“The world is full of people who know the
price of everything and the value of nothing.”
Oscar Wilde, 19th-century writer
The U.S. stock market (as measured by the S&P 500 index) closed the 1st quarter of 2010 up about 5 ½% year-to-date and up about 70% from the low reached a little over a year ago on March 9, 2009. We can’t resist going back to what we were saying in this same communication sent at the end of March 2009 where we made what turned out to be a prescient comment “some positive evidence has emerged that shows we may look back at the 4th quarter of 2008 and the 1st quarter of 2009 as the low point in this recession.”
The problem for many investors a year ago was that they were bombarded daily with media reports of stock price declines- being human beings they responded emotionally by selling to avoid further paper losses versus recognizing the value opportunity at such low prices. Mutual fund money flows are very instructive in terms of what happened here where 2008 and 2009 saw combined domestic stock fund outflows of $181 billion while bond funds for the same period had inflows of $304 billion.
Now let’s consider current times. Although the economy and the markets have recovered nicely over the past year, we remain concerned with several key items that have worried us for some time, including:
• The U.S. (and most other developed nations) incurred tremendous amounts of debt in dealing with the credit crisis. Further, these same countries have a high level of purely structural deficits that exacerbate these debt problems.
• As the U.S. issues additional debt it fuels the concerns of purchasers of that debt which will eventually cause interest rates to rise. It is notable that 10-year Treasury rates that were 2.75% a year ago now stand at 3.83%.
• As government policy stimulus is removed worldwide, it remains uncertain whether or not the private sector can continue to grow in a healthy manner.
One example of U.S. government policy stimulus removal is the March 31, 2010 end of the Federal Reserve’s program of purchasing $1.25 trillion of residential mortgage-backed securities. While this program was in place it supported low levels of home mortgage interest rates, which many observers feel will now increase as much as 100 bps (1%) from present levels.
A key question going forward can be summarized as “will the U.S. and other worldwide economies have the ability to generate healthy growth on their own, as government subsidy of different types is removed?” At Payne Wealth Partners, we believe the answer is “it depends.” If only evaluating economies of developing countries such as China, India, Russia, Brazil and Mexico, we say “yes” these economies can grow in a healthy fashion. But for the U.S. and other developed countries the answer is much less clear to us. Some forecasters see healthy developed economy growth, but many see much more anemic growth. If the answer turns out to be that developed countries (including the U.S.) are in fact economic growth laggards, then the prospect for corporate profits and therefore stock prices would be challenging. Further, poor economic growth and continuing high budget deficits and resultant debt levels for such developed countries could well mean higher interest rates as markets recognize their “debt trap”.
Payne Wealth Partners is making no changes in client portfolios at this time, however we see an increasingly attractive case for moving up portfolio targets for bonds issued by government issuers we believe have a good and improving national balance sheet, such as Brazil and Mexico (we presently have 5% targeted for this area). Further, we believe the case for commodities is improving as those would be a good hedge against currency devaluation from excessive developed country debt issuance while commodities would also be expected to benefit from emerging country economic growth. We will continue to evaluate these and other possible changes to client portfolios as the path of economic recovery and growth becomes clearer.
Our firm also believes we should be commenting in these monthly letters to clients on matters related to wealth planning. As we have evolved to provide a majority of our clients with comprehensive services that include planning, we want communications to our clients to properly reflect the importance we place on wealth planning opportunities. In this month’s letter we want to address estate taxes.
As of January 1, 2010 the federal estate tax was eliminated. This applies to those dying in 2010 only. As the law is currently written, on January 1, 2011 federal estate taxes return for those dying with estates valued in excess of $1 million. One of the biggest moral issues this situation presents is the incentive for someone with a very large estate to die in 2010 and avoid federal estate taxes that can be as high as 45%. While this may be hard to imagine, there have already been numerous cases reported of families making questionable decisions as to wealthy relatives on life support and in critical condition. These provisions were part of legislation passed in 2001 and we were very surprised that Congress didn’t act prior 12-31-09 to correct this. Further, we would have thought that 2010 would have seen a timely solution to this problem with the resolution being retroactive to January 1, 2010 but have yet to see any action taken.
So here we are now having completed the first calendar quarter of 2010 and still no estate tax fix. To us, this is a major failure of this Congress. Our hope and expectation is that Congress will soon take up this issue and clarify the estate tax rules. When they do, individuals will need to evaluate how the new rules affect them and determine if any changes are required to their current estate planning documents. If Congress simply lets the present law continue as-is, this too should be addressed by individuals in evaluating their estate plan. In any event it is something we should all have on our radar going forward in 2010.
