- When the President put forth his proposed budget for the 2014-15 fiscal year which begins October 1st, he went out of his way to offer an olive branch to the Republicans on entitlement programs - especially Social Security and Medicare. The President proposed changing the cost of living adjustments in such a way that, over time, there would be significant savings to the government, but of course, take the money away from the recipients. He also proposed raising the Medicare premiums in order to put this program on sounder ground. The backlash by liberal Democrats was fast, and the backlash from senior citizens was furious. Now that the Republicans have those items on the table which have been proposed by the President rather than by themselves, they appear to be shifting gears towards overall tax reform. Former Senators Simpson and Bowles have updated the plan their bipartisan committee developed almost two and a half years ago, and they believe it now has the political and financial possibility of being passed. To Simpson and Bowles, it honors the basic principles of both parties while at the same time making the tax policy simpler and fairer. Of course, like beauty, all of this is in the eye of the beholder. Look for Republicans to begin to embrace this newest version of Simpson Bowles and to push it forward through the rest of the spring and into the summer. If they are serious about eliminating deductions and exemptions at both the corporate and personal levels, making the income tax process simple, lowering the tax brackets, it will be difficult to reject the basics. The devil will be in the details. We will keep you up-to-date as the jostling continues.
- Why would a company (Apple) with $145 billion in cash want to borrow $17 billion and incur the costs of borrowing that money? While on the surface the answer may appear simple, it really is quite complicated. Many corporations are taking advantage of the low interest rate environment by issuing long-term bonds It is their belief that by “financing” future needs at these low interest rates, they will be able to produce superior investor returns in the future. There is a lot to be said for that, if you are a long-term investor. In the short run of course, even at the ridiculous rate of 2.74%, there is still a cost.
Apple investors have been demanding that the company return some of this cash to stockholders if they are not going to use it to build the business. As large as $145 billion is, the problem for Apple is the fact that $102 billion of this is parked overseas. That is to say, it is profit earned outside the U.S. which they have not repatriated back into the U.S. because of the high tax rate. Thus, by borrowing $17 billion, they are in essence financing their stock buy-back program and dividend pay-outs. Think about it like this: On the stock buy-back program, if the stock rises at a rate faster than 2.74% (is there anyone who doesn’t believe that will be the case over the next few years?) then it becomes accretive to the remaining shareholders. With the low interest rates today, it doesn’t make sense for a company to sit on such a large amount of cash, unless it is going to reinvest it into the company or use it to purchase other businesses. All of that cash only holds back growth. Between low earnings on cash and the high tax rate in the U.S. for foreign profits, it’s a true conundrum.
- There were no April showers in the broad stock market, as measured by the S&P 500, as for the sixth month in a row it produced a gain. This April the S & P 500 was up 1.8% in spite of a lot of volatility. Most of this was led by a relatively strong earnings reporting period. The question is whether will the lack of April showers will bring May flowers to set a seven month string of gains. Only time will tell.
- A suggestion and a warning regarding your cell phone. The other day we went in to get new cell phones and after purchasing the phone the store associate asked if we wanted him to see if there was a “better” plan for us. We thought it was going to be a pitch, but it was quite the reverse. By examining the current plan, he determined that we could lower our costs over 25%! So, we suggest that you contact your wireless carrier to see if they have a “better” plan for you. They are not going to call and tell you about the potential for savings, but if you ask they are obligated to provide you with the information. Now for the warning. Do not give out your cell phone number to on line offers you may receive. These pitches look very inviting and you think they are coming from the legitimate website you signed into. It might say something like, “Congratulations, you have been chosen to do a survey and we will provide you with a $100 gift certificate for completing the survey”. It is a come on. They will ask you for your cell number to “verify” your participation with an authentication code, and presto, the next thing you know, they are sending you offers for services you don’t need at a cost. Also, you should check your phone bill each month for services (charges) you didn’t request. This is a practice called cramming and, while illegal, it happens. If you fall victim to this, just ask your wireless carrier to reverse the charge and then ask for their blocking program.
- There are people accusing the Japanese of intentionally deflating their currency in order to make their exports cheaper. It wasn’t that long ago that a dollar would only purchase about 80 yen and today it’s at about 100. That means that Americans traveling to Japan will pay 25% less than they once did, which also translates into their exports being that much cheaper also. There are two ways that a currency becomes stronger or weaker. Given the natural process a currency becomes stronger when one economy is growing faster than another, generally as a result of increased productivity. While the United States is growing faster than Japan, it is clearly not in hyper mode and this dramatic difference in currency rates is not reflective of the growth mode. The second way that a currency is influenced is if economic policy leaders force the value of their currency up or down through monetary policy. Japan appears to be forcing their currency lower.
But, the issue with Japan goes far beyond any currency manipulation that may be occurring. It was not that long ago (25 years) that headlines were screaming about Japan burying the United States. Remember when they famously bought all of those high end real estate properties – including the fabled Pebble Beach Golf Links? That was when their currency was really strong relative to the dollar. But for the past couple of decades, Japan has been mired in an economy that has been stagnant and in a deflationary spiral. As we have mentioned in the past, inflation is a problem to be solved – deflation is extremely difficult to solve. This is one of the reasons that Ben Bernanke has been so diligent in trying to make the U.S. economy grow.
The economic crisis of 2008 and 2009 was extremely deflationary, particularly as it related to the stock market, which declined over 50%. Perhaps not more importantly, real estate values fell 30% nationwide, and in some isolated situations, declined as much as 50%. It is not good when things decline in value, but when things decline in value and you borrowed money to purchase them – whether it’s credit card debt, bank debt, or mortgage debt, it can have a long-term effect on the growth of a country,.
A good part of Japan’s issue is simply that it does not consume goods and services as a country the same way as the United States. If Japanese citizens are not consuming goods and services, the only way they can grow their economy is to export. Keep in mind that as big as our economy is, 70% of it is driven by consumers. Another aspect of the Japanese economy that cannot be ignored is their lack of innovation. They continue to make and export product, but when is the last time you remember them creating a new product or technology?
- Earlier this year the Republicans in Congress thought that they would have an opportunity to have a serious discussion around tax reform and entitlement reform because the debt ceiling was looming. Because of the tax act passed at the beginning of the year raising taxes for mostly those in the upper tax brackets there is more revenue available than first thought. Additionally, with the sequester starting in early March spending is down. As a result, the debt ceiling may not need to be adjusted until late September or early October. It will likely keep the Republicans frustrated for several months. It's a shame that Congress will probably wait until the last minute once again, but then that seems to be the way Washington works these days.
- For the past several years bank depositors have cried and laughed at the same time as they looked at the interest rate they were receiving on their savings. It has been next to nothing, and negative after taxes and inflation, even considering the low level of inflation. The federal government, of course, has been enjoying the ability to finance its debt at historically low interest rates. Last week the Treasury sold 10 year notes at an interest rate of 1.77%. From the standpoint of investors, it means that they believe inflation will be relatively tame for the next 10 years, a concept we don't subscribe to for a number of reasons. That is a story for another day. Nonetheless, safety is still the watchword even as the stock market has continued to set records and even the NASDAQ is at a 12 ½ year high. Treasury bills are issued for 30, 90, and 180 days. Like other interest rates these have been extremely low and essentially at a 0% interest rate. Well, not exactly…until last week when the Treasury sold $20 billion of treasury bills for 30 days at 0.0% interest. In other words, investors were willing to lend money just to be able to get their principal back. The demand for Treasury bills was five times higher than what the government was willing to sell. While the stock market is up dramatically through the first 4 ½ months of 2013, the bond market is essentially flat for the year. At some point, investors will move away from the safety of US government paper, and the extremely low interest rates that are attached to it today and seek both the income and growth potential of the stock market. Unfortunately, many investors have missed one of the greatest bull markets in the history of US stocks. Even with low growth in revenues, corporations have been able to grow their bottom line, albeit slowly. This means that they have cut waste and are getting greater productivity out of the existing workers and have continued to find ways to cut costs. But they can only cut costs for so long. Eventually they must grow the top line, i.e. revenues. Given the stronger job market of last year and even stronger job market this year, those extra dollars are going to find their way into the top line of corporations. A significant amount of that additional revenue is going to find its way to the bottom line of corporations developing a situation where earnings could accelerate during the latter part of this year and into next year. The market has moved from being undervalued to slightly under-valued and we wouldn't disagree too strongly with the notion that it is fairly valued given today's earnings. However, if we're right about the extra revenues showing up late this year and early next year there is still opportunity for the bull to run. Everyone keeps calling for a correction and we certainly have been reminding you that one could occur at any time, but we believe it would be a just that…a correction, not the end of the bull market. We have never been market timers, and we are certainly not going to start now. It usually at a point in time that everyone "knows" exactly what is going to happen that just the opposite actually does. Please keep a long term perspective and try not to be swayed by the talking heads.
- The ink on the New Year’s tax bill is hardly dry and Congress is already beginning to talk about “tax reform” again!! Of course the reason is to “make things simpler” J Certainly that is a very relative term. In an effort to broaden the tax base and lower rates, one of the items being carefully examined is capital gains treatment on appreciated assets. It is entirely possible that come 2015 this tax favored treatment will disappear in favor of a lower tax bracket. In other words, capital gains could be treated as ordinary income especially if the top tax bracket falls to 28% or less. It is possible right now that the top tax bracket could exceed 43%. While it doesn’t make any sense to sell assets at this point because it’s a long way off – if it occurs at all – everyone needs to be vigilant. This could be especially true for Baby Boomers who own their own businesses and who are looking to sell as they retire. Again, it always makes sense to do things that are smart economically – not just smart tax wise. We’ll keep you posted as we learn more.
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 over 26 years.
RAY, KIM, ERIC, BRUCE, LOU, NANCY, TINA, JON, STEVE, and DOROTHY
© 5/15/13 ProVise Management Group, LLC
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