September 25, 2012
Coping With Taxmageddon
The Investment View from Prescott, Arizona
By Will Hepburn
Politicians, doing what politicians do, have enacted the largest tax increase in US history. In 2010 the Democrat controlled Congress passed the law which President Obama then signed.
Cleverly, it was not to become effective until January 1, 2013, after the 2012 election so they all can smile and say “Who, Me? What taxes?” during the re-election campaign.
Taxes take money out of the economy. With the economy already struggling, sucking large amounts of money out of it might push us back into recession and that is why pundits have labeled 1/1/2013 a “fiscal cliff” or “Taxmageddon”. So let’s take a minute and look at some of these specific tax increases and how they may impact you.
The current tax brackets of 10%, 15%, 25%, 28%, 31% and 35% are scheduled to rise to 15%, 28% 31%, 36% and 39.6%. So everyone will be getting a tax hike.
Eliminating the 10% bracket means that crowd will now pay 15%, a 50% increase in their taxes. So much for watching out for the little guy, huh? Middle income folks now paying 25% get bumped to 28%, a 12 % increase in taxes. And top bracket folks get bumped to 39.6%, a 13% increase.
Long Term Capital Gains – the tax paid on investments jumps to 20% next year, 1/3 more than current 15% levels.
Dividends will go from being taxed at a maximum of 15% this year to being taxed as ordinary income next year, making the top rate 39.6%. An increase of 164% for top rate payers. Ouch!
A Medicare surtax to pay for Obamacare will be 3.8%. It will apply to certain types of investment income, such as interest, dividends, royalties, annuities and rents as well as capital gains and for some high income folks, earned income.
All in all, the rate changes plus the surtax will add up to a serious haircut for many investors.
What can one do to avoid taxes, short of moving to the Cayman Islands?
Focus on capital gains over dividends as they still have one of the more favorable tax rates. At Hepburn Capital we have already modified our growth strategy to allow us to pursue more long term capital gains.
Consider municipal income. It will not be subject to the surtax, and already avoids most if not all income tax, so income investors will gain a nice advantage with municipal income. HCM’s Municipal Income* strategy had been our best performer this year and as tax sensitive investors turn to munis over the next year or so, I would expect them to continue to perform well.
And there are other, non-investment steps you can take to soften the tax blow scheduled to come next January. Hepburn Capital does not provide tax advice, so talk to your tax adviser to see if there is more that you can do.
Next Scottsdale Date
Please call (800)-778-4610 to make and appointment if you would like to meet Will in the Scottsdale office.
Shriners Have Fun and Help Kids
The Shrine Circus was in town two weeks ago, and the throng of little ones that came to watch it had a wonderful time.
The Shriners hold various fundraisers during the year to help operate the 22 Shrine Hospitals around the country. Shrine Hospitals specialize in treating children with burns, orthopedic issues and cleft palate, all at no cost to the family.
If you know of a child that needs care, please contact me and I will be happy to help get the admission process started.
How’s The Market Doing?
The Federal Reserve announced that they would add about $40 billion per month to their bond buying effort in what is called QE3 (short for Quantitative Easing Program III). They were already spending over $40 billion on Operation Twist, which continues. This means that the Fed will be shoveling almost $1 trillion per year into our economy.
Clearly they are trying to get inflation going to combat deflationary forces in the world. Right now it is not happening, but at some point it will. The big question is when, and no one knows when that will be. Since inflation has been “about to happen” for many years, but hasn’t yet, the key in this market is to wait until we actually see inflation happening and then react.
One of the early editors of the Wall Street Journal once said “The graveyards of Wall Street are littered with the body of investors who were right too soon.” It could be a mistake to be too early investing to fight inflation.
Treasury bonds have pulled the bond market backwards as they dropped to multi-month lows last week. Fortunately we don’t own treasuries in our Flexible Income* portfolios, and other segments of the bond markets have been doing well.
The stock market jumped when QE3 was announced, and then did nothing this past week.
September has the reputation of being the toughest month on investors, but not so this year. It has been a good month, so far, for the stock market, with the worst period, last week, best described as boring. And that is not all bad.
It will be interesting to see if the flood of Fed money will keep the stock market up despite weakening economic data coming in from all over the world. QE3 is scheduled to actually begin this week. Stay tuned on that one.
A Well Deserved Thank You
Ron Greene and Ken Imes have been working on my cars at Downtown Paint and Body for over 20 years. I was originally referred to them because they do work for Allstate. When I got T-boned by a red light runner 5-6 years ago they put my Infiniti back in like-new condition.
A few weeks ago they did me a favor after someone caved in the corner of my bumper in a parking lot. Since the bumper was plastic I asked them if they could just pop it back out before deciding to replace and repaint the whole thing. Ken said “let me put my big hair dryer on it and see what we can do”.
In about 30 minutes Ken called and said my car was ready. And I can’t even tell it got bumped. Ken wouldn’t charge me for the quick-fix, so this is my way of saying thank you.
If you ever need auto body or paint work done, I would strongly recommend you consider using Downtown Paint and Body at 578 Miller Valley, 776-0006, behind Filibertos.
What’s Going On In Your Portfolio?
Flexible Income* continues to rack up slow-and-steady gains and as of this writing, on September 23rd, is on track to put in its best month in a year when September closes. If it ain’t broke I’m not going to fix it. So, there have been no changes in the portfolio.
Flexible Income* continues to hold a mix of municipal, floating rate, high yield and diversified bond funds.
The real estate and retail sectors which have been strong most of this year weakened last week, so I sold off some holdings in those categories, replacing them with a home builder’s stock and another biotech company, both of which have been strong lately.
Our Municipal bond* funds are up a tiny bit this month and continue as our best performing strategy for the year.
What We Said Back Then
Transports Point to Trouble
In the first quarter of this year I twice commented on weak shipping pointing to economic trouble. For the second time this year we have reached a low in shipping rates that equals the depths of the Great Recession in 2008.
Some think this is good. Low prices save money, right? But that is only part of the equation. Let’s take a look at what this effective indicator means.
Manufacturing goods requires the transportation of raw materials to factories and the shipping of finished products from factories to stores. By watching key indicators related to shipping, we can tell what is really going on in the economy, despite all the election rhetoric and flood of cheapened dollars that obscure the picture.
The Dow Jones Transportation Average (or “Transports”) is made up of the stocks of 20 companies representative of the US transportation industry – airlines, railroads, delivery service, trucking and such. If their prices are going up, the US shipping business is prospering and that usually means business, in general, is good, too. When the economy is in a long term downtrend, the Transports will become weak. Right now they are weak.
Instead of growing with successively higher prices, the Transports have been putting in a series of lower highs since February. They have been going down, a classic sign of weakness for US markets.
Lease rates for ocean-going ships have also dropped to the lows of 2008. This tells us that there is very little materials or goods being shipped between China, the US and Europe.
So despite what you hear in the news, much of it driven by politics right now, the worldwide economy is very weak. Any sudden shock could push us further into recession.
Q: There are 14 punctuation marks in English grammar.
Can you name at least half of them?
A: Fullstop, comma, colon, semicolon, dash, hyphen, apostrophe, question mark, exclamation point, quotation mark, brackets, parenthesis, braces, and ellipses.
Our Spotlight Strategy
With our Traditional / Municipal Income Strategy we strive to provide high total return consistent with capital preservation using bond market investments. Municipal income investments may be used upon client request.
This is a bond rotation strategy where holdings are monitored closely and if a downtrend occurs that fund is sold and the proceeds promptly moved into another type of bond fund that is going up in value. Analysis of holdings is done on a daily basis. Stocks are not used at all in this strategy: [Traditional / Municipal Income]
If you would like a current copy of our SEC Form ADV, Part 2, it is on our website at hepburncapital.com/form-adv.html
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
Shock Absorber Growth
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.