July 2, 2012

Obamacare has most recently captured the headlines but to quote an economist from TD Economics, the “Eurozone debt crisis is hanging over the global economy like a sword of Damocles.” The good news is we are still growing. The DOW opened the year at 12,397, went up to 13,264 the first quarter and then has dropped to 12,880 last Friday to end the quarter down but is still up for the year. The rate of growth has slowed to close to stall speed and the  Fed is keeping interest rates low and doing every-thing it can to stimulate the economy (they are running low on options). I have just returned from Chicago where I attended the Morningstar Investment Conference. I think it is one of the best places to learn from the best and brightest. You have to pay to attend and all the speakers are invited by the Morningstar analyst to speak. This is a major difference from the usual investment conference where you become a sponsor and you get to speak. Global money managers from around the world spoke as well as several economists from several business schools. The big take away were to look at the global debt offerings, be very wary of US Government debt (a bubble), equities and farm land are good long term places to invest. So with US equities being close to fairly valued and with confidence slipping, volatility up and the global uncertainty what do you do? I’ll get to that below. Why is everyone afraid of US debt? The safety and value of the US treasuries looks like fine investment, and has done so incredibly well recently. The chart on the next page helps explain. This is from FRED the Federal Reserve Bank in St Louis. http://research.stlouisfed.org/fred2/. The blue line shows what we are currently spending and the red line shows tax revenue. The economy has contracted and the hope is we grow the economy so much the tax revenue/income catches up. The problem is a big one. The spending is now projected to go up another trillion dollars (off the chart to 4.6 trillion) from the original projections (Obamacare), and we have what is being called the fiscal cliff coming up. The Bush tax cuts expire with mandated spending cuts creates a perfect storm. The combination of tax increases and budget cuts is enough to push us back into a recession.


Click the image for a larger version

The current environment can be best described by ex-senator Lugar from Indiana; “the Republicans refusing to discuss tax increases and the Democrats refusing to discuss any entitlement reform”. I think we may have an opportunity for both parties to be forced to give in and we can have some meaningful tax and spending reform. Letting the Bush tax cuts expire for everyone may be an option. The buffet rule while being a great sound bite does nothing to solve the problem. It would reduce the debt from $3.072 trillion to $3.025 trillion less than 2% of the problem. The second problem with our bonds is that interest rates essentially can’t go any lower so the only way is up. When interest rates rise, bonds prices drop and the extra expense sends the budget more out of whack. Enough on why US debt may become like Europe, we must quit over promising and underfunding. So why the global debt? What I didn’t know about global corporate and sovereign debt is that unlike Europe and the US almost all other countries, Canada and especially Asia have very strict controls on corporate reporting and government spending. China being an exception (they have their own rules). Balanced budgets and higher interest rates look better than the US offerings.

Obamacare is another topic that I need to address. There are more than two dozen new or higher taxes (Pelosi was correct we needed to pass it to see what’s in it). One of several that effect many of you is the surtax on  investments. If you are married and your investment income is above $250,000.00 ($200,000.00 single) you are subject to the new higher tax rates. Being married carries a penalty let me explain.

Capital Gains Dividends Other*
2010-2012 15% 15% 35%
2013+ (current law) 23.8% 43.4% 43.4%
2013+ (Obama budget) 23.8% 23.8% 43.4%

Read more: http://www.atr.org/comprehensive-list-tax-hikes-obamacare-a5758#ixzz1zK69iKMb

Using the current 2013 law if you are married and have over $250,000.00 of dividend income the 43.4% tax kicks in. Assume you have $400,000 of dividend income. You pay the higher tax on income above the  first $250,000. In this case $400,000.00 – $250,000.00 = $150,000.00. Two single people would each get  $200,000.00 and only pay the 15% rate. $150,000.00 taxed at 15% is $22,500.00 vs. the married couple paying the higher 43.4% rate, or $65,100.00. The penalty for being married is a whopping $42,600.00. This affects other income as well, including Sub S Corps, however at this time I am not clear on the affects. At this time I am not sure the15% rate will apply to the first $250,000 couple/$200,000 for single. Thus the exact numbers may shift but there is definitely a penalty. Needless to say our investment strategies will shift do to these new realities.

I thank you for the trust you place with us and leave you with a quote from Chris Davis Chairman of Davis Advisors. “Investors repeatedly abandon a sensible wealth building strategy just because it is not generating Short-term results, and almost without fail, give up on it at precisely the wrong time”. I hope you are all well and enjoying your summer.

Yours Truly,


Willis Ashby, CFP®

Disclaimer: I am not a tax expert and the tax scenario described above is based on my current understanding of the law. 

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