Perspectives from Above the Noise – Week of February 25, 2013

3 Stories in the global economy that should not go un-noticed

The minutes from January’s meeting of the Federal Open Market Committee (FOMC) acted as a brick wall for markets this week, with the S&P 500 Index declining .22 percent. The minutes were released Wednesday and implied that an increased number of FOMC members are voicing concerns regarding the pace of asset purchases. The language indicated that there may be an increasing bias to end asset purchases sooner than expected.

Also looming over investors is the impending sequester of the U.S. government, which is set to take effect March 1. With this deadline comes automatic spending cuts with a potential total of $85 billion, or 2.3 percent of total spending.

While slowing asset purchases by the FOMC, and automatic spending cuts act as a speed bump to economic growth, it certainly does not appear to be enough to cause the economy to fall off a cliff.

Here are the 3 stories this week that rose above the noise:

A Fine Italian Mess

On Monday, investors had a close eye on Italian elections. In a blow to austerity and financial reform, parties that promised to scale back many of the financial sacrifices enacted by the current Monti government fared well.

Markets had hoped to see a strong showing by Monti’s party, which would have been a vote of confidence on the slow road to reform Italy appeared to be on. The strong showing by both center-right and center-left parties which have criticized these measures leaves markets uncertain and worried about a renewal of European sovereign debt concerns.

Sign of a Comeback: U.S. Carmakers Are Hiring

U.S. employment in the auto industry dropped from a peak of 1.1 million in 1999 to just 560,000 in 2009, but that trend has reversed in the last few years as 90,000 jobs have been added back. Auto sales have improved, increasing to almost 15 million cars sold in 2012 after dropping below 11 million in 2009.

Increased auto sales have helped boost employment in the auto industry, but more competitive wages have also contributed. Major U.S. carmakers have a two-tier wage system for assembly workers, which makes it easier to hire new employees, who start at a reduced rate of $16 an hour compared to $28 an hour for veteran employees.

In recent weeks, both top carmakers announced large investments in refurbishing plants and hiring new employees, including new assembly plants and the hiring for hundreds of new employees.

China Has Its Own Debt Bomb

A recent opinion piece in The Wall Street Journal written by Ruchir Sharma details the bear case on the Chinese economy. In particular, Sharma does a good job of summarizing the alarming level of public and private debt that has accompanied China’s dramatic growth over the past decade.

The article also references several recent studies that examine how similar periods of rapid debt accumulation have often led to future financial crises. Our intermediate-term view of the Chinese economy is far more optimistic than the author’s and we believe a modest acceleration of growth is likely in 2013.

However, the article raises important issues that could lead to a rapid growth deceleration down the road. We will be watching for evidence that the bear thesis for China is gaining traction.

Perspectives from Above the Noise – Week of February 18, 2013

3 Stories in the global economy that should not go un-noticed

Markets ended a quiet week basically flat, though the S&P 500 managed to chalk up its seventh week of gains. For the week, the S&P 500 gained 0.12%, while the Dow lost 0.08% and the Nasdaq trimmed 0.06%. Europe is weighing on markets as a disappointing GDP report showed that the economies of France, Germany, Greece, Italy, and Portugal all contracted in the fourth quarter of 2012. As a result, the fourth quarter Eurozone GDP shrank 0.6% compared with the third quarter. Looking farther ahead, we’re anticipating some market headwind in the form of the March 1st sequestration deadline that is fast approaching. This automatic series of federal spending cuts was temporarily extended in January during the fiscal cliff wrangling to allow Congress and the President more time to negotiate. However, with no resolution thus far, and Congress in recess this week, it appears as though the deadline may pass with no action.

Here are the 3 stories this week that rose above the noise:

Swelling U.S. Labor Force Keeps Fed at Ease

The unemployment rate has fallen from a 26-year high of 10 percent in October 2009 to last month’s 7.9 percent. Some of the decline is attributable to a contraction in the labor-force participation rate — the proportion of Americans ages 16 and older who are working or seeking work.

However, this trend may be reversing as a reviving economy may now be coaxing more Americans back into the job market. Short-term, this development will lead to a slowdown in the falling unemployment rate. This article highlights that a gradual fall in unemployment will allow the Fed to continue its very accommodative monetary policy as long as inflation isn’t forecast to rise to more than 2.5 percent and unemployment stays above the central bank’s threshold of 6.5 percent.

China Services Job Gains Key for Shift to Consumption

The Chinese economy has evolved rapidly over the last 30 years, shifting from an agrarian-based economy to one dominated by its manufacturing and service sectors. In recent years, the service sector has experienced fast growth and now the employs the largest proportion of workers of any sector in China for the first time. The growth in the service sector is the result of the Chinese economy being driven more by consumer spending than exports and investments.

An International Monetary Fund paper from 2010 highlighted a direct link between employment growth in the service sector and rising consumer consumption. South Korea and Japan previously experienced a similar evolution, going from export-driven economies to consumption-oriented economies. Both countries took about 30 years to increase the proportion of their workers in the service sector to over 60 percent from the level that China is currently at, 35 percent.

Why Siemens Is Expanding U.S. Manufacturing

Over the last decade, many headlines have focused on the loss of U.S. manufacturing jobs to China and other cheap labor markets. Recently, this trend has slowed and manufacturing jobs have begun to make their way back to the U.S. as labor markets overseas have become more expensive, shipping costs have increased and many companies have seen the overall quality of their product compromised due to lower standards abroad.

In a recent article, Siemens executive Helmuth Ludwig discusses another very important factor that is attracting more manufacturing back to the U.S.: software. Ludwig argues that software will be a game changer for the manufacturing industry because it ties “the real and virtual worlds together in a way that erases all boundaries between the two.” The U.S. is the global leader in software, and this will inevitably cause companies to bring manufacturing jobs here, where their product design and software teams are based. Housing these groups in the same location will allow companies to gain efficiency and quality through collaboration.

New Year, New Rules – Time to Re‐Think Tax Strategies

This past Saturday morning we hosted our New Year, New Rules workshop, where we discussed the legislative tax changes for 2012.  These include the big changes written in to the final “Fiscal Cliff” package, as well as the changes imposed by the Medicare (Obamacare) laws. As most of our clients are residents of California, they are also looking at an income tax hike at the state level as well. Following up on this workshop, I thought I would take a few minutes to review a couple of the key issues.

Tax Hikes All Around

Married California couples in the top 4 Federal brackets (25%+) are looking at combined marginal tax rates of 33%, 42.3%, 44.3%, & 48.9%. Couples in the highest bracket will also be exposed to higher dividend and long‐term capital gains rates. The combined minimum long‐term capital gains rate for Californians in the highest bracket will be 29.3%‐‐and that’s before we add in the Medicare surtax on investment income (see next section).

Medicare Tax Impact

People who earn more than $200,000 (single) or $250,000 (MFJ) will face an additional surtax on investment income of 3.8%. This means that dividend and long term capital gains rates for California earners above these thresholds would be 28.1%. If you happen to fall into the highest bracket ($400k/$450k+) then you could be looking at a tax of 33.1%.  Those workers earning more than $200,000 will also face a greater Medicare hospital insurance tax on earning above this threshold. The normal hospital insurance portion of the payroll tax is 1.45%. This is increased to 3.25% on earning above the $200k threshold. There can be a complication for couples since employers (who account for payroll tax withholding) do not know if the couple exceeds the $200k in household income even though the individual may not. You should consult your tax advisor to help you adjust withholding if you are above this threshold as a household.

Asset Location

Because of these hidden tax drags on invested assets, the decision of how to “locate” your capital becomes ever more important. Tax‐deferral can be a great tool for lowering taxable income now (as in the case of retirement plans), but it also shields the asset’s growth from being taxed as the money is growing. This could allow you to grow interest on the money you would have paid in taxes along the way. Other investment vehicles that could provide tax deferral may also provide this kind of compounding.  Municipal securities are also exempt from the Medicare surtax, meaning that an allocation to this asset class may make some sense on a case by case basis.

What is assured is that if you have annual household income approaching $200,000, it will make sense to re‐assess your investment plan on assets outside of your retirement plan. You may want to adjust your financial plan in favor of increasing savings into retirement plans (if you are not already maxing these out). The time to revisit this is now, since these are the new rules for 2013.

Perspectives from Above the Noise – Week of February 11, 2013

3 Stories in the global economy that should not go un-noticed 

Markets lost some exuberance last week as news out of Europe weighed on U.S. investors. Despite some selling pressure however, the rally rolled on as the S&P 500 edged to a five-year high. Major indices ended the week mixed, with the S&P 500 gaining 0.31%, the Dow losing 0.12%, and the Nasdaq gaining 0.46%.

Troubles in Europe drove most of the market action last week as downbeat European equities prompted selloffs in the U.S. Scandals have rocked European markets as regulators investigate several banks for trading irregularities as well as one of Greece’s leading statisticians, who has been charged with falsifying fiscal data

Here are the 3 stories this week that rose above the noise:

OPEC Raises Demand Forecast, Suggesting Improving Global Economic Activity

Despite rising supply from U.S. shale oil development, OPEC said yesterday that it will need to pump an additional 100,000 barrels per day this year. OPEC’s forecast suggests that global economic activity is potentially re-accelerating. Since U.S. oil production is projected by the Energy Information Agency (EIA) to increase 900,000 barrels per day in 2013 compared to an increase in global demand of only 650,000 barrels per day over the past two years, an oversupply situation and lower crude oil prices appeared possible in 2013.

However, crude oil prices have actually risen 6 percent year-to-date to $97.03 per barrel. One possible explanation for the crude oil price strength is that global demand is being underestimated due to improving economic activity — coming out of the 2007-2009 recession, global demand rose 2.3 million barrels per day in 2010.    

China Trade Growth Hints at Strong 2013

A recent Financial Times article summarizes Chinese trade data released last week, which seems to indicate solid growth in China and globally in January. Chinese exports rose 25 percent year-over-year in January, the fastest pace since April 2011. Imports increased 28.8 percent, which was a sharp acceleration from December’s 6 percent rise.

Analysts caution that there are significant distortions in the data caused by the timing of the Chinese New Year holiday, which fell in January last year but is happening in February this year. As a result, it will be important to average the first two months of the year once February’s results are released to get an apples-to-apples comparison of the trade data. Despite the concerns over the impact of the holiday, the trade data from China provides encouraging evidence that growth in China and abroad has accelerated in recent months.

Yellen Signals Fed Would Sustain Easing After Ending QE

Federal Reserve Vice Chairwoman Janet Yellen defended the Federal Reserve’s quantitative easing program and low interest-rate policy in a speech to the AFL-CIO yesterday. She reasoned that easy-money policy was necessary to help provide a spark to stubbornly slow economic growth in order to help drive unemployment lower, with inflation currently remaining below the Fed target of 2 percent.

In regards to the potential for budget sequestration, Yellen cited Europe’s struggles with fiscal austerity as an example to avoid deep budget cuts when economic growth is weak and unemployment is elevated, a view shared by Chairman Bernanke. Additionally, Yellen hinted that the Fed may maintain low interest rates (near zero) following the conclusion of the Fed’s bond-buying program, which will end after the Fed reaches its stated short-term target of 6.5 percent for unemployment or 2.5 percent for inflation.

Perspectives from Above the Noise – Week of February 4, 2013

3 Stories in the global economy that should not go un-noticed 

Markets continued their rally last week, with the Dow cracking 14,000 for the first time since 2007. Boosted by positive employment news, all the major indices continue their climb. Last week saw the release of a flood of economic data. In an unexpected surprise, U.S. GDP contracted in the fourth quarter by 0.1%. January’s final consumer sentiment number beat expectations, as consumers regained confidence lost during December’s fiscal cliff debate; though people are still worried about the new tax increases and gas price hikes.

Here are the 3 stories this week that rose above the noise:

Brazil to Scrap Food Taxes as Rousseff Fights Inflation

We are keeping a close eye on emerging markets, as they are one of our 2013 growth themes. This article highlights Brazil’s plan to scrap federal taxes on a basket of staple foods in an effort to slow inflation, which increased to 6.02 percent through mid-January.

The Brazilian economy has recovered at a slower-than-expected pace, and the administration is seeking alternative measures to rein in inflation, instead of raising the benchmark interest rate, which sits at a record low 7.25 percent.

Amidst a Banking Dry Spell, Small Businesses Kickstart Themselves

In a recent opinion piece from Reuters, Zachary Karabell discussed the recent phenomenon of “crowdfunding,” in which individuals form a network and provide funding for causes, or in this case, business ideas. Global financial institutions have remained tight and cautious lenders even as the global economy has rebounded from financial crisis of 2007-2009.

This has left small business owners and entrepreneurs with fewer sources of capital. As a result, many promising business ideas have turned to websites like Kickstarter, which allows individuals to collectively fund projects for very small amounts. While this model is still getting off the ground and is not currently competitive with traditional forms of lending, Karabell sees crowdfunding potentially disrupting the banking model the way digital music changed the recording industry.

Housing Packs Punch for U.S. Growth in 2013 and Beyond

Bloomberg published a recent article highlighting the housing recovery’s widespread impact on the U.S. economy, including a rise in consumer purchasing power from rising home prices, acceleration of durable goods orders from increased home construction, and increased bank lending. Additionally, rising home prices have increased property tax revenues, helping state and local governments close budget deficits.

Many economists foresee the housing recovery accelerating in 2013. According to Moody’s Analytics Chief Economist Mark Zandi, “the housing recovery will kick into a higher gear as the year progresses. We’re going to get a lot of juice from the channels through which it affects other parts of the economy.”

A Few 2013 Social Security Changes

As an important piece of the puzzle for structuring retirement income, the Social Security system can be daunting for the average American to understand & access. 2013 sees a few adjustments the administration and impact of Social Security Funds. The first important change to look at is always the annual cost of living adjustment. Social Security has deemed a 1.7% annual cost of living increase for 2013, which began this January. The average monthly Social Security benefit in January increased from $1,240 to $1,261.

Let’s take a brief look at a few of the other items worth noting:

Higher Payroll Tax Threshold
With the return of the normal payroll tax (which goes toward funding SS & Medicare benefits, Americans will also see an increase in the cap on earnings that are exposed to payroll taxes. Starting this year the cap increased from $110,100 in 2012 to $113,700. People whose earnings exceed this threshold do not pay SS taxes on earnings above the limit.

Higher Earnings Allowed for “Working” Retiree
Many early retirees go back to work part-time or via consulting. If you are claiming Social Security and are between the ages of 62 and 66, this can result in a temporary penalty of $1 for every $2 earned above a certain threshold. The 2013 threshold is $15,120. Those who turn 66 this year will have $1 of benefits for every $3 earned above a $40,080 limit. However, once you turn age 66, the earnings limit no longer applies. Benefits may be recalculated at age 66 to reflect the withheld benefits and continued earnings—that is why this is termed a temporary penalty; one that is “paid back” to the pensioner at full retirement age.

Shift Toward Online Services
More an administrative and cost-saving move, you are now encouraged to start your payments through online request. 2012 online services allowed Americans to access statements online that reflected their full earning history. This is coupled with reduced office hours at your local Social Security office.

As these advising resources change, it is incumbent upon people to get educated on their benefits and how those benefits fit in to their overall retirement income plan. Be sure to join us in the coming months for our Social Security and Medicare Workshop to get some more clarity on this issue.