Here we are at the end of the first quarter of 2011 and we watched the markets move basically upward for the first six weeks of the year, advancing as much as 8% in some cases. Then, uncertainty escalated around the world beginning in mid February. First, there was the fall of the Tunisian and Egyptian governments, along with unrest in other Arab countries. By mid to late March, the United Nations, led primarily by Germany and France along with the help of the U.S., were creating a no-fly zone over Libya which is now the responsibility of NATO. Then in mid March, Japan suffered one of the worst natural and human disasters in history between its 9.0 earthquake, the tsunami, and of course, the serious issues at the nuclear facility. Meanwhile, the U.S. government kept itself running by passing a series of continuing resolutions, while the politicians still could not come to grips with an approved budget and deficit.
Through it all, the U.S. markets, while experiencing increased volatility, were not able to create a bull market correction of 10% or more. In fact, after all this turmoil, the market finally closed the quarter up 5.92% on the S&P 500, 7.11% up on the Dow, 3.37% up on the MSCI EAFE, and 7.94% up on the Russell 2000. This is rather amazing when you consider that any one of the above mentioned events could have been an “excuse” for the markets to take an anticipated breather. The current phase of the bull market has now gone on for almost nine months without a correction, so if these types of events can’t drag it down, what does it say for where the market might be headed? In fact, the market had its best week (March 21st - 25th) since last July, as it rebounded from the news concerning Japan. The Federal Reserve not only left interest rates unchanged, but it committed itself to the completion of the $600 billion target of buying Treasury Securities by June 30th. Further, for the first time in awhile, they actually gave a slightly upbeat report, indicating that core inflation was tame, “the economic recovery is on a firmer footing”, and unemployment seems to be abating. AT&T shocked the wireless world with its offer of $39 billion for T-Mobile. Warren Buffet made a $9 billion purchase on behalf of Berkshire Hathaway and was quoted as saying that he still had some dry powder for other significant purchases. Corporations continued to produce positive earnings surprises as well as providing upbeat projections.
So what did investors do? They became bearish and, during March, they moved money out of equity mutual funds. If you are a contrarian, then the smart investor does just the opposite of the smaller investor. Certainly people who were willing to buy on some of the negative news are probably feeling good today. From our perspective, these short-term events are just that; short-term events that certainly cause the markets to react with a lot of volatility and bring discomfort to many investors. We have never been investment traders – we have been investors – believing that, in the long-run, it is best not to react to these types of short-term events and the 24/7 news programs that report about them. Little has changed to fundamentally knock the economic recovery in the U.S. or the world off its perch. Yes, some growth will be taken off the table, but it could be argued that the long-term events of having dictators removed from power and replaced hopefully by democratic forms of government, that the rebuilding of Japan, and a U.S. Congress where debate and compromise are once again important could all be positive events, rather than negative ones. Recognizing these long-term trends sometimes isn’t easy given all the “noise” in the short-run. The processes we employ have generally proved over and over again to be the right course to take in the long-run.
Einstein once said that the definition of insanity was “doing the same thing over and over again and expecting different results.” It appears that Representative Jan Schakowsky, (D-IL) is showing her own form of insanity. She has introduced a Bill in the House that would raise the top tax bracket to 45% for anyone who earns more than $1 million annually. Oops! We forgot. If you earn over $1 billion annually, your tax bracket would be 49%. She said that this wasn’t about revenge, “it’s about fairness”. Her proposal also taxes capital gains and dividend income at regular ordinary rates, rather than at the special rate of 15%, enjoyed today. Fortunately, the House is controlled by Republicans and therefore this Bill won’t get very far. It is another example of some politicians thinking it’s better to tax their way out of overspending rather than to cut expenses.
We recently read an interesting article concerning estate planning mistakes made by very wealthy and well-known people. Some of them just make you shake your head in disbelief, while others are downright laughable. Take the “do nothing” approach of Jimi Hendrix who had someone he barely knew in control of his legacy. Thirty years after his death his estate was finally settled. Or take the example of Supreme Court Justice Warren Berger whose will only had 176 words. However, he left out some key provisions and it cost his family a great deal of money. Keeping his will up-to-date was a problem for Heath Ledger, who wasn’t planning on dying so young. He forgot to update his will when his daughter was born. Thus, once again, lawyers made a lot of money. It’s important to let people know where your estate documents are located. That was one of the reasons it took over four years for Olympian Flo Jo’s estate to finally close. A very common mistake is creating a trust but then not fully funding it. Whatever is not in the trust ends up in probate, which can lead to a lot of wrangling over the estate. Michael Jackson failed to properly fund his trust. Saying one thing, but forgetting to write it down is another issue. Allegedly, Marlon Brando made promises to his housekeeper about giving her a home and continued employment after his death. Because he never wrote it down…Lawsuit, lawsuit, lawsuit. As incredible as it seems in this day and age there are still people like Sonny Bono who died without having a will in place. Need we say more? Why in the world would anyone choose their butler to be the trustee of their billion dollar foundation? But, that is exactly what tobacco heiress Doris Duke did when she died. It’s important to name people who are competent and trustworthy. Finally, there was Joe Robbie, Miami Dolphin owner, whose estate had to liquidate his sports empire at a deep discount in order to raise the cash to pay for estate taxes as a result of poor planning. With the change in the estate tax law, it may be time to revisit your estate plan. (Source: Trial and Heirs)
A lot has been said about the government borrowing money and it will continue to be an important subject for many years to come, especially next year during the Presidential election. Short-term interest rates remain historically low and U.S. government interest rates are well below average. Nonetheless, given our debt, every 31 hours the Treasury pays investors (many of whom are foreign investors) $1 billion. As interest rates drift upward, this will become a very big problem for the U.S. Turning to the consumer side, the picture is a bit brighter. Consumers have reduced their debt by $35 billion since the first of the year. As impressive as this sounds, it is equal to only $311 of debt reduction per 112.5 million American households. While the average household net worth stands at $505,000 as of December 31, 2010, the distribution looks a lot like a barbell with a big weight on one end and a small weight on the other end. Total net worth for U.S. households is $56.8 trillion. (Source: Treasury Department and Federal Reserve)
It seems that former Secretary of the Treasury Henry Paulson knows how to make money – not just for Goldman Sachs but for the government as well. The Federal Reserve paid the U.S. government a record $79.3 billion on the $81.7 billion it earned last year. This easily eclipsed the previous record set in 2009 which was “only” $47.4 billion. Where did this money come from? It was as a result of bailing out many of the financial institutions during the “great recession” and taking back equity in those companies. As the government sold off their positions in those companies they not only got most of their money back, but in many cases made a profit. Do you think it’s time for a government takeover of Goldman Sachs?J
The IRS is feeling a need to audit more returns for taxpayers who make a lot of money. So much so that the number of audits for taxpayers who made more than $10 million rose from 10.6% to 18.4%. If you “only” made between $5 and $10 million, your chances of an audit increased from 7.5% to 11.6%. Taxpayers with an income between $75,000 and $100,000 have the least chance of an audit, coming in at a rate of only 0.64%. Overall, the IRS audited 1.1% of all tax returns during the 2010 tax year. Given the government’s need for more money it won’t be surprising to see your chance of an audit continue to rise.
Would you like to see the top tax bracket reduced from 35% to 25%? This is actually being given serious consideration in Washington, as lawmakers are talking about how they might be able to “reform” the Tax Code. The trade-off is that lowering the tax bracket will require making modifications and perhaps an outright elimination of the ten largest individual tax deductions, which make up nearly 70% of the total tax relief at the individual level. (Source: Congressional Research Service) So, which of these are you willing to give up to have a lower tax bracket? Perhaps we should ask, which combination, or are you willing to give up all of them? (1) non-taxability of employer provided health care; (2) & (3) elimination of mortgage interest deduction on both first and second home; (4) deductions for contributions to retirement plan; (5) higher tax rates on dividends and long-term gains; (6) elimination of the earned income credit; (7) elimination of the child tax credit; (8) non-taxation of Medicare benefits; (9) elimination of charitable deductions; (10) no longer having a state and local income tax deduction. As you can see, each one of these will have proponents and opponents. Without a willingness by their constituents, don’t look for Congress to do anything soon.
How is it possible to get a raise and be unable to enjoy it? For the past couple of years Social Security recipients have seen no adjustments in their Social Security benefits. The Social Security Administration is now projecting a yearly modest 1.2% cost of living increase, which will give the average recipient $10 to $13 more per month. Even this small amount is meaningful for someone living on a fixed modest income. However, it is also being projected that the entire increase will be wiped out by the corresponding increase in Medicare Part B premium payments. Part B is the portion of Medicare that covers doctor visits. By law, the premium increase for Medicare cannot be greater than the increase in Social Security benefits, but it can equal it. Because there has been no increase in Social Security benefits for the past few years there has also been no increase in Medicare Part B payments for many Social Security recipients. The final adjustment does not occur until September, but this early news is not good for most senior citizens.
For people who believe interest rates will remain where they are for at least another year, there is historical precedent for this belief. There have been three recessions over the last 25 years (including the one that ended June 30, 2009). The Federal Reserve Board first raised interest rates 34 and 31 months after those earlier two recessions “officially” ended. That would indicate that somewhere between January and March of next year they might raise interest rates. Only time will tell. (Source: National Bureau of Economic Research, Federal Reserve)
As always, we encourage you to give us a call if you would like to discuss anything further. We will visit again soon. Proudly and successfully serving our clients for 25 years in 2011.
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