Tuesday, January 22, 2013

2013 Outlook: New Normal not too bad

The May-Investments economic forecast for the year ahead is based on a continuation of the 2012 trend toward “normalcy.”  That we’re living in a “new normal” only means that the future will look a bit different than the past, but that’s not “new” and it isn’t necessarily anything about which we should worry.  As market volatility, valuations, and investment spending return to more normal levels, the outcome for stock investors could be quite satisfactory.

The lone “red flag” that is on the horizon is the May-Investments Leading Economic Indicator, which weakened in the fall, and dipped again right at year-end, perhaps in conjunction with the fears surrounding the “fiscal cliff.”  The tax increases, in and of themselves, are not as worrisome as the fears that surrounded the debate.  Investors feared a 40 percent tax on dividends, but it didn’t happen.  People feared an increase in the capital gains tax above 15 percent, but the vast majority of filers will pay the old rate.  Most of the tax increase was limited to “fat cats,” who will see their tax rates jump pretty significantly by the time you factor in the total impact from increased tax rates, capital gains taxes, phasing out of deductions, and additional Obamacare tax burdens.  All told, however, the $60 billion raised isn’t that significant.  In fact, about a week later, roughly that same amount of additional spending was pushed through Congress for Hurricane Sandy relief.

The “new normal” in Washington looks a lot like the spending binge we’ve been on for the last two decades.  In the long run, this spending is an issue.  In the short run, however, the market has little reason to fear contractionary fiscal policy.

It is true that there are some “new” facets to this upcoming “normal,” but it merely represents the ever-present “change” that provides both a hurdle and an opportunity to investors.  While not chosen thematically, companies in the May-Investments core portfolio are well positioned to benefit from many of the same changes about which many conservative Western Colorado voters complain.  Dodd-Frank, which is limiting borrower choice and forcing small lenders out of the market, should lead to market share gains for the mega-lender we recently purchased.  The same natural gas glut that is keeping a lid on local economic growth is a boon for energy companies we own in Pennsylvania and North Dakota.  Solar subsidies and the political push for renewables may be inflating the budget deficit, but they also create opportunities for vendors that sell solar components to major utility companies and for electronics vendors whose components hook these systems up to the grid.

While investors have complained about empty product pipelines at the major pharmaceutical companies, hurt by drug approval processes that take ever longer, our biotech companies are focusing on developing and cashing out on the launch of new products purchased by the big companies for distribution in their marketing system.  While stock guys complain that no one cares about equities anymore, annuity vendors are growing nicely by providing “income for life” solutions for the millions of baby boomers transitioning from the accumulation phase to retirement’s distribution phase of investing.

During the 12 months following the 2011 Economic Forecast, the stock market provided many investors with double digit returns, largely for the reasons that we had anticipated.  Corporate earnings grew a bit, but much of the appreciation came from an increase in the market Price/Earnings multiple from 12.8-times earnings (in January of 2012) to 14.3-times in 2013.  In 2013, it wouldn’t shock us if the P/E ratio continued to improve, on top of another small increase in corporate earnings, which could again provide investors with another nice year of appreciation in equities.  In the meantime, cash equivalents provide little return and bonds could force losses on investors if interest rates rise much.

2012’s 4th Quarter Gross Domestic Product (GDP) growth will be reported in about a week and we believe that our year-ago forecast for 2 percent real GDP growth will be on target.  It is likely that consumer spending will be a little weaker than anticipated – largely due to the year-end spending pause as consumers weighed the impact of the fiscal cliff – but foreign trade and U.S. government spending are both likely to be a little stronger than expected.  For 2013, we are forecasting slow growth, but slightly faster than a year ago.  The 2013 forecast for 2.5% growth in GDP factors in slightly slower consumer spending, resulting from tax increases impacting both very high and very low wage consumers, but offsetting this would be greater business confidence now that the divisive and tumultuous 2012 political campaign is behind us.  Companies have the financial resources to increase their rate of investment and we believe that they will do so as 2013 continues our slow move back toward normalcy.

Of course, “normal” does not mean a problem-free, peaceful, predictable status quo.  Uncertainty, after all, is normal.  For us, we think it means that markets will continue to move beyond crisis mode, price volatility will stay low, asset class correlations will diverge so we move away from the politically driven risk-on/risk-off trading environment of 2008-2012.  In a normal environment, there are both winners and losers and it is no longer just a question of “fully invested” or “in cash.”

Normalcy is a figment of our faulty memory.  Markets climb a wall of worry.  Once things have appreciated, the anxieties experienced on the way up are mostly forgotten.  If we are right and 2013 takes us one step closer to normal, it doesn’t mean that our political problems will be resolved, that our economic concerns will melt away, or that robust global growth is just around the corner.  However, it is an improvement from the dark days of the Great Recession, not too long ago, and we were happy to again be able to provide a positive outlook at our annual forecasting event.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

Friday, January 4, 2013

Make January Your Charitable Giving Month

Nestled somewhere in the middle of the legislation to “avert” the fiscal cliff, which is really little more than a bill to make permanent most of the tax cuts of 2001 and raise taxes a bit on the wealthy, is a provision to extend taxpayers’ ability to roll IRA distributions directly to a qualified charity.  For folks taking required minimum distributions (RMDs), January could be a great month to do some charitable giving to help minimize your 2012 tax bill.

Fidelity’s “Crisis Averted” article describes the key provisions of the bill.  As I’ve already blogged, one of the positive impacts is that it makes permanent tax cuts and estate planning changes that, up until now, have been the grist for annual political muckraking, leaving accountants and investors uncertain about how to plan for the future.  By making permanent these tax laws, investors finally have a reasonable basis for tax and estate planning.  Perhaps the legislation will help everyone start moving forward, after years of being in limbo.

At least two types of readers will find the extension of the IRA charitable rollover of particular interest.  First, development staff in the non-profit world ought to be aware of the preferential treatment that January contributions will have over the exact same charitable gift, made sometime after January 31, 2013.

Second, retirees who have been forced to take required minimum distributions from their IRAs, and who make substantial charitable gifts over the course of the year, might want to front load their giving in 2012.  While people still have the opportunity to offset 2013 RMDs with direct charitable rollover gifts, for those folks with significant charitable giving plans – enough to offset two years worth of RMD payouts – the clock is ticking.  It probably makes sense to make some of those gifts in January, so they can be applied to help reduce your 2012 Adjusted Gross Income (AGI) calculations.  Since I'm not an accountant, you probably want to run the idea past your CPA first, but it seems to me that there might be a strategy to reduce taxes for some people and the opportunity to take advantage of this ends in less than 27 days.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

Wednesday, January 2, 2013

Fiscal Tiff

The Lame Duck Congress (emphasis on the word “lame”) thinks that they “resolved” the fiscal cliff with a late night New Years day vote.  In fact, all they did was raise taxes, but there is some good news buried in those actions of incompetence.

First, looking at the late December retail sales figures, it looks like consumers ignored the political grandstanding and kept right on spending.  In spite of the uncertainty, and potential anxiety, shoppers were not so put off that they stopped spending.

Second, most of the “fiscal cliff” drama is now behind us.  I think we’ll find that there was more (negative) impact to the economy during the 4th quarter, than there will be in 2013.  The melodrama was costlyEconomic activity did slow as the year ended, but now there are some rules for income tax planning and estate planning that can form the basis for decision making in the future, so maybe it will allow investors to begin making decisions, once again, and start moving forward.  We almost hit stall speed during 3Q 2012.  Personally, I am really happy to put 2012 behind me.

Third, it appears that Congress has re-learned how to compromise.  Rather than letting extremists hold Congress hostage, the Administration (Biden, mostly) and Congressional leadership figured out how to find some agreement near the center, involving both sides of the aisle, in order to forge a majority.  Previous administrations haven’t had such difficulty doing this, but the agreement surrounding tax hikes was the closest thing to a traditional compromise that we’ve seen in at least four years.  That is, after all, how Washington D.C. is supposed to work.  I thought that they’d forgotten.  Maybe now they can repeat the process and come to some agreement on the spending reduction side of things.

Fourth, most of the tax rates determined are “final.”  The accountants have been dealing with temporary estate planning rules since 2001.  Many of the rules established in the fiscal cliff negotiations are actually supposed to be permanent.  Wow.  What a concept. The Alternative Minimum Tax (AMT) fix, indexation, is also permanent.  It’s great to have some sense of finality to the negotiations.

Fifth, in my opinion, the GOP was more successful than I would have predicted.  Especially given that they lost the election in November, so taxes were bound to go up, the impact of these tax increases negotiated over the New Year holiday are relatively limited.  Given a trillion dollar annual deficit, if the tax increases account for roughly $60 billion (only 6% of the gap), that is pretty minimal.  If the rest of the gap gets filled from spending reductions (Ha!), then that would be about $16 spending reduction for every $1 of tax increase.  In reality, I think the deficits will continue ad nauseum, but the basic point remains; given the size of the deficit, the extent of the tax increase was pretty minimal.

There are plenty of things not to like about the upcoming potential for a constitutional crisis related to the debt ceiling debate we’ll be hearing over the course of the next few months.  Still, there are a few good things that came out of the final package that will help investors going forward.  It doesn’t hurt to notice them, too.

Addendum(dtd 1/7/2013):  Fidelity Investments just published a good summary of the recent changes.  Let us know if you would like us to e-mail you a copy of their Crisis Averted report.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .