December 31, 2012

Barone: 2013: Forecasts for the unsettled road ahead

Posted in Economy, Markets, taxes, Uncategorized tagged , , , at 7:59 PM by Robert Barone

Forecast 1: Slow economic growth in 2013’s first half; second half could be better.

Whether we go over the “fiscal cliff” or not, the first part of 2013 will be quite slow with the possibility that even the “official” numbers could show up as negative. At this writing, it does not appear that the Washington politicians will reach any sort of meaningful deal by year’s end. But, even if they do:

• Economic confidence already has plummeted.

• There are significant 2013 tax increases in Obamacare and a return to normalcy in the employee portion of the Social Security tax; furthermore, the end of extended unemployment benefits is a significant hit to consumer income.

• The job market remains weak; much of it due to a skills mismatch, which is a very long-term structural issue.

• Consumers’ real incomes continue to fall.

The second half of the year might be a different story. If some fiscal certainty is delivered in January, U.S. business investment spending, currently at a six-decade low, easily could pick up and spur the economy above the 1 to 2 percent growth rates we have seen in recent years.

Forecast 2: Nevada’s housing market will continue to struggle.

The housing market in Nevada appears to have been a bright spot for 2012. Realtors indicate that the rise in the median price is due to a shortage of supply, not an increase in demand. Nevada’s AB284, effective in October 2011, all but halted foreclosures. There remains a dearth of first-time and move-up homebuyers. I suspect this scenario will change in 2013 as the Legislature, prodded by the powerful banking lobby, deals with the technical issues in AB284 that now make it difficult and dangerous for mortgage holders to foreclose. That means more supply in 2013’s second half, and, perhaps, a plateau in home prices.

Forecast 3: Europe will sink further in 2013.

The markets are thrilled that Europe is uniting to save its insolvent banking system. While the immediate crisis has been averted through the injection of liquidity, the insolvency issues remain. The chosen path for Europe is to inflate its way out.

In 2013, the European Union will continue to be ensnared in a significant recession (depression in Greece, Spain and Portugal). France, considered to be part of the strong northern European core, also will enter recession in 2013. Even the mighty Germans will be hard-pressed to show more than a flatline.

Forecast: We have not yet seen the last of the European Union implosion. It has just been placed on the back burner with the European Central Bank’s adoption of Bernanke-style money printing policies.

Forecast 4: The Chinese miracle will continue in 2013.

China avoided a “hard landing” in 2012. The reason: A one-party political system doesn’t end up in policy gridlock. There is hot debate as to the sustainability of the current Chinese turnaround, but one thing is for sure: Economic policies, be they right or wrong, are carried out quickly and the economic impacts are felt with minimal time lags.

Forecast 5: The currency race to the bottom will intensify in 2013.

All of the world’s major central banks (the Fed, Bank of Japan, ECB and Bank of England) are printing money at breakneck speed.

The Fed is printing at least $85 billion per month, which, at least temporarily, allows the Washington politicians to shirk their fiscal responsibilities. After all, even if foreign demand for U.S. treasuries (i.e., Japan and China) dries up, the Fed will purchase any new debt due to the tax and spending imbalance.

The same scenario is true in Japan where the newly elected Prime Minister Shinzo Abe has successfully attacked the independence of the Bank of Japan, which now appears willing to print enough to cover the fiscal deficits on which Abe campaigned. Ditto for the U.K.

All of this money printing is really a form of mercantilism, i.e., policies aimed at producing a positive trade balance, resulting in higher factory output and employment levels at home. China is the world’s role model in this regard.

I call this the “race to the bottom,” because when every country does this, as is the current situation, not only is it a zero-sum game (i.e., no one wins), but there are significant unintended consequences. We see this throughout the world with zero interest rate policies penalizing seniors and savers.

Forecast 6: Precious metal, art and gem nominal prices will rise in 2013.

After 10 years of strong gains, the prices of precious metals recently have seen downward pressure due, in part, to profit taking ahead of inevitable capital gains tax increases in the U.S. in 2013. There also is a rumor of significant liquidations in a large hedge fund (Paulson), which has heavy gold investments.

Nevertheless, the underlying demand for precious metals, art, gems and other hard assets is strong, especially in the face of the “race to the bottom.” My forecast is for the nominal prices of these assets to continue their upward trajectory as every country in the industrialized world has chosen inflation over fiscal austerity.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 17, 2012

The Demonization of Corporate Tax Avoidance

Posted in business, Corporate Tax, Uncategorized tagged , , at 9:28 PM by Robert Barone

Like a doctor who takes the Hippocratic oath always to put his patients’ best interests first, so, too, a director of a company, especially a large or publicly traded one, has, under the law, a fiduciary duty always to serve the best interests of its shareholders. Profits always have been an important measure of the health of a company, and it is an accepted norm that shareholders are better off when profits are higher than when they are lower.

As a result, there is a high correlation between rising profits and rising stock prices. So, why, I ask, is there now a movement to vilify boards of directors and managements if they opt legally to minimize corporate taxes? Isn’t that in the best interests of the shareholders (i.e. higher profits)? In fact, why would anyone (corporate or individual) pay more taxes than they have to?

The movement to demonize legal corporate tax avoidance exists on both sides of the Atlantic. One manifestation is the vilification for holding cash in low tax countries. Another is for paying out dividends in 2012 to avoid the inevitably higher dividend tax rates on shareholders beginning Jan. 1.

The Wall Street Journal ran an article featuring the huge cash hordes of major U.S. corporations held offshore (“Top U.S. Firms Are Cash-Rich Abroad, Cash-Poor at Home,” Linebaugh), including household names such as Apple, GE, Johnson & Johnson, Microsoft, Oracle and Staples.

•On Dec. 4, the New York Times (“British Lawmakers Accuse Multinationals of  Avoiding Taxes”) reported that “the British government announced plans … to  crack down on tax dodgers (emphasis added) as a parliamentary report criticized United States companies for what it described as tax avoidance (emphasis added).”

Margaret Hodge, chair of the Public Accounts Committee of Parliament wrote: “Global  companies with huge operations in the U.K., generating significant amounts of  income are getting away with (emphasis added) paying little or no corporation tax here. This is outrageous (emphasis added) and an insult to British businesses and individuals who pay their fair share (emphasis added).” (Note the tone of the emphasized words!) Companies named by Hodge include Amazon, Google and Starbucks, which  legally use lower tax jurisdictions within Europe (Ireland, Luxembourg and Switzerland) to record much of their revenues.

Let’s first examine the large cash hordes held offshore, both for the U.S. and the U.K. The cost of bringing that cash back must be examined in the context of the cost of pursuing other avenues of access to cash. In the U.S., for example, it would cost those large corporations, in taxes, 35 percent of the cash repatriated, while borrowing costs can be had for interest rates in the very low single digits. If the political class in the U.S. really desires to have the cash repatriated to spur economic growth, perhaps it should consider, at least temporarily, a lowering of the 35 percent cash repatriation tax. Getting 3 percent in repatriation taxes is better than nothing; and, oh, by the way, we might even see some job growth as a result of that cash being deployed domestically!

For Hodge of Great Britain, the answer is the same. Who has control of the tax policy that drives the cash offshore? It is you, Madam Hodge, and your fellow pols. No board or management of a privately held corporation is going to pay more than it must. It is its duty legally to avoid such payments! Just think what any rational person would think of AT&T if he or she complained that those other, smaller telecom companies were undercutting AT&T’s pricing, and that it was unfair or unethical. Yet, this is the argument that Hodge is making. What’s wrong, U.K.? Can’t compete anymore?

The very concept that legally avoiding such taxes is unfair is a direct attack on capitalism and free markets. The tone of the language used by Hodge, and also present here in the U.S. (“tax dodgers,” “tax avoidance,” “getting away with,” “outrageous,” “fair share,” “shared sacrifice”) all imply that the behaviors of the corporations, their managements and the boards of directors somehow are immoral or unethical. The “profit motive,” Adam Smith’s “invisible hand” (i.e. free markets), and economic opportunity and self-interest propelled the U.S. and the western industrialized societies to the highest living standards in history in the 20th century. With “profit” now a dirty word and legal use of competitive jurisdictions with lower tax rates now under frontal attack by
overspending and uncourageous governments, it isn’t any wonder that living standards in these societies are now plunging.

Investors should be encouraged that the multinational corporate sector displays such behavior. The appropriate response by government should be to figure out how to become more competitive internationally. On the other hand, investors should be wary of investing in countries where they see governments restrict the free flow of capital in order to confiscate taxes, as this is always an act of desperation by politicians who have no idea about how economies work or the unintended consequences of their actions.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 7, 2012

Advisors Could Be Affected By Proposed Money Market Fund Reforms

Posted in investment advisor, investments, Mutual Funds, Uncategorized tagged , , at 10:35 PM by Robert Barone

December 6, 2012 • Juliette Fairley

As soon as Robert Barone heard rumors that money market funds were in trouble back in 2008, the financial advisor switched his clients’ assets out of prime money market funds and into government-backed money market funds.

Fast forward to 2012, financial advisors may want to examine money market fund assets before investing or transferring, given proposed regulatory reforms that, among other things, would allow the net asset values of money market funds to float based on their portfolio values rather than be guaranteed at $1.

“We didn’t want any of our clients’ money in European banks, which is why we switched to money market funds guaranteed by the U.S. government. As a result, my clients haven’t lost any money,” said Barone. “If prices float, financial advisors will make decisions on the quality of the paper of money market funds.”

The reforms have come, in large part, as a response to events on September 16, 2008. That day America’s oldest money-market mutual fund, Reserve Primary Fund, broke the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers, which had declared bankruptcy the day before. Panicked investors subsequently redeemed their holdings en masse.

“The Fed ended up saving money market mutual funds by making so much liquidity available that risky assets were all able to find the cash to pay,” said Barone, who currently has up to $20 million of his $90 million in assets under management invested in government-backed money market funds.

Barone refers to the optional guarantee backed by the Treasury Department’s Exchange Stabilization Fund announced on Friday September 19, 2008, which promised that if a covered fund broke the buck, it would be restored to $1 NAV.  The insurance stabilized the system and put a stop to outflows.

Since then, a new regulatory agency called the Financial Stability Oversight Council (FSOC) has proposed money market fund reforms that the SEC is being asked to implement.

According to the U.S. Treasury Department, FSOC’s proposed reforms include:

• Funds floating their net asset value to reflect actual market value rather than maintaining it at $1 per share.

• Funds maintaining 1 percent of assets as a NAV buffer to absorb day-to-day fluctuations in value. A small amount of a shareholder’s investment would be subject to a delayed redemption and could be lost if the fund suffered losses over the NAV buffer.

• Funds maintaining 3 percent of assets as a buffer to increase their resiliency.

The FSOC is holding a comment period on the reforms that ends January 18. After the comment period closes, FSOC will make a final recommendation to the SEC, which will then have 90 days to implement it or explain in writing why it is not.

“The SEC, by virtue of its institutional expertise and statutory authority, is best positioned to implement reforms to address the risks that MMFs present to the economy,” said Treasury Secretary Timothy Geithner in a prepared statement.

Geithner added that FSOC’s proposal should take into account the concern expressed that reform of money market funds may result in outflows from them to less-regulated parts of the cash-management industry. “Our objective should be to propose reforms to MMFs that protect their stability, without creating a competitive advantage for unregulated cash-management products,” he said.

The SEC declined to elaborate on why its chief Mary Schapiro withdrew a similar proposal for reform in August.

“While we pursue this path, the council and its members should, in parallel, take active steps in the event the SEC is unwilling to act in a timely and effective manner,” said Geithner in September.

In other words, FSOC isn’t taking no for an answer and will be prepared to wage its authority as granted under title I of the Dodd-Frank act.

Meanwhile, the ICI issued a press release explaining its displeasure with the proposed fixes.

“We are disappointed by the proposals featured in the FSOC’s release, which forces money market funds to float their value, capital requirements and daily redemption holdbacks,” said ICI President and CEO Paul Schott Stevens. “If implemented, they will increase risks to the financial system by concentrating assets in a few large institutions or drive assets into alternative products that are far less regulated and transparent than money market funds.”

Barone said if the proposals are implemented, money market funds will have to invest in less risky assets producing lower returns or introduce some sort of capital or parent-company guarantee, leaving less for investors. “Smaller MMFs lacking capital will either close or be merged into larger funds, resulting in less competition and no need to pay out as much,” he said.

Charles Schwab has stepped up with a proposal to apply the reforms to prime money market funds that invest in corporate, government and international securities rather than funds that invest only in state and federal government notes.

Barone says floating rates and higher capital among prime money market funds will bring market discipline to bear, allowing investors to choose how much risk they want to tolerate for the return.

“The new rules should mitigate the moral hazard issue of taxpayers coming to the rescue,” said Barone.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 3, 2012

Barone: Spending: the nation’s real fiscal cliff issue

Posted in Economy, government, recession, taxes, Uncategorized tagged , , , , at 11:51 PM by Robert Barone

The business media is fixated on the “fiscal cliff” issue, not because its avoidance will spur economic growth, but because failure to avert it likely would mean another severe contraction in an already underperforming economy.

The most likely short-run outcome is for Congress and President Barack Obama to reach a “compromise,” which “kicks the can down the road” and gives these institutions additional time to resolve the issues. “Kicking the can” is a skill that has been mastered by politicians throughout the world, especially over the past five years.

The most significant and serious issue of the fiscal cliff, one that has been discussed but poorly analyzed, is the “spending” issue. Most Americans who pay some attention to the federal budget issues believe that the deficits have been $1.1 trillion to $1.5 trillion in the Obama era, and about half of that level when George W. Bush was president. The reality is that the federal budget deficit is grossly understated. It is calculated on a “cash” basis, meaning that only current cash-in and cash-out is counted. Future promises are completely ignored in calculating this deficit.

Think about this: Every single day for the next decade or so, 10,000 Americans will become eligible for Medicare and Social Security. These programs have no real assets of their own and must be financed out of current tax revenue. Today, 86 perrcent of all federal revenue collected already is committed as “transfer” payments (Social Security, Medicare/Medicaid, income security and federal pensions) (USDebtClock.org). Just think of how much federal revenue will have to rise just to take care of these newly eligible benefit recipients. If interest on the debt (at historically low interest rates) is added, 97 percent of federal revenues are already accounted for. That leaves precious little for all of the rest of the federal functions, including defense, education, environment, homeland security, immigration, agriculture, foreign policy, etc.

Every publicly traded company in America is required to report their financials on a Generally Accepted Accounting Principles (GAAP) basis. GAAP reporting includes, via a present value process, taking into account the cost of future promised payments. The underfunding of public pensions has become a big issue in America today.

But, even a pension that is 40 percent underfunded still has 60 percent of the assets that it needs. The promises made for all of the social programs of the federal government have 0 percent of the assets needed to meet the required payments. All must come from current tax collections and borrowing. You can see how the problem is exploding, given the current demographics of the population and those rapidly becoming eligible for such transfer payments.

Once each year, by statute, and to little fanfare, the U.S. Treasury reports (Dec. 15) what GAAP accounting would be for the federal budget. In 2004, under Bush, the headline federal cash-based deficit was $412 billion, but, because of changes to Medicare that year (prescription drugs), the GAAP-based deficit exploded to $11 trillion. For the first three years of the Obama era, the GAAP-based deficit exceeded $5 trillion each year.

The Treasury recently has postponed release of the 2012 fiscal year (ended Sept. 30) GAAP deficit until Jan. 17 so as not to inflame the fiscal cliff negotiations. I’ve seen an estimate from John Williams, a noted economist (shadowstats.com), that puts the 2012 GAAP deficit at $7 trillion, or about 44 percent of the entire output (GDP) of the country. Worse, while the official U.S. debt is approaching $15.2 trillion, the actual amount of promises already made for Social Security, Medicare and prescription drugs is more than $121.6 trillion, according to USDebtClock.org (and about $88 trillion using official U.S. Treasury estimates, according to Williams). Using the USDebtClock.org data, which appears to be more comprehensive, that amounts to $386,000 in unfunded promises for every U.S. citizen and $1,059,000 for each U.S. taxpayer.

Just to put this in perspective, the estimated value of all U.S. business, corporate and household assets is only $87.4 trillion. Now, do you see the magnitude of the spending issue?

No amount of spending cuts outside the social and entitlement programs and no amount of tax increases can bring the real GAAP budget deficits into balance. This fiscal cliff appears to be the last real opportunity to address the deteriorating spending issue.

Unfortunately, unless the social programs are addressed, the overspending issue isn’t going to be touched.

No doubt, a successful fiscal cliff can-kicking will encourage equity investors and most likely propel stocks upward, at least for the short term. But, if the social program and entitlement issues are not addressed, then all of us should worry about the future value of the dollar and future interest rates. The current situation in Greece will be just a microcosm of what could happen here.

Given the recent track record of Congress and the president on spending issues, you should begin to prepare your portfolio now.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.