Shareholders’ “Powerball” Payout December 7, 2012

Weekly Market Commentary from Garrett & Robinson

Last week’s record $587 million Powerball jackpot grabbed headlines. But some shareholders may get their own “Powerball” payout in the next few weeks as companies seek to distribute special dividends that may total a record $100 billion to shareholders ahead of the likely expiration of the Bush-era 15% top tax rate on dividends at the end of the year. Cash has built up with companies hesitant to spend on hiring and new equipment, given fiscal cliff concerns and stalling earnings growth. Companies are paying out a record amount of this cash to shareholders this quarter in the form of regular and special dividends.

Special dividends are one-time cash distributions companies make to shareholders outside of regular dividend payouts. Dividends are currently taxed at 15% based on the Bush tax cuts passed 10 years ago in 2003. However, dividends will likely revert to the prior 39.6% rate at the end of this year and rise to 43.4% for households earning more than $250,000, due to the added investment tax from the Affordable Care Act (ACA). That potential tripling of tax rates on dividends has prompted a response among corporations.

Last week saw Whole Foods and Las Vegas Sands among the latest companies to announce a special dividend. In addition, some companies, such as Wal-Mart Stores Inc., have moved up their regular quarterly dividend payments to the end of December from the beginning of January to get ahead of the potential tax changes. Companies are scrambling to distribute dividends — even if they do not have the cash to do it. Dividends are typically paid out of earnings, but Costco’s $7 per share special dividend is largely funded by a new bond issue.

Will such payouts become rarer after the rates go up? That may depend on where the rates go. The dividend payout ratio (the percent of earnings paid out to shareholders as a dividend) has been volatile due to recessions that cut earnings while companies often maintain dividend payouts. Examining the trend over a long period reveals that the dividend payout ratio appeared to stabilize following a 50-year decline after dividend tax rates were lowered in 2003, but has not started to trend higher [Figure 1]. Much higher tax rates on dividends — going from 15% to 43.4% — would make it less likely that payout ratios will rebound much beyond this quarter.

However, we do not expect dividend tax rates will nearly triple in 2013. Instead, the tax bill that passed the Democratic-led Senate this summer had a top rate for capital gains and dividends of 20% (plus 3.8% for the ACA). If the Republican-led House were to pass this bill — or a similar one in a lame duck session compromise — it could be quickly signed by the President to turn a massive dividend tax surge into a modest rise that may not have much of a discernible effect on corporate or investor behavior in 2013.

No matter how much dividend tax rates go up in the quarters ahead, companies may find it more efficient to return capital through share buybacks than dividends. The dividend yield of the companies in the S&P 500 has nearly intersected with A rated corporate bond yields. The gap has shrunk from 5% to about 0.5% over the past four years, as you can see in Figure 2. If this gap closes further — a possibility if we go over the fiscal cliff — companies may find not only is it more tax efficient to buy back shares in order to return cash to shareholders, but it may actually generate more cash for companies to substitute lower yielding debt for stock. And some companies may be doing just that. Investment-grade bond issuance exceeded $120 billion in November 2012, the second largest on record, as share buybacks are on the rise.

High dividend-yielding U.S. stocks, particularly in the telecommunications services, consumer staples, and utilities sectors, could now take advantage by issuing debt to buy back shares to conserve cash and seek to maximize shareholder returns. So if you are looking for yield, stocks are becoming more attractive relative to bonds for both investors and for corporate leaders.

The stock market capitalization weighted debt rating of the S&P 500 companies is as follows:

• 42% of the market capitalization of the S&P 500 is rated A;
• 23% rated higher (AAA or AA);
• 26% rated lower (BBB or worse); and
• 9% are not rated

IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk, including the risk of loss.

Investment-grade corporate bonds: The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Dividend-paying stock payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer.

An obligation rated ‘AAA’ has the highest rating assigned by Standard & Poor’s. The obligor’s capacity to meet its financial commitment on the obligation is extremely strong.

An obligation rated ‘AA’ differs from the highest-rated obligations only to a small degree. The obligor’s capacity to meet its financial commitment on the obligation is very strong.

An obligation rated ‘A’ is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor’s capacity to meet its financial commitment on the obligation is still strong.

An obligation rated ‘A’ is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor’s capacity to meet its financial commitment on the obligation is still strong.

All company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL financial does not provide research on individual equities.

INDEX DESCRIPTIONS

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Member FINRA/SIPC

Budget Myths November 20, 2012

As Congress and the President work together to avoid the looming fiscal cliff during the lame duck session of Congress, a more intransient problem remains in the background: the United States’ structural budget deficit. In our recent Weekly Economic Commentary: Budget Debate (10/29/12), we wrote about how often the budget was mentioned during the campaign season, and we pointed out that the economy and the labor market got more attention than the longer term budget issues facing the country. In late 2010, three different non-partisan organizations released plans that would put the U.S. budget on a path toward a balanced budget, using a combination of revenue/tax increases and spending cuts to achieve that goal. These organizations are:

• The President’s National Commission on Fiscal Responsibility and Reform (commonly known as Bowles-Simpson);
• Bipartisan Policy Center (commonly known as Rivlin-Domenici); and
• Pew-Peterson Commission on Budget Reform.

While each plan differed on certain aspects of the longer term fix for our budget woes, they all generally agreed that there are no easy answers and no quick fixes. Both Democrats and Republicans populated the three commissions. Some hold (or once held) elected office, while others served in the federal government or were on the boards of the many think tanks in and around Washington. All were focused on finding bi-partisan solutions to the problem. In general, the three commissions concluded that in order to successfully tackle the longer term deficit problem, formerly politically untouchable areas must be on the table in any serious negotiation. These areas include:

• Social Security;
• Defense spending;
• Farm subsidies;
• Medicare;
• Medicaid;
• Personal and corporate tax rates; and

„„ So-called tax expenditures, more commonly known as personal and corporate tax deductions ( e.g., home mortgage interest, state and local real estate tax, or charitable contributions).

The plans did vary on the amount of revenue increases (via some combination of higher tax rates, fewer deductions, and more income subject to taxation) relative to spending cuts (across all categories of federal spending) needed to achieve a long-term path toward fiscal stability. The outcome of the November 6 election suggests that the ultimate mix of revenue increases and spending decreases that will set the country on that path is likely to be more reliant on revenue increases than spending cuts than if Governor Romney won and/or the Republicans took control of the Senate.

Absent from the list above are several budget items that receive a great deal of attention in the media, but are not a significant source of the nation’s long-term budget woes. For example, both the Bowles-Simpson plan and the Rivlin-Domenici plan noted that budgets cannot be balanced by eliminating waste or earmarks, by just cutting domestic discretionary spending, by growing our way out of the deficit, or by only raising taxes or cutting foreign aid — or all of these together. To illustrate why this is the case, we focus on the impact of waste, fraud, and abuse, domestic discretionary programs, and foreign aid have on our budget. In future commentaries, we intend to tackle some of the other items in the budget.

 

 

 

 

 

 

 

 

 

 

 

 

 

Waste, Fraud, and Abuse: Impact
The libertarian Cato Institute, a Washington, D.C.-based think tank, estimates waste, fraud, and abuse in the federal budget at between $100 billion and $125 billion per year. On an absolute basis, this is an enormous amount of money, and taxpayers and the financial markets would welcome any and all steps to eliminate this from the budget. However, the annual outlays of the U.S. federal government in fiscal year 2012 were $3.5 trillion. So even if somehow the federal government were able to eliminate every dollar of waste, fraud, and abuse in the budget, federal outlays in fiscal year 2012 would still have been well over $3.3 trillion, and the federal deficit in fiscal year 2012 would have been $960 billion instead of $1 trillion.

Domestic Discretionary Spending: Impact
Let us now examine domestic discretionary spending. The federal budget can be sliced and diced several ways. One way to look at the budget is by function or cabinet post, i.e., Department of Labor, Department of the Interior, Department of Defense, etc. Another way is to group the spending categories together by legislative mandate. For example, all mandatory spending (regardless of function) is grouped together, and all non-mandatory spending (also known as discretionary spending) is grouped together. Mandatory spending is all spending that is not controlled through Congress’ annual appropriation process. For the most part, mandatory spending is based on eligibility criteria and benefit of payment rules set into law. Examples include Social Security, Medicare, Medicaid, and interest on the public debt. In recent fiscal years, mandatory spending has accounted for nearly two-thirds of all federal spending, and this slice of the pie is set to rise dramatically in the coming decade.

Discretionary spending is what Congress agrees to spend each year on things like national defense, education, Veterans Affairs, the national park system, etc. In recent fiscal years, discretionary spending has accounted for about one-third of federal budget outlays. Nondefense discretionary outlays ($528 billion in fiscal year 2011) alone account for only 10 – 15% of total outlays. Thus, even if we eliminated all nondefense discretionary spending — which would literally wipe out whole Cabinet level departments and hundreds of politically sensitive programs championed by both Republicans and Democrats — it would only make a small dent in the overall deficit.

Foreign Aid: Impact
Although not a single line item in the budget, foreign aid receives a great deal of attention in the media. A 2010 poll conducted by the University of Maryland’s Program on International Policy Attitudes found that Americans thought that the United States spends 25% of its budget on foreign aid. Foreign aid is mostly part of discretionary spending, but at around $40 – 50 billion per year accounts for roughly 1% of federal budget outlays, far less than the 25% of the budget the public thinks is spent. These outlays are found in the budgets of the U.S. Treasury, the Department of Agriculture, the State Department, and even the Department of Defense for items such as:

• Embassy security;
• The Peace Corps;
• Disaster assistance;
• Peacekeeping;
• Direct economic support to foreign nations;
• The World Bank, IMF, and United Nations; and
• Global health initiatives.

 

 

 

 

 

 

Putting It All Together
All together, waste, fraud, and abuse, non-defense discretionary spending, and foreign aid amount to a sizable portion (more than $700 billion), roughly 20% of total federal outlays. But 80% of the budget lies outside of these three areas of the budget. Although there is certainly some merit in taking a hard look at each of these categories as part of a longer term budget reform, the real task lies in the 80% of federal outlays that are growing at an unsustainable pace and will contribute the most to our medium- and long-term budget woes in the coming decade.

 

IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

* Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

^ Federal Funds Rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis.

† Private Sector – the total nonfarm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The nonfarm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. It doesn’t include:
– general government employees
– private household employees
– employees of nonprofit organizations that provide assistance to individuals
– farm employees

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk including loss of principal.

The index of leading economic indicators (LEI) is an economic variable, such as private-sector wages, that tends to show the direction of future economic activity.

International investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.

INDEX DESCRIPTIONS
Purchasing Managers Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

This research material has been prepared by LPL Financial.
To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is
not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

Wall Street and the Election – Garrett and Robinson Weekly Market Commentary September 6, 2012

What Wall Street Is Saying About the Election May Surprise You

While there are many election polls, what matters most to investors is what is priced in on Wall Street rather than what people are saying on Main Street. A stock market-based “election poll” is useful, in that it highlights what the market is pricing in about the outcome of the November elections.

Based upon the most legislation-sensitive industries, earlier this year we created two indexes to help us track the market’s implied forecast of the election outcome reflected in the performance of these industries. Each index is composed of an equal weighting among eight industries that when combined total well over 100 stocks in the S&P 500 index. To track what the market has priced in for the Democrats’ odds of retaining the White House and Senate, we took our Democrats index and divided it by our Republicans index. This is what we track as the “Wall Street” Election Poll, published by LPL Financial Research on Thursdays. An upward sloping line suggests the market may be pricing in a rising likelihood of the Democrats retaining the White House and their majority in the Senate, while a downward sloping line suggests improving prospects for the Republicans.

What Wall Street is saying about the election may surprise you. Our “Wall Street” Election Poll suggests Republicans have yet to erode the gains in the odds that Democrats retain their control. These odds improved early this summer as the Supreme Court upheld the Affordable Care Act, more commonly known as Obamacare. Our poll reflects the path taken by other market-based assessments of the election such the Intrade.com futures contracts on President Obama’s re-election and on the party control of the Senate, which have moved from about a 75% chance the Republicans prevail in the Senate to a toss-up now.

With the S&P 500 having risen back to around four-year highs, investors may have become too complacent that the Senate Democrats will retain their seats and quickly find a grand compromise with House Republicans on extending the Bush tax cuts and other actions to avoid going over the so-called fiscal cliff into a recession in 2013. The Congressional Budget Office recently confirmed our long-held view that a recession is a given in 2013, if no action is taken to moderate the combination of tax hikes and spending cuts totaling over $500 billion already written into current law. We think a compromise may be harder to reach than the market seems to think if the Democrats prevail in the Senate and the House remains, as is likely, in the hands of the Republicans. Recall that the status quo in Washington was no help to markets last year, as the unwillingness to compromise on both sides of the aisle led to the debt ceiling debacle last August sending the S&P 500 down over 10% in three trading days.

Governor Romney’s Vice President pick of Congressman Ryan may raise the stakes further for investors in 2013. If President Obama wins by focusing his re-election campaign on attacking the controversial and potentially unpopular elements of the Ryan plan (which is supported by the House Republicans and, notably, Ryan is chairman of the House Budget committee), it may make a grand compromise even more difficult between the White House and Congress in 2013 to avoid going over the fiscal cliff into a recession and bear market.

It is possible that stocks may be overstating Democrats’ momentum ahead of what are likely to be close elections. If so, look for a potential surge in the Republican-favored industries. If not, stocks may begin to stumble until a clear path to a compromise on the fiscal cliff can be reached.

It is not just this year that markets may begin to fear a divided Congress. Since 1901, the Dow Jones Industrial Average has fallen an annualized -3% during the 12% of the time that featured a split-party Congress, according to Ned Davis Research. Returns were much better when the control of Congress was in the hands of one party or the other. Gridlock is unlikely to be good for investors in 2013.

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Dow Jones Industrial Average (DJIA): The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and non-utility) goods and services. The Dow Jones Industrial Averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore their component weightings are affected only by changes in the stocks’ prices.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.

Not FDIC/NCUA Insured | Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any Government Agency | Not a Bank/Credit Union Deposit

LPL Financial, Member FINRA/SIPC