the fiscal cliff

[2/19/13]  Holding their noses, senators of both parties came together to pass overwhelmingly (89–8) a tax bill that preserves the Bush-era income tax rates for 99% of Americans. After some rumbles, the House of Representatives cleared the measure the next day by a solid bipartisan majority.

I’m not happy with everything in the new law. (It does nothing to alter the 3.8% Obamacare surcharge on high earners’ investment income, for example.) However, I’m pleased that the basic 15% tax rate on dividends and long-term capital gains has been made permanent for most taxpayers. Even the “rich” will pay a lower rate on dividends under Obama than they did under Ronald Reagan!

Far from being an economic disaster, the new tax regime should promote growth, at least marginally, by reducing uncertainty and preserving significant incentives to save and invest.

[Profitable Investing February 2013]

[1/1/13] WASHINGTON (Reuters) - The U.S. Congress approved a rare tax increase on Tuesday that will hit the nation's wealthiest households in a bipartisan budget deal that stops the world's largest economy from falling into a deep fiscal crisis and recession.

By a vote of 257 to 167, the Republican-controlled House of Representatives approved a bill that fulfills President Barack Obama's re-election promise to raise taxes on top earners.

The Senate passed the measure earlier in a rare New Year's Day session and Obama is expected to sign it into law shortly.

The United States will no longer go over a "fiscal cliff" of tax hikes and spending cuts that had been due to come into force on Tuesday but other bruising budget battles lie ahead in the next two months.

It was a reversal for House Republicans, who were in disarray despite winning deep spending cuts in earlier budget fights. But they saw their leverage slip away this time when they were unable to unite behind any alternative to Obama's proposal.

House Speaker John Boehner and other Republican House leaders stayed silent during the debate on the House floor, an unusual move for a major vote.

The deal shatters two decades of Republican anti-tax orthodoxy by raising rates on the wealthiest even as it makes cuts for everybody else permanent.

[12/31/12] WASHINGTON » Squarely in the spotlight, House Republicans were deciding their next move today after the Senate overwhelmingly approved compromise legislation negating a fiscal cliff of across-the-board tax increases and sweeping spending cuts to the Pentagon and other government agencies.

In a New Year's drama that climaxed in the middle of the night, the Senate endorsed the legislation by 89-8 early Tuesday.

It would prevent middle-class taxes from going up but would raise rates on higher incomes. It would also block spending cuts for two months, extend unemployment benefits for the long-term jobless, prevent a 27 percent cut in fees for doctors who treat Medicare patients and prevent a spike in milk prices.

The measure ensures that lawmakers will have to revisit difficult budget questions in just a few weeks, as relief from painful spending cuts expires and the government requires an increase in its borrowing cap.

House Speaker John Boehner met with rank-and-file GOP lawmakers to gauge support for the accord, and an aide said GOP leaders would not decide their course until a second meeting later in the day. That suggested that House voting might not occur early.

*** [11/17/12] What happens if we fall off the cliff?  According to Dan Newman (relaying the CBO):

The deficit would shrink to 0.4% of GDP by 2018 compared to 4.2% (in the alternative scenario where all tax cuts except the payroll tax cut are extended, the alternative minimum tax is indexed for inflation, Medicare payment rates are not cut, and the automatic spending cuts don't happen.)

Debt would go down to 60% of GDP compared to 90%.

Unemployment would rise to 9% compared to 8%, but would go down to about 5% in 2022 in either scenario.

GDP growth would go down to 0.5% compared to about 1.7%.  However by 2022, GDP growth would be about 2.3% compared to about 2.0%.

[So, according to this, falling off the cliff would actually be better in the longer run.]

outflows continue (for actively managed funds)

[6/3/13] The ongoing rally in the U.S. equity markets (with the S&P 500 TR Index up 16.7% since the start of the year) has done nothing to persuade investors to put more capital into actively managed U.S. equity funds, according to the most recent fund flow data provided by Morningstar Direct. Much as we've seen the past five years, the majority of the capital that has been going into equities is being directed at passively managed products--index funds and exchange-traded funds--which have become the default option for investors looking to gain exposure to equities.

Even as the U.S. equity markets gained more ground in the second quarter (with the S&P 500 TR Index up more than 5% since the end of March), investors have reverted to shunning actively managed U.S. equity funds, with January just a blip in what has been a six-year trend of outflows from the category. Flows have been positive for actively managed U.S. equity funds in just 13 out of 72 months, with more than half of those positive flow periods occurring during the first two months of the calendar year. This means that absent the portfolio rebalancing and retirement funding that typically takes place in the first quarter of any given year, the flow picture would be even more dire for managers of actively managed U.S. stock funds.

[2/4/13] At close to $130 billion, 2012 went down as another record year of outflows from actively managed U.S. stock funds, surpassing the $108 billion that flowed out of these funds during 2008 (according to data provided by Morningstar Direct). The results were less dire when excluding the impact of American Funds, which accounted for one third of the total outflows. That said, outflows are now coming from a much wider array of managers overall, with American Funds accounting for more than 40% of total outflows during both 2010 and 2011.

It also should be noted that December was the 22nd straight month of outflows from actively managed U.S. stock funds, with the segment seeing positive flows on only 12 occasions during the past five years: February 2008, April 2008, May 2008, August 2008, January 2009, April 2009, May 2009, June 2009, January 2010, April 2010, January 2011, and February 2011.

While actively managed U.S. stock funds stayed in net redemption mode last year, index funds and ETFs posted their best annual flows since the financial crisis. The biggest winner on the index side of the business continues to be Vanguard Total Stock Market Index, which until the end of last year tracked the MSCI U.S. Broad Market Index and accounted for more than half of the $24 billion that flowed into U.S. stock index funds during 2012.

Even after excluding the impact of net redemptions at American Funds, flows for actively managed international stock funds remained in negative territory during the latter half of 2012. Adjusted flows for the full year looked much better, though, with the more than $12 billion that flowed into the category during April accounting for the lion's share of the $13 billion in inflows that were recorded last year.

Much as we had anticipated, flows into taxable bond funds tapered off enough during November and December to keep 2012 from beating the record level of inflows that was recorded for the category during 2009. Flows into actively managed taxable bond funds of around $239 billion were about $17 billion shy of 2009 levels, while index fund inflows were about $9 billion lower than they were four years ago. Flows into taxable bond ETFs, though, were much stronger last year, with the more than $48 billion that flowed into the category not only $10 billion higher than 2009 levels but $5 billion higher than the record inflows of $43 billion in 2011.

Although 2012 was not a record year for taxable bond inflows, the fact that more than $314 billion flowed into the category last year continues to astound us, given that taxable bond yields remain at extremely low levels and the stock market (as exemplified by the S&P 500 TR Index) was up 16% during 2012. Add flows into tax-exempt fixed-income funds, and total inflows for bond funds overall were $368 billion last year (below the record level of $406 billion that flowed in during 2009), which compares with just over $45 billion in inflows for equities--U.S., sector, and international stock funds combined--during 2012, which is on par with 2009 results.

At this point of the cycle, it looks to us as if investors continue to be lured more by the notion of capital preservation than the potential for capital appreciation.


[12/28/12] While the passing of the elections last month eliminated one of the biggest uncertainties hanging over the markets, it was quickly replaced with concerns about the impending fiscal cliff and the impact that any negotiated deal (or lack of a deal) would have on not only the markets, but also tax rates. Even with all of the uncertainty we've seen in the markets this year, the S&P 500 TR Index was up nearly 15% through the end of November.

But such strong market returns have not translated into positive flows for actively managed U.S. stock funds, which remain in net redemption mode (versus what looks to be a near record year for passive equity flows). The nearly $115 billion that has flowed out of these funds since the start of the year has already surpassed the record $108 billion that flowed out of them during all of 2008.

With just one month left in the year, outflows from actively managed U.S. stock funds had already surpassed the record level of outflows during 2008. At close to $115 billion, outflows during the first 11 months of 2012 are already $6 billion higher than they were during 2008 and more than $14 billion higher than they were last year, which was the second-highest year of outflows on record (according to data provided by Morningstar Direct).

While actively managed U.S. stock funds remain in net redemption mode, index funds and ETFs dedicated to the category are on pace not only to surpass the level of inflows that were seen during 2011, but also post their best year since 2008. The big winner on the index side of the business continues to be Vanguard Total Stock Market Index, which currently tracks the MSCI U.S. Broad Market Index and has accounted for more than 40% of the $29 billion that has flowed into U.S. stock index funds this year.

*** [9/24/12]

Despite gains in the U.S. equity markets, as represented by the S&P 500 Index, during June (up 4.3%), July (up 1.0%), and August (up 2.3%), investors continued to pull money out of actively managed U.S. stock funds last month. This marks the 18th straight month of outflows from the category, leaving 2012 on pace to match the level of investor outflows that were recorded last year, which at $97 billion were second only to the nearly $115 billion that flowed out during 2008.

[see also]

Five surprising winners

We have just a few days to go in 2012, and the S&P 500 is up a refreshingly robust 14% year to date. It may come as a surprise to see the numbers lining up to make this year a slightly better than average year for the markets.

Didn't we have a contentious presidential election? Isn't Europe still a mess? What about this fiscal cliff we keep hearing about?

Well, the market isn't the only surprising climber this year. Let's take a closer look at five well-known companies that are trading nicely higher in 2012.

Apple up 30%

Netflix up 36%

Amazon.com up 49%

Sears Holdings up 39%

Microsoft up 9%

the optimal tax rate

For most of the past six decades, the U.S. government has taken a lenient approach toward taxingfinancial wealth. Dividends from stocks and gains on long-term investments are currently taxed at 15 percent, compared with rates on ordinary income as high as 35 percent. The differential treatment has resulted in such attention-grabbing distortions as Warren Buffett paying a smaller share of his income in taxes than his secretary, and Mitt Romney paying an effective federal rate of only 14.1 percent on $13.7 million in income last year.

In a certain kind of world, such a system makes sense. In the 1970s and 1980s, researchers built models of the economy showing that, if everyone started out with nothing, made money by working and didn’t pass anything on to their children, the optimal rate on investment income would be zero. The logic was that if you tax people once on their labor income, it’s not right to tax them again on the part that they set aside for the future. Doing so would inhibit saving, starving the economy of the investment it needs to grow. Fewer jobs would be created. Everyone would be worse off.

Now consider a different world. Here, some people are born well-off, with inheritances so large that they can live comfortably without working. Most, however, are born relatively poor, with little or no capital at all. In this world, taxing labor income alone would amplify the inequality by putting an outsized burden on people who work. Taxing capital, by contrast, would take some of the pressure off labor, increasing the incentive to work and providing a net benefit to the majority of the population.

The second world closely resembles the present-day U.S. As of 2010, the wealthiest 10 percent of families commanded about 75 percent of all households’ total net worth, while the poorest 50 percent held only 1 percent, according to Federal Reserve data. The distribution of inheritances is similar.

To get a sense of what tax rates should be in such a world, two researchers -- Thomas Piketty of the Paris School of Economics and Emmanuel Saez of the University of California, Berkeley -- built a model of the economy that took into account the vastly divergent financial endowments.

They found that the distribution of wealth makes a big difference: The more it’s concentrated in the hands of a few, the more the benefit of shifting the tax burden off labor income outweighs any potential negative impact on saving. They estimate that in the extremely concentrated case of the U.S., if the aim is to make humanity as a whole better off, the optimal tax rate on capital -- including bequests, corporate profits and investment income -- would be as much as 60 percent.

What does all this mean for the current U.S. tax system? It suggests that if you think the government needs more revenue to reduce its budget deficit, raising taxes on investment income is a good solution.

Grantham is depressing

Last year, legendary investor Jeremy Grantham of GMO published a treatise on exploding commodity prices.  He also offered a startlingly depressing outlook for the future of humanity.

Grantham believes the world has undergone a permanent "paradigm shift" in which the number of people on Earth has finally and permanently outstripped the planet's ability to support us.

Grantham believes that the planet can only sustainably support about 1.5 billion humans, versus the 7 billion on Earth right now (heading to 10-12 billion). For all of history except the last 200 years, the human population has been controlled via the limits of the food supply. Grantham thinks that, eventually, the same force will come into play again.

The headline of the article was what caught my eye.  We're Headed For A Disaster of Biblical Proportions.  But it wasn't Grantham who said it.  It was, of course, Dr. Peter Venkman.