Mid Year Client Letter

As we end the month of July, I write to provide perspective on what happened in the first half of 2012 and to share my thoughts on how to position portfolios for the period ahead.

The first half of 2012 was a tale of two quarters. The first quarter represented the strongest start for the US stock market since 1998, with Japan turning in its best first-quarter gains in 24 years. This was largely driven by a reduction of fears about Europe, as well as stronger economic data in the US.

The second quarter gave many of those gains back and regression occurred. Of note in the second quarter:

• Markets were driven by escalating concerns about the future of the European currency union and slowing global growth, accompanied by discouraging data on employment.
• Slowdown in China and India, putting downward pressure on the prices of oil and other commodities as well as stocks in general
• Toward the end of the second quarter, signs of the European situation stabilizing after the markets showed an increase of 7% in May; meantime markets around the world showed recovery with 4% gain in June 

Here's a summary of global market performance in the first half of 2012:

Source: MSCI returns including dividends

The dilemma for investors: dangerous stocks, unattractive bond yields

On the surface, investors today face a range of unattractive choices. While stocks appear fairly valued by most measures, the second quarter saw volatility well above historical norms. Holding stocks has always been risky if your time frame is short, but geopolitical uncertainty and market swings make owning stocks feel especially dangerous today.

Bonds pose different risks. We're seeing historically low interest rates as central banks around the world keep interest rates down to stoke economic growth. Given current inflation in normal times we would expect to see interest rates about 2% higher than today, but of course these are not normal times

And, of course, holding cash to eliminate risk from stocks and bonds virtually guarantees depreciation of purchasing power, and for many investors cash gives them no chance of earning the returns they need to achieve their long-term goals.

Watching the 3 Es - Earnings, Economy, Europe

Looking forward the markets will be driven by the upcoming earnings season, Europe - Spain in particular - is still on the radar and European economy remains front and center.

We have seen some weakness in the reporting of second quarter earnings. Companies such as Apple and Starbucks didn't have stellar quarters and it seemed like the technology sector in general struggled in the second quarter. The poor earnings didn't seem to have an effect on the stock market as the Dow closed above 13,000 last week. This week most of the focus will be on the central banks on both sides of the Atlantic, as the US Federal Reserve and the European Central Bank will both meet to discuss possible measures to boost the economy.

The Fed will kick off a two day meeting to start the week, culminating in an announcement on monetary policy Wednesday. At last month's meeting, the Fed announced plans to extend Operation Twist, the policy of swapping short-term Treasuries in the central bank's portfolio for bonds with a longer duration. Further quantitative easing or other stimulus probably is not going to be announced this week, but we may see hints of further measures down the road.

The ECB will take central stage as their governing council meets in Frankfurt on Thursday. It will be interesting to see if ECB president Mario Draghi will announce any concrete steps to help relieve pressure in the Eurozone. Even though it has been a couple of weeks since Europe was in crisis mode, it looks increasingly evident that Spain will need a sovereign bailout.

Now that the US Supreme Court has upheld the constitutionality of the Patient Protection and Affordable Care Act (PPACA), we can begin to focus on what this new law is all about and how it will impact your financial planning.

Pre-existing conditions

Currently individuals that are not covered by employment-based health insurance that have pre-existing conditions may have a hard time obtaining insurance.

PPACA: Children with pre-existing conditions have been able to get health insurance since 2010, when the law's first provisions took effect. Starting in 2014 the ame rights will be extended to all Americans. Until then, the Affordable Care Act's Pre-Existing Condition Insurance Plan ensures that people with pre-existing conditions will be able to get health insurance without paying more on account of their health status.

Parents with dependent children under 26

In the recent past, some students get kicked off their parent's insurance policies at age 19 or upon graduating from college and found themselves with no insurance during the time it takes to get a job and obtain employer-sponsored health insurance of their own.

PPACA: As of 2010, insurers are required to provide dependent coverage for adult children up to age 26. The adult child does not have to be living with the parent, does not have to be a dependent on the parent's tax return, and does not have to be a student. Both married and unmarried young adults qualify for the dependent coverage extension, although the coverage does not extend to a young adult's spouse or children.

Clients over 65 on Medicare

Currently Medicare is the primary health insurance system for all Americans over 65. Unless a client is still working and covered by an employer group health plan that covers 20 or more employees, he or she must enroll in Medicare at age 65

PPACA: As general health care costs rise, Medicare beneficiaries are forced to pay higher premiums, deductibles, and coinsurance amounts. PPACA is supposed to bring these costs down by slowing the rate of growth of payments to health care providers, improving program efficiency, and phasing out the prescription drug coverage gap over time.

Rights and Protections

In recent years there have been reports of hundreds of abuses by the insurance industry, including canceling policies retroactively when a claim is filed due to "mistakes" on the application, denying coverage for high cost care that is medically necessary, discriminating against women of childbearing age, and dramatically increasing premiums even when the cost of care has not risen to the same degree. The Affordable Care Act is supposed to stop some of these abuses.

The Cost

The Affordable Care Act is expected to cost a total of $938 billion, according to the Tax Foundation. Medicare fixes will cover nearly half, or $416.5 billion. The next biggest source of revenue, or $210 billion, will come from increased taxes on high income taxpayers.

• Higher Part A tax on wages. Starting Jan. 1, 2013, the Medicare Part A tax rate rises by .9% to 2.35% from 1.45% on wages over $200,000 for single individuals and $250,000 for married couples filing jointly
• 3.8% surtax on unearned income. Also starting Jan. 1 2013, a 3.8% tax will be imposed on unearned income over $200,000 for single individuals and $250,000 for married couples filing jointly. The surtax applies to investment income - including interest, dividends, capital gains, annuities, rents, and royalties

As health care costs have spiraled out of control, it is no longer possible for individuals and families to easily manage out-of-pocket costs for medical services. Insurance is mandatory if clients are to protect themselves against financial ruin. It is important to understand the portions of the law that can help you and to take advantage of the benefits.

For example, if you retire before becoming eligible for Medicare at 65 you will benefit greatly from the law, as you will now be able to obtain comprehensive individual health insurance at a reasonable price. The second aspect to prepare for is the new 3.8% Medicare tax on unearned income. It is prudent to work with your tax advisor on a plan on how to reduce the bite with alternative strategies such as taking capital gains this year instead of next, or possibly deferring such gains far in to the future may be viable options.

Please contact me if you have any questions about the articles above or about your personal or business finances.

Sincerely,