CSQ ADVISOR
Alan S. Hopkins
Chief Economic Strategist, Manchester Financial
Mr. Hopkins joined Manchester Financial, an Investment Counsel, in 1995 as chief economic strategist after several years at Charles Schwab & Co. Mr. Hopkins was responsible for developing Schwab’s high net-worth clients by teaching courses in financial planning, trading techniques, and retirement strategies. Prior to Schwab, Mr. Hopkins was a consultant to the State of California in the takeover of the Executive Life Insurance Company and worked on the merger of Bank of America and Security Pacific’s mutual fund departments. Mr. Hopkins has served on several boards including the Alliance for the Arts and was president of the Wellness Community, a national cancer charity. Mr. Hopkins holds a B.S. and an M.B.A. in Economics. He and his wife, Kristy, were married in 1990 and have 2 children.
Manchester Financial
805/495.4405
A Penny Saved Is A Penny Taxed
The Beatles’ George Harrison wrote these famous lyrics in “The Taxman” when he realized his earnings were pushing him into the 95% tax bracket in England:
Should 5% appear too small, be thankful I don’t take it all,
‘cause I’m the taxman, yeah, I’m the taxman.
Rates will climb from 14% to 187% over the next three years, so income taxes are on their way up in a big way! During the “Roaring 20’s,” taxes were in the 25% range for top earners. Due to lower tax receipts at the onset of the Great Depression, Congress increased the tax rate in 1932 to 63%, and then steadily pushed it up to 91% by 1963. It was still as high as 70% in 1980, before President Reagan slashed it down to 28%. History doesn’t repeat itself, but it does rhyme.
| Income Type | 2010 | 2013 | % Increase |
|---|---|---|---|
| Ordinary Income | 35% | 40% | 14% |
| Interest Income | 35% | 43% | 23% |
| Long Term Gains | 15% | 24% | 60% |
| Divident Income | 15% | 43% | 187% |
While the economic outlook has decidedly improved over the past year, we remain skeptical about the sustainability of the current market rally, as recent optimism gives way to a number of challenges over the next few years. Why? The short answer is that we can’t predict the emotion (fear or greed) that will prevail in the short run, but we have a better feel for the facts that will prevail in the long run: increasing budget deficits leading to higher interest rates, causing even larger deficits, to be supposedly solved with higher taxes, leading to slower growth, and lower tax revenues, which again increases budget deficits.
Our government faces a trifecta of problems: a mountain of debt, ballooning short-term debt that comes due in the months ahead, and interest rates that will soon climb higher. All that debt could be thought of as a form of borrowing against future consumption - - now we must pay it back in the form of less spending. This lower spending suggests we could see a sluggish economy for a number of years to come. Even worse, one third of our debt is short-term and its refinancing will cost more than the wars in Iraq and Afghanistan combined, each year! So, to pay for all of this, our political savants have decided to raise our taxes over the next three years as shown in the table above.
To prepare for the coming tax onslaught, the savvy investor will need to utilize a variety of strategies. Superior results can be achieved at three levels: tax-efficient asset allocation, tax-wise asset location, and tax-savvy strategy implementation. Each of these three areas requires strategies ranging from simple to complex. You’ll need to design, implement, and maintain the proper strategies for your situation. Remember, it’s not just what you earn, it’s what you keep!
While the economic outlook has decidedly improved over the past year, we remain skeptical about the sustainability of the current market rally.
Investors looking back on strong returns deserve to feel good, especially given the level of nerve that was required to get their gains in the aftermath of a very difficult period. Looking back helps us understand how our economy got to the place it is today. But making good investment decisions requires us to look forward and understand how things are likely to unfold in the months and years ahead. The past few years (and let’s face it, the past decade) have been difficult and fraught with investment danger. Investors that did not adjust to changing economic and market conditions have generally suffered the consequences of greatly diminished wealth.
While recent signs of economic strength are encouraging, they mostly stem from temporary factors like stimulus spending and inventory rebuilding. We believe that, based on current valuations, it is unlikely that stocks will return much more than single-digits (annualized) in the next five years. With the return outlook not very exciting, and significant risks in the markets, we don’t see an incentive right now to take on a lot of pure stock market risk.
As always, it’s important to work hard to understand the reality we live in and its impact on financial markets, and make investment decisions accordingly. In looking ahead, we do see positive ways to generate returns that are better than what the markets provide. We are enthusiastic on the unusually wide risk-reward trade-offs that currently exist and can be taken advantage of in today’s environment. As in the past, the wise investor will ratchet down risk when it doesn’t make sense to take it, and take strategic advantage of opportunities when they are presented. If so, your own outlook is decidedly better than the mediocre outlook suggested by the big picture and current valuations.
As always, fortune favors the prepared.
