April 30, 2010
Dear Clients and Friends:
Health Care Legislation
According to an article in UPI.com, revenues in the health care industry in 2009 were nearly $2.5 trillion, or 17% of the U.S. economy, as measured by the Gross Domestic Product. The impact of recent health care legislation on this sector of our economy is uncertain. Whether the legislation results in better health care for more citizens and contributes to controlling health costs, is a matter of significant disagreement and speculation.
The financial impact of the legislation will be felt by patients, health care professionals, corporations, and investors. It will take years to implement and to gauge its effectiveness.
The unemployment rate is still close to 10%. However, the rate has stabilized and should improve. The worst of the massive job cuts seem to be over, and more jobs are slowly being generated. We should see a gradual decrease in the unemployment rate over the next year or so. As the job market improves, more individuals who had given up hope finding work, and therefore were not included in the actively unemployed, will re-enter the job market. Their participation in the job-seeking pool will soften improvements in the unemployment rate.
Middle class job growth is essential to the health of America. The engines for that growth remain uncertain. The two areas that have recently shown significant growth are the public sector (government) and health care. Growth in these areas will not help us address government deficits and health care costs. Job growth in private industry is urgently needed to reduce deficits and build financial security for the majority of Americans. The best way to foster private industry job growth is to create a regulatory and tax framework that incentivizes investment and innovation, not consumption. Politically, this is the more difficult thing to do because the benefits are not felt in the near term.
Much like jobs, the worst may be over, but the road to recovery seems long. We believe that the confidence to buy homes is tied to job creation and a stable labor market. If your financial security appears threatened, you delay plans for buying a new home.
Up to 70% of the U.S. economy is dependent on consumer spending. Unfortunately, far too much of economic growth prior to the recession was driven by the expansion of credit, and not from wage growth. The credit spigots have been turned down, if not turned off, for many. Adding job instability and a decrease in home equity to the credit contraction, creates a recipe for a mediocre contribution to economic growth from consumer spending.
Corporate bond yields have continued to compress towards that of U.S. Treasuries. Translation: investors earn less yield for taking more risk. Additionally, yields remain low despite the massive government spending that has transpired over the last couple of years. We will continue to neutralize some of the interest rate exposure by shorting Treasuries. This is not a prediction that rates will rise, but insurance against the consequences of such an event.
The stock market is forward-looking and appears to have predicted an economic recovery, despite the concerns about unemployment, and the impact of a debt-laden financial system. An interesting dichotomy exists. While the stock market shows signs of recovery, the bond market clearly does not display the same degree of confidence. Bond rates have stayed low, which indicates either deflationary concerns, or a general flight to quality.
Divergent views and statistics are commonplace with regards to the stock market. You can generally find a bull for every bear, and the number of opinions on how to invest in various environments is limited only by one’s imagination. Investing is not a science. To put it simply, prudent investing requires limiting exposure to assets that are overvalued, and overweighting assets that are discounted. However, determining a fair price for assets is easier said than done.
Market experts commonly disagree on asset values. One of the most common tools commentators use in valuing the relative attractiveness of the stock market is the ratio of price over earnings per share. This is known as the P/E ratio. However, there are different ways of calculating the P/E ratio. One method is to use trailing earnings, another uses forward, or projected, earnings, while a third method uses cyclically adjusted earnings. The cyclically adjusted price to earnings ratio, referred to as CAPE, attempts to smooth out earnings from boom and busts. Intuitively, this has the most appeal to us.
Using CAPE, the market P/E is currently around 22. For reference, the historical average dating back to 1881 is 16, with a low of 4.78 in 1920, and a high of 44.2 at the peak of the dotcom bubble at the end of 1999. CAPE had been above 20 from 1992 until September 2008, and moved to as low as 13.32 in March of 2009.
In summary, the only time equities looked undervalued since the early nineties was in late 2008 and early 2009. However, a lot of other asset classes looked undervalued as well, so there was no compelling reason to load up on stocks at the expense of bonds or other risk assets. Current valuation levels have caused us to limit exposure to U.S. equities, and to look for alternative investments to outpace inflation. This theme will continue to be expressed in our portfolio allocations.
To the surprise of virtually all estate planning commentators, the federal estate tax was allowed to expire as of December 31, 2009. If no action is taken, the individual exemption will revert back to $1 million in 2011, down from $3.5 million in 2009. In the long-term, we believe that the exemption will return to at least $3.5 million. In the short-term, estate plans should be in place that anticipates the return of a $1 million exemption next year. Please contact us if you would like to discuss the adequacy of your current estate plan, and whether a visit with an estate planning attorney should be scheduled.
Roth IRA Conversions
All taxpayers, regardless of income level, can convert some or all of their traditional IRAs into Roth IRAs in 2010. We will incorporate Roth conversion reviews for clients as part of 2010 fall income tax planning. Each client’s available funds, tax situation, and stage of life are unique and will require a separate analysis. By delaying the conversion reviews until later in the year, we should have a better understanding of your expected marginal tax bracket.
Vincent was interviewed for an article about Roth IRAs in USA Today, on March 26, 2010. Please see the reprint attached for your review.
2009 Tax Returns
Please provide us with a copy of your completed 2009 federal and state income tax returns, along with a copy of any planned 2010 estimated tax payments, if you or your tax
preparer has not already done so. We enter this information into our software, enabling us to more effectively perform tax planning.
SEC & Custody Issues
The SEC has been in the spotlight with regard to its responsibility for financial industry oversight. As you may know, there is considerable debate over which government office will be responsible for regulating the various areas of personal and business finance. As of the date of this writing, those roles are still undetermined.
The SEC was embarrassed by the Bernie Madoff scandal, as well as the other criminal acts in the financial industry that have emerged during the recent crisis. As a result, the SEC has been more aggressive across almost all fronts, including imposing new requirements for federally registered investment advisors, like Schiavi + Dattani.
The impact of any new regulations on our operations, and how we serve you, is yet to be determined. We will keep you informed as we work our way through these regulations.
New Addition to the Cross Household
Ryan Cross, CFP, a financial advisor with Schiavi + Dattani, and his spouse Ivy are the proud parents of Liam, born on April 22. We are happy to report that the family is doing well.
We continue to work daily to earn your trust and confidence.
Vincent A. Schiavi, CFP®, CPA/ PFS Ravi P. Dattani, CFP®, CPA