Capital Ideas Newsletters



May/June 2013

Yep, IRS stands for It Really Stinks!

There is no one I know, Republican or Democrat, who is not outraged at what has recently occurred with the IRS targeting conservative organizations. The Obama Administration is having a tough time with a few scandals but that has not stopped the U.S. stock market from surging ahead. Despite the surge, since 2000, investors are not yet even on an inflation-adjusted basis. Furthermore, savers have been punished brutally with historically low interest rates that have put many retired Americans on a very restricted budget.

The stock market loves low interest rates but it particularly loves income producing stocks, which can explain the outperformance of income/high dividend stocks and Master Limited Partnerships (MLPs). As savers plunge into these stocks, valuations are becoming less relevant. Income vehicles are the new darlings of Wall Street.

The S&P 500 was up 2.20% in May after rising 12.7% in the first four months of this year. High dividend stocks beat the S&P 500, returning 16.4% through April but did lag slightly in May. This may be a warning that these stocks have gotten more expensive and perhaps that a rise in interest rates is coming.

We are not so sure of the latter. One of the reasons is that the U.S. needs interest rates to stay low so that its interest costs are manageable relative to the overall budget. If rates rise, it could be a budget buster that threatens President Obama’s agenda of entitlements, as the country would be forced to cut entitlements in order to attract foreign capital to finance its deficits. This scenario is no different than in other countries that must reduce their spending.

Interestingly enough, margin debt, the debt from people borrowing against their securities, increased to its highest level since June of 2007. Is this a sign of confidence or a rise in speculation due to a rising market and low interest rates?

U.S. companies spent $450 billion buying their own shares back in 2012 and are set to spend more this year. Because compensation is typically tied to earnings per share, reducing shares outstanding through a buyback is usually a good way to raise those earnings. Unfortunately for shareholders, buybacks are not always to their advantage. Very often companies buy back shares at the wrong time resulting in a waste of corporate cash and opportunity. The most destructive thing about buybacks is that they do not represent core “capital investments” and thus, do not necessarily create jobs.

The 16th Amendment created the federal income tax. According to the IRS, Americans spend 3 million man-years and $168 billion annually complying with the tax code. Everyone complains about the complexity, but will it ever change? I seriously doubt it. In reality the tax code is a good way of implementing social policy. In our view, more should be done in this direction because we do not believe that simplification will ever occur.

As China slows, Japan shakes, rattles and rolls, and Europe struggles, it is the United States that looks most attractive to investors worldwide. Corporations are flush with cash and their borrowing rates are at all-time lows. Energy and water are abundant resources in America and are delivering distinct advantages to us. Our challenge now, I believe, is to get our political house in order. If government can start to function at a more practical level, I believe that we are unbeatable.

The investor’s ultimate challenge is to capture the most upside with the least amount of downside risk. Clearly each investor must understand himself in order to achieve the best goals. It is our job to help guide you in these directions.

As our firm approaches its 25th year, I am proud to welcome my eldest son, Aaron, into our business.

Most recently, Aaron was an Associate at the law firm of Schulte Roth & Zabel in their investment management/hedge funds group. Aaron received his law degree from the Benjamin Cardozo School of Law. Prior to Cardozo, Aaron graduated from the Olin School of Business at Washington University in St Louis and interned at Bear Stearns and Lehman Brothers.

Aaron will be working closely with Andrea Tessler and our teams to learn all aspects of our business and of course with me.

As we face many challenges of the 21st century, and at a time where there seems to be so many problems, I thought of a quote I once heard by Calvin Coolidge, the 30th President of the United States, about the value of persistence. He said, “Nothing in this world can take the place of persistence. Talent will not; nothing is more common than unsuccessful people with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent. The slogan ‘Press On’ has solved and always will solve the problems of the human race.”

Have a great early summer!

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