Friday, December 17, 2010

I Admit it; I'm a Deficit Geek (Warning: ranting ahead)

"Government debt is every politician's dream: it gives him the ability to buy votes by spending on government programs (with funds raised through borrowing) that will make him popular now, while putting the lion's share of the cost on future taxpayers, who must pay off the debt through taxes. It is the ultimate something-for-nothing scheme."

- Hamilton's Curse by Thomas J. Dilorenzo, Chapter 2

I'm a little embarrassed to admit that I'm a deficit geek. I have been since I was in high school and when I was a Young Republican during my first year of college. My political philosophy on many issues has changed since then, but I'm still a fiscal conservative on budget issues.

I wish Republicans were still conservatives, too, but Republicans aren't fiscal conservatives anymore; they just use this issue when it suits them. When the federal budget deficit doubled with George W. Bush in power, there was nary a peep. Within months of President Obama's inauguration, their talk-show PR squad started getting hysterical about fiscal irresponsibility. When the federal government spends money on health care, education and helping the poor, it's flagrant spending. If it's on wars, bribes to corrupt foreign leaders and enriching military contractors, that's OK.

Their other solution is cutting taxes, particularly for the richest Americans. Anyone who manages a household budget knows that if you spend more than you earn, you have to do two things: cut spending and earn more money. If Representative John Boehner were a financial advisor, he'd suggest that you get out of debt by taking Thursdays off work. If Senator Mitch McConnell were a dietician, he'd suggest that the best way to lose weight is by eating more desserts.

Supply-side economics, as they are afraid to call it, has risen its head again. Candidate George H W Bush called this strategy, proposed by Ronald Reagan, "voodoo economics." The myth is that when the economy turned around it was because of tax cuts. In actuality, it was because of a massive stimulus program for military spending. During Reagan's eight years in office, revenues increased by 15% while federal spending increased by 25%, and federal debt grew from about $1 trillion to over 2.8 trillion, or 20% per year. That's the shining example of "fiscal conservatism?"

During Clinton's "high-tax-rate" years the debt increased by about 4% per year, and he ended his presidency with a surplus. George W. Bush nearly doubled the debt in the following eight years.

Republicans and President Obama just cut a deal to extend the 2001 and 2003 Bush tax cuts that particularly benefited the very rich. Supposedly this would creates jobs. Here's what the Wall Street Journal said in January, 2009 about job creation during the Bush administration's eight years in office:

"The Bush administration created about three million jobs (net) over its eight years, a fraction of the 23 million jobs created under President Bill Clinton’s administration and only slightly better than President George H.W. Bush did in his four years in office."

So, if these tax cuts didn't create many jobs during the last nine years, why should they work now?

This attitude of "we'll fix the deficit next time" makes me crazy. Most Congressional Republicans are hypocrites and most Democrats are spineless. Something needs to be done--soon.

If you are interested in learning more about budget issues and how the federal government is really spending tax dollars and borrowed funds (I bet you can't wait) here are some interesting links from a variety of organizations:

Monday, November 8, 2010

The Upside of Uncertainty

R. Kevin O’Keefe, CIMA®, AIF® Chief Investment Officer

From First Affirmative Financial Network's Market Commentary October, 2010

The Standard & Poor’s 500 Index rallied 11.3% in the third quarter, nearly making up losses suffered during the second quarter. Thanks to the strongest September for stocks in generations, the Index finished the quarter just shy of where it stood six months earlier—up 3.9% for the year.

Lack of Enthusiasm, Volume
Despite the market’s gains, most investors’ taste for stocks turned even more sour. According to Morningstar, investors withdrew $43 billion more from U.S. stock funds in the third quarter than they invested, bringing total net withdrawals since the beginning of 2009 to approximately $100 billion. Even September’s impressive gains came on extremely low trading volumes.

Concerned about the pace of the economic recovery and the upcoming mid-term elections, investors sought refuge in bonds and gold. Bond mutual funds took in an estimated $87 billion (net) in the third quarter, according to the Investment Company Institute. Since the start of 2009, a whopping $620 billion has been invested in bond funds. Corporations have embraced the opportunity presented by the combination of low interest rates and investor demand for yield by issuing near-record levels of debt.

The price of gold rose 5% during the quarter and has continued to set new records. Some investors consider gold to be a safe haven in the event of another financial market crash. And, some own gold as protection against inflation, which is worrisome longer term, given the declining dollar, massive government budget deficits, and the potential for additional easing by the Federal Reserve.

Will the herd be right? We wouldn’t bet on it. Hatred for stocks is actually a bullish condition. Those who have poured their money into bonds and gold may very well look back wistfully at 2010 if it turns out to be a great year for buying stocks.

Headwinds Persist
High unemployment and low consumer confidence in the U.S., combined with record low interest rates and strong corporate profit reports are cause for confusion for even some of the most sophisticated investors. Anxiety reigns supreme, at the moment. Housing remains very weak, with the supply of vacant or foreclosed houses weighing on home prices and new construction. Both consumers and businesses are reluctant to spend. Consumers are working to reduce their personal debt.

Concerns have resurfaced recently about European debt problems, particularly in Ireland and Portugal. There also are growing worries about the potential for economically destructive trade wars, especially revolving around China’s restrictive currency policies.

The Case for Stocks: Near Term
With all the uncertainty and concern, why would one own stocks? For one thing, with the national jobless rate stuck near 10%, many now expect the Federal Reserve to stimulate the economy by once again injecting money into the financial markets through purchases of Treasury securities. This course of action, which the Fed refers to as “quantitative easing,” led to a surge in stock, bond, and commodity prices last year. A second round may produce a new rally.

Another potential catalyst for a stock price rally is the level of cash in corporate coffers. Consumers may not have much money to spend, but according to Standard & Poor’s, as of June 30 (the most recent data available), corporations do. Industrial companies in the S&P 500 had a record $843 billion in cash on their books, up from $773 billion a year earlier—equal to a record high 11.6% of the market value of the companies holding the cash, and nearly double the average reading from 1980 through the end of 2007.

These companies will eventually have to do something with all that cash. Companies that repurchase their shares can help support stock prices by reducing the number of shares in circulation. Announcements of stock buybacks are down from a year ago; there is room for repurchase programs to grow.

Another potential use of corporate cash is dividends. Many corporations cut dividends during and after the crisis, and dividends have only slowly begun to recover. Increasing payouts could boost stock prices for companies paying higher dividends.

One reason often given for why corporations are reluctant to reduce their cash holdings is the uncertainty around tax laws and regulations. If uncertainties are resolved after next month’s mid-term elections, we could see more announcements of dividend increases and/or significant stock buybacks.

Another way for companies to utilize excess cash is to reinvest that money in their businesses by expanding or updating equipment to improve productivity. Broadly speaking, corporate balance sheets are strong, and that bodes well for investors.

The Case for Stocks: Longer Term
Stocks have been a good long-term investment. Since the start of the modern stock market era in 1926, stocks have produced an annual average inflation-adjusted return of about 6.7% (including dividends) and an annual average nominal return of 9.9%. One dollar invested in 1926 would be worth $2,000 today. Adjusted for inflation, that dollar’s purchasing power would have increased about 200 times.

But stocks have also delivered long stretches of significant below-average returns. For the ten-year period ending September 30, 2010, a period that includes two bear markets, the average annual return for the Russell 3000 Index, which represents the broad U.S. stock market, was a measly 0.1%. It is truly disappointing to have nothing to show for more than a decade of investing in stocks. But long, disappointing stretches have occurred before, and they have been followed by periods of reward (see right).

Why should the next decade be any better? The expectation of healthy long-term returns from stocks may be difficult to sustain during periods of economic disruption, but such an expectation might be most justified following a long stretch of underperformance.

It is important to remember that stocks have been resilient over the long term because the private sector has been competitive and dynamic. To survive and prosper, companies have to take risks and embrace change. More than ever before, corporate managers understand that continuous improvement is imperative. This is why corporate dynamism and adaptability is on the rise, and why corporate cultures around the world are becoming more proactive and more responsive. Such change is good—both for companies and for their stakeholders.

Saving vs. Investing: The Upside of Uncertainty
There is a difference between investing and saving. Investing in stocks requires that one embrace uncertainty—and it is precisely because of this uncertainty that stocks have outperformed more certain investments such as bonds over the long term.

Why would anyone invest in a risky asset if the probability of reward were low? To compensate investors for enduring high volatility and uncertainty, expected returns for stocks must be higher than expected returns for safer assets. This compensation, which is known as a “risk premium,” is the excess return that investors expect from their stock holdings, as compared to investments in U.S Treasuries, or CDs, or insured savings accounts.

To increase the likelihood of realizing the risk premium, you have to stay invested even when it’s uncomfortable to do so. History shows us unequivocally that investing only when it “feels safe” is not likely to produce good results.

That’s why at First Affirmative, we try to help our clients stay invested and to tolerate uncertainty. Investment discipline is the key. We continue to believe that investors should embrace the time-tested principles of investing:

Choosing an asset allocation strategy suited to your investment objectives and to your ability to tolerate volatility;

  • Proper diversification among asset classes, types of investments, and managers;

  • Managing investment costs; and

  • Periodic rebalancing—trimming investments that have performed well, and adding to those that have underperformed, thus “buying low, selling high.”

Kevin O’Keefe, Managing Member and Chief Investment Officer of First Affirmative Financial Network, is responsible for due diligence and monitoring of mutual funds and separate account managers.

This article does not necessarily reflect any opinions or views of PIA.

PIA and FAFN are neither affiliates nor subsidiaries of each other.

Wednesday, September 8, 2010

Is it Time to Roth and Rollover?

The Basics

Roth IRAs first became available in 1998. Unlike traditional IRAs, there is no immediate tax break. The advantage of a Roth is that the growth within a Roth investment is not taxed upon withdrawal as long as you are over 59 1/2 and have held the account for five years.

The Opportunity

The opportunity to rollover a traditional IRA into a Roth has always been available if your income was below a certain level and you were willing to pay a large tax bill on the funds transferred.

This year, no income limit applies. If you rollover funds to a Roth in 2010 you have two options: 1) include all the income on your 2010 tax return, or 2) split your income between 2011 and 2012 to be taxed at the tax rates in those years.

The Timing

Even if this opportunity did not exist, this is a good time to convert your traditional IRA to a Roth. Since the stock market is down, your tax will be less than if you converted your account when it was worth more. This is one of the few benefits of a negative stock market. I'm making the bold assumption here that the stock market will go up eventually.

One more reason to do a Roth conversion this year is that many experts predict that tax rates will increase to help balance the federal budget.

An important factor to consider is whether you will be in a higher tax bracket when you take the money out versus your tax bracket when and if you do a conversion. This requires some serious calculations and assumptions.

The Risks and Warnings

Paying taxes now depletes your limited supply of cash, so be cautious.

Do not take the money to pay the tax for the Roth conversion from an existing IRA or retirement account, especially if you are under 59 1/2.

If the account drops dramatically, you will overpay your taxes with more expensive dollars. If your IRA had dropped the same amount you would pay less in taxes on a smaller account value.

The Dilemma

Whether you make the right decision depends on many factors, but the biggest one may be whether your account increases dramatically, stays flat or drops in value. If you invested in a Roth ten years ago your investment might be the same as when it started due to the growth-challenged stock market of the last decade.

The Disclaimer

This discussion just deals with federal tax laws. Each state will treat Roth conversions differently.

You don't have to switch investments to make this move. It can stay in the same fund, you just change the titling on the account.

The potential scenarios are numerous and the variables are many. Converting a Roth is not a step to take without first talking to your investment person, your tax person and your psychic.

If you want to discuss doing a Roth conversion, call me.

Monday, June 7, 2010

Bob's Quarterly Update Moves On

I've always loved newsletters: reading, writing and producing them. My last newsletter, Bob's Quarterly Update (BQU), ran from Spring 1994 through November 2008. Forty five issues.

I wrote my final newsletter (see website archives) shortly after President Obama was inaugurated. I hadn't planned for it to be the last issue, but my desire to write waned as my Bush-inspired rage was replaced by Obama-inspired disappointment. My loss of hope coincided with the dramas of the stock market and economy which demanded more of my attention. Consequently, issue #46 was never hatched.

During the last eighteen months, I’ve often updated my website commentaries, but never notified anyone. My past stock market/economy commentaries are posted on my website if you want to know what I was thinking during the last several years.

I hope to provide more frequent and timely communications with clients, friends and others. Indirect contact like this is intended to supplement, not replace direct communications, so never hesitate to call me if you wish to talk.

I hope my periodic commentaries will accomplish the following objectives:

• Provide timely stock market/economic commentaries, political rants, and photo/art show notifications when important developments arise.

• Notify you of in-depth commentaries on my website or important articles available on the Internet.

• Reduce paper consumption. As much as I liked paper copies of BQU, this used lots of paper and it was expensive to print and mail. I'll notify you via email when I've updated my website. You can ask to be removed from this list anytime.

• Inform you when I have an upcoming photo or art show. I'll be posting a new photo to this page every week. You can always see over 200 of my photos and artworks by clicking the main photo on my website.

• Finally, and most importantly, if you’ve read this far, please give me some feedback on what you’d like to see or read. I look forward to hearing from you. Call me at 916-444-2233 or email me at