Summer 2013 – Newsletter

It’s no exaggeration to say that the undecideds could go one way or another.

George H W Bush, 41st President of the United States

The Washington Post recently ran an article describing the residual pain suffered by retired football players in the wake of their violent NFL careers. One player after another recounted tales of collisions, paychecks and pain killers, quite the lethal combination . Getting hit by a defensive tackle produces 1,700 pounds of force, the equivalent of nearly a ton of bricks falling on top of you – the lasting affects should have been obvious.

As of this writing the S&P 500 has outperformed every other index that typically makes up a diversified portfolio by wide margins, even beating hedge funds by 10 percent . Very much like NFL athletes who regularly play with broken ankles and dislocated shoulders, recent performance may come at a price to be paid later. After all, loose monetary policy is simply a painkiller by a different name.

My 15 year old MP3 downloading son wouldn’t know the significance of calling something a broken record, and maybe that’s the problem. Like many investors, he’s used to immediate results, a world without busy signals on telephone lines, one that demands no trip to the library. Things that got broke used to take time to get fixed and that seemed to prevent bad things from getting much worse.

The Federal Reserve has created $3 trillion of fake money in the last five years that it used to buy bonds from the balance sheets of the banks who in turn purchased stocks in the open market (lending money to the American public is far too risky). This is not news, and thus the broken record of fixing the 2008 crisis is heard once again. What is important is that our central bank took those measures to “jumpstart the economy”, the American public having decided that the word “sacrifice” be permanently banned from the English language, a practice embraced by public companies.

Throughout this downturn, major corporations reduced the size of its workforce, maximized technology and partook in the global economy, leading to record corporate profits and high unemployment. Lest we forget, the sole purpose of any business is to create wealth for its investors, and these record profits had to go somewhere. With no viable destination due to exceedingly low interest rates, public companies have progressively bought back their own stock which has had the effect of reducing the number of outstanding shares and increasing the price at an ever faster rate.

Stock repurchases are on pace to increase by 88 percent from last year , which would total an additional $268 billion of demand chasing fewer shares. Even when companies don’t reduce the number of outstanding shares, the intent is to bolster record executive compensation plans in lieu of reinvesting in the future, using shares purchased in the open market to replace stock grants so they don’t dilute the earnings.

What’s the big deal? Exxon had a $5 billion repurchase program that helped increase earnings per share by six percent over last year . Moreover, eight of the top ten components of the S&P 500, representing 14.87 percent of the index that investors use to benchmark returns, have announced or implemented a buyback program of their own in the last 12 months.

Financial engineering notwithstanding, transformative innovations might finally be coming to fruition. China passed the United States to become the world’s leading importer of oil and a number of experts believe the U.S. could become energy independent by the end of the decade . In fact, the U.S. is projected to be the biggest gas manufacturer in the world by 2015 and prices are so low relative to what’s available in Asia and Europe that foreign companies are relocating factories here, lured by attractive price advantages that are only expected to get better.

Gains in technology have also made it possible for market participants and skilled workers to compete for business globally at lower costs. Barriers to entry, such as brick and mortar, have since been replaced by twitter handles, Klout Scores and video conferencing. These are significant advancements that should not be understated. Government cannot solve economic problems; it can only nudge private enterprises in the right direction with R&D and subsidies, hopeful that more revenue comes into the bucket and fewer expenses escape from the bottom.

The U.S. economy has undoubtedly recovered, with housing prices rebounding, consumer confidence at a six year high and a shrinking deficit, but not all demographics are thriving. The unemployment rate for workers with a college degree is 3.9 percent, while 14.1 percent of high school educated adults are without a full time job . Those who cannot find employment have been on the outside looking in, as 37 percent of the unemployed have been without a job for 27 weeks or longer , in constant search of jobs that haven’t been created yet.

I suppose they should consider themselves lucky, as the unemployment rate is 27.1 percent in Spain, 10.1 percent in France and 27.2 percent in Greece . Europe (as always) had a plan: cut government spending, raise taxes, and as they say in Paris, voila, the recession will be gone. Instead, the euro zone economy has contracted for the sixth consecutive quarter .

This presents an issue: if a government cannot cut spending without harming the economic recovery manufactured by a central bank that has created $3 trillion out of thin air, and at the same time the public is unwilling to accept tax increases, what is a government for the people and by the people who could care less about the people to do? Well, apparently they have been increasing taxes, and not just on the top ten percent, who already pay 70 percent of all personal income taxes .

The nagging debate over tax cuts and their impact on economic growth has plagued the national discourse for well over three decades. Nobody would argue with the idea that more money left in the hands of consumers should increase GDP, but if the source of that extra money is the Federal Reserve (or reckless deficit spending), and not the lowered tax rates, it would be the classic bait and switch.

To add some perspective, in 1980 the top tax rate was 70 percent , the national debt was $900 billion and the Federal Reserve held $150 billion of assets on its balance sheet. It was then argued that a burdensome tax code prevented consumers from maximizing economic activity, and as a consequence, voters demanded lower federal rates, even as they remained content to accumulate costly government benefits.

Congress, intent on fabricating prosperity, couldn’t resist selling something that doesn’t really exist. While capital gains, dividend, estate and federal income tax rates have declined, many working class families could take home as little as 50 cents on the dollar if they considered all of the regressive taxes and fees that they pay. Middle class tax cuts, like many feel-good stories, are not altogether accurate.

Let’s consider the FICA tax, which has actually increased over the years to 15.3 percent from 8.1 percent in 1980 and is unavoidable for those with earned income (401k contributions won’t reduce your exposure). Many workers believe FICA taxes are 7.65 percent, but that’s because their employer is paying the other half. Heavens forbid you’re a job creator, because the self-employed must contribute the entire 15.3 percent to the social security trust fund that (according to the government) will run dry by 2038 . Thanks for playing.

Sales and local taxes are another expense that we seldom consider, even though it averages 9.6 percent across the nation . Every gallon of gas is taxed at an average rate of 49.5 cents and there’s also the additional cost for hotel rooms, rental cars, toll roads, photo enforcement tickets, dog licenses, vehicle registrations and various telephone surcharges. These and other fees add up to three percent of government revenue , increasing the tax rate for all Americans.

The Federal Reserve, however, may be responsible for the most egregious of all hidden taxes, artificially reducing interest rates to spur growth at the expense of those who diligently saved their money, increasing its balance sheet to $3 trillion in just a few short years . Furthermore, loose monetary policy has reduced the value of the dollar and stunted purchasing power, playing a role in the rising energy and food prices that disproportionately affect the rank and file.

A case can be made that there has been no tax cut for average wage earners, only a shifting and undetected burden. As a percent of their income, lower federal taxes (that mean little to the upper middle class households subject to the Alternative Minimum Tax) have been unequal compensation for inflationary policies, rising FICA obligations and covert assessments at the local level.

The $16 trillion national debt only adds insult to injury, not to mention the long line of people anticipating government benefits that they paid for. The boon from cutting federal taxes and running up the debt offered advantages to a select few, even if we will all be present for the benediction. It is the swindle of the century, to be told that tax cuts will increase your wealth by both political parties (who have similar voting records on important pieces of legislation), when for a great many of households the exact opposite is true.

So here we are, paying high overall taxes in an economically divided country deep in debt with a stock market rising on the magic carpet of the Federal Reserve, stock buybacks and game changing innovations. It sure would save us all a lot of trouble if Pfizer just made a pill to make these problems go away.

Earnings are represented by “earnings per share”, calculated by dividing the net income by the number of outstanding shares (the fewer the shares the greater the quotient). In the latest earnings season, 72 percent of companies beat analysts’ earnings expectations, although 52 percent didn’t beat sales expectations . Companies aren’t selling more stuff; they just have lower labor costs, more efficient business models and fewer shares of stock, trends unlikely to continue at the same rate.

The current risk in the market is not a function of the economy or fundamental analysis; it is an event that would somehow stop the latest pinwheel from spinning. You can’t predict what a central bank will do. Nobody knows if companies can increase profits with inanimate sales, whether tighter margins will cause buybacks to moderate or if (and by what means and at what velocity) interest rates will rise – this is indeed a time to tread carefully. The glass is still half-full and there are positive developments all around us, but we’re a long way away from “red light green light 1-2-3”.


Securities offered through LPL Financial, Member FINRA/SIPC (http://brokercheck.finra.org/). Investment advice offered through Delancey Wealth Management, LLC, A registered investment advisor and separate entity from LPL Financial.


1. Do no harm: Retired NFL players endure a lifetime of hurt, Washington Post, 5/16/13
2. Are NFL Football Hits Getting Harder And More Dangerous?, NPR, 2/1/13
3. Hedge Funds Trail S&P 500 by 10 Percentage Points, Goldman Says; Bloomberg, 5/22/13
4. Big reason for stock boom? Companies buying back stocks, NBC News, 5/19/13
5. ExxonMobil and Its Shareholders Are Learning a Tough Lesson, The Motley Fool, 5/5/13
6. How the US oil, gas boom could shake up global order, NBC News, 4/1/13
7. European industry flocks to U.S. to take advantage of cheaper gas, Washington Post, 4/1/13
8. College Graduates Fare Well in Jobs Market, Even Through Recession, New York Times, 5/3/13
9. Long-Term Unemployment Is Turning Jobless Into Pariahs, Bloomberg, 5/3/13
10. Unemployment misery deepens in Spain and Greece, CNN Money, 4/25/13
11. Europe’s endless recession, in one chart, Washington Post, 5/15/13
12. The rich pay majority of U.S. income taxes, CNN Money, 3/12/13
13. National Taxpayers Union
14. TreasuryDirect.gov
15. Social Security Fund to Run Out in 2035, Trustees Say, Bloomberg, 4/24/13
16. Average U.S. Sales Tax Rate Drops–A Little, Forbes, 2/2/13
17. Heritage Foundation
18. Fed Balance Sheet Hits Record $3 Trillion, CNBC, 1/24/13
19. U.S. Stocks Climb After Dow Tops 15,000 Amid Earnings, Bloomberg, 5/8/13