Glassman Wealth Services LLC

As financial advisors, we look at a broad range of market and economic forces to form our investment decisions. In our monthly economic report, we take a look at the effects these forces have had on markets nationally and globally during the month. This broader perspective helps us to provide more insightful investment and financial planning advice to our clients. Click Here for report.

Last week, two key reports on the state of the financial and consumer sectors were released. By all accounts, the consumer deleveraging cycle remains intact, despite an apparent willingness on the part of banks to reengage the lending machine. That will continue to pressure economic growth in the coming quarters, similar to prior debt deleveraging cycles.

At the start of the week, the Federal Reserve Bank of New York released its quarterly review of household debt and credit, an aggregated view of trends in consumer debt. According to the NY Fed, aggregate consumer debt fell 1.1% in the fourth quarter to $11.53 trillion.

The largest decline in debt outstanding occurred in housing-related debt, which saw mortgage balances fall an additional $134 billion in the fourth quarter. Unfortunately, the housing situation remains tenuous as 2.2% of mortgage balances moved into delinquency.

One of the primary reasons for the continued persistence of high delinquency is the number of homeowners estimated to be “underwater.” Mortgage data provider CoreLogic estimated there were 11.1 million homeowners underwater in the fourth quarter, or roughly 23% of all residential properties that have a mortgage. In total, CoreLogic believes there is more than $715 billion of negative equity weighing on the housing markets.

There is a degree of good news on the horizon. The number of delinquent loans grew exponentially from 2008 through early 2010, before beginning a slow, gradual reversal. With the recent announcement of a $25 billion mortgage settlement, delinquent balances are likely to fall more quickly. This is due in part to the fact that $10 billion is earmarked for principal reductions and loan modifications for borrowers nearing foreclosure. Another $3 billion is going to help underwater borrowers who remained current on their payments.

The other bit of encouraging news came from the Federal Deposit Insurance Corporation (FDIC) in the form of its Quarterly Banking Profile. Based on FDIC data, bank profitability reached a 5-year high in 2011.

At the same time, the number of banks failing or considered “problematic” is on the decline. In the fourth quarter, 18 financial institutions failed and the number of “problem” banks fell from 844 to 813.

With banks feeling more sanguine about their current situation, they have become more willing to lend capital to consumers and institutions. Loan balances were up $130 billion in the quarter, representing the third consecutive quarter of loan growth. It also represented the largest quarterly increase since 2007.

Although banks are seemingly more able to lend, consumers are simply not in the frame of mind to embrace another credit binge. Bank lending will provide obvious benefits to the economy, but until consumers feel more secure in their own financial situations, the push and pull between lending and borrowing will act as only a modest stimulant to the economy.

By:  Barry Glassman, CFP, president of Glassman Wealth Services

Anytime you have to redraw or resize a chart to accommodate one piece of data – a severe outlier, if you will – you have to talk about it. Since it likely means something is amiss, you ignore it at your own peril. It begs the question, then, as to why the media, economists and politicians of the world continue to furiously debate the potential ripple effects of debt-laden economies like Greece, Spain, Italy and, to a lesser extent, the U.S., while ignoring the elephant in the room: Japan.

Let’s take a step back and get some perspective. With the benefit of hindsight, most of us can look back at different points in our lives and wonder, “How did I miss that?” Take, for example, the dot-com bubble. Anyone who got burned when the bubble burst wishes they could go back in time and do things differently. But in 1998, when valuations for companies that were little more than business plans fetched millions of dollars, everyone seemed to have a reason or two to overlook the obvious flaws in this model.

Similarly, just about everyone hopped on board the real estate express train – and got burned when it derailed in spectacular fashion. When we look back at the signs – such as the 2006 home affordability index – it’s clear that the gains in home prices simply could not continue.

If we were to go back, then, and create charts using the valuations of houses and dot-com stocks as data points, we would have needed to redraw the scale of the chart to accommodate a few stratospheric outliers – a clear sign that something wasn’t quite right. Spider-Man’s “Spidey Sense” would have been ringing off the hook.

Well, what we see from the chart below should be causing our early-warning systems to shift into full air-raid mode. Not only is the bubble representing Japan’s debt crisis a big giant outlier, it looks just overripe enough to burst. Or, as John Mauldin put’s it in his book, The End Game: “Japan is a bug in search of a windshield.”

Click here to enlarge

What Mauldin means by this is that any entity, whether it is an individual, family or a nation-state, can handle debt a whole lot easier when interest rates are low. But when you’re already deeply leveraged, as Japan is, even the slightest upward tick in the cost of that debt will have a massive impact on that entity’s ability to keep servicing their debt. Translation: Bug meets windshield.

Case in point: Mauldin estimates that a 1% hike in Japanese interest rates would eat up a full 10% of the nation’s tax revenue. Compounding the problem is that any additional small changes in the nation’s savings, growth or inflation rates could easily increase the cost of servicing its debt to a point of no return. Compare that to the U.S. where a bump in the interest rate from 2% to 3% could easily be digested.

So why hasn’t Japan made the headlines for risk?

1. First off, Japan has the lowest borrowing rate in the developed world. Even with the fallout from their recent earthquake, tsunami and nuclear meltdown, the country’s bond yields plummeted and its currency soared. Demand for government bonds has kept constant due, at least in part, to high private savings rates combined with the requirement of their multi-national banks to own Japanese bonds.
2. Japanese citizens and banks own the vast majority, some 94% of the country’s bonds. That’s why Japan, unlike the U.S., is able to fund its own debt.
3. Japan has experienced long-term deflationary pressures, which has helped to keep interest rates low.

Add in Japan’s rapidly aging population, which could soon cause a downward shift in the nation’s savings rate, and you’re left without any good long-term solution to this equation. We’re fond of saying that growth solves everything. But in the case of Japan, growth – and the accompanying spike in inflation and borrowing costs – could be its worst nightmare. While no one might want to admit it, therefore, Japan might just be too big to save.

Knowing the exact point when a bubble is going to burst is hard to predict, however, as our examples of the dot-com and housing markets show. That means that Japan might not find itself in any further dire straits for some time to come. The idea, then, is that we need to keep Japan on our radar so we can monitor any fluctuations in the nation’s borrowing rate due to things like inflation or even just plain old fear.

  This article was also published in Investment News.  Click HERE for the article.

2012 is going to be a busy year. Not only because of the presidential election but also because by the end of the year it’s likely that many Americans will face higher tax bills.

Why the higher taxes? Well, part of it is due to the expiring Bush tax cuts and the other part to a new Medicare tax on investment or unearned income for families with incomes above $250,000.

Whether Obama wins or loses the election, most believe that at a minimum, he will let the Bush tax cuts expire for those families earning more than $250,000, and perhaps for those below that threshold as well.

With this in mind, we have outlined the projected tax increases, and suggested ways to lessen the impact of these impending higher taxes on your income.

Since the year is still young and we expect there to be a lot of political maneuvering in the upcoming months, we plan to revisit this issue throughout the year, and provide updates to our strategies as circumstances change.

Projected Tax Increases on Earned and Investment Income in 2013:

Unless Congress decides to keep the Bush tax cuts for families whose income is below $250,000, rates will increase for all tax payers.

For those who earn more than $250,000, your Medicare tax rate will also increase from 1.45% to 2.35%. For every $100,000 of income you will pay $900 more in Medicare tax.

The biggest increase will be felt for those who depend on investment income. Up to now, unearned or investment income has not had to pay the Medicare tax that is imposed on earned income. That changes in 2013. Not only will tax rates substantially increase on dividends and capital gains, an additional 3.8% Medicare tax will be added to families making more than $250,000 a year.

Fortunately, a significant exemption applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans.

8 Strategies to Reduce Your Tax Bill:

With these tax increases in mind, here are eight ways to potentially reduce your future tax bill:

1. Sell appreciated assets to realize gains this year at the 15% rate
2. Exercise your non-qualified stock options and pay the ordinary tax at today’s lower rate
3. Shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities and IRAs, or to Roth accounts. Increasing contributions will reduce income and may help you to stay below applicable thresholds. Small business owners may want to set up retirement plans, especially 401(k) plans, and should consider increasing their contributions to existing plans.
4. Delay charitable donations until 2013. The value of those deductions will be greater as the tax rate increases. Ex. For those who itemize deductions, the tax savings on a $10,000 donation is $460 more when calculated at 39.6% rather than at the 35% rate.
5. Delay to 2013 rather than prepay 4th quarter estimated state income tax payments. This could be particularly attractive if congress eliminates the alternative minimum tax in 2013.
6. Run the numbers again on taxable vs. tax-free investments to see if the equivalent yield on your taxable investments (taxable yield less the taxes you paid on it) is greater than the tax-free yield. Higher tax rates may make tax-free investments more attractive.
7. Business owners and LLC corporations should consider billing earlier if possible to realize more income before year end rather than in January, 2013
8. Consider a Roth conversion this year if you anticipate that your future tax rate will increase next year and in retirement

Estate and Gift Tax May Increase Too

Most estate planning attorneys and policy-makers believe that the estate tax exemption, currently at $5 million has nowhere to go but down. If nothing is done by year end, the exemption will revert to $1 million – levels last seen in 2001/02, and the estate tax rate on anything above that amount will rise to 55% from 35%. In addition, for 2011 and 2012, the lifetime gift tax exclusion follows the $5 million estate exemption. Up to this time the lifetime gift exclusion was decoupled from the higher estate exclusions. Many see this as a passing opportunity that may not come this way again.

Then there is the issue of portability. Let’s say that one spouse dies and has used only $2 million of their $5 million exemption. Portability allows the surviving spouse an $8 million exemption – their $5 million and their spouse’s remaining $3 million. Without any new legislation in 2013, the portability provision is slated to disappear. This causes many to question traditional gift splitting techniques.

“We have already put on the brakes for gift splitting on clients who have not exceeded the current $5,000,000 per person lifetime limits,” said Chris Sintetos, a partner at Argy, Wiltse and Robinson, a tax and business consultancy firm in McLean, VA.

For example, let’s say that a couple has not used any of their lifetime gift exclusions and plans to make a $2 million gift this year. If each spouse gifts $1 million this year, they risk using all of their lifetime gift exclusions should the law revert back to $1 million next year. If their entire $2 million gift is given by one spouse, they would have no tax to pay in 2011-2012, while the second spouse still has their $1million in tact in the event portability does not survive.

All of the unknowns will require each of you to examine your own crystal ball as many tax professionals are questioning their own beliefs regarding the direction of tax changes. Because of this, where there are income recognition elections, many are extending their clients’ tax returns for both 2011 and 2012 to get the benefit of more election- year hindsight.

Regardless of political affiliation, everyone agrees the deficit must be reduced. Most likely this will require both an increase in revenue (taxes) as well as spending cuts. Once this compromise is reached, the debates will begin on who can afford the increase in tax. My guess is if you are reading this article your taxes won’t be going down. It is just a question of how they will be determined.

The yield on Treasuries has long been considered risk-free because the likelihood that the government would default is perceived to be extremely low. But what if the actual yield is negative? Would that be considered risk-free? Hardly.

With 10 year Treasuries yielding around 2%, there’s very little room for our cost of living to go up before the actual return on those “risk-free” Treasuries becomes a negative number.

Now, as our dollar continues to weaken, prices are going up on the things we import like gas, computers, cars, and clothes. In fact, prices on all imports have increased 7.1% in the last 12 months according to the Bureau of Labor Statistics. If we look at just fuel imports alone, prices have increased 20.8% during that same time.

While investing in Treasuries doesn’t make much sense for the average investor, Europe’s banks can borrow at a 1% rate from the European Central Bank (ECB) and make a 100% risk-free return by investing in US Treasuries at 2%.

We have long said that the Fed is using these low rates to help fix the economy, while giving little help to those who can ill afford taking on more risk – retirees and those needing income from their portfolios. While we can hope that inflation stays below the 10-year Treasury level, this is no “safe” place for most investors.

Every few months, inflation or deflation resurfaces as the featured topic of discussion. There seems to be an even divide of individuals who believe inflation is a foregone conclusion and those who feel deflation may actually be the bigger concern. Both outcomes are relevant in their own right, but there are growing signs that hidden inflation is creeping into the American economy.

For example, in the month of January, consumer prices rose 0.2%. That came after little or no increase to CPI from October through December. By most accounts, inflation is far tamer than earlier in the post-recession period.

By other accounts, however, inflation is at the start of a pernicious cycle. The Federal Reserve Bank of Cleveland looks at median CPI, which provides a more accurate assessment of underlying inflation trends. Median CPI is approximately 50% more accurate than CPI and 25% more accurate than core CPI.

Based on the Cleveland Fed’s analysis, median CPI rose 0.2% in January, following identical 0.2% gains in each of the previous four months. In fact, median CPI has gradually trended higher for the better part of the past 18 months. Over the past 12 months, median CPI is up 2.4%, the highest reading since early 2009.

Higher Prices and Stagnant Wages

A critical component of the inflation picture remains unsolved: wages. With the unemployment rate still stubbornly high at 8.3%, and every ounce of productivity being squeezed from those who are employed, there is little room to negotiate higher salaries.

At the same time, Americans are likely paying the most attention to what they are spending at the pump. Retail gas prices are at the highest level ever for this time of year. Nationally, prices are at $3.53 per gallon and $4 gas is expected by summertime. According to some economists, a 25-cent per gallon increase costs the economy and consumers some $35 billion.

Gasoline is certainly not the only input into the cost of everyday living, but it is one of the most noticeable and prevalent for consumers. Concerns about the evolving situation in Iran only enhance fears that prices could skyrocket at a moment’s notice.

Banks/High Unemployment Keeping Inflation in Check for Now

Inflation has long been a fear of economists given its “sticky” and stubborn unwillingness to retreat once achieved. Those fears were only heightened once the Federal Reserve began a radical expansion of its balance sheet to prop up banks and other struggling institutions.

Thus far, those measures have aided the firms in need, but largely remained trapped within those echelons and unable to find their way into the broader economy. If, and when, banks and other financial institutions deem it timely to begin lending en masse, we will see a quick shift in inflationary dynamics.

That event is viewed as being far away, but with the economy improving, and inflation returning to many segments of the economy, banks may be the next frontier.

Investors should pay close attention to what the banks do next, as they hold the key to any future inflation. For now, inflation is not ready to fully reveal its presence given high unemployment and only moderate economic growth, but do not be surprised if prices accelerate over the next few quarters.

As financial advisors, we look at a broad range of market and economic forces to form our investment decisions. In our monthly economic report, we take a look at the effects these forces have had on markets nationally and globally during the month. This broader perspective helps us to provide more insightful investment and financial planning advice to our clients. Click Here for report.

Consumers are an integral cog in the American economic engine, but since the financial crisis hit its crescendo, consumers have been under high attack. By most traditional measures, the economy is larger today than any time in our history, but it is hard to argue that consumers are feeling the benefits of that expansion. That said, consumers seem to be taking a new view on debt and spending, all in the name of prudence.

With the benefit of hindsight, virtually everyone can agree that consumers came through the mid-2000s with too much debt, and too little concern about how to pay that debt. Measures such as the household debt service ratio, which measures debt payments on mortgage and consumer debt, reached record highs, nearly hitting 14% in the third quarter of 2007. The good news is that those figures have actually fallen faster than they rose.

Since 2008, the debt service ratio has fallen nearly 3 percentage points and stands at levels last seen in the mid-1990s.

As consumers started to feel mildly better about the economic outlook and about their personal financial situations, they naturally began spending more money.

Throughout 2011, for instance, consumer spending posted a 2.2% gain, after rising a similar 2.0% in 2010. However, those gains are largely coming from a drawdown in savings as opposed to wage growth. After peaking at above 7%, the personal savings rate has steadily declined over the past two years and fell as low as 3.5% in November before a slight rebound in December.

One of the primary reasons consumers have been reticent to spend has been a simple lack of sustained wage growth. In recent months, wages have bounced around in a volatile fashion, falling over the summer, before jumping in the fall and weakening again as winter approached.

Consumers have at least one reason to be optimistic. Labor markets are inching toward definitive improvement for the first time since the recession ended. Initial claims for unemployment benefits have consistently tracked below 400,000 since early November, the longest such period since mid-2008.

Consumers are in better shape than 2007-08, be it from “strategic defaults” or through intentional efforts to act responsibly, but there remains a long way to go to reignite such a vital cog. The good news is that labor markets are gradually thawing, and such improvement should lead to higher wages and better employment prospects.

Glassman Wealth Services was ranked in the top 10 nationally of RIA “Practices to Watch” by Financial Planning Magazine.  Read more about our Awards and Accolades.

As financial advisors, we look at a broad range of market and economic forces to form our investment decisions. In our monthly economic report, we take a look at the effects these forces have had on markets nationally and globally during the month. This broader perspective helps us to provide more insightful investment and financial planning advice to our clients. Click Here for report.