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 IHA Monthly   
January, 2012  
In This Issue
Market Commentary
December 2011 Asset Class Returns
Financial PLanning Calendar
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History Speaks
Eastman Kodak
In recent weeks, Mitt Romney has had to defend the 'creative destruction' of capitalism as the tactics of Bain Capital, the private equity fund he managed, have been questioned by his opponents in the Republican primary. We have seen an example of the 'destruction' part this last month as markets anticipate an Eastman Kodak bankruptcy. Kodak offers an excellent case history on the temporary nature of most market dominating positions: George Eastman founded Kodak in 1892 to sell the Kodak camera which he had specifically developed to utilize his patented "roll" film. Kodak sold cameras cheaply but made huge margins on film- in which it had a 90% marketshare in the U.S. as late as 1976. Kodak became synonymous with photography and a "Kodak moment" was an image thatKodakAd needed capturing. Unfortunately Kodak sat on their market leader position and was slow to react when Fuji film started taking marketshare in the 1980's. However, the real existential threat came from the development of digital photography- ironic since Kodak had developed the first working digital camera. Kodak wasn't late to the digital market, partnering with Apple to produce a camera as early as 1994, but never found much profit in the business. They developed the EasyShare line of cameras that helped propel them to the number one U.S. digital camera sales position in 2005 but soon exited the business because of losses. Kodak is now exploring the possibility of selling their patent portfolio- perhaps here we will find the 'creative' part- in order to save some value for shareholders and creditors.
Market Commentary

InnerHarbor Advisors is a Manhattan based financial advisory firm specializing in: Financial Planning - Wealth Management - Insurance 
If you would like a fresh perspective on your finances, please contact John O'Meara or Michael Keating at 212.949.0494 ...or simply 'reply' to this email.


A quick note before we get started- 2012 marks the beginning of our third year publishing the IHA Monthly. A great source of pride for us. We thank-you for your encouraging feedback and we thank-you for reading. Here's to another great year.

Without further ado...

One of the features of the financial markets over the last decade has been increased correlation of world equity markets. With interconnections between national financial systems and global business cycles it often seems that all markets move together. Over the last couple of years, the terms "risk -on" and "risk-off" have been adopted by the financial media to describe this phenomenon, highlighted by the introduction of two new exchange traded notes that allow investors to trade either strategy. What has been lost in this view is that even if markets are correlated, they do not always produce the same return. Looking at 2011: daily correlation between U.S. and international developed markets was 94%... and between U.S. and emerging markets the correlation was 87%. Keep reading because as U.S. large caps had a mildly positive year in 2011, international developed markets lost over 12% and emerging markets were the big loser- down over 18%. In this month's newsletter we look at some of the key indicators from each of those regions.


United States

The U.S. was the safe-haven market in 2011 as economic performance continued to muddle forward despite the train-wreck unfolding in southern Europe and the mid-year slowdown in emerging markets. The primary indicator of national economic health is employment and the number of jobs in the U.S. grew by 1.2% in 2011. Employment growth will continue to be the focus in 2012. One of the strengths of the U.S. is labor mobility and the fluidity of capital towards areas with the perceived highest return. The following chart  shows the overall employment level for the country since the start of the recession in December 2007 along with the employment levels for two of industries that were leaders before the recession (Real Estate Sales/Leasing and Residential Construction) and two of the industries that have been growing employment since the recession started (Oil and Gas Extraction and Computer Design/Support).  


This shows that even in the worst of times, some industries can expand and help lead a recovery. Some key points to mention: the total number of people employed by the expanding industries is much smaller than those employed by the shrinking industries; and there is a skill gap to overcome-selling condos in Vegas doesn't prepare you very well for extracting oil in North Dakota. However, jobs dynamism is the primary reason the U.S. market outperformed last year. 


International Developed Markets 

This includes much of Europe, Japan  and Australia. As we detailed last newsletter, it is the lack of jobs dynamism in much of Euroland that is having such a significant effect on their sovereign debts. Those debts are held in European banks and the question of whether the problems associated with them will be contained within those European banks is the question of 2012. If it appears the Europeans are reaching a deal whereby Germany and the northern European countries will guarantee everyone's bonds, then the rates paid by the southern European countries will decline to a level closer to their German counterpart. If a deal is not reached those widening spreads will force one of the big, southern nations to default and very possibly cause the dissolution of the Euro.  


The tightening of spreads over the last month (as indicated in the above chart) is due to the announcement of a three-year financing facility for Euro banks by the European Central Bank. This was seen as a welcome measure by the market which has been looking for the ECB to massively expand their purchase of European sovereign bonds (similar to what the Fed has done here). The ECB has been unwilling to do this without the express authority of its member governments and the facility they opened is not a long term answer but the markets have taken it as an indication that the ECB wants to do more and is willing to be a little creative in how it accomplishes that.


Emerging Markets

In light of 'forced' U.S. and European deleveraging, due to the massive build-up of debt in their public and private sectors, a reasonable expectation would be for investor attention to move toward the growing emerging markets. After all, Goldman Sachs famously predicted that the BRIC nations (Brazil, Russia, India, China) could constitute four of the six biggest economies in the world by 2050. But after a quick recovery to the financial crisis of 2008-2009, most emerging markets had a very disappointing year.  The following chart shows the performance of the primary stock indexes for the BRIC nations in 2011.

Black- Brazil    Red- India    Green- Russia    Purple- China 

The question with emerging markets is whether they can develop the internal demand necessary to sustain economic growth regardless of what happens in the developed world. Most of the countries that fall into this category, led notably by China, tout an economic model that emphasizes trade surpluses and tight currency controls. It is a legitimate question to wonder whether this simply makes them high beta plays on economic growth in the developed world. 

Looking forward into 2012, it appears the biggest risks to U.S. financial markets will come from abroad, either the Euroland sovereign debt/banking crisis or a hard landing in China. Barring bad news on those fronts, the U.S. markets should gain even if the lackluster domestic growth continues (this seems the most likely scenario). On the bond front, interest rates are at historic lows but with the ECB's new President Mario Draghi already cutting rates, China and Brazil recently announcing plans to ease monetary policy and with the Federal Reserve ever more dovish there does not appear to be much pressure on rates to rise.  

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Asset Class Returns

Through December 31st, 2011 - Monthly and 52 week returns for major asset classes. Performance information is for total return assuming reinvestment of interest and dividends. It excludes management fees, transaction costs and expenses.   


Equity market ended a wild year with a bit of a whimper as most indexes were up or down just a percentage point in December. For the year, U.S. large cap stocks outperformed most of their peers including their small cap brethren and trounced international markets, particularly emerging nations. Income producing assets performed better, especially those on the safer side of the spectrum. While REIT's and high yield bonds returned around 6%, investment grade bonds yielded over 9% and U.S. treasuries and TIPS well over 10% each. Easing monetary conditions in Europe, Brazil and China helped push yield down in December, giving some juice to bond returns for the year.

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Financial Planning Highlight

Financial Planning Calendar 

Helping Your New Year's Resolution


If you made another New Year's pledge to straighten out your finances, we are here to help. This month we offer you a financial planning calendar. Simple- one task per month will move you a long way towards your goal.


January - Review Your Investment Strategy

This starts with looking at your asset allocation to determine if it still fits your financial position and time horizon. It is also a good time to rebalance your portfolio so that it actually follows your planned asset allocation.


February - Review Beneficiaries

Use this month to check beneficiaries on your IRA accounts, qualified retirement plans at work and life insurance policies. Also review the beneficiaries in your will and any trusts to make sure they reflect your current family situation.


March - Review IRA/401(k) Contributions

IRA's and 401(k)'s are generally the best vehicle for retirement savings. March is a good time to make sure you maximize your previous year's IRA contribution or if you didn't maximize your 401(k) contribution in 2011, adjust your monthly contribution so you do hit the max ($17,000 in 2012 for most of us) this year.


April - Update Your Emergency Fund

You should always have 6-12 months of monthly expenses in reserve in the case of an emergency. If you don't have one, start funding one right away. If you already have a fund use this time to review if it is adequate given changes in your cash flow over the previous year.


May - Determine Your Effective Tax Rate

Your effective tax rate is the percentage of  your income that actually went to taxes in the previous year. It is calculated by adding up your total tax you paid to the federal (including payroll taxes), state and city governments and dividing that by your total income plus any 401(k) and IRA contribution. This is a good number to know because it lets you know how much of your income is actually available to you.


June - Determine Your Marginal Tax Rate

Your marginal tax rate is the percentage of the last dollar you made that went to taxes. It lets you know how beneficial tax shelters (such as 401(k) contributions) are to you. Ask your accountant, or look at your 'taxable income' (line 43 on your form 1040) then look up the tax bracket for that income. You will need to do the same for your state return. Add those two percentages and you will get your marginal tax rate (it is a little different if you are in the AMT). You can find federal and state tax brackets here:

Tax Brackets 


July - Determine Your Total Assets

These are the things you own. This includes  personal assets such as a home, car and jewelry. It also includes intangible assets such as bank and brokerage accounts. This month, collect all your statements and estimate fair value for your tangible assets. Use a spreadsheet or this Net Worth worksheet.


August - Determine Liabilities and Calculate Net Worth

Your liabilities are the amounts you owe. They include mortgages, credit card balances and student loans. The Net Worth spreadsheet link above can help you here as well. Once you calculate your total liabilities, subtract that number from your total assets to calculate your net worth.


September - Cash Flow

Cash flow consists of income and expenses. Most people know their income but determining expenses takes some legwork. We recommend looking at three months of expenses to get a better feel for this number because not all expenses occur every month (think insurance payments). Using one debit or credit card for most of your expenses will help you keep close track of your expenses and many banks will provide a breakdown of  expense categories (forewarning: food has become really expensive).


October - Calculate Personal Financial Ratios

The two primary ratios you should worry about are your Savings to Income and Debt to Income. You want the first to be high and the second to be low, but also focus on the direction over time. This article on personal financial ratios can give you a general target based on your age.


November - Review Insurance Coverage

Take this month to review your protection against financial threats. In particular, examine your auto and home insurance limits to make sure they will cover the replacement value of the asset. Make sure you have adequate liability coverage on top of the basic insurance. Also, review your life insurance policies, particularly if there have been any additions in your family over the last year. Also, review benefits available to you through work to see if you should be taking advantage of them at the next enrollment period.


December - Tax Loss Harvesting

At the end of the year, see if it is possible to offset any gains you have throughout the year by realizing a loss. Remember, even if you have no net gains you can use $3,000 of your losses against your earned income.





Thank-you for reading,
John O'Meara, CFP, MS
Michael Keating, CFP


As always, we welcome your comments on style and content.


Mike and John InnerHarbor Advisors 

Contact Info:
InnerHarbor Advisors, LLC
212-949-0494 and