doesn't trickle down from the top. It percolates upward from working people who are adequately educated, sufficiently rewarded, and who feel they have a fair chance to make it in America.

-- Robert Reich (see article comments for opposing views)

***

Many are convinced that tax increases have little or no damaging impact on the economy. We hear over and over again that notions of damaging effects from higher taxes are merely based on “trickle down” theory, which has been proven false.

This is not true. There exists robust empirical evidence that taxes impede economic activity. In conventional economics, only the magnitude of the negative impact of taxes on economic output is debated, not the existence of such an effect.

Let us focus on one such negative impact, the effect of taxes on the activity of business owners, an important segment of the economy. Business owners account for 40 percent of American capital, while firms with less than 500 employees employ half the private sector workforce.

The argument that taxes do not negatively affect small and medium-size business tends to rely on a number of fallacies. One example is an article by Berkeley economics professor Laura Tyson, a member of Obama’s advisory board, which was published in the New York Times. In the article, she claims that “the relationship between tax rates and economic activity, even though it has superficial appeal, is not supported by the evidence.”

The most common fallacy repeated by Tyson is that taxes do not matter because the economy was booming during the Clinton years even though taxes went up. But tax increases are not the only economic event associated with the Clinton years, and therefore cannot be claimed to cause all events that took place in his presidency. The Clinton years also contained entry into NAFTA, welfare reform, and recovery from the 1992 recession. Most importantly though, the Clinton years included the IT boom, which dramatically raised productivity growth in the United States as well as in other developed countries. It would strain the imagination to believe that Clinton’s moderate marginal tax increase somehow caused the PC and Internet Revolution.

Instead of picking one historic event that happens to fit your preferred theory, a more reasonable approach is to investigate all historical periods where taxes increased or decreased. This has been done by former Obama advisor Christina Romer and her husband David Romer. They also take into account the causes of tax increases.1 They find that tax increases tend to reduce economic growth, stating that “tax increases appear to have a very large, sustained, and highly significant negative impact on output,” as “an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent.” Similar results have been obtained by Harvard economist Alberto Alesina using a different methodology.

Friday, October 19, 2012

the 1987 crash (25 years ago)

The 23% Dow decline in 1987 hasn't been equaled since, not even during the 2008 crash. What was remarkable about the 1987 event was that the averages still ended 1987 with a gain. The market recovered all of its losses in about 15 months.

The Dow and the S&P 500 are still 6% and 8% below their 2007 peaks. The Nasdaq, however, is 5% over its 2007 high -- thanks especially to gains for Apple and Google.

The Dow's 508-point loss wasn't exceeded until Oct. 26, 1997, when the Dow fell 554 points as a financial panic in Asia hit markets. On Sept. 17, 2001, the first day of trading after the Sept. 11, 2001, terror attacks, the Dow fell 685 points.

The two largest one-day plunges occurred in the fall of 2008 after the Lehman Bros. collapse.

Today's problems are quite different from the 1987 crash, when the market fell due to program trading that fed upon itself throughout the day. Also, interest rates had been rising in the spring and summer.An overheated market ultimately fell over. There were worries about tax increases and a slowing economy as well.

***

[see also five years ago]

Wednesday, October 17, 2012

a loser's game

the idea that trading adds value contains an economic fallacy that can be seen using a simple exercise described by Jack Bogle in a 2009 interview with The Motley Fool.

In this exercise, he suggests imagining that half the shares outstanding of all the stocks in the S&P 500  Index are owned by long-term investors and the other half by traders. By definition, the long-term holders who own half the shares and do not trade them will earn the market return. The traders on the other hand are trading with each other because the long-term investors are not trading with them.

As Jack concludes, “It follows as the night to the day that the traders will lose by the amount of money paid to the intermediaries, the croupiers in the middle [as well as to the IRS!]. It therefore follows logically and mathematically that buying and holding is a winner’s game and buying and trading is a loser’s game. Simple as that. No way around it.”

Friday, October 12, 2012

scary earnings

Autumn is in the air, and it's not just the leaves that will be losing their green in the coming weeks.
The Wall Street Journal is reporting that -- for the first time in nearly three years -- companies in the S&P 500 are expected to post an overall decline in profitability.

Thomson Reuters sees a 2.9% decline in earnings. S&P Capital IQ sees a slightly smaller deficit. However, both analyst trackers do see companies, on average, posting lower net income this time around.

In other words, earnings season has never been this scary.

Thursday, October 04, 2012

Buffett Rule fails to pass Senate

[4/16/12] Senate Republicans on Monday blocked President Barack Obama's "Buffett Rule" legislation, which would have put a 30-percent minimum tax on millionaires, in a debate that is likely to resonate through the November general election.

Democrats, as expected, failed to garner the 60 votes needed in the 100-member Senate to move to a full debate and vote on the bill aimed at getting more tax revenues out of the wealthy.

"Tonight, Senate Republicans voted to block the Buffett Rule, choosing once again to protect tax breaks for the wealthiest few Americans at the expense of the middle class," Obama said in a statement.

Fifty-one senators voted for the bill, while 45 senators voted no, effectively killing it. Republican Senator Susan Collins voted for the tax hike, while Democratic Senator Mark Pryor voted against it.

Wednesday, October 03, 2012

famous last words

What are investors thinking when they make mistakes? What's going through their heads? The frame of mind that guides the biggest investment fumbles might be best summed up with a list of famous last words.

"I thought I was getting guaranteed high returns."
Everyone wants that, so no one will get it. Any legitimately "guaranteed" investment will attract so much money that returns will be pushed down to zero -- and negative after inflation. You aren't entitled to anything you're not willing to pay for.

"I want to get in now before I miss more of the upside."
One of the fastest roads to poor results. Buy businesses, not regrets.

"This was a one-in-a-million event."
Maybe it was. Or maybe you severely miscalculated the odds. Reality is almost always the latter.

"You can't afford not to own this stock."
As close as it gets to ringing a warning bell at the top of a bubble.

"I'm going to wait on the sidelines until there's more clarity."
The easiest way to ensure you'll miss the bulk of bull markets.

"It's different this time."
A cliche among famous last words, but easily the most important. Risk will never be eliminated, growth will never be limitless, and markets are never fully efficient. When it comes to big, basic principles of investing, it's never different this time. This truth explains the majority of investment blunders.

[I don't care, I'm still buying Apple.]

Tuesday, October 02, 2012

2012 To-do list

In a normal year, I would say there's no reason to hustle to rebalance your portfolio before year-end. But this year is different because a host of Bush-era tax rates that were favorable to investors are set to expire at the end of December, barring Congressional action. Top of mind for rebalancers? Long-term capital gains taxes, which are set to rise from 15% currently to 20% for those in the highest tax brackets, and to 10% from 0% for those in the 15% tax bracket or below. (This article summarizes some of the key investment-related tax changes that will kick in next year.)

If your portfolio review indicates that it makes sense to lighten up on a winning position that you've held for more than a year--either because its valuation seems high or because it's too large a piece of your portfolio--it's a layup to do so this year, at today's low capital gains rates. After all, tax rates may stay the same, but no one's talking seriously about them going any lower than they are right now. On the other hand, there are risks in going overboard in an effort to lock in low long-term capital gains rates. If you don't have a convincing fundamental impetus for selling a security and tax rates stay the same, unloading it now will trigger a gain that you might have otherwise deferred. This article provides an overview of key tips and traps to bear in mind if you're considering selling something preemptively.

Yet another maneuver that's worth putting on your radar between now and the end of 2012 is converting traditional IRA assets to Roth, a tack that would have multiple benefits in a higher-tax climate. First, the taxes due upon conversion would be based on 2012's relatively low income tax rates. Second, Roth assets will be even more valuable if income tax rates rise in the future because Roth withdrawals are tax-free. Finally, Roth assets aren't subject to the new Medicare surtax going into effect in 2013, which I discussed in this article.

The American budget

For more than a century, the Bureau of Labor Statistics has published a list of how an average American consumer spends his or her annual budget. Rather than the raw numbers of inflation we tend to obsess over, it highlights the impact certain goods have on people's budgets in relation to their incomes.

Take, for example, how much of an average consumer's annual budget is devoted to food:

In 1901, the consumer spend 46.4% of their budget on food.  This dropped to 32.5% in 1950.  Then to 22.6% in 1972.  And to 12.8% in 2005.  It may have bottomed though as it was 13.0% in 2011.

How about apparel?  It was 17.6% in 1918.  8.4% in 1972.  3.5% in 2011.  (My budget for apparel is probably like 0.01% or less.)

In 1960, typical consumers devoted 36.3% of their budget to food and apparel (combined). Today, 16.5% of an average budget goes to those two categories. That's a difference of 20 percentage points. And since we aren't eating less or wandering around less clothed; it truly does mean that one-fifth of an average consumer's budget was freed up within with 50 years. And that's just looking at food and apparel alone.

What happened to that 20% of our budget? That's where things get interesting. Spending 20 percentage points less on food and apparel means we get to spend more on other categories. And a lot of those other categories include products and services that have made our lives demonstrably better.

For example, the percentage of our budgets devoted to health care has more than doubled since 1901.
Some will say that's a bad thing. Healthcare, after all, has seen inflation well beyond the rate of wage growth in recent decades. But there's another, deeply positive side to it. The quality of the medical care grew exponentially in the last century. And we can afford to spend more on health care today in part because large parts of our budgets have been freed up thanks to the relative decline in expenses like food and apparel. We've traded expensive pants for penicillin. That's a wonderful thing. And it has helped push average life expectancy up from 48 years in 1901 to 78 years today.

What else are we spending more of our budgets on today? Education:

In 1901, it was 0.0% (!).  1.1% in 1960.  2.1% in 2011.

[And how about cable TV?  I'm pretty sure it was 0.0% in 1901!]

Monday, October 01, 2012

the fiscal cliff

WASHINGTON (AP) - A typical middle-income family making $40,000 to $64,000 a year could see its taxes go up by $2,000 next year if lawmakers fail to renew a lengthy roster of tax cuts set to expire at the end of the year, according to a new report Monday.

Taxpayers across the income spectrum would be hit with large tax hikes, the Tax Policy Center said in its study, with households in the top 1 percent income range seeing an average tax increase of more than $120,000, while a family making between $110,000 to $140,000 could see a tax hike in the $6,000 range.

Taxpayers across the income spectrum will get slammed with increases totaling more than $500 billion — a more than 20 percent increase — with nine out of 10 households being affected by the expiration of tax cuts enacted under both President Barack Obama and his predecessor, George W. Bush.

The expiring provisions include Bush-era cuts on wage and investment income and cuts for married couples and families with children, among others. Also expiring is a 2 percentage point temporary payroll tax cut championed by Obama.

The looming expiration of the large roster of tax cuts is one of the issues confronting voters in November, with the chief difference between Obama and GOP candidate Mitt Romney being the tax treatment of wealthier earners. Obama is calling for permitting rates on individual income exceeding $200,000 and family incoming over $250,000 to go back to Clinton-era rates of as much as 39.6 percent.

Both candidates call for rewriting the tax code next year, but any such effort promises to be difficult and could take considerable time.

Economists warn that the looming tax hikes, combined with $109 billion in automatic spending cuts scheduled to take effect in January, could throw the fragile economy back into recession if Washington doesn't act. The automatic spending cuts are coming due because of the failure of last year's deficit "supercommittee" to strike a bargain. The combination of the sharp tax hikes and spending cuts has been dubbed a "fiscal cliff."

the dividend cliff

Last week, NYU Stern professor Aswath Damodaran wrote a blog post on the coming fiscal cliff and the impact it could have on dividend stocks in particular. Later in this article, I'll get more specific about which stocks are most likely to see effects from higher taxes on dividend stocks, but first, let's take a closer look at Professor Damodaran's argument.

The crisis we're facing now is a direct result of the way in which tax cuts were structured over the past decade. In 2001 and 2003, new tax laws reduced rates on ordinary income, dividends, and capital gains substantially, with one of the biggest benefits being given to dividends. For most stocks, dividends had their maximum tax rate reduced to 15% -- a big savings over prior law's treatment of dividends as ordinary income potentially subject to much higher marginal tax rates for high-income taxpayers.

With these tax laws, though, was a catch: They would expire in 10 years. After a two-year extension back in 2010, these cuts are now once again slated to go away at the beginning of 2013, and the coming election gives politicians little incentive to do anything about the looming deadline until after the first week of November.

Damodaran does a good job of explaining what impact higher dividend taxes should have on rational investors. Essentially, he argues that investors value stocks based on their after-tax dividend yield. So if taxes on dividends rise, investors will demand a higher pre-tax dividend yield in order to end up with the same amount of income after taxes.

To show his work, Damodaran goes through a concrete example in valuing the S&P 500 under a change in tax laws. Based on his latest observations, he believes the S&P 500 could be vulnerable to a roughly 15% drop from current levels based solely on dividend taxes.