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The Markets

Michael Schwartz | Thursday, February 11th, 2010

The Markets

Volatility in the financial markets has risen noticeably in the past few weeks as investors remain on edge about a multitude of issues.

A mixed employment report for January, continued budget deficit issues in Portugal, Italy, Ireland, Greece and Spain, monetary tightening in China, and a growing sense that the worldwide economy might be running on government stimulus fumes instead of stable gas all contributed to worldwide jitters, according to the Associated Press. In the U.S., the S&P 500 index dropped for the fourth week in a row and it is now down 7.3% from its January 15 recovery high, according to data from Yahoo! Finance. Foreign stocks, commodities, and gold are also down for the year as shown in the chart below.

The increase in investor anxiety helped send the value of the U.S. dollar up, up, and away. Last week, the dollar reached an eight-month high against the euro and a seven-month high against a trade-weighted basked of six major currencies, according to MarketWatch. The good news about a stronger dollar is that it suggests investors still have faith in the U.S. as a “safe haven” in times of uncertainty.

The global economy is still recovering from the Great Recession and the path to future prosperity will likely be bumpy. With proper seat belts, though, we will do our best to make the trip as smooth as possible.

Data as of 2/5/10 1-Week Y-T-D 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks) -0.7% -4.4% 22.8% -9.7% -2.4% -2.9%
DJ Global ex US (Foreign Stocks) -3.4 -7.6 40.0 -8.9 1.9 0.0
10-year Treasury Note (Yield Only) 3.6 N/A 2.9 4.8 4.1 6.6
Gold (per ounce) -1.9 -4.2 15.0 17.7 20.6 13.0
DJ-UBS Commodity Index -1.9 -9.1 13.3 -8.5 -2.3 2.6
DJ Equity All REIT TR Index -0.3 -5.5 51.4 -16.4 0.6 10.2

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s,, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable or not available.

CORPORATE AMERICA IS MAKING AN EARNINGS RECOVERY, but the revenue recovery is slow to develop. For 2009, The Wall Street Journal projects that the S&P 500 companies will show a sales drop of $1.1 trillion, or 13% from the prior year. In the fourth quarter of 2009, revenue is expected to total just over $2 trillion, which would be the same number as the first quarter of 2006. In other words, this Great Recession has set corporate America’s revenue back nearly four years.

Interestingly, while revenue is back down to levels from nearly four years ago, total U.S. employment in January 2010 was back down to where it was in April 2000 – that’s nearly a 10-year setback in employment – according to data from the Department of Labor. This indicates that on a comparative basis, corporations have cut employment more dramatically than the decline in revenue. With employment levels back to where they were in early 2000, you can see why corporations are showing solid earnings growth (up 47% so far in Q4 2009 from the year earlier quarter excluding financial companies, according to The Wall Street Journal) even though revenue growth is weak (projected to rise just 0.9% in Q4 2009 from the year earlier quarter, according to The Wall Street Journal). Corporate America is showing profit gains partly due to the leverage from keeping employment costs low.

The good news is that Corporate America cannot keep employee headcount low indefinitely if revenue starts to rise significantly. Eventually, companies have to hire to support revenue expansion. When this new revenue expansion/hiring cycle starts is anybody’s guess. But, when it does, that could be a positive sign for the financial markets.

Weekly Focus – Think About It

“Investors repeatedly jump ship on a good strategy just because it hasn’t worked so well lately, and, almost invariably, abandon it at precisely the wrong time.”

– David Dreman

Value vs. Growth Investing

Here are the numbers (2/5/10)

Name 1-Week YTD 4-Week 13-Week 1-Year 3-Year 5-Year
US Market -0.74 -4.26 -6.12 0.86 30.62 -7.20 0.35
Large Cap -0.74 -4.24 -6.04 0.11 26.82 -7.30 -0.12
Large Core -0.74 -3.60 -4.85 0.56 28.41 -5.08 1.12
Large Growth -0.05 -6.06 -7.68 0.25 32.66 -4.84 -0.19
Large Value -1.37 -3.15 -5.69 -0.50 19.28 -12.27 -1.81
Mid Cap -0.60 -4.26 -6.21 2.69 40.56 -7.29 1.57
Mid Core -0.30 -4.17 -6.03 2.74 39.70 -7.43 1.14
Mid Growth -0.81 -5.32 -7.33 1.49 34.65 -6.30 2.20
Mid Value -0.74 -3.35 -5.34 3.78 47.70 -8.56 1.04
Small Cap -1.10 -4.50 -6.74 3.31 43.13 -6.69 1.00
Small Core -0.70 -4.06 -6.47 2.75 45.11 -7.65 1.04
Small Growth -1.35 -6.00 -8.06 0.80 31.72 -6.82 -0.16
Small Value -1.29 -3.55 -5.78 6.30 53.35 -6.12 1.75
US Core -0.64 -3.76 -5.22 1.16 31.65 -5.57 1.21
US Growth -0.29 -5.91 -7.63 0.54 32.99 -5.25 0.38
US Value -1.24 -3.22 -5.63 0.86 26.84 -11.05 -0.93


©2004 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) is not warranted to be accurate, complete or timely. Morningstar is not responsible for any damages or losses arising from any use of this information and has not granted its consent to be considered or deemed an “expert” under the Securities Act of 1933. Past performance is no guarantee of future results.  Indices are unmanaged and while these indices can be invested in directly, this is neither a recommendation nor an offer to purchase.  This can only be done by prospectus and should be on the recommendation of a licensed professional.

Office Notes

Current State of Estate Planning

As you may have heard, the federal estate tax rules changed radically in 2010 and could change radically again in 2011 unless Congress passes new legislation. This letter is intended to advise you of what has happened and encourage you to reevaluate your estate plan as soon as possible.

2001 Tax Act. In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) which provided for significant phased-in increases in the federal estate, gift and generation skipping tax (GST) exemptions and lower tax rates.  EGTRRA provisions included:

  • In 2009, the estate and GST exemptions increased to $3.5 million per decedent, with a flat 45% estate and GST tax rate on any excess. The gift tax exemption was $1.0 million, with tax rates from 41% to 45%.
  • In 2010, the federal estate and GST taxes were repealed for one year. The gift tax $1.0 million exemption remained, with a lower flat tax rate of 35%. Thus, you had to die or pay gift tax to get the benefit of the change. The step up in basis rules (which gave a “fresh-start” fair market basis for most assets of a decedent) was replaced with an adjusted carry-over basis.  These new basis rules permit a step up in basis of up to $1.3 million, plus an additional $3.0 million for certain spousal transfers at death.
  • On January 1, 2011, EGTRRA was automatically repealed, resulting in an odd situation: A $3.5 million estate and GST exemption and flat 45% tax rate in 2009, no estate and GST tax in 2010, and a $1.0 million estate exemption and tax rate up to 60% in 2011.

What Happened in 2009? Estate planning practitioners universally expected Congress to carry the 2009 estate tax rules across 2010 (both Representative Rangel as Chair of the House Ways and Means and Senator Baucus as Chair of the Senate Finance Committee said it would happen earlier last fall). However, unexpectedly in December the House failed to act on a one year extension and instead sent the Senate a bill to make the 2009 rules permanent. Because the Senate was focused on health care and there was broad disagreement in the Senate on what to do with estate taxes, Congress enacted no changes to the EGTRRA’s 2010 rules. Thus, effective as of January 1, 2010, there is no federal estate or GST tax.

Planning in Chaos. Congress’s failure to adopt estate tax legislation in 2009 and the possibility that changes will not be adopted during 2010, radically change the estate planning considerations of many clients. For example, Congress has indicated that in 2010 about 6,000 decedents will benefit from the elimination of estate taxes, but over 70,000 heirs will pay higher income taxes because of the change in the income tax basis rules for assets received from decedents.

2010 Changes. The U.S. has an unpredictable planning environment in which any number of radically different changes may occur in 2010:

  • Congress may do nothing in 2010, in which case there is an adjusted carryover basis, and no federal estate or generation skipping tax for people who die in 2010. While you probably will not die in 2010, you still need to consider planning for that possibility, because not planning for these changes, if death occurs, can be disastrous. For example:

o       Formula clauses (e.g. terms that allocated your estate exemption to a “by-pass trust”) in your planning documents could inadvertently disinherit some heirs and/or your surviving spouse and/or create conflicts among family members on how your documents should be properly interpreted.

o       Conflicts could arise among your heirs and fiduciaries on asset basis issues.

o       Inadvertent generation skipping taxes could be incurred after 2010.

o       Passing assets directly to your surviving spouse may result in higher estate taxes after 2010.

o       Inadvertent state taxes could be incurred from out of date terms in your documents.

  • Congress may adopt legislation to carry the 2009 rules over 2010, retroactive to January 1, 2010. There is broad disagreement on whether a retroactive tax bill is constitutional. If a retroactive law it adopted, it will be challenged as unconstitutional and it could take years for the Supreme Court to rule on the issue. Until such a ruling, uncertainty will prevail. Those dying after the enactment should not have that uncertainty. In any event, your estate plan should contemplate dying both before or after a potential retroactive enactment, which may or may not be constitutional.
  • If Congress acts in 2010 to address the estate tax issues, it could:

o       Adopt permanent estate tax exemption, beginning in 2010 or 2011. If so, most commentators anticipate estate tax exemptions to fall between $2-5.0 million and tax rates 35% to 45%.

o       Adopt a temporary higher estate exemption.

o       Adopt rules to limit or eliminate valuation discounts.

2011 Changes. Unless Congress enacts new legislation in 2010, then on January 1, 2011, a number of automatic changes occur to the federal tax code, including:

  • The estate tax exemption drops to $1.0 million per decedent.
  • The estate tax rate increases (e.g., 55% above $3.0 million and 60% above $10 million).
  • States which remain “coupled” to the federal estate tax will have their state death taxes restored. Thus, if you own property in one of these coupled states, you could have new exposure to a state estate tax.
  • The fair market value step up in basis returns for assets passing from a decedent.
  • The top income tax rates go up by at least 4.6%, capital gain tax rates go up by up to 5% and dividend tax rates go up by up to 24.6%.

Higher Taxes. No matter what happens to the estate tax, substantial tax increases are looming. A $12 trillion deficit is projected for the next decade. The Congressional Budget Office indicates that the social security trust fund will pay out more then it receives starting in 2011 or 2012. Taxes will have to increase across a broad range of Americans. Both the Washington Post and the New York Times have stated that the President will have to abandon his pledge to only increase taxes on taxpayers earning over $250,000. Given slow economic recovery and the fact that we are in a mid-term election year, the federal government will probably not increase taxes until sometime in 2011. While substantial tax increases are likely, we just don’t know any details.

ROTH IRAs. In 2010, taxpayers can convert traditional IRAs to ROTH IRAs and can pay the income taxes due on such conversion in 2010 or equally in 2011 and 2012. There are significant benefits and traps for the unwary in making these decisions.

Effectively, unless Congress adopts new legislation, in 2010 the estate tax rules rotate 180 degrees from where they were in 2009, and then rotate 180 degrees again in 2011 – only the estate tax and income tax rules could be even worse than what we had in 2009. Uncertainty makes it difficult to plan, but waiting to see what happens next is not a good idea. The earlier you can implement flexible tax and estate planning to respond to these changes the better.

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