|
October 13, 2010
The Economy is Stuck in Low Gear
The 3rd quarter ended in unexpected fashion as the stock market posted its most positive September in more than 70 years. Historically, October is a month of unhappy surprises and this year is replete with dire economic and political justification for the month to perform accordingly. While worries about the economy are legitimate, they do not necessarily translate into weak prospects for stocks.
A combination of reassuring words from the Fed and positive earnings news from companies kept the markets moving higher from early August on, albeit with less than ideal conviction in terms of volume and breadth. Bonds continued to enjoy the favor of buyers, pushing yields to historic lows. After suffering from a tech meltdown and a credit crisis within a ten year span, investors still prefer safety and lower volatility to high yields, so they have poured money into the bond market. Companies are rebounding from the recession in impressive fashion, having posted profits in the second quarter that were 38% higher than the year-ago period.
The great recession of 2008-2009 officially ended in June of 2009, we learned recently, although most people are hard pressed to feel good about that, as things still feel rather slow. The Fed is being quite transparent about its commitment to accommodating a recovery, but it seems that a critical ingredient is missing at this point. Low interest rates are an ideal catalyst for increased economic activity - provided there is a pool of willing borrowers with sufficient room on their balance sheets to lever up and buy stuff. Today, 2 years after the bad end to the credit bubble, households are de-levering and increasing their savings in response to the dim economic prospects that many families face. Unemployment remains stubbornly high as companies are in no hurry to add staff when the political and economic view is as murky as it has been. Confidence is hard to come by - confidence in leadership, financial system reforms or our ability to weather this downturn. Meanwhile, businesses are doing what they need to maintain their vitality in the absence of good news. As a result, the earnings yield for the S&P 500 stands at 8.6% versus the risk-free yield of the 10 year treasury bond of 2.5%.
Equity valuations remain favorable, the Federal Reserve policy remains focused on insuring a solid recovery, corporate balance sheets have been repaired and are now flush with cash that continues to expand at a rapid pace. It is easy finding problems in an economy that is still not performing satisfactorily. But given time and even a hint of good news, growth is far more likely to improve and not deteriorate, as others might expect. |
 |
|
Investing in Foreign Companies
The shares of foreign companies are most often traded as American depositary receipts, or "ADRs" on U.S. exchanges. ADRs are issued by U.S. depositary banks, with BNY Mellon being the largest player in the field. The depositary bank issues depositary receipts that represent one or more shares (or fractional shares) of a foreign stock. The depositary bank actually holds the shares that the ADRs represent in the home country of the foreign corporation. ADRs are easier for most investors to hold because difficulties with exchange rates and trading on foreign exchanges are avoided, and owners of ADRs receive all dividends and capital gains from the foreign corporation through the depositary bank without doing anything differently or more complicated than they would while holding the shares of domestic corporations.
If you own foreign stocks, you may have noticed expenses related to the income payments from these foreign names, characterized as "foreign taxes" or "ADR fees". The foreign taxes are exactly what the name implies - taxes paid to the home country of the stock. The rates of taxation by foreign governments are negotiated by treaty, and vary by country, by corporate structure, and by account registration type. For instance, dividends on Canadian corporations are taxed at a 15% rate for taxable brokerage accounts, but at 0% for tax-deferred accounts such as IRAs. Income payments on Canadian trusts are taxed at the 15% rate for all accounts. Income payments from British corporations are not taxed by England, but for some holdings there is a small "ADR fee" of up to 5 cents per share.
Holding a select group of stocks from around the world can provide a relatively safe, sane way to diversify and let your money work for you in ways that make sense for today and tomorrow. |
Bond Market Bubble?
What's all this chatter about a "bubble" in the bond market? Unless you have spent a good portion of this year living on the international space station, you probably have heard or seen comments about a bubble developing in the bond market and the disastrous consequences that are sure to follow. As a refresher, in this context a bubble is a condition that can develop around an asset or asset class wherein extreme demand can push the price of an asset to unsustainable levels until the "bubble" bursts and then the price level falls dramatically thereafter. Recent examples include the technology stock bubble in 2000 and the more recent real estate bubble. This is pertinent if you have a portfolio that is a combination of stocks and bonds.
One potential solution to mitigate the bond interest rate risk is by sticking to short and intermediate term maturities rather than long term bonds. For a given change in interest rates, long term bonds will fluctuate in price much more dramatically than the short or intermediate term bonds. You can also dampen the interest rate risk by staggering or laddering the maturities of the bonds such that there will be maturities in regular intervals from the shortest maturity to the longest maturity. The result is a portfolio that functions as a hedge against the movement in interest rates. So, what about that bubble? There is no question that nominal interest rates are extremely low. It is also an undeniable fact that significant amounts of money have been flowing into bonds, bond mutual funds, and fixed income ETFs. If one were inclined to bet, I would think there is a greater probability that interest rates will be higher rather than lower in the intermediate term from today. If interest rates rise, you will benefit by being able to reinvest the regularly occurring maturities at the then higher interest rates. If interest rates continue to decline, you will benefit by having invested in bonds with higher coupons that won't mature for 5 or 10 years.
If you take a conservative and passive approach to bond management, it allows you to earn a competitive rate of interest in today's environment, maintain a healthy amount of principal protection in your portfolio, while still being positioned to reinvest your proceeds as bonds mature at what may be higher interest rates in the future. |
Taxes in Limbo
It looks like Congress will not come to any resolution before the November elections on the looming tax changes scheduled to take effect in 2011.
To recap the issues for you, in 2011 tax rates are scheduled to increase on income, capital gains, dividends and estates. It seems clear that neither party is interested in allowing taxes to rise on what they consider the "middle class." The debate centers around whether it's fair and prudent to raise taxes on the "wealthy."
The Obama Administration defines the wealthy as individuals who make more than $200,000 and families that make more than $250,000. The proposal from the Obama Administration is to raise capital gains and dividend taxes to 20%, from their current 15%, for everyone over the income threshold, but leave the current tax rate of 15% in place for everyone under those limits. They would also look to raise the upper income tax brackets several percentage points. The 33% bracket would go to 36% and the 35% bracket would go to 39.6%.
Whether any of these potential tax increases will impact your particular situation depends on your total income and the type of income you receive; meaning are you still working and receiving wages or are you retired and living off of dividends, interest and retirement plan distributions. Any potential impact on your investments has to be analyzed based on whatever tax rate changes are made and then how those changes impact your unique tax structure.
For instance, if you have most of your investments in a rollover IRA, then changes to capital gains and dividends probably won't impact you. But a change in income taxes might, if you take large distributions from the IRA.
With respect to the estate tax, you may know that this year there is no estate tax, but if Congress does nothing, then next year it will come back with a $1 million exemption per person ($2 million per couple) and about a 55% tax for amounts above the exemption. Most in Congress feel the $1 million limit is too low, and there is a pretty steady stream of discussion about raising the limits to around $3.5 million per person ($7 million per couple).
You may recall that in 2009, the limit was $3.5 million per person before the estate tax was repealed for 2010. Many tax analysts thought that Congress would have settled the estate tax issue early in 2010 at around the $3.5 million exemption, but unfortunately no action has been taken. |
|
IRA Required Minimum Distribution Reminder
This is our annual reminder regarding required minimum distributions from IRAs. If you are over age 70 ½ or are the owner of an inherited IRA, then you must take what is called a required minimum distribution (RMD) each year from your IRA.
|
Northstar Investment Advisors, LLC, is a registered, independent investment advisor based in Denver, Colorado. A leader in Denver's investment community, Northstar has been providing clients with exceptional service, timely communications, and clear guidance in all aspects of personal portfolio management since 1995. The firm's five portfolio managers, well-known for developing innovative tools to help investors understand and prepare for retirement, oversee approximately $300 million in client assets. For more information, call 800-204-6199, or visit www.northstarinvest.com.
|
|
Fred Taylor
Charlie Farrell
Dick Kopp
Tim Waymire
Northstar Investment Advisors
700 17th Street, Suite 2350
Denver, CO 80202
(303) 832-2300 phone
(800) 204-6199 toll-free
(303) 832-0034 fax
For archives of our newsletter and more places where Northstar is in the news, please visit our website. For reprints of any article in this issue, please call or e-mail us at the address listed above.
|
|
Disclosure and Disclaimer: The content in this email does not constitute tax or legal advice. Consult your individual tax or legal advisor. Past performance is no guarantee of future returns. Investing involves multiple risks, including but not limited to the risk of loss of principal. |
|
