The French Connection

Tax analysts may get a chance to test out their latest theories. In a recent paper Christina and David Romer studied the effect of changes in tax rates on reported taxable income. They did this on taxpayers in the top 20th of the income distribution—the top .5%–studying the 20 years between 1919 and 1939. This period is interesting because top rates changed a lot.

To no one’s surprise they found that as taxes go up, reported income goes down. Higher taxes discourage work. But the elasticity—the effect of taxes on reported income—was surprisingly small: about 0.2. This implies that tax revenues would be maximized with a top marginal tax rate somewhere north of 80%. Wow.

To my way of thinking, this is nuts. Maybe people in the ‘20s and ‘30s didn’t have many ways to avoid taxes, but the super-rich sure do now. But there may be a test soon of this theory. In France the Socialist candidate for President, Francois Hollande—currently leading in the polls—has called for increasing the top marginal income tax rate from 40% to 75% on incomes over 1 million Euros per year.

Critics say that such a change would drive France’s high earners abroad, but Hollande is sticking to his proposal. If he’s elected and the revisions are enacted, France could provide a real-world test of this idea.

Maybe they’re right: maybe wealthy French taxpayers will be patriotic enough or distracted enough or whatever to just pay up. But I’m glad they’re running the test.

Douglas R. Tengdin, CFA
Chief Investment Officer
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(Un)Seasonal Greetings

It looks like the gloom-crew just might score a couple for their team. For the past five months economic data have been stronger than expected. At the end of September it was widely assumed that the US economy was rolling over, that we were headed towards another recession, and that stocks were headed into another bear market.

But it turned out to be a bear trap. The economy didn’t roll over, and for the past five months almost all the economic data have surprised to the upside. This was aided by the mild winter we’ve been having. When the weather is nice more people go shopping, more construction gets done, and people just feel better.

But weather isn’t climate. In order to make comparisons easier, our economic data have seasonal adjustments built into their computations. A mild winter means that it’s easier to outperform low expectations. But when spring comes there’s normally a buying surge as people get out and make up for lost spending. This year spring may have already come, economically speaking.

So we may soon see a raft of data that undershoot their expected levels, as the normal economic surge that heralds spring doesn’t show up. That doesn’t mean the economy is falling apart, only that things aren’t going as well as predicted.

The economy didn’t boom this winter and it won’t collapse in the spring. We’re in a slow-growth recovery where we gradually claw our way back to normal. Seasonal factors don’t change this.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The State of States

A year ago there was a general consensus that the states were in trouble. Many felt that a stagnant US economy would lead to declining revenues and budget turmoil. States then would have to curtail support payments to municipalities, cutting them adrift to fend on their own. A waterfall effect would ensue, leading to hundreds of defaults.

A year later that prediction doesn’t look very accurate. Across the country state revenues have been trending up. With employment improving across the country, tax receipts are improving from a year ago. In New York for the last 6 months receipts are up 5% from a year ago and are ahead of budget. In Illinois state taxes are up an eye-popping 16%, driven by an increase in the State income tax rate. In California revenues are down 3% from a year ago, but that is due entirely to a decline in estimated taxes. Actual income tax withholdings and sales taxes are up about 5% from ago. In Michigan the State actually ran a fiscal surplus during the calendar year.

Across the country most governors and state treasurers are feeling better. Over the past four years the states struggled to close more than $500 billion in budget shortfalls, leading to spending cuts and clashes with public employee unions as the states sought to shore up their finances. Now state revenues are rising at the fastest rate since 2006. And the mild winter means that many States that budget for significant weather-related outlays will under spend in that that category, freeing up even more funds.

As the states do better you can look for them to ease up on some of the cutbacks they’ve enacted. 2012 will not see a fiscal Armageddon in the States. The fiscal state of the States is good.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Return of the King

Apple is discussing what to do with its cash. Over the past five years Apple has been a cash machine. Although five years ago their principal products didn’t exist, the iPhone and iPad are now so popular that they generate three quarters of the company’s revenue. And profitability has been eye-popping: 25% of every dollar the company generates in sales flows to the bottom line as earnings.

As a result, they’ve built up a lot of cash—almost $100 billion. That means that $100 of their $535 stock price consists of cash and short-term investments. Now the Board is actively discussing its options. Unlike Steve Jobs, CEO Tim Cook has admitted that they don’t need all that money.

Well I have a suggestion: pay it out to shareholders. The company has been so successful at what it does that it makes little sense to make a huge acquisition. They’d just dilute their own growth. Shareholders have been rewarded so far with a higher stock price, but prices can fluctuate. Nothing transmits wealth to shareholders so effectively as a dividend.

The tax climate is supportive right now: the 15% dividend tax rate is under assault in Washington. Stock buybacks also reward shareholders, but only those that are leaving. Dividends reward owners that are staying.

A one-time dividend of $60-80 billion wouldn’t change Apple’s culture and wouldn’t affect their operations. They should take a lesson from Nike, and just do it.

Douglas R. Tengdin, CFA
Chief Investment Officer
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What Do Investors Want?

Once upon a time, a college endowment was managed by a famous investor. The investor did well; sometimes very well. But a time came when that investor underperformed. He didn’t lose a lot of money, but he didn’t do as well as his peers. During the late ‘90s, while the world was going all techie, he was busily investing in infrastructure and finance. After a very bad year, they hired someone else.

Eventually, his approach was vindicated. Tech stocks pulled back and value stocks recovered. Fortunately for the college the new manager didn’t load up with tech stocks at the top. But the value-manager was gone. Did he do anything wrong?

The short answer is no. He had an investment style that worked, stuck to his guns, and was ultimately vindicated. But there was a problem: a school is a public institution. Alumni and other donors watch how its endowment does and compare it to their own investments. If the school doesn’t do as well as them it’s easy for a large donor to tell the President: “Look, I love your school, but why should I give now, when my money is growing faster than yours? I can always donate later.” Ouch!

The investor erred because he didn’t understand all the pressures a big school faces. In order to be able deliver long-term performance, an investor needs to provide short-run satisfaction. This includes all constituencies. For a school it means donors, alumni, administrators, and trustees. For a family this might mean a husband, a wife, and several generations. Expectations matter.

Investment isn’t just about making money; it’s about satisfying financial needs, both now and in the future.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Homing In

Is housing about to come out of its funk?

The current economic downturn is unique. It was based on a boom and bust in housing, which is both a financial asset and a place to live. It’s the largest single purchase most people ever make, and it’s an essential consumer good. It also is a key component of the US financial system, so it’s no wonder that a housing bust caused a financial panic.

Continue reading Homing In

Too Much Information!

Information comes at us from all sides, these days. We have smart phones, smart cars, a smart electric grid, and I can check the latest sports app to see my nephew’s downhill skiing results in real time.

What do we do with all this data?

The easy answer is to ignore it. Or at least to ignore the parts that we don’t like. If we don’t want live tweets of the air traffic of the coast of England, we don’t need to follow them. But that forgets the fact that more data are available. Not just self-styled pundits in the blogosphere, but real-live data. With the right screens and feeds anyone could have known about the Libyan bombing or Greek rioting before the images went live on CNN.

The key is to understand the difference between data, information, and knowledge. Data is raw numbers: ones and zeroes on a digital drive. It can be massaged, managed, and manipulated. It’s the basic stuff of life. Twitter feeds are often raw data. Information is that data coalesced and managed. Government labor reports and company outlooks are information. Think of data as nutrients and information as different types of food.

But information isn’t enough. Different foods need to be combined into meals. That’s knowledge. Knowledge combines the BLS employment report with Census data to conclude that more people are retiring, and they’re not coming back into the labor force, so there won’t be an army of discouraged workers re-entering the workforce soon. Knowledge helps us understand that low bond yields and a strong corporate sector portend healthy equity returns over the next 10 years.

By recognizing these distinctions, we can start to make sense of the information overload we experience every day. And use improved knowledge to make better decisions.

Douglas R. Tengdin, CFA
Chief Investment Officer
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College Costs, Mortgages, and Student Debt

The numbers say no. Our aggregate debt figures have come back some, but the overall debt burden is way down from its peak in 2007. And with lower interest rates, debt payments relative to income are reasonable. But the incidence of the debt is changing.

Young adults are graduating with significant student loan burdens. This is happening because the price of a college degree continues to grow faster than inflation. Over the past 25 years aggregate prices have doubled, but tuition costs have gone up six-fold. Tuition and fees at New York University now run almost $60 thousand a year.

Against this backdrop students are borrowing more. Total student debt now approaches almost $1 trillion. Recent college graduates carry an average debt load of more than $25 thousand each. After graduating it’s hard to qualify for a mortgage, even if they find a good job. 10 years ago, people aged 25 to 34 made up a third of all home buyers, while last year they were only a quarter of purchasers.

And first-time home-buyers are crucial to the recovery of the housing market. They enable current owners to trade up. So single-family housing starts are languishing, while multifamily rental-unit construction is surging.

One solution might be to allow first-time buyers to roll their student loans into a mortgage. They’d have to settle for a smaller loan, but at least they could qualify. But that’s just a temporary fix. The real problem is that college costs too much. The solution to this will come from the supply-side: innovative online programs like the MIT.x degree or Khan Academy could enable young people to acquire the world-class skills necessary for today’s global economy without the world-class debt-load that now attends a college degree.

But that will take time and a cultural shift. If employers begin to look favorably on these alternatives and a lower debt-load when they evaluate job candidates, it would be a start. With interest rates so low it’s no wonder college debt is exploding while college savings languish. Something needs to change.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Downside of Liking

An old poker-playing maxim goes something like this: in every game, there’s a patsy (that pays for the other players). If within five minutes you can’t tell who the patsy is, you’re the patsy. It’s like that with all kinds of different enterprises: if you don’t know what the business is selling, they’re probably selling you.

With TV, radio, and newspapers we’ve known that all along. Ad revenues have a big part of their business strategy. That free newspaper that you pick up at the local convenience store isn’t free. They’re monitoring how many people pick it up, and using their circulation data to sell advertising.

It’s like that with Facebook, but a little creepier. “Liking” something is a public action. If I go to my Facebook page and tell people that I like the author Walter Isaacson, then I may get an email notice the next time he comes to the Northeast on a book tour. That’s not necessarily a problem. But if it turns out that people who like Isaacson’s biographies tend to be late on their mortgage payments, I may start getting offers for secured credit cards and financial counseling services. That just goes into the spam box: annoying, but not evil.

But I might be more concerned if a future employer or institutional client decides that Isaacson-likers just aren’t for them. And banks could start including likes and dislikes in their credit-scoring models. All this data is for sale. And there’s no law protecting various likers from discrimination. Privacy statutes in the US are relatively lax. In Europe they’re more strict—that’s why Facebook has issues with the EU. But over here it’s “liker-beware.”

Which puts a new twist on another old saying: be careful what you like—because you’re going to get it.

Douglas R. Tengdin, CFA
Chief Investment Officer
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