March 27, 2012

Tax the Rich?

The Investment View from Prescott, Arizona

The “haves vs. have-nots” politics of the country disturbs me.  These days it is incarnated in the 99% vs. the 1%, which as a sound bite, may be considered clever, but also acts like a cleaver dividing the country.

People who wish us ill have a strong interest in dividing this country to weaken us.  Whether the motivation is angst about the banking/Wall Street bail outs, religion or any of the many ways that jealousy or “rage against the man” manifests itself, none of this is good.  Tax the rich is just the latest way this issue appears.

This anecdote about taxation that has gone around the Internet for years comes to mind at the moment:
 

Every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that’s what they decided to do. The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. “Since you are all such good customers”, he said, “I’m going to reduce the cost of your daily beer by $20. Drinks for the ten now cost just $80”
The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. What happens to the other six men – the paying customers? How could they divide the $20 windfall so that everyone would get his ‘’fair share”? They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
And so:
The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33% savings).
The seventh now pay $5 instead of $7 (28% savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.
‘I only got a dollar out of the $20,’ declared the sixth man. He pointed to the tenth man, ‘But he got $10!’
‘Yeah, that’s right,’ exclaimed the fifth man. ‘I only saved a dollar, too. It’s unfair that he got ten times more than I!’
‘That’s true!!’ shouted the seventh man. ‘Why should he get $10 back when I got only two? The wealthy get all the breaks!’
‘Wait a minute,’ yelled the first four men in unison. ‘We didn’t get anything at all. The system exploits the poor!’
The nine men surrounded the tenth and beat him up.
The next night the tenth man didn’t show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important.
They didn’t have enough money between all of them for even half of the bill!

And that, my friends, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

A Slice of Life

I was in Phoenix last week visiting clients and actually started this newsletter in my motor home where I stayed while down there for a few days.  The snowstorm ten days ago caught us on the way back from son Matt’s graduation in California, and I couldn’t have driven the rig to my house if I tried. We’re at a 5,680ft elevation where we had 18” of snow.

So I made lemonade out of lemons and saved myself some hotel bills this last week and next by staying in the motorhome.

I also discovered a fun restaurant down here – sort of casual in a Scottsdale way – with absolutely the best pot roast I have ever had.  I actually wondered if they started with prime rib it was so good.  The place is called Wally’s at 7704 Doubletree Ranch Road in Scottsdale.  Cathy had “Vesuvius Chicken” (you’ll understand the name when you see it) which was also superb, and not too pricey, either.  Check it out when you are in the area.

Welcome Seleznov Capital Advisor Clients

Mark Seleznov, Phoenix radio personality, educator, mutual fund manager and long time trader passed away suddenly a few weeks ago, and Hepburn Capital was called to step in and manage your accounts in Mark’s absence.

HCM got the nod for several reasons, perhaps the biggest being that we are also active managers.  Will Hepburn is an educator of individual investors, teaching basic and advanced investment analysis at Yavapai College for 20 years, as well as training other investment managers around the country.  Will also managed two mutual funds at various times, and being in Prescott we are close enough to meet face to face with you at the SCA office.

Although none of us at HCM knew Mark personally, we understand his style and see that we use a lot of the same tools such as moving averages and mean reversion techniques, in addition to some unique indicators that we have developed in-house.  However, despite using some of the same tools, Hepburn Capital’s style has marked differences. 

Your accounts with us should experience much lower turnover (meaning much thinner 1099s) and our growth strategy, Shock Absorber Growth, is more conservative than Mark’s style with our multiple layers of risk reduction built into it.

This award winning newsletter is our primary way of keeping you posted with a special section covering what is happening in your accounts. It is published every two weeks and we hope you enjoy it.

We look forward to meeting and speaking with you over the next few weeks, and getting you settled in, if we haven’t done so already.

Will Hepburn is our lead portfolio manager. Bryan Jarman, CFA, is our primary client contact and assistant portfolio manager.  The administrative staff takes care of just about everything except actual investment management.

These staff members have each been with HCM from 7-10 years and are committed to making sure our clients “feel the love”.  Yvette Romero is our Operations Manager, assisted by Sheri Congdon who is also responsible for running our front office, publishing this newsletter and in general, keeping us organized.  Laurel Taylor Fitzhugh is our technology coordinator.

Welcome to the Hepburn family of clients.  Just let us know if you have any questions or concerns.

How’s the Market Doing?

The U.S. stock market has been cooling off for the past few weeks.  It is too early to tell if this is a topping process for the market or just a breather before the uptrend resumes.  As usual, there are arguments for both possibilities.

China has entered another clear downtrend after spending the past few months trying to break out of a year long slide.  Currently the downtrend is minor, about 8%, but the trend for the leading Chinese stock index is showing a clear pattern of lower highs and lower lows, the basic definition of a downtrend.

There is a saying that used to apply to the US markets that now goes:   If China sneezes will the world catch a cold?  With China’s economy being one of the most vibrant in the world we might find that out if their down trend continues.

World shipping rates are currently at the same level they bottomed at in the middle of the financial crisis in 2008.  This means that fewer goods are being shipped overseas, another sign of weakness in both China and the U.S.

Commodity prices continue to be weak, which signals weak demand from global industry; another dark cloud on the economic horizon.

Strong growth in China pulled the rest of the world along as it recovered from the 2008 bear market.  I’m not sure we can count on them during the next round.

High gasoline prices have triggered almost all recessions in recent history as they suck money out of the economy.  That money can’t be spent on goods from China, the US or anywhere else, the weak economic numbers that are appearing may be a reflection of $4 gasoline prices.

With China stumbling and the air being let out of our economic balloon by high gas prices, the likelihood of continued recession is high.

Mental Floss

Tip O’ the Day

Bread tags make the perfect cord labels.

What’s Going On In Your Portfolio?

We made a periodic adjustment in our Shock Absorber Growth* holdings – a change made not because one of our indicators said “take cover”, but to stay in sync with the market.   

All of our back-testing was done on a calendar quarter basis, but many mutual funds, pension funds and institutions partake in “window dressing” at end of quarters when a snapshot of holdings is taken for their reports. Window dressing infers that their portfolios often look different than what they report.  We want to identify longer term trends and don’t want our analysis based upon deceptive buying patterns by the institutions, so we moved the timing of this work up a few weeks from the end of the quarter.

Success is the sum of all the angles played, and all that.

As of March 26th we hold stock funds in long-time favorite retail, plus automotive, technology, value and Japanese stocks.  Our shock-absorber hedge is an inverse small company index fund.

Flexible Income* accounts saw their values flatten out and dip a fraction of a percent as interest rates spiked up two weeks ago.  Treasury bonds, which have been the darling of investors recently, got hit much harder.  We held no Treasuries and our focus on the high yield bond market really helped us weather that storm. 

Since my last writing we sold off our high quality corporate bond fund and added a small amount of an inverse Treasury bond fund as this portfolio’s shock absorber.  If treasuries continue to decline, this ought to stabilize the Flexible Income* portfolio.  That may not happen, but Treasuries are priced very high right now, so a fall from here could be a really big one – something we want to be protected from.

Due to the strength of the market over the past few months, our Adaptive Balance* Indicator has us maxing out on growth for both Adaptive Balance* and Adaptive Growth* , 50% and 80% Shock Absorber Growth*, respectively, with the balance allocated to Flexible Income*.

*    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 Equity

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.