The War on Retirement Savings May Be Beginning

This article from the Washington Post indicates that Congress is beginning to eye retirement savings tax breaks (e.g. 401(k) plans, IRA plans, etc.) for possible "reform".  In other words, the $200 billion/year in tax breaks currently enjoyed by anyone who is contributing to a retirement plan may be on the chopping block.  The article is very non-specific, except for indicating that the head of the House Ways and Means Committee has scheduled hearings to look into this matter.

http://www.washingtonpost.com/business/economy/lawmakers-consider-changing-tax-breaks-on-retirement-savings/2012/04/17/gIQARfV7OT_story.html?hpid=z12&sub=AR

Why Companies Continue to Pay Dividends

This article, published on the Bloomberg web site and written by University of Chicago professor Douglas J. Skinner, mentions reasons why companies continue to pay dividends when they may be better off not doing so.

http://www.bloomberg.com/news/2012-04-11/why-u-s-companies-continue-to-pay-dividends.html

One issue that Mr. Skinner does not mention:  some investors, such as trusts, require the purchase of dividend-paying stocks.  This is often the case when the trust has a "split interest" -- there are current income beneficiaries, but there are also future heirs to the trust who will receive a payout of interest, if not the entire principal, of the trust.  Current beneficiaries may be limited to receiving income distributions.  Were it not for the dividend requirement, the income beneficiary would be out of luck.  In some cases, the purchase of only dividend-paying stocks may be required by state law in which the trust calls home.  In other cases, the trust document itself may require that only income-producing assets, such as dividend-paying stocks, must be purchased.

Bond Vigilantes

In the 1980s and 1990s, a new term was coined:  Bond Vigilantes.  These are/were professional investors active in the bond market whose presence kept the Federal Reserve Board in line in terms of its interest rate policy, and the U. S. Government in line as far as its spending.  During that period, Bond Vigilantes had soe much more money to play with than the Federal Reserve Board that the Fed had trouble managing interest rates.

Right now, the Bond Vigilantes have their sights set on Europe, as this blog post by Ed Yardeni mentions:


http://blog.yardeni.com/2012/04/euro-mess-again_11.html

Apparently, the Bond Vigilantes only have so much capital to make the lives of central bankers and national governments difficult.

Eventually, these Bond Vigilantes will turn their sights again on the U. S. Treasury market.  But right now, the Federal Reserve Board has expanded its purchasing of bonds to the extent that the Bond Vigilantes feel it is more profitable to play in smaller ponds (Europe) rather than the deep capital pool that is the U.S. bond market.

The Wisdom of Marty Whitman

As I noted in my most recent newsletter to clients, Marty Whitman, founder of Third Avenue Funds, is a legendary investor on Wall Street who criticizes indexing and excessive diversification.  His quarterly newsletters are written for investors who are fairly knowledgeable about investing.  In my newsletter, I decided to quote a passage from his Chairman's Letter, and decipher his statements for the average investor.  My plan is to continue excerpting certain parts of his newsletter that provide insight into investing in general, and investing in the current market environment in particular.

Mr. Whitman notes in the Third Avenue Funds Portfolio Manager Commentary and First Quarter Report (2012):

"A primacy of earnings approach clearly is in conflict with the desire of most companies to minimize income tax burdens.  Income from operations are taxed at maximum corporate rates.  Taxation of capital gains is much preferred, because the taxpayer usually can control the timing as to when the tax becomes payable.  And the ultimate corporate tax shelter for businesses which don't need cash return is unrealized appreciation."

Whitman is saying that companies have two options: work to maximize their profits or work to minimize income taxes.  Investors who buy common stock in publicly traded companies face double taxation -- the corporate tax in the year that the income was earned, then again at the investor's level as a tax on dividends paid and capital gains (when the common stock is sold).  Whitman argues that from an investor's standpoint, companies that tend to minimize dividend payments and maximize the amount of capital appreciation are better for investors who like to decide when they pay a tax.  Dividend income is taxed in the year it is distributed.  Capital gains (capital appreciation) is taxed only when the investor decides to sell his common stock.

But more importantly, Whitman is saying that companies that retain their earnings, rather than paying dividends, ultimately have a cheaper source of capital to grow their business, because the government is not taking the tax on dividends in addition to the corporate earnings tax in any given year.  Instead, only the corporate tax is assessed, and the remaining after-tax earnings are free to be invested as the company sees fit.  The company therefore has less need to issue new common stock to investors.

Think about it this way:  If the company paid out a dividend of $100, and the stockholder was taxed at a 15% rate, there would be $85 left to reinvest in another stock.  So if the company decided to sell more common stock, the stockholder would have only $85 to invest.  Yet if the company instead paid no dividend, and retained the $100, there would be more money available to the company for reinvestment in the business.

Why Americans Work so Hard But Feel So Poor

This article from "The Atlantic" gives a short but informative view of why America's work force works harder, while productivity has risen, yet workers feel financially squeezed.

http://www.theatlantic.com/business/archive/2011/07/squeezed-dry-why-americans-work-so-hard-but-feel-so-poor/241252/#

Chinese Imports to the US

Newspaper headlines are dominated these days about the rise of China as a global economic source.  Frequently, Chinese imports are blamed for joblessness in the US.  But how much of today's unemployment picture relates to Chinese imports?  How much do we really buy from China?  The San Francisco Federal Reserve Board's web site includes the results of a recent study concerning the percentage of goods and services sold in the US that are sourced from China.  The authors, Galina Hale and Bart Hobjin, conclude the following:

Of the 2.7% of U.S. consumer purchases going to goods labeled “Made in China,” only 1.2% actually represents China-produced content. If we take into account imported intermediate goods, about 13.9% of U.S. consumer spending is attributable to imports, including 1.9% imported from China.

Since the share of PCE [personal consumption expenditures] attributable to imports from China is less than 2% and some of this can be traced to production in other countries, it is unlikely that recent increases in labor costs and inflation in China will generate broad-based inflationary pressures in the United States. 

The entire article may be read at the following link:

http://www.frbsf.org/publications/economics/letter/2011/el2011-25.html?utm_source=home

Investing in Stocks

I sometimes get asked about how I decide what stocks to buy for client portfolios.  The answer is not easy or simple, however, a general summary might give some insight into the process.

Investing in stocks requires original research.  Research can be looked at in two ways:  macro and micro.  I define macro as looking at “the big picture”.  This includes international economic trends, international politics, domestic (U.S.) politics and domestic economic trends, what is happening in the bond market and commodities markets.  Macro research also covers industry trends.  For example, I ask the question: Which economic sectors should outperform and underperform, given the outlook for international and domestic economic and political trends?  Normally, in a bad economy, or heading into a bad economy, so-called “defensive” industries tend to do better than ones that will suffer in an economic downturn.  Procter & Gamble is a classic “defensive” stock.  Everyone has to wash clothes, eat, and spend money on grooming products, regardless of the economy.  People might trade down from name brands that P&G sells, but nevertheless, companies that sell everyday necessities that are consumable products are a natural investment option in a bad economy.

Micro-level research involves researching specific companies.  For example, before I invest in a stock, I look at research reports from various research providers, but I also do my own research by looking at the current annual report and SEC-mandated 10-K report to assess a company’s prospects.  I have specific criteria that I use when evaluating a company’s financial strength, future prospects and ownership structure.  Once I decide that a company meets my criteria, and if the time is right from a macro level, that stock may be purchased for client portfolios.

Because I am more a strategic than a tactical investor, I tend to hold stocks for a longer time than a typical mutual fund.  This holds down taxes for clients who have standard accounts that are subject to tax whenever a sale is made in their portfolios.  It also helps hold down transaction costs for all clients, including clients who own IRA accounts and other types of tax-deferred accounts.