Is the Latest Tax Proposal What We Need?

The chatter for tax reform is increasing.  There is more talk of restructuring the tax code to provide a more permanent solution.  There is a bipartisan proposal worth noting…S.3018, by Senators Wyden (D_OR) and Gregg (R-NH). 

The proposal would limit the tax brackets to three.  Couples would pay 15% on the first $75,000 of income, then 25% on the next $65,000 and 35% over $140,000.  Note the 35% bracket starts much lower then the current $373,650 for that bracket.  This proposal would cut the income levels in half for single tax-filers.  They would also like to limit itemized deductions so the standard deductions would increase sizably, up to $30,000 for couples and half that for singles.

This would eliminate the alternative minimum tax and deduction phase outs for those with higher incomes. There is a 35% exclusion on dividends and long term capital gains, which affectively makes the top rate on those items 22.75%.  The proposal would also eliminate deductions on items such as moving expenses and deferred interest on newly issued savings bonds.  Employer provided meals and lodging would be taxed as income to the employee.

It is estimated that the net of all this would be a $200 billion tax hike on individuals over ten years.

However, the proposal would also lower the corporate tax to a flat 24%. That is much lower than the current 35% bracket.  This effectively lowers the corporate tax bill over ten years by $200 billion.  

Wow, that is a revenue neutral move for the government and a tough sell for law makers.  It would allow corporations to spend and invest more, which would allow them to hire more workers, so it could have a simulative effect on the economy.  However, this bill may not come to pass.  It could be turned upside down so that an individual’s taxes could decrease and corporation’s taxes could increase.  We will have to wait and see.  

Gregory D. James, CFP®

Partner

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Weekly Market Update

as of September 3, 2010        
  Total Return
Index 12 months YTD QTD MTD
Stocks        
Russell 3000 13.25% 0.99% 7.49% 5.48%
S&P 500 12.32% 0.41% 7.57% 5.28%
DJ Industrial Average 14.85% 2.12% 7.49% 4.33%
Nasdaq Composite 13.71% -0.93% 6.09% 5.67%
Russell 2000 15.87% 3.71% 5.76% 6.87%
EAFE Index* 1.61% -6.06% 10.15% 4.16%
*EAFE index does not include dividends.        
         
Bond market data not available due to holiday.      
         
    Current   Prior
Commodity/Currency   Level   Level
         
Crude Oil    $  73.20    $  74.67
Natural Gas    $  3.84    $  3.72
Gold    $  1,247.60    $ 1,237.50
Euro    $  1.2749    $  1.2705
         
         
RECOVERY!        
  Since 3/09/09      
Index  annualized      
Stocks        
Russell 3000 44.10%      
S&P 500 42.01%      
DJ Industrial Average 40.93%      
Nasdaq Composite 47.66%      
Russell 2000 54.67%      
EAFE Index* 38.84%      
*EAFE index does not include dividends.        

Mark A. Lewis

Research & Trading Associate

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Weekly Market Update:

as of August 27, 2010  
Total Return
Index 12 months YTD QTD MTD
Stocks
Russell 3000 6.09% -2.80% 3.45% -3.26%
S&P 500 5.36% -3.26% 3.64% -3.15%
DJ Industrial Average 8.87% -0.85% 4.37% -2.67%
Nasdaq Composite 7.22% -4.50% 2.27% -4.37%
Russell 2000 7.02% -0.61% 1.36% -5.16%
EAFE Index* -3.74% -9.68% 5.91% -3.20%
*EAFE index does not include dividends.        
         
Bonds
Barclays US Aggregate 8.96% 7.21% NA 0.71%
Barclays Intermediate US Gov/Credit 8.04% 6.39% NA 0.66%
Barclays Municipal  9.98% 6.88% NA 2.18%
         
         
    Current Prior
Commodity/Currency Level Level
Crude Oil    $   74.67    $   74.12
Natural Gas    $   3.72    $   4.08
Gold    $   1,237.50    $   1,225.50
Euro    $   1.2705    $   1.2697
         
         
RECOVERY!
Since 3/09/09
Index  annualized
Stocks
Russell 3000 41.07%      
S&P 500 39.09%      
DJ Industrial Average 38.75%      
Nasdaq Composite 44.76%      
Russell 2000 51.11%      
EAFE Index* 35.75%      
*EAFE index does not include dividends.        

Mark A. Lewis

Research & Trading Associate

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SDG Market Indicator: Future Nobel Prize Winner?

Every day, it seems someone has a new model that claims to predict the next stock market meltdown or boom.  Two of my colleagues, Mark Lewis and Sarah DerGarabedian, and I had a stock market theory we tested a couple of years ago.  We called it the “SDG Market Indicator.”  

At the time, Sarah’s almost one-year-old son was having some difficulties sleeping through the night.  Whenever she did not get a good night’s sleep, we noticed on most of those days the stock market dropped.  Over a 48-day period, we compared her sleep cycle against the market’s performance.  If she slept well the night before, the market increased 42 percent of the time.  The market was either flat or declined 58 percent of the time when she had an average to bad night’s rest.  

You are probably saying to yourself, “This is the stupidest thing I have ever heard.”  You are right.  Some people accept far-fetched theories like the SDG Market Indicator as sound market guidance, though.  As they chase the next theory’s prediction, they risk losing more than they could potentially gain.  

Market timing statistically does not work.  A study by Morningstar highlights the dangers of market timing.  This study shows that, during the period 1926 – 2009, an investor who invested $1 in stocks would now have $2,592.  The study also shows that if that investor missed the 37 best months during this time frame, but was otherwise invested in stocks, the investment would only be worth $19.66 at the end of 2009. 

At Parsec, we prefer to take the long-term view when evaluating the market.  It is impossible to predict on a day-to-day basis what the market will do.  However, as studies have shown, the market will eventually recover from declines.  It is all part of the cyclical nature of financial markets.  

The next time you see a hot new theory, just think of the SDG Market Indicator.  Now, I am off to force feed Sarah a turkey sandwich and slip an Ambien in her tea.  It is time for a few positive days in the market.

Cristy Freeman, AAMS
Senior Operations Associate

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Market update through 8/20/10

as of August 20, 2010        
  Total Return
Index 12 months YTD QTD MTD
Stocks        
Russell 3000 9.11% -2.34% 3.95% -2.80%
S&P 500 8.55% -2.66% 4.28% -2.55%
DJ Industrial Average 12.25% -0.27% 4.98% -2.10%
Nasdaq Composite 10.61% -3.36% 3.49% -3.22%
Russell 2000 8.80% -1.59% 0.36% -6.09%
EAFE Index* -1.57% -9.48% 6.14% -2.99%
*EAFE index does not include dividends.        
         
Bonds        
Barclays US Aggregate 9.20% 7.33% NA 0.82%
Barclays Intermediate US Gov/Credit 8.31% 6.57% NA 0.82%
Barclays Municipal  9.88% 6.33% NA 1.65%
         
         
    Current   Prior
Commodity/Currency   Level   Level
         
Crude Oil    $        74.12    $      81.19
Natural Gas    $          4.08    $        4.76
Gold    $  1,225.50    $ 1,184.50
Euro    $     1.2697    $    1.3188
         
         
RECOVERY!        
  Since 3/09/09      
Index  annualized      
Stocks        
Russell 3000 42.18%      
S&P 500 40.29%      
DJ Industrial Average 39.91%      
Nasdaq Composite 46.66%      
Russell 2000 50.90%      
EAFE Index* 36.51%      
*EAFE index does not include dividends.        

Mark A. Lewis

Research & Trading Associate

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How to Make a Little More Money on Your Excess Cash (with a Bit of Work on Your Part):

With short-term interest rates at very low levels, many are wondering if there is any way to earn a higher return on their cash balances. We generally recommend that clients maintain an emergency reserve of 3-12 months worth of after-tax living expenses. The specific amount varies by client and depends on a number of factors such as the level and predictability of your income as well as your personal preference. Many clients choose to meet their liquidity needs by keeping a home equity line of credit available, and keeping their cash invested with a long-term focus at their desired asset allocation.

This column will focus on how to get a little more yield on an existing cash balance. Currently, money market rates at Fidelity and Schwab are almost zero. As of last week, the national average for a 1-year certificate of deposit was 0.72%. One thing to consider for small cash balances is Series I Savings Bonds issued by the U.S. Government, which are currently earning an annual rate of 3.36% for the next 6 months.

The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate (think “I” as in “inflation”). The 3.36% earnings rate for I Bonds purchased through April 30, 2010 will apply for their first six months after issue. The earnings rate combines a 0.30% fixed rate of return with the 3.06% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). The inflation rate changes every 6 months, so your earnings rate will increase with increases in inflation. The fixed rate applies for the 30-year life of I bonds purchased during each six-month period. The bonds cannot be redeemed for 12 months after issuance, and there is a penalty of 3 months’ interest if they are redeemed before 5 years. Purchases are limited to $5,000 per Social Security Number in electronic bonds and $5,000 in paper bonds, so a couple could purchase up to $20,000 annually.

So why would you want to invest a portion of your liquid cash in something that carries a penalty for 5 years? Because if you act by April 30, you are in effect creating a 1 year CD with a yield of about 2.45%.

Here’s how it works:

You go to your bank and buy a series of $1,000 I Bonds. For the next six months, these bonds will earn interest at an annual rate of 3.36%. The rate will then reset, but we already know what the inflation component will be since CPI-U has already been published. We just don’t know the fixed rate, which is set every six months by the Treasury. If the fixed rate stays the same at 0.30%, the earnings rate for the next 6 months will be an annual rate of 1.84%. So you could reasonably expect a return of at least 2.45% over the next year versus 0.72% in a bank CD.

What if there is an emergency and you need the money? You cannot redeem the bonds for 12 months, so you need to leave some liquid cash on hand. After 12 months, just pay the penalty and you are still ahead of where you would have been (say 1.77% yield if you cashed the bond in after 12 months and one day, versus 0.72% in a bank CD).

You can then repeat this process to create a ladder of bonds maturing at different points, say every 3-6 months. You can set up an electronic account at www.treasurydirect.gov and manage this process from the comfort of your couch. You can just deposit any paper bonds that you buy into your account and convert them to electronic form.

All I Bonds that are outstanding have the same inflation component, currently 3.06% annualized. The only difference is in the fixed rate that each bond offers. If the fixed rate increases significantly, just redeem some bonds and pay the penalty. Then buy some new bonds with the higher fixed rate (but remember the $10,000 annual limit on purchases for each Social Security Number).

Some other benefits of I Bonds include:

–Interest is exempt from state income tax;
–If you buy the bonds on the last day of the month, you still get interest for the full month;
–You don’t have to worry about FDIC insurance or shopping around to different banks for the best rate. I Bonds are direct obligations of the government, whereas FDIC insurance is a fund consisting of a small percentage of deposits that are covered.

Bill Hansen, CFA
April 23, 2010

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All Things Green

Remember those “green shoots” we kept hearing about in the economy? It appears that the buds are finally breaking and spring has come. Over the past year we’ve heard that term quite a bit from economists and commentators referring to small hopeful signs of recovery from the Great Recession. Since then the news has gotten even better. No one talks of green shoots anymore, but rather full-on recovery.

In other news of things “green,” Parsec awarded the first quarter Parsec Prize to Carolina Mountain Land Conservancy and Southern Appalachian Highland Conservancy. The prize ($9,000 to each), was given to these organizations because we wanted our first quarter Parsec Prize to go toward supporting land conservancy and stewardship in North Carolina. Both CMLC and SAHC are such great organizations that we couldn’t choose between the two. Thanks in part to the work of these groups North Carolina is a beautiful place to live.

Lastly, today is April 1, and it appears we may have survived this gray and icy winter. The weather here in Asheville is warm and sunny and the flowers are blooming on the trees. Happy Easter, Happy Spring, and have a great weekend!

Harli L. Palme, CFP®
Financial Advisor

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Asset Allocation

As our life expectancies have increased, our years in retirement have also increased. If your plan is to retire at age 62, for instance, you need to be prepared to have a portfolio that will last for your lifespan, possibly age 100. Unless you are retired from the government, pension plans are becoming a thing of the past. You will need to supplement Social Security with your own savings and retirement plans.

There is much written about asset allocation, or the mix of stocks and bonds in your portfolio. You may have read articles urging “aged based” asset allocation, or increasing your allocation to bonds as you get older. The historical ten-year equity return through 12/31/2009 is 10.3% and the bond return is 5.18%. Equities, of course, have more volatility than bonds and the last 18 months has been an equity roller coaster ride. Many investors now view the equity market with apprehension and caution, wanting an increased bond allocation. Unless you have extreme wealth, a large fixed income allocation may not be a smart strategy. A 30 year time horizon, with 30 years of inflation, means you will need enough growth to meet those challenges. Everyone has a different situation that must be evaluated before an allocation is chosen. Some investors have money they will never need, so essentially the investment is for their children or grandchildren, warranting perhaps a 100% equity allocation. If you are concerned about your allocation or would like to discuss this further, please contact your advisor.

Barbara Gray, CFP®
Partner

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Bond Market Highlights

Bond Market Highlights

Municipal Bonds

  • According to Moody’s, investment grade municipal debt had an average default rate of 0.03% from 1970 through 2009.
  • Current muni market is shaped by historically steep yield curves and historically wide quality spreads.
  • Anticipation of higher tax rates at both federal and state levels still exists.

 

 Corporate Bonds

  • According to Moody’s, investment grade corporate debt had an average default rate of 0.97% from 1970 through 2009.
  • Corporate spreads have narrowed considerably from a 25 year peak of 268bp to 153bp currently (AAA yields minus 1-yr Treasury yields).
  • Current corporate market is shaped by a steep yield curve and still wide quality spreads.

 High-Yield Bonds

  • In early 2009, the spread between 10-yr B-rated corporate vs. treasuries peaked at over 1,200bp.
  • At year end, spreads were around 425bp which compares favorably with the long-term average spread of approximately 250bp.
  • The amount of “distressed bonds” fell to $117 billion from $250 billion six months ago.  Distressed bonds yield at least 10 percentage points above benchmark rates.
  • Current default rate near 13% as of 3Q ’09.  Historical average is around 5%.

 International Bonds – OIBYX (4th Quarter commentary)

  • The Eurozone, particularly the export-driven economies of France and Germany, responded well to the turnaround in global manufacturing but strains within the euro family grew more prominent given the ongoing credit issues in Greece, Spain, and countries in Eastern Europe.
  • In the wake of possible higher global interest rates, the team is continuing to under-weight developed market debt and over-weight emerging market country debt.
  • Within the Developed Markets sleeve, the fund was largely able to side-step the issues surrounding Greece.  The fund’s Greek bond exposure was drawn down to zero by late November.

 US Treasuries

  • The break-even rate between yields on 10-yr Treasuries and TIPS, a measure of the outlook for consumer prices, has widened from 0.12% to 2.15% at the end of February.
  • A newer gauge of investor expectations for inflation rose to 3.27% in early January, approaching the high of 3.36% reached in May ’04.  This gauge, called the five year/five year forward break-even rate, was created by a Federal Reserve Bank insider.
  • A survey of 80 financial services firms forecast CPI of 2.15% in 2010, 2.00% in 2011, and 2.30% in 2012.

 Mark Lewis

Research & Trading Associate

March 2, 2010

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The Importance of Dividends–Part 2

In an earlier column, I discussed some of our philosophy regarding dividends.  This week, I would like to expand on that somewhat as well as give a quick update regarding taxation of dividends in the President’s budget proposal.

Modern financial theory holds that the value of any investment is the sum of the present value of its future cash flows.  This logic applies whether the investment is a publicly traded stock, a piece of commercial real estate or a hot dog stand.  With a dividend-paying stock, you are getting a return on your initial investment each quarter rather than relying purely on future earnings growth to make a profit. While short-term volatility can be considerable, over longer time periods stock prices follow rising earnings and dividends.

As part of our investment process, we compare the current market price of a stock to its theoretical value using a dividend discount model.  The output indicates whether the company is overvalued (expensive) or undervalued (on sale) based on certain assumptions. All else equal, a company that does not pay a dividend must have a higher expected growth rate than a dividend-paying stock to command the same valuation.  Part of our job is to analyze whether the model’s assumptions regarding dividend growth, the sensitivity of a stock to movements in the overall market, and other factors are reasonable. 

The dividend payout ratio is the proportion of a company’s earnings that are paid out as dividends to shareholders. If a company earned $1.00 per share for a year and paid a $0.40 dividend during that time, the dividend payout ratio would be 40%.  The traditional theory taught in universities and graduate schools all over the world used to be that the lower the dividend payout ratio, the higher the earnings growth rate in subsequent periods.  Recent studies have demonstrated exactly the opposite, that is, that higher dividend payouts actually resulted in higher future earnings growth.  This relationship was shown to hold true across a number of different countries and time periods.  If this theory continues to hold true, it would be a double win for investors, since they would capture both a higher current dividend as well as higher future earnings growth by investing in dividend-paying stocks.  (If you are asking yourself why we don’t invest exclusively in dividend-paying stocks, please see my November 25, 2009 Blog entry). 

Currently, qualified dividends are taxed at the same rate as long-term capital gains, at a maximum rate of 15%.  If the Bush tax cuts currently expire at the end of 2010 as scheduled, dividends would be taxed at higher ordinary income rates for 2011 and beyond. Tax brackets are scheduled to increase, with the top bracket rising back to 39.6% from the current 35% level.  However, President Obama’s budget proposal that was recently submitted to Congress has a maximum 20% tax rate on qualified dividends for single taxpayers earning over $200,000 and couples earning over $250,000.  For those earning less, the qualified dividend tax rate would remain at 15%.  While an increase in taxes on qualified dividends from 15% to 20% is not anyone’s first choice, it is a lot better than going from 15% to 28% or 39.6% as many feared.  It is too early to say whether this portion of the budget proposal will pass, but I believe that the result is unlikely to be significantly worse.

Bill Hansen, CFA

February 26, 2010

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