Hobos and welfare for America's Rich – Telegraph Blogs

Leave it to a British columnist to point out a potentially difficult social problem arises in America.

This from Ambrose Evans-Pritchard in the London Telegraph:

...Republicans on Capitol Hill who backed the mobilization of $3 trillion of fiscal and monetary support to bail out the financial system are now going to great efforts to prevent the roll-over of temporary benefits to 1.2m jobless facing an imminent cut-off.

I don’t wish to enter deeply into an internal US dispute....but I do think think that the American political class will have to face up to the new reality of a semi-permanent slump for a decade or more that will blight a great number of lives. The cyclical recovery that normally makes it possible for most Americans to find a job if they want one is not going to happen this time because the overhang of debt, fiscal tightening, and a liquidity trap have combined to jam the mechanism.

And Ambrose goes on:

At some point this will become very political. Everybody knows that the wealthy have in fact been bailed out. Part of the purpose of quantitative easing was to raise asset prices, in the hope that this would course through the economy – and ultimately trickle down. The rich have benefitted enormously from federal action...

...But once welfare has been deployed so generously for the rich, it cannot be denied so easily for the poor. This was the Faustian Pact.

Part of the American ethos, it seems to me, is a belief that if one works hard and plays by the rules they can realize a share of the American Dream.

This is the reason that most Americans don't begrudge somewhat becoming wealthy, since most of us believe that we, too, have the same opportunity.

But with real incomes stagnant for more than a decade, housing prices continuing to fall, and the broader measure of U.S. unemployment 16.5%, it is harder to keep the Dream alive.

Besides being of concern to us citizens, what kind of investment implications does all of this have?

For a start, I would think that tax rates on the wealthy might rise far more than many are anticipating. For example, most of my clients are assuming that the federal estate tax will be permanently moved to begin above $3.5 million, just where it was in 2009. However, I am beginning to think that it might just revert to $1 million, where it was in 2001, and where it still is in many states (including Massachusetts).

I am also thinking that the tax rate on dividend income might go to the maximum 39.6% compared to 15% currently.

More to follow.



Hobos and welfare for America's Rich – Telegraph Blogs

Malcolm Gladwell: The Sure Thing

I'm a latecomer to the Malcolm Gladwell fan club but you can now consider me a full-fledged member.

Malcolm Gladwell, if you don't already know, is a writer for the New Yorker magazine. However, he is better known as the author of a variety of best selling books, including The Tipping Point; Outliers; Blink; and most recently What the Dog Saw: And Other Adventures.

I had the chance to see Mr. Gladwell give a talk here in Boston a couple of weeks ago, and he was great. The title of his talk was "Puzzles and Mysteries". He discussed how we often look at everyday problems as a puzzle to be "solved" when in fact there often is not a clear answer, only a mystery to be pondered.

In fields as diverse as medicine, defense, and even investment management, we expect experts to have solutions, but often there are only a series of choices, each with a different probability of success.

In any event, Gladwell has a website that features a variety of his articles for the New Yorker. I just read one article that I really enjoyed that was originally published in the January 18, 2010, magazine that was titled "The Sure Thing: How Entrepreneurs Really Succeed" I have included the link to his site below.

The article discusses the fact that many of the success stories that we read about - ranging from Ted Turner's billion dollar media empire to hedge fund manager's John Paulson's $4 billion payday (due to his correct assessment that the U.S. housing market was poised for a fall) - are often less risky to the entrepreneur than we might expect.

Gladwell gives numerous examples of how these wildly successful entrepreneurs were constantly worried about downside risk, and structured their investments to try to minimize any potential financial exposure should their investments fail to work out as planned.

This is, of course, tremendously relevant to the investment business. It is axiomatic in my business that the major difference between an older portfolio manager and a younger one is the fact that older investors tend to fret most about downside risk. Younger investors - who either have never been through a bear market or have only known profitable trades - tend instead to think about upside potential.

Given my age (53 years old) and the number of years I have been working with clients on investments (almost 30 years) you can guess what type of investor that I am.



gladwell dot com - the sure thing

Global economic policy: Austerity alarm | The Economist

I liked the beginning of this piece from The Economist, so I thought I would share it with you. In my opinion, it is a pretty good description of where we are now in the economics cycle:

ECONOMIC policymaking, like hemlines, has fads. Last year the leaders of the G20 group of big economies led a global Keynesian boost, pledging fiscal stimulus worth a combined 2% of world GDP to prop up demand. At their most recent gathering, in Toronto on June 26th-27th, the club’s rich-world members pledged “at least” to halve their deficits by 2013. Though they left themselves wiggle room, the change of tone was clear. Thanks to Greece’s sovereign-debt crisis, which has terrified politicians, stimulus is out and deficit reduction is in.

Global economic policy: Austerity alarm | The Economist

I think the reason I like this paragraph is that it captures the tone of the most recent G-20 meeting. Last year, political leaders reveled in the idea that they were making statesmen-like judgments in the midst of the economic downturn. This year, however, the vigilantes have arrived in the bond market, throwing a major scare into these same leaders, and forcing them to adopt a Calvinist approach to fiscal woes.

The Economist's piece goes on to suggest that a more reasoned, rational economic approach will yield the best results. Providing some sort of direct fiscal stimulus, together with structural reforms in entitlements programs, should yield the best long-term results. The only question is whether the popular will can be summoned, or whether we will continue to lurch between easy and tight fiscal policy.

Payback Time - Budget in the Red, Illinois Has Stopped Paying Bills - NYTimes.com

It's no secret to anyone who reads a paper or listens to the news that municipalities throughout the United States are in deep financial crisis.

This article in last Saturday's New York Times had a long piece about the problems confronting the state of Illinois. Here's an excerpt:

For the last few years, California stood more or less unchallenged as a symbol of the fiscal collapse of states during the recession. Now Illinois has shouldered to the fore, as its dysfunctional political class refuses to pay the state’s bills and refuses to take the painful steps — cuts and tax increases — to close a deficit of at least $12 billion, equal to nearly half the state’s budget.

Then there is the spectacularly mismanaged pension system, which is at least 50 percent underfunded and, analysts warn, could push Illinois into insolvency if the economy fails to pick up.

States cannot go bankrupt, technically, but signs of fiscal crackup are easy to see. Legislators left the capital this month without deciding how to pay 26 percent of the state budget. The governor proposes to borrow $3.5 billion to cover a year’s worth of pension payments, a step that would cost about $1 billion in interest. And every major rating agency has downgraded the state; Illinois now pays millions of dollars more to insure its debt than any other state in the nation.

Payback Time - Budget in the Red, Illinois Has Stopped Paying Bills - NYTimes.com

After reading stories like this, one cannot help but wonder whether we should be considering avoiding investing in municipal bonds.

I wouldn't, judging from past history.

As the Times article notes, states cannot technically go bankrupt. Cities and towns can, but have done so only on very rare occasions.

Municipal bonds almost always pay creditors on time for the very simple reason that they cannot afford not to. In the 1970's, for example, New York City decided to forgo paying interest on its bonds - and then was shut out of the credit markets for the next 7 years. It could only return to the bond market after it paid all of the interest due in arrears. Orange County in California tried to declare bankruptcy in the mid-1990's after massive losses on its investment portfolio, but then realized that it needed to issue more bonds, and so all creditors were eventually repaid.

Even during the Great Depression of the 1930's very few municipal bonds defaulted.

This is not to say that the poor financial health of our cities and towns should be dismissed. Much like the problems at the federal level, the only way out of most of the problems is to cutback services (which will hurt the poor and the needy) and raise taxes (slowing economic growth). Unfortunately, as the Times series is titled, it's Payback Time in America, and it's going to be painful.

Factories Ready to Hire, but Skilled Workers Scarce - NYTimes.com

I had a couple of thoughts after reading this article on the front page of this morning's New York Times.

First, I think I read somewhere that 4 out of 10 jobs employing people today are in industries and specialities that did not exist at the beginning of the 21st century. The importance of continuing education - especially for those of us over 50 years old - remains crucial. In fact, the Center for Retirement Research has noted on several occasions that one of the main reasons that older workers have trouble finding work is the lack of relevant skills in today's workplace.

And, second, it is a sad statement on our education system when you read paragraphs like this (I have highlighted one section):

Here in this suburb of Cleveland, supervisors at Ben Venue Laboratories, a contract drug maker for pharmaceutical companies, have reviewed 3,600 job applications this year and found only 47 people to hire at $13 to $15 an hour, or about $31,000 a year.

The going rate for entry-level manufacturing workers in the area, according to Cleveland State University, is $10 to $12 an hour, but more skilled workers earn $15 to $20 an hour.

All candidates at Ben Venue must pass a basic skills test showing they can read and understand math at a ninth-grade level. A significant portion of recent applicants failed, and the company has been disappointed by the quality of graduates from local training programs. It is now struggling to fill 100 positions.

“You would think in tough economic times that you would have your pick of people,” said Thomas J. Murphy, chief executive of Ben Venue.

Factories Ready to Hire, but Skilled Workers Scarce - NYTimes.com

Taxable Gifts Get New Look From Wealthy

From Financial Advisor Magazine:

Right now, anyone can make unlimited gifts to individuals of up to $13,000 each year without owing tax on them. Any amount above that is taxed. There is a $1 million lifetime gift tax exemption.

For 2010, the gift tax rate is 35%. Differences between the estate and gift tax rules mean that if the donor survives the gift by three years, the effective gift tax rate is effectively only 26%. Next year, unless Congress acts, the top tax rate on gifts and bequests over $1.2 million will be 55% with an additional 5% surtax on transfers from $10 million to $17.1 million.

Prepaying gift tax rather than waiting and paying estate tax can make sense in certain scenarios.

An example: A man has $6 million left, and his estate will be in a 55% tax bracket after 2010. If he waits until he dies and bequeaths the money, the net transfer is only $2.7 million. If instead in 2010 he makes a taxable gift, he can give $4.4 million—64% more—and pay the taxes with the rest; at a 35% rate, the gift tax would amount to $1.5 million. He must survive the gift by three years for the tax brackets to apply.


Taxable Gifts Get New Look From Wealthy

Are We Heading for a New Bear Market?

I read somewhere once where Ben Franklin felt that he was not qualified to debate someone unless he understood his opponent's arguments better than they did.

With Ben in mind, and after re-reading some of my recent somewhat bearish posts on the world and the economy, I thought I should lay out some of the reasons that we might not be heading for disaster.

After a difficult second quarter (the S&P 500 dropped by -15% from its peak in mid-April), it is hard not to feel bearish on the markets. The S&P's performance was the worst since the final three months of 2008.

In addition, gold continues to move higher, rising +12% over the last quarter to a record $1245 per ounce (Gold ETF's, by the way, are now the second largest ETF's in asset size, with roughly $50 billion in assets). Gold is telling us that investors are fearful of inflation or government policies, or both.

Interest rates have moved sharply lower. The 10 year Treasury note now yields about 2.95%, or more than 100 basis points lower than just three months ago. Two year Treasury notes yield 0.6%, which represents their lowest yield - ever. Clearly there is a "flight to quality" mentality in the bond market.

Technically the market looks vulnerable as well. Goldman Sachs put out a research piece yesterday saying that if the market broke lower through current levels (around 1030 on the S&P) the next stop is 24% lower.

That's where we are. So where do we go from here?

I listened to two bullish strategist discussions yesterday, and have read research pieces from a few other sources. Most seem to feel this is simply a pause in the market, mostly due to the fact that their data would suggest that stocks in general, and large cap stocks in particular, are priced attractively.

Another piece of the bull case rests on the continuing good news from the emerging markets. True, it looks like China's growth rate might be slowing, but moving from +10% quarterly GDP growth to +8% hardly seems like a disaster. Today's New York Times carried an article discussing the strong growth in Latin and South America, particularly in Brazil.

Other bullish signals (via Merrill Lynch): strong corporate productivity gains; disciplined corporate capex strategies; manufacturing remains strong; healthy corporate balance sheets; and lower US interest rates.

Finally, most strategists would suggest that the fact that the general public remains skeptical of stocks means there could be considerable buying power if the market stabilizes. With money market rates stuck at 0%, it wouldn't take too much to convince investors to move at least a portion of their savings into the market.

I obviously hope the bulls are right. However, I also think that the bond and commodity markets are sending us messages that we might not want to hear. In addition, as I have written in numerous posts over the last couple of weeks, I am convinced that policy makers are making a huge mistake in raising taxes and cutting government spending at a time when growth is still anemic.

Stay tuned.