November 6, 2012
President Obama or President Romney?
What does the election mean?
The Investment View from Prescott, Arizona
Probably the most often asked question I have heard over the past couple of months has involved what to expect from today’s election.
Both candidates’ agendas have to be assessed within the context of the government’s financial situation. With the national debt now topping $16 trillion and rising more than $1 trillion this year alone, both candidates agree that the government must get its fiscal house in order.
Whether the winning candidate follows through on his agenda is another matter — one that depends to a large degree on the outcome of congressional elections. Mr. Obama’s budgets could continue to be rejected by the House of Representatives, which is expected to remain in Republican control. Mr. Romney’s plans for tax and entitlement reform could be stymied by the Senate, which many expect to remain in Democratic control. A divided Congress likely would force either candidate to compromise on his positions, something Romney experienced governing in Massachusetts, Obama not so much.
As the election approaches, here is where the presidential candidates stand on three major financial issues.
TAXES:
Mr. Obama’s position on taxes is clear: Wealthy Americans should pay more. He wants to undo the Bush-era tax cuts for “high-income” 
individuals — those making more than $200,000 annually (and married couples making more than $250,000). Tax hikes scheduled for next year, also change the lowest tax bracket from 10% to 15%, so lower-income taxpayers can expect hikes, too.
Mr. Romney wants to make the Bush tax cuts permanent and reduce them another 20%. He has said his plan would be revenue-neutral, meaning it wouldn’t cut revenue to the government or reduce the share of federal taxes paid by wealthy people. He would offset the lower rates by capping or eliminating tax deductions and credits but hasn’t specified which ones are on the table.
HEALTH CARE:
Mr. Romney has said he will repeal the Patient Protection and Affordable Care Act, better known as Obamacare. That’s not without irony, given that the health care reform Mr. Romney implemented as governor of Massachusetts paved the way for the president’s very similar health care bill.
Mr. Romney has said the Massachusetts plan was appropriate for that state but that he believes states should be allowed to craft their own health care solutions, including increased competition among insurers.
SOCIAL SECURITY:
The Social Security Administration projects that the program’s trust funds will be depleted by 2033. Without changes to the system, retirees will receive only 75% of promised benefits beyond that year. The trust funds can be shored up by changing eligibility rules, reducing benefits or increasing revenue to the funds.
Mr. Obama has not laid out specific actions to bolster the Social Security trust fund but says he is willing to discuss ideas to stabilize the program. He has said he would not reduce benefits for future retirees and does not favor any privatization of Social Security accounts.
Mr. Romney would not change benefits and eligibility rules for current seniors and those over 55 and would slowly increase the retirement age for people who are under 55.
Disaster Plans
This past week saw the stock exchanges closed for two days due to the effects of Hurricane Sandy. I’m guessing that you were not inconvenienced in any way since the business continuity plans of both Ceros, our back-office services provider and our main account custodian, National Financial Services were executed flawlessly.
Both of these companies were able to carry on operations from remote locations without any interruption of services.
The best example of how effective business continuation plans occurred on September 11, 2001 when National Financial’s headquarters was destroyed in the attacks on the World Trade Center. As the disaster unfolded, business was quickly transferred to NFS operations centers in Cincinnati and Oklahoma City. Here in Prescott we were unaware that the headquarters was gone. Business went on as usual. That is pretty awesome if you think about it.
Hepburn Capital also has a business continuation plan, although ours is much simpler than National Financial’s. It is designed to allow us to continue to serve you even if our main office becomes unavailable or critical services, such as power or Internet are no longer available in Prescott.
As unnerving as the stock market closures were, it was comforting to see all services, except trading, happening as smoothly as possible.
Mental Floss
“You never really learn to swear until you learn to drive.”
“What hair color do they put on the driver’s licenses of bald men?”
“If Fed Ex and UPS were to merge, would they call it Fed UP?”
Quotes by George Carlin
How’s The Market Doing
The stock markets have continued to lurch lower over the past 7 weeks through November 2nd. This lurching feeling is called volatility; sharp drops followed by sharp run-ups followed by more sharp drops. The overall effect for those watching is a feeling of despair one day followed by relief the next.
I have found that volatility marks changing markets – where buyers who have already bought become potential sellers instead, and the market’s balance changes.
This dynamic rules the markets and is the main reason markets don’t go in straight lines. Each action by a seller or buyer changes the forces of supply and demand and the fact that the results are so counter-intuitive is what makes the markets so hard to figure out.
So, change is afoot as noted by increased volatility. Our Safety Net volatility indicator flashed a sell signal two weeks ago, meaning this is not a time to be buying stocks, but is a time to defend account values.
The bond market as indicated by Barclays U.S. Aggregate Bond Index also has been trending down for the past six weeks or so.
Also, gold has been going down for a month or so.
Do you see a pattern here? One thing about bad markets is that everything begins to go down at the same time. The few segments of the markets that are doing OK, attract the “hot money”, that which is coming out of declining sectors until the good performers become overheated and reality sets in bringing them down, often in violent corrections. At that point there seems to be no place to hide.
I still believe the tax issues scheduled to take effect on January 1st will bring forth a wave of selling that will pull the market down between now and then as investors with gains try to get them taxed at today’s better rates instead of next year’s higher rates.
Could an announcement of a tax change after the election cause the market to rally? Yes, but right now the market is going down and that is the environment that counts today. If the market begins to rally we can re-evaluate, but investing based upon what could possibly happen is speculation, and usually not a good idea.
Scottsdale Office Date
Please call the office for an appointment if you would like to meet with Will in the Scottsdale office.
(928) 778-4000
What’s Going On In Your Portfolio?
Our growth model began generating sell signals several weeks ago, and most individual stocks were sold off beginning in early October to preserve the gains we had made.
Increasing volatility has caused me to hedge the growth portfolio so that it will go up when the market goes down. This involves owning “inverse” investments, those that go up when the market goes down. Since the market is in a downtrend this move makes sense and so far, is working.
Our growth portfolio did poorly earlier in the year, but has outperformed the S&P 500 since we made strategy changes in mid-August. If the current decline picks up steam, it will do very well with the hedges in place.
Flexible Income model account balances remain steady despite the general decline in the bond market. And all of our Flexible Income model holdings generate a steady dividend stream, which helps accounts grow a bit even when the market stops going up.
We are currently holding 27% in cash in Flexible Income portfolios, after receiving a sell signal a couple of weeks back on one holding which has not yet been replaced.
Our Spotlight Strategy
Model Portfolios
When I use the term “model portfolio” or “strategy” it describes a hypothetical $100,000 account, our practical minimum account size. We often accept smaller accounts as an accommodation for existing clients, referrals and friends, but larger accounts are most efficient for us to manage.
Despite trading at the same time in investments with similar objectives, smaller accounts occasionally end up with different results than larger accounts.
The reason for this is that some trades involve fixed transaction charges, such as the $15.50 the custodian charges to execute a stock or ETF transaction. Large accounts have larger trade sizes and can absorb these fixed costs without greatly affecting performance. The profitability of a smaller trade can be more greatly impacted by transaction costs, so as a policy matter we try to have fewer of them in smaller accounts.
This may lead to different holdings in different sized accounts, and can create different performance results, too. There were six times in 2011 that we had different holdings in Flexible Income accounts of various sizes. Usually, the performance difference is minimal, but not always.
One exception occurred in February 2011 when we bought gold and silver in the Flexible Income model. To minimize transaction charges in smaller accounts we only bought gold in them while we bought both gold and silver in larger accounts, incurring two transactions charges.
As it turned out, Silver was one of our biggest trades for the year, adding almost 5% onto the return of larger accounts. Unfortunately, there was no way to know that ahead of time, so smaller accounts did not participate in this particular gain.
So when I mention model returns it is possible that your returns will be different, sometimes significantly. I’d be happy to sit down with you in person and show you how this works anytime you have questions.
IRA Fees Being Billed
Account Custodians under SEC regulation are required to bill the expenses of the extra tax accounting for IRAs to each IRA account at least annually. As a result, IRA fees are billed and will be deducted from your account in early December. There is nothing for you to do. The bill you may have received from National Financial was just a notice that this was happening.
If custodians were allowed to absorb these costs, non-IRA accounts would be indirectly subsidizing the IRA costs and someone in the regulatory structure thought this would be unfair to non-IRA accounts. There. Don’t you feel safer?
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.
Traditional Income
Flexible Income
Adaptive Balance
Adaptive Growth
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.
