Economic & Market Outlook: Summer 2010 

Provided by Mark Holloway

Mid-year is an appropriate time to reassess where we are economically and politically.  While the economic outlook is still uncertain, there are some inferences we can draw from the sea of recent economic data released by governments here and overseas.

First, European economies are reaching a crisis point in terms of deficits, economic growth, sovereign indebtedness, and in some cases, social unrest.  Plans by politicians to reduce social programs and reduce spending have been met with skepticism from the banking system and from more stable members of the European community. This has caused the Euro to decline against the dollar and heightened fears of a second wave of European bank problems.    
Second, there are a number of recent signs that the United States economy is slowing.  Sales of new and existing homes have shown surprising declines in spite of the tax incentives for first time buyers and very low mortgage rates.  Foreclosures and home price declines all accelerated in the last quarter indicating that the real estate crisis is still an ongoing problem and will continue to have a negative impact on consumer balance sheets, confidence, and spending habits.

Business confidence, spending, and hiring are all being adversely impacted by the unknown future costs of mandated health care, the cap and trade legislation, new financial regulation, and tax increases.  All of this has created an anti-business climate and higher than normal unemployment.  Businesses will be reluctant to add to payrolls until some of the costs associated with these issues are resolved.  Expect high unemployment for a longer than normal period of time resulting in reduced consumer spending and lower tax revenues.

The expiration of the Bush-era tax cuts on income, capital gains, and dividends is contributing to a decrease in investor confidence.  This lack of confidence is evident in the recent increase in stock market volatility.  Stock market volatility is up by almost every measure indicating that investor time horizons have shortened.  Additionally, fixed income markets have become less liquid as a result of increased regulatory requirements on capital ratios and liquidity at brokerage firms.  These new regulatory restrictions have made dealers reluctant to risk capital in the secondary market thus making bids on seasoned bond issues harder to obtain.

Third, Government spending at the state and federal level has increased significantly while at the same time tax revenues have been reduced by the slow economy and high unemployment.  The resulting deficits have limited the government's ability to respond to another slow down in economic activity.  It is also questionable whether government spending is the most efficient way to stimulate economic activity.

Finally, the world has become a more dangerous place. The threats of a nuclear Iran and North Korea, the Iraq and Afghanistan wars, and the threat of terrorism have further deteriorated consumer and investor confidence.  The cost of the wars and the increased expense of homeland security to protect us from terrorist activity are adding to the budget deficit.
How will all of these factors impact the capital markets?  First we expect interest rates to remain low well into 2011 for the following reasons:

»    Inflation remains under control.  Inflation is directly related to the level of interest rates.  High inflation begets higher rates and vice versa.  Low inflation will also allow the Federal Reserve to keep rates low to support the economy and the weak housing market.
»    The recent strength in the dollar has made dollar-denominated securities more appealing.  The economic problems in Europe are causing bankers and investors to shift funds to the United States because of the relative stability of our economy.  This increase in demand will help keep rates low.
»    The Federal Reserve appears firmly committed to supporting the fragile recovery and the weakened banking system.  Their main policy tool for positively impacting economic activity is lower rates.
»    Interest rate futures contracts indicate that rates will remain low through next year.
Second, the stock market will become more volatile and returns will be lower.  The bell shaped curve representing historical returns has flattened over the last decade with the probability of extreme tail returns increasing and the long term average return from the stock market declining.  The high correlation in returns from traditional financial assets will continue to make it more difficult to diversify portfolios adequately to protect them from market declines.

During this period of uncertainty and higher volatility we have reemphasized the importance of dividends in our security selection process.  Dividends were a large part of the total return from stocks and provided downside support during past economic periods that were similar to what we are experiencing today.  We are also concentrating on companies with stable sales and earnings growth and that have clean balance sheets.  Companies with these financial characteristics are better able to reward shareholders with increased dividends and share repurchases.  We continue to scrutinize corporate financial filings to determine the suitability of the accounting methods the company uses and to insure that management values are in line with shareholders as to corporate governance and cash flow strategies.  
 
 
  

Investment Strategy For 2011 Tax Changes

Provided by Cynthia Armstrong

 
The year 2011 brings higher taxes in three important areas-income, capital gains, and dividends. As a result, investors will benefit from guidance by financial and investment advisers to adjust their portfolios ahead of the new tax environment that they will face in 2011.

Many of the Bush-era tax cuts are set to expire at the end of this year, the two significant items being income tax rates and capital gains tax rates. The long-term, capital gains tax will rise from 15% to 20%. The tax on dividends will rise from 15 percent to a maximum of 39.6 percent, because dividends will be treated as ordinary income.

Additionally, the health-care bill that Congress passed in March of this year contains a new 3.8% "Medicare" tax on net investment income on couples earning more than $250,000 ($200,000 for singles). Please note that the bill also contains an additional 0.9% federal payroll tax for these so-called high earners. These additional taxes are effective beginning with the 2013 tax year.
Net investment income consists of gross income from interest, dividends, annuities, royalties, and rents not derived from an active trade or business, any other gain from a passive trade or business, and net taxable gain from dispositions of property not used in an active trade or business, less expenses. According to the Joint Committee on Taxation, only amounts included in taxable income are included, so amounts such as tax-exempt interest and excludable gain from the sale of a residence are not subject to the tax.

Therefore, many wealthy Americans in the top tax brackets will face an increase in taxes on their investments in 2011, and again in 2013.

What should a  "high earners" do now? The increase in the taxes on dividend income, besides encouraging investors to favor capital gains over dividends, might encourage more investors to favor tax-exempt bonds. A comparison of taxable versus municipal bonds considering a person's tax bracket is still necessary to determine which investment vehicle is appropriate. Our investment team at Stock Yards Bank & Trust Co. also believes municipal bond buyers should be cognizant of quality ratings and purchase bonds, such as financing necessary services due to recent state budget constraints.

Does it make sense to cash out some winners and accelerate capital gains taxes?  Should those who have been meaning to rebalance a taxable portfolio do so in 2010, when taxes on both long-term and short-term gains (taxed as ordinary income) should be lower?
Our investment and administrative teams are proactively reviewing the upcoming tax law changes when implementing financial and investment strategies for our clients.

 

Wealth Management Group Continues To Grow

Provided by Kathy Thompson


Alex Say recently joined the Wealth Management Group as a Wealth Advisor who assists clients with estate planning.  Alex is also responsible for the administration of personal trust accounts and estates, particularly those including complex or special assets.  Prior to joining Stock Yards Bank he served as in-house counsel for a large national foundation and also practiced law in the areas of tax and estate planning. 

Welcome Alex!