Rolling Stone

It’s (almost) never too late to get important things done. We all know the saying “A rolling stone gathers no moss” and moss, in this case, is missed opportunities that expire at the end of this year (the most pressing deadline at the time, of course). Remember 529s funding, charitable contributions, portfolio sales, annual exclusion gifting and IRA Required Minimum Distributions (including inherited IRAs) must be completed by 12/31 to be recorded in the 2010 tax year.

Additionally, for those considering Roth IRA conversions, you must have the conversion complete by 12/31 to qualify for the special two-year deferral of income recognition (this is only available for conversions performed in 2010). This opportunity should be considered along with recharacterization opportunity changes, investment holdings outlook, other tax goals, etc. when deciding whether to wait or act now.

Last Minute Race

Last Friday President Obama signed into law the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.” The implementation of this bill signaled the end of a last-minute race at the end of this year to avoid significant tax increases scheduled to occur January 1, 2011. There are a number of ramifications of this bill, none of which are insignificant.

One outcome was a temporary, two-year “fix” of the federal estate tax. There are many details of this provision although a few points are; the federal estate tax exemption, generation skipping transfer tax exemption and lifetime gift tax exemption have all been “reunified” and set at $5 Million per person, and the federal estate tax exemptions are now “portable” (i.e. a spouse can use their deceased spouses unused federal estate tax exemption amount). There are many planning opportunities created by these changes that must be addressed in the next two years and evaluating those opportunities in context of a broad wealth plan will be more important than ever.

Why are interest rates rising in the US?

When the Federal Reserve announced a second round of quantitative easing (QE2) in early November their goal was to lower long-term interest rates to help further boost the economy.  However, we’ve seen the exact opposite effect in the market.  Interest rates on a wide variety of bonds have been rising over the past month.  Why?  The reason rates have been increasing is because the economy continues to improve, investors now have a greater appetite for risk, the US tax compromise deal working its way through Congress, and because of concern that inflation will increase as a result of QE2.

November 2010 Market and Planning Update (Posted to our blog two weeks after sending to clients.)

"It takes far less courage to cling to the past than it does to face the future"

- Sandra Brown (author of over fifty-five New York Times bestsellers)

MARKET COMMENTARY

The markets faced renewed challenges in the month of November due to the continued debt crisis in Europe (most recently affecting Ireland), monetary tightening in China, North Korea’s military attack on South Korea, and FBI raids on several well-known hedge funds for possible insider trading violations.

Although the “wall of worry” has reappeared after a 2 ½ month hiatus, we take comfort in the gains we have experienced for the year and over the past 12 months. As we wrote in last month’s commentary, year-to-date returns from both stocks and bonds have likely exceeded investor expectations coming into this year. This leaves everyone with the question of how to properly position investment portfolios for the future.

Our expectations for bonds in the US are tempered with a concern that present low interest rates and a second round of “quantitative easing” (QE2) will combine to result in upward pressure on bond yields and downward pressure on bond prices and returns. We are concerned that inflation expectations will build as the Federal Reserve continues to pump money into the bond market. How and when they start to remove this additional stimulus and can they do it before inflation starts to escalate is a big question? We may also see foreign investors demand higher interest rates on our Treasury bonds to compensate for additional US government credit risk.

On a positive note, the US economy continues to improve. The latest revision to GDP for the third quarter was a better-than-expected 2.5% and many economist estimates for the fourth quarter of 2010 are heading higher. Key leading economic indicators, like falling unemployment claims, are rebounding after a summer lull. Consumer spending has been ahead of expectations for five straight months. Business and consumer confidence are recovering and recently, hours worked and real wages/salaries have been increasing.

We continue to position investment portfolios based upon the following longer-term themes:

1. The US and Europe will see slower economic growth in the years ahead.

2. Emerging market economies, like Brazil, India and China, will continue to grow more strongly than the rest of the world.

3. Emerging market currencies will have long-term strength against slow growth, debt-burdened developed markets. Thus, we expect the US dollar to continue to weaken over time.

4. It’s important to have some protection against higher inflation rates.

5. Active equity mutual fund managers can add substantial value as they find those companies that will succeed in a world that rewards winners and punishes losers more than ever before.

6. Active bond mutual managers can add value through diligent credit analysis and trading expertise in a world where debt levels and credit risk have increased significantly.

Our guidance to investors and to ourselves: Be prepared for short-term volatility, but use it as opportunity to tactically position for maximizing long-term returns.

PLANNING COMMENTARY

As we referenced on our blog last week, the draft proposal issued by Simpson and Bowles as co-chairmen of the Federal Deficit Commission released earlier in November created quite a stir. The draft is not an official proposal, yet it still came under a great deal of scrutiny particularly regarding the reductions in “entitlement” benefits (primarily Social Security and Medicare). It is important to note that any official proposal must receive 14 votes out of the 18 member commission to be submitted to Congress- something that no one sees as likely. Furthermore, even if a proposal survives the commission’s vote there is no requirement for Congress to address the recommendations. This speaks to the tendency to “cling to the past” and avoid making difficult, often contentious decisions needed to improve our future.

Of course it doesn’t take much courage to attack difficult proposals that include shared sacrifices on the basis that everyone is “entitled” to benefits, low taxes, social programs and pork projects. What does take tremendous courage is to face today’s challenges and be proactive about shaping the future in a positive way. This action inevitably leads to controversial decisions that are difficult to make but absolutely necessary for a positive future.

What we really need is a proposal from the Federal Deficit Commission, un-amended, that Congress must vote up or down. That would take courage on the part of Federal Deficit Commission members, Congress and citizens of this country alike. What all this means to a personal wealth plan is an understanding of the responsibility one has for their own financial future and how these important decisions made (or not) in Washington, Indianapolis and here at home affect that plan. Tax policy, “entitlements,” the state of the domestic and world economy along with many other variables will change as these developments occur. We continue to monitor client wealth plans in context of these developments and keep working to provide proactive recommendations that help our clients face and control their future.

Tick Tock

President Obama agreed to work with Republican leaders earlier this week in dealing with Bush-era tax cuts set to expire at the end of this year. The compromise, which we still await details on, includes a temporary (2 year) extension of current income and capital gain tax rates for all taxpayers. In order to reach this agreement there will be an extension of unemployment benefits and temporary payroll tax reduction (2% cut in Social Security tax collected in 2011) among other sweeteners for Democrats. Some Democrats are fighting the deal and may derail the current version (see http://tinyurl.com/2awtu4w for more details), largely due to the estate tax reductions included in the deal when compared to 2009 estate tax law.
While these are good signs that our leaders are finding their way to compromise so that action can be taken to address key issues, these decisions remind many of “business as usual” as it relates to deficit spending. There was no mention of revenue raisers or spending cuts now or in the future to even partially offset the costs of this compromise (i.e. all new spending). While a weak economy needs to be addressed we must also realize that the clock is ticking as it relates to facing our financial responsibilities as a country.

Kick the Can

Today, the Federal Deficit Commission held their vote (originally scheduled for Wednesday) to determine whether a formal proposal would be released for Congress' consideration.  As many predicted, the commission failed to garner the 14 votes required for this to occur, out of the 18 member panel.  There were 11 votes for the proposal, more than what many predicted the vote would generate.  This is why some are arguing that we may see action from our nations leaders, yet others feel this is the reason Washington was looking for to go back to business as usual.  A member of the panel, Andrew Stern, was quoted as saying "We have changed the issue from whether there even should be a fiscal plan for this country, to what is the best fiscal plan for this country."

The fact that it has taken this long and this much debate for someone to realize our country needs a fiscal plan is precisely why it is easy to believe our leaders will keep playing the political games- "kick the can" if you will, as long as they have the room to do so.  The goal of the game- kick the issue down the road so we don't have to deal with it now.  The good news- the terrain is all uphill from here- the longer we chose to kick the can, the harder it will become to continue doing so.  Hopefully this will spur our leaders into acting to face these challenges sooner rather than later.