Fagan Associates Columns

This past week, Standard & Poor’s (S&P), perhaps the country’s premier rating services agency, reduced its outlook on direct debt of the United States Government.  In a lengthy release S&P stated that “it affirmed its ‘AAA’ long-term and ‘A-1+’ short-term sovereign credit ratings on the U.S.  Standard & Poor’s also said that it revised its outlook on the long-term rating of the U.S. sovereign to negative from stable.”

S&P elaborated on the reason behind the change to negative from stable, the first such change ever for the United States.  “Our ratings o the U.S. rest on its high-income, highly diversified, and flexible economy.  It is backed by a strong track record of prudent and credible monetary policy, evidenced to us by its ability to support growth while containing inflationary pressures.  The ratings also reflect our view of the unique advantages stemming from the dollar’s preeminent place among world currencies.”

“Although we believe these strengths currently outweigh what we consider to be the U.S.’s meaningful economic and fiscal risks and large external debtor position, we now believe that they might not fully offset the credit risks over the next two years at the ‘AAA’ level.”

“More than two years after the beginning of the recent crisis, U.S. policy makers have still not agreed on how to reverse recent fiscal deterioration or address longer-term fiscal pressures,” this according to S&P credit analyst Nikola G. Swann.

What could this shot across the bow mean?  Well, most likely nothing for now.  However, should our elected officials not get the country’s fiscal house in order, Americans might expect a continuation of the decline in the dollar and inflation in the form of higher interest rates.

Like it or not, however we believe for the good, the financial markets will most likely determine how quickly our politicians respond to this pending crisis.  For example, just this past week the Euro rose to a fifteen month high relative to the dollar.  Despite the fact that a weakening dollar is good for exports, too much so makes imports (see oil) more expensive and is thus inflationary.  Furthermore, also this past week, the ultimate safe haven, gold, crossed over the $1,500 per ounce mark as debt concerns surrounding the United States as well as the countries of Western Europe has sparked interest in not only this precious metals, but semi-precious metals, industrial metals and commodities, as well.  In fact, in addition to tensions in the Middle East and global demand, many analysts believe that oil would be some $30/bbl lower if it not for the falling greenback.

All the while our Congressmen fiddle as Washington burns.  S&P’s Swann also stated that “our negative outlook on our rating on the U.S. sovereign signals that we believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years.  The outlook reflects our view of the increased risk that the political negotiations over when and how to address both the medium- and long-term fiscal challenges will persist until at least after national elections in 2012.”

In response to S&P, U.S. Treasury Secretary Timothy Geithner said this past Tuesday that there was “no risk” that the United States would lose its ‘AAA’ credit rating noting that “the President recognizes and the leadership in the Congress recognize that we have to start to bring these deficits down.”  In our opinion that is easier said than done as America must guard against forfeiting its reputation as the “land of opportunity” for one as the “land of entitlements.”

Standard & Poor’s has effectively managed to heighten the increasingly contentious debate between Republicans and Democrats, one which came to the attention of most Americans with the publishing of the recommendations on how to deal with our budget deficit by White House Fiscal Commission co-chairs Alan Simpson and Erskine Bowles and may only end with what may be one of the most important elections of our collective lifetimes, the 2012 Presidential Election.

THE BOTTOM LINE – America and Americans, including our elected officials, respond best in a time of crisis.  Make no mistake about it.  If we do not get the U.S. budget deficit under control, a crisis will occur.  Perhaps Standard & Poor’s, which by the way many believe is itself not without fault for the way it did or more accurately did not dispense accurate ratings information during the recent financial mess, has, by way of its ratings outlook revision from stable to negative, in a roundabout way issued a challenge to our President and Congress.  “Fix it.  Get us on the right track.”  Unfortunately, we believe that “fixing it” will include spending cuts by all municipalities, Federal, State and Local; tax hikes and changes to entitlement programs, including Social Security and Medicare.  If this is what it takes to right the ship, we’re all for all of the above and we believe so are the financial markets.

During February 2009, the Federal Reserve conducted a stress test of sorts, one in which evaluated the capital levels of the nineteen largest U.S. bank holding companies, those deemed “too big to fail.”  As a result of this test and according to a press release from the Federal Reserve, “the Federal Reserve advised bank holding companies that safety and soundness considerations required that dividends be substantially reduced or eliminated.  Since that time, the Federal Reserve has indicated that increased capital distributions would generally not be considered prudent in the absence of a well-developed capital plan and a capital position that would remain strong even under adverse conditions.”

In laymen’s terms, the Federal Reserve was attempting to make certain that the largest U.S. Banks had adequate capital to take them through another financial crisis without being bailed out by the U.S. Treasury.

Speed forward to present day.  A week ago Friday, the Federal Reserve announced that it had completed a second stress test, called the Comprehensive Capital Analysis and Review (CCAR) and as a result announced that “some firms are expected to increase or restart dividend payments, buy back shares, or repay government capital.”

One of the banks that have since announced dividend increases include J.P. Morgan whom raised their dividend from $0.05 per share per quarter to $0.25 per share per quarter for a yield of 2.18% based upon the closing price Thursday, March 24.  Prior to the whole financial mess that came to a head during early 2009, J.P. Morgan was paying a quarterly dividend of $0.38 per share resulting in a yield of more than 3.00%.  We believe that if an investor were to own only one bank, it would be J.P. Morgan.  We believe that they provide the best opportunity for capital appreciation relative to the risk that you would be assuming.  In addition, we believe that further dividend increases are likely and would provide a hedge against inflation.

Another bank that responded to the recently concluded CCAR by raising their dividend was Wells Fargo which announced a special $0.07 per share dividend for the first quarter in addition to their normal $0.05 per share dividend for a total dividend of $0.12 per quarter.  We believe that this “special” dividend may be incorporated into their normal dividend for the second quarter and beyond.  If so, Wells Fargo will now pay an annual dividend of $0.48 per share for a yield of 1.50% based upon their closing price Thursday, March 24.  In addition, the Board of Directors of Wells Fargo announced a 200 million share buyback plan totaling $6.4 billion.

Finally other financial institutions either announced dividend increases, share repurchases or plans to begin to repay the TARP funds borrowed by banks from the Federal Government.

THE BOTTOM LINE – It appears as if the Federal Reserve believes that the worst is behind us for the economy and as such the banks.  However, more so now than ever, there will most likely be a wide moat between the winners and the losers.  We believe that J.P. Morgan is a winner.  Another bank we are high on that is not cited in this column is First Niagara, a bank that combines the potential for capital appreciation along with solid income from dividend payments.

Many investors purchase or sell securities at precisely the wrong time.  Specifically, they buy high and sell low!  We believe that part of the reason behind these untimely transactions has to do with the rational expectation that one should accentuate the positives and reduce or eliminate the negatives in life.  Unfortunately, many times this does not work when investing money.  Let’s take a look at a couple of examples how this natural reaction works against you when investing.

We have many clients who own common stock in Ford Motor.  Ford has recently been trading at approximately $14.50 per share, twenty-five percent below its fifty-two week high of $19.00 set within the past twelve months.  In our opinion, the stock has been weighed down by a number of factors, not the least of which being the slowdown in the economy as well as the tragedy in Japan.  This drop in value has generated several telephone calls from individuals who think that Ford Motor may be a timely buy at these levels.  To bolster their case, they justifiably cite many reasons why business should remain strong for Ford, including their long-term global business outlook.  The question as to whether or not Ford is a good buy, in part because the share price has dropped is an appropriate manner of investing.  One may believe that the price has fallen to a point that more buyers than sellers will step in and, given the current economic environment, the share price will begin to rise.  Conversely, we are also receiving contacts from individuals who are concerned that the recent decline in share price is not yet over and are deciding whether or not to unload their shares.  They believe that the uncertainty surrounding the issues noted above will continue to weigh down the stock.  Only time will tell which investor has made the correct decision, the one who perhaps buys shares at this time or the one who sells.  However, both are making decision based upon the share price fluctuation and many times, this is a mistake.  Just because a stock you buy goes up, it does not mean you made a wise investment and conversely, just because a stock declines after your purchase, it does not mean you have made an unwise

decision.  We suggest that investors make informed decisions based upon the fundamental outlook for the company, the industry it operates in and the macroeconomic outlook both domestically and, the case of Ford Motor, globally.

Our second situation pertains to the individual who contacted us during 2010 and wished to

purchase shares of Ford Motor because it had moved from ten for fourteen dollars per share.  Or the individual who wishes to purchase shares because his neighbor has made a ton of money with Ford or the individual who won’t sell his or her shares because “Ford has been good to me over the years.”  All of these situations may be accurate, but it does not answer the prevailing question when deciding whether or not to make an investment.  That is, what is the potential for the stock price to appreciate?  Again, to answer these questions, one must once again look at the fundamental data surrounding business conditions for Ford Motor.

In our opinion, the change in the share price over a period of time is not nearly enough of a reason to purchase or sell the security.  You purchase a stock because you believe it has potential.  You sell when you believe there is a lack of potential or to move on to a company with more potential.

The potential for an investor to buy high and sell low is clearer when analyzing cash flows into mutual funds.  Mutual funds experience their greatest net inflows after having beaten their peers on a total return basis over a given time frame.  However, many of these same investors are buying high only to experience pain as those investments that made the mutual fund successful correct back down to a reasonable price.  For example, the emerging market funds during the year 2010.

Finally, cash outflows from bond-based mutual funds are at their greatest after interest rates rise.  This occurs because the trailing returns are subdued by the inverse relationship between bond prices and interest rates (as interest rates go up, the value of bonds decline and visa versa).  However, poor returns on bond funds are usually an indicator that the bond fund will perform better in the future.  This is once again due to the inverse relationship described above.  Therefore, generally speaking you should sell bond funds after a period of good performance and buy bond funds after a period of underperformance.

We revert back to our initial observation that when investing, it is often prudent to accentuate the negative and reduce the positives.  This translates into buying low and selling high.

As he does every year, famed investor, Warren Buffett, the “Oracle of Omaha” and Chief Executive Officer of publicly traded Berkshire Hathaway, writes a letter that precedes the Annual Report.  Needless to say, due to the historical stellar investment returns that Mr. Buffett has achieved at this conglomerate, what he has to say and what Berkshire has done is closely monitored.  We thought it might be of some benefit to investors to relate some of what Buffett has to say.

One of the more popular tenets Warren Buffett adheres to is one in which “we simply attempt to be fearful when others are greedy and greedy only when others are fearful.  This can be illustrated in the fact that during 2010, “in the face of widespread pessimism about our economy – we demonstrated our enthusiasm for capital investment at Berkshire by spending $6 billion on property and equipment.  Of this amount, $5.4 billion – or 90% of the total – was spent in the United States.  Certainly our businesses will expand abroad in the future, but an overwhelming part of their future investments will be at home.  In 2011, we will set a new record for capital spending — $8 billion – and spend all of the $2 billion increase in the United States.”

Should there be any doubt as to what this investment means, Mr. Buffett follows up this paragraph with “money will always flow toward opportunity, and there is an abundance of that in America.  Commentators today often talk of ‘great uncertainty.’  But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001.  No matter how serene today may be, tomorrow is always uncertain.”

Why do we focus on the day-to-day deafening negative noise filling our airwaves, newspaper columns and internet when someone with the business acumen of Buffett observes that “throughout my lifetime, politicians, and pundits have constantly moaned about terrifying problems facing America.  Yet our citizens now live an astonishing six times better than when I was born.  The prophets of doom have overlooked the all-important factor that is certain:  Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective.”  Wow!

Buffett wraps up the less Berkshire specific section of his letter with “we are not natively smarter than we were when our country was founded nor do we work harder.  But look around you and see a world beyond the dreams of any colonial citizen.  Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead.

Why do we believe they do not?  Do we listen to, read and then draw conclusions from those that have a vested interest to disseminate such negative information?.  As we often say, the Weather Channel has to sell advertising and can only do so by providing exciting, riveting weather-related information, sometimes regardless of the fact that perhaps it is 75 degrees and sunny outside with a forecast of more of the same.  We can say the same thing of the Business Channel.  All this said, we do believe that America is faced with many challenges.  However, over the long haul, we’re with Buffett.  We’d rather be on the side of America then bet against it.

As of the close this past Wednesday, the stock market as represented by the S&P 500 (the largest 500 publicly traded companies domiciled in the United States) has doubled from its ominous-sounding intraday low of 666.79 set on March 6, 2009.  With this in mind, rather than focus on how much higher this index might be able to go from here, a prudent investor is asking his/herself what could derail this upward momentum.  As prudent investors, our response detailed below.

First and foremost, the catalyst for the recovery that we have witnessed initially in the stock market and subsequently in the U.S. economy can be directly attributed to trillions of dollars of stimulus from the Treasury Department as well as the Federal Reserve in the form of a reduction in interest rates, taxes and two rounds of quantitative easing.  The hope is that this “kindling” will be enough to light a lasting fire under the economy, one that won’t go out after this “kindling” either is removed or runs out.  To date, this stimulus has been relatively effective, but, in our opinion, temporary in nature and temporary in its impact.

With Unemployment hovering around nine percent and down from a multi-decade high of over ten percent, a substantial change in the direction of the recently improving labor market could derail this stock market by dimming the optimism currently shared by businesses and consumers and result in a reduction in spending on both fronts.  For businesses, this would mean a curtailment in the addition of employees and reduction in capital investment.  For individuals, this would imply a reduction in discretionary spending as well as a reduction in spending on big ticket items like homes, cars and appliances.  Keep an eye on the job market.

A second potential catalyst for some serious downside to stocks could be a second leg downward in the housing market.  As is well documented, from mid-2003 through mid-2008 home ownership in the United States climbed from an historically normal low-sixty percent range to the mid to upper sixty percent range as banks and other financial institutions such as government agencies Fannie Mae and Freddie Mac eased lending standards and then packaged those loans to unsuspecting investors.  The result was a near cataclysmic drop of more than 30% in housing prices nationwide which ran concurrently with a severe economic slowdown which, as a nation, we are still emerging from.  At the present time housing demand remains tepid despite the historically low mortgage rates, rates which are slowly helping new homeowners soak up the excess inventory from overbuilding.  Should this demand weaken substantially, the entire U.S. Economy would also weaken placing this recovery in jeopardy.  Watch the housing market.

Rising commodity prices that may eventually cause inflation or worse stagflation is a cause for concern.  Food costs have risen 0.5% over the past month at the retail level while geo-political tensions in the Middle East as well as strong demand from the BRIC (Brazil, Russia, India, China) Countries have fueled higher energy costs.  The result is that consumers have less discretionary dollars in their pockets and businesses have become a bit cautious.  Watch food costs.  Watch what you pay at the pump.

Keep an eye on the politicians.  While researching the historical returns of the stock market over the past century or so we found that stocks during the third year of a Presidential Election Cycle (calendar year 2011) outperform the other three years by about a two-to-one ratio.  Furthermore, during the first six months of this third year stock investors reap almost their entire gains for the year.  After that, stocks historically move sideways until the Presidential Election, November 2012.  The reason is clear.  As the election season draws near, the political rhetoric and divisiveness grows thereby dimming the optimism of most Americans.  Listen to the news.  Listen to the rhetoric.  See if the Democrats and Republicans continue to play nicely together or begin swinging at each other.

THE BOTTOM LINE – We’ve had a nice rally off the lows.  Time will tell whether this was a short-term, cyclical rally or the beginning of a longer-term, secular move.  By paying attention to the job market, the housing market, commodity prices and our elected officials you may find a chair should the music stop.

Investors in the U.S. stock market seemed to have a classic case of “bubble-phobia,” loosely defined as “fear that this bull market will collapse in a similar fashion to ones in the not so distant past.”  These symptoms can afflict both the experienced professional as well as individual investors and include a failure to commit an appropriate percentage of assets to stocks based upon a fear that the current bull environment is unsustainable.  This “bubble-phobia” can further manifest itself in a lack of action by the investor thereby keeping said investor out of the stock market and reducing one to being reactive rather than pro-active.

Our prescription for the above referenced malady is simple – set up disciplines and follow those disciplines.  One way or another, decisions are made.  Either you make them, or through procrastination, they are made for you.

To help ease your case of “bubble-phobia,” we point to several reasons why the stock market is not in a bubble.  First and foremost, investors can feel comfortable that relative stock valuations are reasonable.  The thirty stocks that comprise the Dow Jones Industrial Average are expected to earn an aggregate of $945 this calendar year.  With the Dow trading at just over 11,800 this places the Dow’s Price-to-Earnings (P/E) Ratio, a common tool used for valuation, at 12.5, somewhat below the normal historical range.

Corporate profits benefit from a stable interest rate environment, one which makes for a more healthy current business climate as well as enabling business to better predict future trends.  Over the past two years, the ten-year U.S. Treasury Note has traded between 3.00% and 4.00%, very predictable indeed.  Furthermore, the Federal Reserve appears to be on hold with regard to raising interest rates.  In fact, some believe that the next move from the Fed will be to lower rates.

At this time, rampant inflation appears not to be an issue.  Due to the slack in the economy, both the Consumer and Producer Prices Indices, key measures of inflation, are subdued and now, with oil trading somewhere around $90 per barrel, the pressure on manufacturers and service providers to raise prices appears to have ebbed.

The leading stocks over the past few months have been quality companies with sound earnings and foreseeable growth in corporate profits.  They have not been speculative companies.  Historically, a market led by the “blue chip” companies, usually has not reached its peak.  It is when it is led by the speculative companies, those that retail investors like, the market has historically topped out.

Finally, retail investors have not fully embraced this rally.  As long as “bubble-phobia” continues to persist, there is most likely room left to run.  At this point in time, stocks are still climbing that venerable wall of worry.  At this time and if history is any guide, after a brief, relatively shallow pullback, we look forward to strong stock market at least over the first half of 2011.

Much ballyhooed financial analyst Meredith Whitney, the president of Meredith Whitney Advisory Group, whose prescient call on the banking sector during 2008 brought her to prominence in the financial services industry, has made another call.  However, this one has resulted in some criticism from equally prominent investors.  Either way, we believe that municipal bonds and bond funds will experience some headwinds for a variety of reasons.

First and foremost, let’s recognize one fact that is indisputable.  As interest rates go up, the value of bonds decline.  The only circumstance that would lessen or eliminate this decline would be a rise in the credit quality of the security, an event that most of us cannot count on.  After a nearly twenty-eight year bull market in bonds, the chances of interest rates going up is greater than them declining.   In our opinion, if the recovery proves sustainable, eventually interest rates will rise from these levels.   Furthermore, should interest rates decline this would imply an economic slowdown, one that would more than likely result in a decrease in credit quality rather than an increase.  Heads you lose, tail you lose.

Ms. Whitney recently stated that a crisis in the municipal bond market “is the largest threat to the U.S. economy” and that “fifty to one hundred” counties and cities could default on their municipal bond obligations over the next twelve months.  Adding to their woes is the fact that according to the Center on Budget and Policy Priorities, a Washington Research Group, in the aggregate states will have more than $140 billion in budget deficits, a sum, that will put pressure on the $2.8 trillion muni bond market.  That said, during an interview with Bloomberg News, Bill Gross, who manages the world’s largest bond portfolio for Pacific Investment Management Company (PIMCO) believes that “ultimately, municipal bankruptcies will be at a lower level” and doesn’t “subscribe to the theory that there will be lots of them.”

We would fall more to the side of Bill Gross, thinking that the worst of the financial crisis is over and that municipalities, like individuals, are beginning to come to the realization that they must get their fiscal homes in order.  That said, given the likely interest rate risk in the future as well as the potential for Ms. Whitney being more right than wrong, we would urge caution when investing in longer-dated municipal bonds and bond funds or concentrating all of your investments in this arena in one state or one region of the country.

THE BOTTOM LINE – Make no mistake about it.  Like investors in all bond funds, investors in municipal bonds can lose money.  For example, one of the nation’s largest municipal bond funds, over the past three months, the Franklin New York Tax-Free Income Fund has fallen more than seven percent while a popular fund for local investors, the Rochester Municipal Fund has fallen more than ten percent, sizable losses for normally risk averse investors.  That said, we subscribe to the time proven tenet that a bear market for bonds is still like a day at the beach when compared to a bear market for stocks.  However, this day at the beach may be cold and rainy.  Do not sell all of your municipal bonds.  However, keep them in line with your objectives and tolerance to risk.

If it wasn’t just rhetoric, politics aside, contained with the recent “State of the State” address by incoming rookie Governor Andrew Cuomo was much that should encourage investors.  First and foremost, after noting that “today we are at a crossroads,” in our opinion the governor then immediately and accurately states that “we are at a time of crisis that has been created by national economic pressures, out of control State government costs and a dysfunctional political system that has lost the trust of its people.”  We believe that it is this dysfunction both within New York State and nationally along with the loss of trust that is greatly responsible for the lackluster business climate.  That said, let us be fair and state that Wall Street also shares blame for the current economic malaise.

Although the devil is in the details and time will tell, in our opinion Governor Cuomo seems to have the right solution to turn the state around.  Early in his speech, he attributes part of the reason that 800,000 New Yorkers our unemployed on “the crush of the second highest combined state and local tax burden in the nation.”  Cuomo observes that “New York’s already hostile business climate – ranked 50^th in the nation – must change if we are to have prosperity.”

Echoing other governors regarding austerity measures that must be taken, Cuomo states that “our government costs are simply unsustainable – at this rate government employee pension and employee healthcare costs will collapse the State’s economy.  The cost of pensions and health benefits for active and retired employees will grow from $1.3 billion in 1998-99 to $6.2 billion in 2013-14 – almost a 476 percent increase.  State spending continues to exceed income and inflation.  From 2000 to 2010 State spending grew at an average rate of 5.9%, while personal income only grew 3.8%.”  As much as we would like to disagree with Governor Cuomo, we can’t.  This level of spending is unsustainable and will crush our economy. 

The solution to the above is to take steps that most families in New York have been forced to take, reduce spending and attempt to increase income.  To this Cuomo proposing a reduction in the number of local government entities from the more than 10,500 that currently exist; the creation of Regional Economic Development Councils; commercializing the research done at our states’ universities; creating jobs through better utilization of New York’s Low Cost Power and capping property tax increases at the lesser of the rate of inflation or two percent.

Governor Cuomo also proposes the establishment of the Spending and Government Efficiency (SAGE) Commission “whose charge will be to undertake a comprehensive review of every agency of state government and recommend structural and operational changes” to the more than 1,000 of them.

On a more immediate basis, Governor Cuomo plans to close the more than $10 billion 2011-2012 budget deficit without new taxes or borrowing by imposing a one-year salary freeze on most public employees whose contracts expire as of April 1, 2011 and imposing a spending cap that will limit growth of government.

These are only some of the points addressed in Governor Cuomo’s speech.  We suggest you Google “New York At A Crossroads / A Transformation Plan for a New New York” to read the speech in its entirety.

THE BOTTOM LINE – In order to create an economy that is conducive to job creation, the private and public sectors must work together.  If both try to gain the upper hand or get the most that they can for themselves, both will fall far short of their potential, leaving New York and New Yorkers once again at a disadvantage to other states.

As songwriter and poet Bob Dylan once wrote, “The Times They Are A Changin’” and indeed they are.  Calendar year 2010 closed out with a bang for most of the major stock market indices while bonds went out with a whimper, quite different from the prevailing winds prior to the fourth quarter as the economic ship seems to be slowly righting itself after a tumultuous three years.  Furthermore, despite the challenges of a weak housing and labor market, we believe this recovery has staying power at least into the third quarter of 2011 when the stimulus from the current tax package begins to wane.  At that time, at the latest, we’ll see if the U.S. economy has reached a sustainable, non-government induced, recovery.

For the investor this means, that unlike 2010 which was back-end loaded, we believe that if history is any guide, investors, after a brief pullback, will reap the majority of their returns during the first half of 2011.  In fact, after analyzing the third year of a Presidential Election Cycle, which happens to be 2011, back to the year 1900, it can be determined that this year outperforms all others on nearly a 2:1 ratio with the vast majority of these gains coming during the first half.  Given the level of stimulus coming from the Federal Reserve in the form of Quantitative Easing and low interest rates as well as the continuation and enhancement of the Bush-era tax cuts, until proven otherwise, we see no reason why this “third year” will prove to be any different.

What we believe will ultimately be good news for stock investors will probably be bad news for fixed income (bond) investors.  After a twenty-year year bull market in bonds due to declining interest rates, we believe that interest rates will slowly, but surely head higher, thereby pushing bond prices lower.  With this in mind, investors should focus on bonds with maturities of less than seven years and non-U.S. Treasury securities like corporate bonds and bond funds.

Our belief as stated above is that at this time the U.S. economy is in a cyclical or short-term recovery, one that has gained its footing in great part due to the massive injection of dollars by the Federal Government.  However, whether or not this turns into a secular or multi-year sustainable economic recovery, one that is led by the private sector, remains to be seen.  That said, there are some signs that the trend for our economy has taken a turn for the better.  Initial claims for unemployment benefits have been declining, exports remain strong, orders for durable goods have recovered, consumers have greatly reduced their dependence on revolving debt such as credit cards, temporary staffing has increased and the just passed holiday shopping season was buoyant.

Finally, we believe that given the results of this past November’s election, the voting public has put both parties on notice, indicating their unhappiness with the status quo.  We can once again quote Bob Dylan who writes “come Senators, Congressmen please heed the call, don’t block up the doorway, don’t block up the hall.”  In other words, either get the job done or we’ll vote you out.  Let’s hope this sentiment continues.

THE BOTTOM LINE – After a brief single-digit percent pullback, we believe stock investors would be well-served to add to their investments, be they either mutual funds or individual securities.  For bond investors, be wary of long-dated bonds and bond funds, concentrating on shorter-dated maturities of less than seven years.  Finally, keep an eye on the economy.  After all, “it’s the economy stupid” was a phrase used by Bill Clinton nineteen years ago that still applies today.

President Obama along with cooperation and what some may call it coercion from Republicans passed an all encompassing tax reduction plan, comprised of an extension of the Bush-era tax cuts for the next two years along with several new initiatives, all intended to stimulate economic growth.  The package signed into law this past Friday by President Obama will cost approximately $900 billion over the next two years and is intended to propel the U.S. economy into a sustainable, more rapid path to recovery, rather than the sluggish trajectory we are currently travelling.  There is something in the tax package for every American, from the least to most wealthy, a fact that caused some pushback from both parties.  However, unlike over the past two years, both sides of the political aisle were able to suppress some of the fringe opinions and come to a consensus.  Hopefully, this is a sign of positive compromise to come.

First and foremost, according to data supplied by the American Society of Certified Public Accountants (AICPA) and reported by The Wall Street Journal, the average individual filing single with adjusted gross income of approximately $40,000 will save around $400 per year, the average individual filing single with adjusted gross income of approximately $80,000 will save around $1,600 per year while the average individuals filing jointly with adjusted gross income of approximately $80,000 will save around $2,200 and those individuals filing jointly with adjusted gross income of approximately $160,00 will save around $5,500 for each of the next two years.  All of this is in comparison to what their federal tax burden would have been if the Bush-era tax cuts had been allowed to expire at the end of calendar year 2010.  The White House projected that the average taxpayer would save approximately $3,000 per year over the next two years.

A second major extension to the tax cuts that was passed was a continuation of the taxation of capital gains and dividends at a maximum rate of 15% rather than the 28% that was the previous cap on capital gains and the taxation of dividends as ordinary income, a rate that would have been as high as 39.6%.

The Child Tax Credit of $1,000 was also extended for the next two years.  The credit is available to parents whom have children living with them in their home.  It was set to fall to $500 on January 1^st if the tax package had not passed.  Furthermore, the tax package includes an extension of the Tuition Tax Credit, a credit of up to $2,500 for college students.

The bill also includes several new initiatives, all intended to spur economic growth.  For working Americans, the employee contribution to Social Security will be reduced to 4.2% of the first $106,800 of wages from the usual 6.2% that is currently being levied.  Although it may not sound like a lot, for joint filers with $80,000 of earnings, this will amount to $1,600 in savings.

The wealthy also stand to benefit from the tax package.  The legislation provides an exemption of any Federal Estate Tax for estates up to $5.0 million dollars while those with estates over that will be taxed at 35% beginning in 2011.  If the legislation had not passed or had been delayed, the exempted amount would have been $3.5 million dollars with a tax rate of 45%.

Finally, the tax package also allows for businesses to expense rather than amortize or depreciate business investments in 2011 which should provide an incentive for investment.  Analysts expect this benefit will save corporations approximately $100 billion, marking the largest temporary incentive to businesses in the history of the United States.

THE BOTTOM LINE – We, like many others, view this as another stimulus package, designed to help the United States economy permanently emerge from its deepest recession since World War II.  We also believe that this package could have been better designed, perhaps allocating more of the $900 billion to those with incomes at or around the median and less for those with incomes above.  However, we also believe that the provision for companies to expense capital investment is a home run as is the extension of the income tax rates and the reduction in the employee component of Social Security.  That said, it better work.  We, as a country, are running out of time and money.  All in all, we give this program a B+.