Want to have a little mindless fun? Try balancing the federal budget in ten minutes or less.
Believe it or not, you can actually do this on an interactive web site created by the New York Times. (You can find it here: http://www.nytimes.com/interactive/2010/11/13/weekinreview/deficits-graphic.html) There are two graphics at the top of the page: one is the projected shortfall in 2015 (a scary $418 billion), and the other is a more long-term (and scarier) deficit in 2030 ($1.345 trillion).
To reduce those numbers, you make hard choices. You can cut foreign aid in half, eliminate all farm subsidies, cut the pay of civilian federal workers by 5 percent, reduce the federal workforce by 10 percent, reduce the military to pre-Iraq War size and reduce troops in Asia and Europe, reduce the number of troops in Iran and Afghanistan to 30,000 by 2013 (or make more modest cuts), raise the Social Security retirement age (there are two options), modify estate taxes, reduce or eliminate the Bush tax cuts, or impose a national sales tax and/or carbon tax.
And more. With each box you check (each cut you make or tax you raise), you see how much progress you're making on the overall budget deficit in 2015 and 2030. The choices are not easy ones, and you quickly discover that the "fixes" most often debated on both sides of the aisle in Congress won't make much of a dent.
Unfortunately, there isn't a button on the web site that you can push to make these deficit reduction provisions actually happen in the real world. But having an easy, interactive tool like this will undoubtedly help raise awareness, among the people who don't deal with these budget numbers on a daily basis, about the kind of measures that will have to be taken if we don't want to leave our children and grandchildren with a ton of federal debt to pay off. You'll probably remember this little game next time you hear a politician talking tough about eliminating debt in Washington.
Monday, November 29, 2010
Monday, November 22, 2010
Federal Money Supply
A warning shot
You may have heard recent controversy over the U.S. Federal Reserve Board buying Treasury bonds--$600 billion in all--and wondered what all the fuss was about. You may even have wondered why one branch of the government is buying bonds from another one.
The headlines say that this is a "stimulus" measure, which basically puts more money into the U.S. economy without costing the taxpayers anything. This is true, up to a point; buying Treasury securities means the central bank is essentially creating new money. Other analysts say that creating new money is inflationary, which also tends to be true. However, the Stratfor Global Intelligence service has pointed out that creating $600 billion over eight months is not dramatically more than the Fed's normal actions in managing the money supply, and with $8 trillion in circulation (the M2 money supply figure, which does not include CDs and institutional money market fund balances), dollars are not going to suddenly become dramatically more plentiful. And in a $14.3 trillion economy, the stimulus is not likely to turbo-charge the next round of employment figures. It probably won't even show up in GDP.
So what gives? Looking at the global economic picture, right before the G20 economic summit, Stratfor notes that export nations like Japan and Germany have linked their recovery hopes to selling more to U.S. consumers. The more they sell, the more they drive up the difference between U.S. imports and exports--or, in economic terms, widening the current account deficit and diverting money from our economy into theirs. To do this most effectively, they need their currency to be weaker than the dollar so that their manufactured items look like a bargain. Stratfor notes that Japan has been openly intervening in currency markets to drive down the yen. Germany, meanwhile, doesn't have to: it has benefited from a weakened euro--the result of well-publicized debt problems in Greece, Spain, Portugal and most recently Ireland. An article in the November 5 issue of the Wall Street Journal says that not only Japan, but also Brazil and South Korea have taken actions to depress their currencies against the dollar.
Seen in this light, the Fed's action can be seen as a warning to the other nations that the U.S. is capable of protecting its currency and export industries from these raids on its economy. The $600 billion purchase probably won't affect the value of the dollar, but they show that the Fed is well aware of the actions of the other countries. As U.S. representatives negotiate to stop currency manipulation at the G20 summit, the rest of the world knows that if there is no agreement, the U.S. is capable of fighting back. Sure enough, The Wall Street Journal quoted finance ministers and economists from Brazil, France, South Korea and Germany, all criticizing the purchase and calling for a cease fire in the currency wars.
Should we worry about inflation as these negotiations drag on? At a time when the worst-case economic scenario is deflation, a few small nudges in the inflation rate might not be the worst thing to befall the U.S. economy; today's rate is well below the 2% target informally set by the Fed. Should we worry about a falling dollar? If you're traveling abroad, or buying a foreign car, then you might have to pay a bit more if the dollar weakens against the currency of the nation you're traveling to or where the car was made. But foreign stocks, bonds and mutual funds are always a little more valuable--in dollar terms--whenever the dollar declines in value, so your international holdings could get a small boost in return.
But the most likely scenario is that the Fed's demonstration will keep everybody at the negotiating table. And you'll continue to hear the conventional interpretation: that this is all about stimulus back home--which, to the extent that it keeps other countries from raiding our economy, it is.
Sources:
Stratfor analysis: http://www.stratfor.com/memberships/175231/geopolitical_diary/20101103_washingtons_warning_shot_currency_front
U.S. money supply: http://en.wikipedia.org/wiki/Money_supply
Size of the U.S. economy: http://en.wikipedia.org/wiki/Economy_of_the_United_States
Wall Street Journal articles about the Fed's repurchase: http://online.wsj.com/article/SB10001424052748704353504575596203544367856.html
and: http://online.wsj.com/article/SB10001424052748704327704575614853274246916.html?mod=WSJ_article_MoreIn_Economy
You may have heard recent controversy over the U.S. Federal Reserve Board buying Treasury bonds--$600 billion in all--and wondered what all the fuss was about. You may even have wondered why one branch of the government is buying bonds from another one.
The headlines say that this is a "stimulus" measure, which basically puts more money into the U.S. economy without costing the taxpayers anything. This is true, up to a point; buying Treasury securities means the central bank is essentially creating new money. Other analysts say that creating new money is inflationary, which also tends to be true. However, the Stratfor Global Intelligence service has pointed out that creating $600 billion over eight months is not dramatically more than the Fed's normal actions in managing the money supply, and with $8 trillion in circulation (the M2 money supply figure, which does not include CDs and institutional money market fund balances), dollars are not going to suddenly become dramatically more plentiful. And in a $14.3 trillion economy, the stimulus is not likely to turbo-charge the next round of employment figures. It probably won't even show up in GDP.
So what gives? Looking at the global economic picture, right before the G20 economic summit, Stratfor notes that export nations like Japan and Germany have linked their recovery hopes to selling more to U.S. consumers. The more they sell, the more they drive up the difference between U.S. imports and exports--or, in economic terms, widening the current account deficit and diverting money from our economy into theirs. To do this most effectively, they need their currency to be weaker than the dollar so that their manufactured items look like a bargain. Stratfor notes that Japan has been openly intervening in currency markets to drive down the yen. Germany, meanwhile, doesn't have to: it has benefited from a weakened euro--the result of well-publicized debt problems in Greece, Spain, Portugal and most recently Ireland. An article in the November 5 issue of the Wall Street Journal says that not only Japan, but also Brazil and South Korea have taken actions to depress their currencies against the dollar.
Seen in this light, the Fed's action can be seen as a warning to the other nations that the U.S. is capable of protecting its currency and export industries from these raids on its economy. The $600 billion purchase probably won't affect the value of the dollar, but they show that the Fed is well aware of the actions of the other countries. As U.S. representatives negotiate to stop currency manipulation at the G20 summit, the rest of the world knows that if there is no agreement, the U.S. is capable of fighting back. Sure enough, The Wall Street Journal quoted finance ministers and economists from Brazil, France, South Korea and Germany, all criticizing the purchase and calling for a cease fire in the currency wars.
Should we worry about inflation as these negotiations drag on? At a time when the worst-case economic scenario is deflation, a few small nudges in the inflation rate might not be the worst thing to befall the U.S. economy; today's rate is well below the 2% target informally set by the Fed. Should we worry about a falling dollar? If you're traveling abroad, or buying a foreign car, then you might have to pay a bit more if the dollar weakens against the currency of the nation you're traveling to or where the car was made. But foreign stocks, bonds and mutual funds are always a little more valuable--in dollar terms--whenever the dollar declines in value, so your international holdings could get a small boost in return.
But the most likely scenario is that the Fed's demonstration will keep everybody at the negotiating table. And you'll continue to hear the conventional interpretation: that this is all about stimulus back home--which, to the extent that it keeps other countries from raiding our economy, it is.
Sources:
Stratfor analysis: http://www.stratfor.com/memberships/175231/geopolitical_diary/20101103_washingtons_warning_shot_currency_front
U.S. money supply: http://en.wikipedia.org/wiki/Money_supply
Size of the U.S. economy: http://en.wikipedia.org/wiki/Economy_of_the_United_States
Wall Street Journal articles about the Fed's repurchase: http://online.wsj.com/article/SB10001424052748704353504575596203544367856.html
and: http://online.wsj.com/article/SB10001424052748704327704575614853274246916.html?mod=WSJ_article_MoreIn_Economy
Friday, November 19, 2010
Your Annual Financial To-Do List
Things you can do before and for the New Year.
The end of the year is a good time to review your personal finances. What are your financial, business or life priorities for 2011? Try to specify the goals you want to accomplish. Think about the consistent investing, saving or budgeting methods you could use to realize them. Also, consider these year-end moves.
Think about adjusting or timing your income and tax deductions. If you earn a lot of money and have the option of postponing a portion of the taxable income you will make in 2010 until 2011, this decision may bring you some tax savings. You might also consider accelerating payment of deductible expenses if you are close to the line on itemized deductions – another way to potentially save some bucks.
Think about putting more in your 401(k) or 403(b). You can contribute up to $16,500 to these accounts in 2010, with a $5,500 catch-up contribution also allowed if you are age 50 or older. Has your 2010 contribution approached the annual limit? There is still time to put more into your employer-sponsored retirement plan.1
Can you max out your IRA contribution at the start of 2011? If you can do it, do it early - the sooner you make your contribution, the more interest those assets will earn. And if you haven’t made your 2010 IRA contribution yet, you can still do so through April 15, 2011.1
The 2011 contribution limits on traditional and Roth IRAs are unchanged from 2010. You can contribute $5,000 to your IRA next year if you are age 49 and below, $6,000 if you are age 50 and above.2
Consider a Roth IRA conversion before 2010 ends. Now anyone may convert a traditional IRA to a Roth IRA; there are no longer any income limits in the way. If you pull off a Roth conversion before 2010 ends, you can choose to divide the taxes on the conversion between your 2011 and 2012 federal returns. This nice opportunity won’t be available if you make a Roth conversion in 2011.1
There are still MAGI phase-out limits for contributing to Roth IRAs. For 2010, those limits kick in at $167,000 for joint filers and $105,000 for single filers. If your MAGI will exceed those limits, you still have a chance to contribute to a traditional IRA in 2010 and immediately roll it over to a Roth.3
Consult a tax or financial professional before you make any IRA moves. You will want see how it may affect your overall financial picture. The tax consequences of a Roth conversion can get sticky if you own multiple traditional IRAs.
If you are retired and older than 70½, don’t forget the 2010 RMD. As your IRA custodian has undoubtedly reminded you, the one-year suspension of Required Minimum Distributions has been lifted. Retirees over age 70½ must take RMDs from traditional IRAs - and 401(k)s - by December 31. Remember that the IRS penalty for failing to take an RMD equals 50% of the RMD amount.1,4
If you have turned or will turn 70½ at some point in 2010, you can choose to postpone your first IRA RMD until April 1, 2011. The downside of that is that you have to take two IRA RMDs next year – you have to make your 2010 tax year withdrawal by April 1, and your 2011 tax year withdrawal by December 31.1
Keep an eye on what happens with income, capital gains & estate taxes. We’re all watching and waiting here to see what Congress will do.
If Congress doesn’t extend the current law, the tax rates on long-term capital gains will go from 0% to 10% next year for those in the 10% and 15% tax brackets. Taxpayers in higher brackets will see their capital gains tax rates rise 5% in 2011 to 20%. In addition, dividends are scheduled to be taxed at marginal income rates of 39.6%. As it stands now, time is running out to take advantage of the current capital gains tax break.5
Income taxes are poised to return to pre-EGTRRA levels in 2011, with the lowest bracket set at 15% and the highest bracket set at 39.6%. (The so-called “marriage penalty” would also come back.) No one in Congress wants this on their legacy, so some kind of extension of the Bush-era tax cuts will almost certainly be worked out. We will have to wait and see if Congress extends the cuts for all or simply for the middle class.6
Estate taxes will undoubtedly return in 2011. Hopefully, Congress will prevent them from returning at the 2001 levels (a puny $1 million exemption and a 55% top tax rate).6
You may wish to make a charitable gift before New Year’s Day. If you make a charitable contribution this year, you can claim the deduction on your 2010 return.
You could make December the “13th month”. Can you make a January mortgage payment in December, or make a lump sum payment on your mortgage balance? If you have a fixed-rate mortgage, a lump sum payment can reduce the home loan amount and the total interest paid on the loan by that much more. In a sense, paying down a debt is almost like getting a risk-free return.
Are you marrying next year, or do you know someone who is? The top of 2011 is a good time to review (and possibly change) beneficiaries to your 401(k) or 403(b) account, your IRA, your insurance policy and other assets. You may want to change beneficiaries in your will. It is also wise to take a look at your insurance coverage. If your last name is changing, you will need a new Social Security card. Lastly, assess your debts and the merits of your existing financial plans.
Are you returning from active duty? If so, go ahead and check the status of your credit, and the state of any tax and legal proceedings that might have been preempted by your orders. Review the status of your employee health insurance, and revoke any power of attorney you may have granted to another person.
Don’t delay – get it done. Talk with a qualified financial or tax professional today, so you can focus on being healthy and wealthy in the New Year.
The end of the year is a good time to review your personal finances. What are your financial, business or life priorities for 2011? Try to specify the goals you want to accomplish. Think about the consistent investing, saving or budgeting methods you could use to realize them. Also, consider these year-end moves.
Think about adjusting or timing your income and tax deductions. If you earn a lot of money and have the option of postponing a portion of the taxable income you will make in 2010 until 2011, this decision may bring you some tax savings. You might also consider accelerating payment of deductible expenses if you are close to the line on itemized deductions – another way to potentially save some bucks.
Think about putting more in your 401(k) or 403(b). You can contribute up to $16,500 to these accounts in 2010, with a $5,500 catch-up contribution also allowed if you are age 50 or older. Has your 2010 contribution approached the annual limit? There is still time to put more into your employer-sponsored retirement plan.1
Can you max out your IRA contribution at the start of 2011? If you can do it, do it early - the sooner you make your contribution, the more interest those assets will earn. And if you haven’t made your 2010 IRA contribution yet, you can still do so through April 15, 2011.1
The 2011 contribution limits on traditional and Roth IRAs are unchanged from 2010. You can contribute $5,000 to your IRA next year if you are age 49 and below, $6,000 if you are age 50 and above.2
Consider a Roth IRA conversion before 2010 ends. Now anyone may convert a traditional IRA to a Roth IRA; there are no longer any income limits in the way. If you pull off a Roth conversion before 2010 ends, you can choose to divide the taxes on the conversion between your 2011 and 2012 federal returns. This nice opportunity won’t be available if you make a Roth conversion in 2011.1
There are still MAGI phase-out limits for contributing to Roth IRAs. For 2010, those limits kick in at $167,000 for joint filers and $105,000 for single filers. If your MAGI will exceed those limits, you still have a chance to contribute to a traditional IRA in 2010 and immediately roll it over to a Roth.3
Consult a tax or financial professional before you make any IRA moves. You will want see how it may affect your overall financial picture. The tax consequences of a Roth conversion can get sticky if you own multiple traditional IRAs.
If you are retired and older than 70½, don’t forget the 2010 RMD. As your IRA custodian has undoubtedly reminded you, the one-year suspension of Required Minimum Distributions has been lifted. Retirees over age 70½ must take RMDs from traditional IRAs - and 401(k)s - by December 31. Remember that the IRS penalty for failing to take an RMD equals 50% of the RMD amount.1,4
If you have turned or will turn 70½ at some point in 2010, you can choose to postpone your first IRA RMD until April 1, 2011. The downside of that is that you have to take two IRA RMDs next year – you have to make your 2010 tax year withdrawal by April 1, and your 2011 tax year withdrawal by December 31.1
Keep an eye on what happens with income, capital gains & estate taxes. We’re all watching and waiting here to see what Congress will do.
If Congress doesn’t extend the current law, the tax rates on long-term capital gains will go from 0% to 10% next year for those in the 10% and 15% tax brackets. Taxpayers in higher brackets will see their capital gains tax rates rise 5% in 2011 to 20%. In addition, dividends are scheduled to be taxed at marginal income rates of 39.6%. As it stands now, time is running out to take advantage of the current capital gains tax break.5
Income taxes are poised to return to pre-EGTRRA levels in 2011, with the lowest bracket set at 15% and the highest bracket set at 39.6%. (The so-called “marriage penalty” would also come back.) No one in Congress wants this on their legacy, so some kind of extension of the Bush-era tax cuts will almost certainly be worked out. We will have to wait and see if Congress extends the cuts for all or simply for the middle class.6
Estate taxes will undoubtedly return in 2011. Hopefully, Congress will prevent them from returning at the 2001 levels (a puny $1 million exemption and a 55% top tax rate).6
You may wish to make a charitable gift before New Year’s Day. If you make a charitable contribution this year, you can claim the deduction on your 2010 return.
You could make December the “13th month”. Can you make a January mortgage payment in December, or make a lump sum payment on your mortgage balance? If you have a fixed-rate mortgage, a lump sum payment can reduce the home loan amount and the total interest paid on the loan by that much more. In a sense, paying down a debt is almost like getting a risk-free return.
Are you marrying next year, or do you know someone who is? The top of 2011 is a good time to review (and possibly change) beneficiaries to your 401(k) or 403(b) account, your IRA, your insurance policy and other assets. You may want to change beneficiaries in your will. It is also wise to take a look at your insurance coverage. If your last name is changing, you will need a new Social Security card. Lastly, assess your debts and the merits of your existing financial plans.
Are you returning from active duty? If so, go ahead and check the status of your credit, and the state of any tax and legal proceedings that might have been preempted by your orders. Review the status of your employee health insurance, and revoke any power of attorney you may have granted to another person.
Don’t delay – get it done. Talk with a qualified financial or tax professional today, so you can focus on being healthy and wealthy in the New Year.
Tuesday, November 16, 2010
Could QE2 Lead to Bubbles?
Why some analysts are worried about the Fed’s latest monetary easing effort.
Is the glass half full? The Federal Reserve has committed to buying $600 billion worth of Treasury bonds between now and June, and it wants to purchase up to $900 billion in debt by the end of September 2011.1 This second round of quantitative easing has been dubbed QE2. In a nutshell, the effort would pour cash into the banking system to promote lending and inflation, and it has the potential to help stocks, the housing market and consumer spending.
Or is it half empty? Some economists are worried about the impact of this tactic. They fear it may create a stock bubble – an inflated equities market motivated by speculation and low interest rates instead of earnings. Likewise, some see a commodities bubble that could burst dramatically in the years ahead.
QE2 has already earned some prominent detractors. Bond market guru Bill Gross just called it “a Ponzi scheme” that will end the 30-year bull market in bonds (an event he has actually forecast for some time). Jim Rogers, the Quantum Fund co-founder who astutely called the worldwide bull market in commodities in 1999, recently labeled QE2 “petrol on the fire” of the commodities market and told an Oxford University audience that Fed chair Ben Bernanke “does not understand economics … all he understands is printing money.”2,3
Will more investors turn to stocks? The Fed’s bond-buying program implies lower long-term interest rates, lower bond yields and a weaker dollar. In an environment with lower bond yields, investors are predisposed to enter other asset classes such as real estate and stocks. If the stock and housing markets improve, that will certainly aid consumer confidence which, in turn, should aid consumer spending.
On Main Street, there are two speed bumps on the way to that rosy domestic outcome: a lack of customers and/or demand (especially in the housing market) and unemployment. The Fed’s strategy may have a tough time getting around those economic obstacles.
Why are other nations growing testy? QE2 could invite a trade war. A weak greenback means a big advantage for U.S. exports. Our products will be cheaper in other nations thanks to the increase in the money supply holding down the value of the dollar. Correspondingly, imported goods will cost us more and we will buy less of them. That’s terrible news for nations such as China, Germany, Russia, Japan, France, Great Britain and Hong Kong – all of whom are counting on exports to aid in their economic recoveries.
If U.S. interest rates are too low for too long, investors may try the emerging markets and/or the commodities markets seeking higher returns. So the commodities markets and the emerging markets could get even hotter.
If that happens, it would imply higher prices for oil, crops and raw materials in the United States, which would hamper our economy. Of course, many analysts think the commodities markets will keep advancing with or without influences like QE2 – the ongoing condition is simply too much demand and not enough supply.
Is this the “Hail Mary” play? With interest rates so low and one round of bond-buying already in the history books, the Fed doesn’t have many options left to jump-start the economy. Here’s hoping its latest move gives the recovery more traction.
Citations
1 – money.cnn.com/2010/11/03/news/economy/fed_decision/index.htm [11/3/10]
2 - blogs.wsj.com/marketbeat/2010/10/27/pimcos-bill-gross-qe2-is-a-ponzi-scheme/ [10/27/10]
3 - bloomberg.com/news/2010-11-04/bernanke-doesn-t-understand-economics-investor-jim-rogers-tells-oxford.html [11/4/10]
Is the glass half full? The Federal Reserve has committed to buying $600 billion worth of Treasury bonds between now and June, and it wants to purchase up to $900 billion in debt by the end of September 2011.1 This second round of quantitative easing has been dubbed QE2. In a nutshell, the effort would pour cash into the banking system to promote lending and inflation, and it has the potential to help stocks, the housing market and consumer spending.
Or is it half empty? Some economists are worried about the impact of this tactic. They fear it may create a stock bubble – an inflated equities market motivated by speculation and low interest rates instead of earnings. Likewise, some see a commodities bubble that could burst dramatically in the years ahead.
QE2 has already earned some prominent detractors. Bond market guru Bill Gross just called it “a Ponzi scheme” that will end the 30-year bull market in bonds (an event he has actually forecast for some time). Jim Rogers, the Quantum Fund co-founder who astutely called the worldwide bull market in commodities in 1999, recently labeled QE2 “petrol on the fire” of the commodities market and told an Oxford University audience that Fed chair Ben Bernanke “does not understand economics … all he understands is printing money.”2,3
Will more investors turn to stocks? The Fed’s bond-buying program implies lower long-term interest rates, lower bond yields and a weaker dollar. In an environment with lower bond yields, investors are predisposed to enter other asset classes such as real estate and stocks. If the stock and housing markets improve, that will certainly aid consumer confidence which, in turn, should aid consumer spending.
On Main Street, there are two speed bumps on the way to that rosy domestic outcome: a lack of customers and/or demand (especially in the housing market) and unemployment. The Fed’s strategy may have a tough time getting around those economic obstacles.
Why are other nations growing testy? QE2 could invite a trade war. A weak greenback means a big advantage for U.S. exports. Our products will be cheaper in other nations thanks to the increase in the money supply holding down the value of the dollar. Correspondingly, imported goods will cost us more and we will buy less of them. That’s terrible news for nations such as China, Germany, Russia, Japan, France, Great Britain and Hong Kong – all of whom are counting on exports to aid in their economic recoveries.
If U.S. interest rates are too low for too long, investors may try the emerging markets and/or the commodities markets seeking higher returns. So the commodities markets and the emerging markets could get even hotter.
If that happens, it would imply higher prices for oil, crops and raw materials in the United States, which would hamper our economy. Of course, many analysts think the commodities markets will keep advancing with or without influences like QE2 – the ongoing condition is simply too much demand and not enough supply.
Is this the “Hail Mary” play? With interest rates so low and one round of bond-buying already in the history books, the Fed doesn’t have many options left to jump-start the economy. Here’s hoping its latest move gives the recovery more traction.
Citations
1 – money.cnn.com/2010/11/03/news/economy/fed_decision/index.htm [11/3/10]
2 - blogs.wsj.com/marketbeat/2010/10/27/pimcos-bill-gross-qe2-is-a-ponzi-scheme/ [10/27/10]
3 - bloomberg.com/news/2010-11-04/bernanke-doesn-t-understand-economics-investor-jim-rogers-tells-oxford.html [11/4/10]
Tuesday, November 9, 2010
Assessing the Mid-Term Elections
GOP picks up 60 seats in the House, 6 in the Senate. The 2010 midterm elections are over and frustration has prompted change on Capitol Hill. Republicans will control the House with at least 239 seats; Democrats will retain a narrow majority in the Senate with at least 51 seats.1
Here comes gridlock. “We’re determined to stop the agenda Americans have rejected and to turn the ship around,” Senate Minority Leader Mitch McConnell (R-KY) told the press after the election.2 So will President Obama’s health care reforms be rolled back? Will federal spending be severely reduced?
Through 2012, you may not see much change at all. With Republicans controlling the House, Democrats controlling the Senate and President Obama’s veto pen at the ready, you can expect plenty of legislative stalemates.
Could gridlock benefit the markets? It could be bullish for stocks. With a conservative majority in the House, Wall Street could breathe a collective sigh of relief over the next two years, feeling less regulatory pressure and seeing fewer threats and a more business-friendly environment.
On the other hand, history suggests otherwise. Standard & Poor’s database reveals that since 1900, the S&P 500 has gained an average of just 2.0% in years featuring a split Congress. Since World War II, the average gain in such circumstances has been 3.5%.3 Here’s hoping past performance is no indicator of future results.
What can the lame-duck Congress accomplish? Republicans don’t become the majority party in the House until January … so what will happen with the Bush-era tax cuts and the estate tax?
A compromise could be in the works on the estate tax. Neither party wants to see estate taxes reset to 2001 levels. With death taxes poised to top out at 55% next year, both parties may emerge from the limbo of 2010 and reach a consensus. A CNN report suggests the maximum estate tax rate will be set somewhere between 35-45% for 2011, with the federal exemption ranging anywhere from $3.5-$5 million.4
Both parties want to preserve the Bush-era income tax cuts. Analysts now think Congress may act to extend the EGTRRA/JGTRRA tax cuts through at least 2011.4 Will they be extended for all Americans, as Republicans want? Or just to households with incomes of less than $250,000, as Democrats want?
Two (lame duck) Democrats have proposed extending these tax cuts for all but the really rich. Senate Banking Chairman Chris Dodd (D-CT) would like them extended for households making less than $500,000; Sen. Blanche Lincoln (D-NE) has proposed setting the break at $1 million. In September, 31 House Democrats wrote a letter to their party’s leaders urging the extension of the cuts for all Americans.5
Other matters to tackle. Currently, the unemployed can qualify for up to 99 weeks of federal unemployment benefits. The Tier V unemployment extension is set to expire at the start of December, and if it does, about 2 million Americans will lose that cushion. Additionally, the Medicare reimbursement rate for doctors will be reduced by 21% if Congress doesn’t apply its usual annual “doc fix” by the end of November, and the Alternative Minimum Tax needs its annual patch.4
It is possible that one broad year-end tax bill could address all of the above issues.
What if the economy needs another stimulus? Given the mid-term election results, it is pretty clear that Federal Reserve will have to “ride to the rescue” instead of Congress. The GOP wants to block any new spending that adds to the federal deficit, so any initiative President Obama might propose to pump up the housing market or job market will likely be small-scale. It is hard to imagine another federal stimulus package making it through Congress between now and 2012, though a tax-cutting move might stand a chance.
Obama appeals to the business world. One last item of interest: in the wake of the “shellacking” his party took this week, President Obama spoke of mending fences with America’s business community. He now says he wants to undo Section 9006 of the health care reform law – the section that would require all businesses to issue 1099 tax forms notifying the IRS of purchases exceeding $600 starting in 2012.6
Citations
1 – latimes.com/news/politics/election/la-election-results-map,0,4890426.htmlstory [11/3/10]
2 – marketwatch.com/story/republicans-to-challenge-obama-after-victory-2010-11-03 [11/3/10]
3 – marketwatch.com/story/gridlock-is-no-good-for-stocks-2010-11-02 [11/2/10]
4 – money.cnn.com/2010/11/01/news/economy/lameduck_agenda/ [11/1/10]
5 - money.cnn.com/2010/10/13/news/economy/bush_tax_cuts_possible_compromise/index.htm [10/13/10]
6 - money.cnn.com/2010/11/03/news/economy/Obama_business/index.htm [11/3/10]
Here comes gridlock. “We’re determined to stop the agenda Americans have rejected and to turn the ship around,” Senate Minority Leader Mitch McConnell (R-KY) told the press after the election.2 So will President Obama’s health care reforms be rolled back? Will federal spending be severely reduced?
Through 2012, you may not see much change at all. With Republicans controlling the House, Democrats controlling the Senate and President Obama’s veto pen at the ready, you can expect plenty of legislative stalemates.
Could gridlock benefit the markets? It could be bullish for stocks. With a conservative majority in the House, Wall Street could breathe a collective sigh of relief over the next two years, feeling less regulatory pressure and seeing fewer threats and a more business-friendly environment.
On the other hand, history suggests otherwise. Standard & Poor’s database reveals that since 1900, the S&P 500 has gained an average of just 2.0% in years featuring a split Congress. Since World War II, the average gain in such circumstances has been 3.5%.3 Here’s hoping past performance is no indicator of future results.
What can the lame-duck Congress accomplish? Republicans don’t become the majority party in the House until January … so what will happen with the Bush-era tax cuts and the estate tax?
A compromise could be in the works on the estate tax. Neither party wants to see estate taxes reset to 2001 levels. With death taxes poised to top out at 55% next year, both parties may emerge from the limbo of 2010 and reach a consensus. A CNN report suggests the maximum estate tax rate will be set somewhere between 35-45% for 2011, with the federal exemption ranging anywhere from $3.5-$5 million.4
Both parties want to preserve the Bush-era income tax cuts. Analysts now think Congress may act to extend the EGTRRA/JGTRRA tax cuts through at least 2011.4 Will they be extended for all Americans, as Republicans want? Or just to households with incomes of less than $250,000, as Democrats want?
Two (lame duck) Democrats have proposed extending these tax cuts for all but the really rich. Senate Banking Chairman Chris Dodd (D-CT) would like them extended for households making less than $500,000; Sen. Blanche Lincoln (D-NE) has proposed setting the break at $1 million. In September, 31 House Democrats wrote a letter to their party’s leaders urging the extension of the cuts for all Americans.5
Other matters to tackle. Currently, the unemployed can qualify for up to 99 weeks of federal unemployment benefits. The Tier V unemployment extension is set to expire at the start of December, and if it does, about 2 million Americans will lose that cushion. Additionally, the Medicare reimbursement rate for doctors will be reduced by 21% if Congress doesn’t apply its usual annual “doc fix” by the end of November, and the Alternative Minimum Tax needs its annual patch.4
It is possible that one broad year-end tax bill could address all of the above issues.
What if the economy needs another stimulus? Given the mid-term election results, it is pretty clear that Federal Reserve will have to “ride to the rescue” instead of Congress. The GOP wants to block any new spending that adds to the federal deficit, so any initiative President Obama might propose to pump up the housing market or job market will likely be small-scale. It is hard to imagine another federal stimulus package making it through Congress between now and 2012, though a tax-cutting move might stand a chance.
Obama appeals to the business world. One last item of interest: in the wake of the “shellacking” his party took this week, President Obama spoke of mending fences with America’s business community. He now says he wants to undo Section 9006 of the health care reform law – the section that would require all businesses to issue 1099 tax forms notifying the IRS of purchases exceeding $600 starting in 2012.6
Citations
1 – latimes.com/news/politics/election/la-election-results-map,0,4890426.htmlstory [11/3/10]
2 – marketwatch.com/story/republicans-to-challenge-obama-after-victory-2010-11-03 [11/3/10]
3 – marketwatch.com/story/gridlock-is-no-good-for-stocks-2010-11-02 [11/2/10]
4 – money.cnn.com/2010/11/01/news/economy/lameduck_agenda/ [11/1/10]
5 - money.cnn.com/2010/10/13/news/economy/bush_tax_cuts_possible_compromise/index.htm [10/13/10]
6 - money.cnn.com/2010/11/03/news/economy/Obama_business/index.htm [11/3/10]
Monday, November 1, 2010
The Information Risk Premium: Danger and Opportunity
When you step back and look at the investment landscape, it is sometimes helpful to ask yourself if anything really IS different this time; to try to determine what has changed.
The usual answers point to recent return gyrations: the tech bubble's spectacular burst ten years ago, the near-death experience of global capitalism in 2008-2009. But the truth is, we've seen all this before in one form or another. Ask your grandparents; the 1929 crash and Great Depression were far more painful to far more people than anything we've experienced in recent years.
Michael Aronstein, who manages a mutual fund called the Marketfield Fund, offers an interestingly different take on what is fundamentally different today. In a one-hour speech at the NAPFA Practice Management & Investments Conference in San Diego on September 22, he connected two dots that most of us are aware of intuitively, but may not have consciously considered. He said that the primary challenge for investment advisors, financial planners and money managers today, which is different from the challenges you faced in the past, is the sheer amount of attention that individual investors are now able to pay to the ups and downs in their portfolios.
"In the last 15 years," he said, "we have moved from an era where people who were not in the business would check stock quotes, if at all, in the morning when they got their newspaper. Sometimes, you would listen to a radio program on your way home from work, and it might tell you what the Dow Jones Industrial Average closed at."
Compare that with today, when it's possible to have a running ticker at the bottom of your computer screen, or a portrait of your investment portfolio continuously updating its various components and arriving at new values every 15 minutes. At the same time, news, information and even fundamental analysis might be flowing into your brain through various sources. "Regarding the economy and its various indicators, there are probably ten thousand data points that we could be looking at in real time," Aronstein continued. "Combine that with hundreds and hundreds of opinions being thrown around as important every day, and it is a formula for driving everybody insane--and I think that really is what is happening to the investing public."
Put in its simplest terms, we are being driven to an unbalanced mental state by the sheer amount of information and opinions that are piling into our awareness at increasing speed, and nobody has a vested interest in telling us that paying attention is highly unlikely to improve our investing lives. In fact, to the extent that we feel panic, fear or a concern that we're missing out on some opportunity, all this information may well be sabotaging the average person's returns.
Panic is a particularly dangerous emotion to investment portfolios, and there is some evidence that more of it is being artificially manufactured by the media than ever before. Aronstein pointed out that it has become a pretty good business to give out doomsday information and frighten investors, and a lot of people have become pretty good at it. "It is rare to spend a day watching CNBC or any of the other financial reality programs," he said, "and not hear somebody come out with the most disastrous, frightening, extreme forecast about what is going on in the world and in peoples' portfolios."
That, in itself, helps us get a better handle on this new era of investing. Aronstein said that risk assets like stocks, which tend to be liquid and priced every second, become increasingly unattractive in an environment where there is a negative or confusing spin on their every movement. Who wants to own something which increasingly gives you heartburn and insomnia? As people sell out of the investments in order to avoid this confusion/heartburn factor, risk assets become more attractively priced than their fundamentals would justify. This could raise their future returns the same way value stocks enjoy return advantages over sexier growth companies: they are less attractive to the average investor.
Instead, investors might become more interested in investments which aren't traded every day--such as real estate and certain types of hedge funds. Because there is no way to watch them change in value in real time, the market commentators aren't talking about them or offering doomsday scenarios before the commercial break. Look for these products to proliferate, not necessarily because anybody believes less-liquid products offer better returns, but because they reduce stress.
It would be easy to say that market reality shows represent a scourge on the investing world. Of course they are unhelpful. Of course the moment-by-moment market movements and most of the data and opinions are of less than zero value to your financial health.
But the important thing here is for all of us to recognize that a new risk factor has emerged in the investment marketplace. This emerging "information risk premium" suggests that if you can tolerate (or ignore) the uncertainty and doomsday commentaries while others cannot, you might be able to get better returns for your ultimate retirement.
The usual answers point to recent return gyrations: the tech bubble's spectacular burst ten years ago, the near-death experience of global capitalism in 2008-2009. But the truth is, we've seen all this before in one form or another. Ask your grandparents; the 1929 crash and Great Depression were far more painful to far more people than anything we've experienced in recent years.
Michael Aronstein, who manages a mutual fund called the Marketfield Fund, offers an interestingly different take on what is fundamentally different today. In a one-hour speech at the NAPFA Practice Management & Investments Conference in San Diego on September 22, he connected two dots that most of us are aware of intuitively, but may not have consciously considered. He said that the primary challenge for investment advisors, financial planners and money managers today, which is different from the challenges you faced in the past, is the sheer amount of attention that individual investors are now able to pay to the ups and downs in their portfolios.
"In the last 15 years," he said, "we have moved from an era where people who were not in the business would check stock quotes, if at all, in the morning when they got their newspaper. Sometimes, you would listen to a radio program on your way home from work, and it might tell you what the Dow Jones Industrial Average closed at."
Compare that with today, when it's possible to have a running ticker at the bottom of your computer screen, or a portrait of your investment portfolio continuously updating its various components and arriving at new values every 15 minutes. At the same time, news, information and even fundamental analysis might be flowing into your brain through various sources. "Regarding the economy and its various indicators, there are probably ten thousand data points that we could be looking at in real time," Aronstein continued. "Combine that with hundreds and hundreds of opinions being thrown around as important every day, and it is a formula for driving everybody insane--and I think that really is what is happening to the investing public."
Put in its simplest terms, we are being driven to an unbalanced mental state by the sheer amount of information and opinions that are piling into our awareness at increasing speed, and nobody has a vested interest in telling us that paying attention is highly unlikely to improve our investing lives. In fact, to the extent that we feel panic, fear or a concern that we're missing out on some opportunity, all this information may well be sabotaging the average person's returns.
Panic is a particularly dangerous emotion to investment portfolios, and there is some evidence that more of it is being artificially manufactured by the media than ever before. Aronstein pointed out that it has become a pretty good business to give out doomsday information and frighten investors, and a lot of people have become pretty good at it. "It is rare to spend a day watching CNBC or any of the other financial reality programs," he said, "and not hear somebody come out with the most disastrous, frightening, extreme forecast about what is going on in the world and in peoples' portfolios."
That, in itself, helps us get a better handle on this new era of investing. Aronstein said that risk assets like stocks, which tend to be liquid and priced every second, become increasingly unattractive in an environment where there is a negative or confusing spin on their every movement. Who wants to own something which increasingly gives you heartburn and insomnia? As people sell out of the investments in order to avoid this confusion/heartburn factor, risk assets become more attractively priced than their fundamentals would justify. This could raise their future returns the same way value stocks enjoy return advantages over sexier growth companies: they are less attractive to the average investor.
Instead, investors might become more interested in investments which aren't traded every day--such as real estate and certain types of hedge funds. Because there is no way to watch them change in value in real time, the market commentators aren't talking about them or offering doomsday scenarios before the commercial break. Look for these products to proliferate, not necessarily because anybody believes less-liquid products offer better returns, but because they reduce stress.
It would be easy to say that market reality shows represent a scourge on the investing world. Of course they are unhelpful. Of course the moment-by-moment market movements and most of the data and opinions are of less than zero value to your financial health.
But the important thing here is for all of us to recognize that a new risk factor has emerged in the investment marketplace. This emerging "information risk premium" suggests that if you can tolerate (or ignore) the uncertainty and doomsday commentaries while others cannot, you might be able to get better returns for your ultimate retirement.
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