The Harvester – Fall 2007
The Harvester
09/21/07“May You Live in Interesting Times”
– Unknown Author
To say the last few months have been interesting is an understatement. Even though the stock market today is pretty much where it was at the end of June, the ride has been bumpy. The primary cause of this volatility was the meltdown of the sub-prime mortgage market. This meltdown triggered some unusual phenomena in the financial markets. The credit (bond) markets (except for Treasury bonds) had a complete collapse of liquidity. Commercial paper (for the most part, high quality, short-term paper issued by corporations) fell by almost 11% in a single day. This has never happened before. To combat these breakdowns, the Federal Reserve has lowered interest rates and the European Union has pumped almost $350 Billion euros of liquidity into the overseas financial markets. These actions have calmed the credit markets for now and initiated a rise in the stock market.
The Federal Reserve
One of the main roles of the Federal Reserve is to create liquidity when a financial crisis – like the sub-prime meltdown- occurs. Along with the Fed’s moves, the market has made adjustments to lending that, in the long run, is very good for the integrity of the credit markets. Lending standards have tightened up. No longer are hedge funds able to leverage up like they have in the past and mortgage lenders are no longer giving 100% loans to anyone who has a heart beat. A problem that this tightening created, however, was that credit worthy borrowers were unable to obtain financing. The entire credit market froze up. This is why the Federal Reserve came to the rescue like it did for the Long-term Capital Fund collapse (1998) and Savings & Loan crisis (1990). If the credit market stabilizes, we believe the Fed will hold off on further cuts until inflation (especially gold and oil prices) subsides. If there are more problems in the credit markets, we anticipate more interest rate cuts ahead.
Stock Market – expect continued volatility
We believe that the stock market will have increased volatility in the future based on two factors: 1) the market is just getting back to historical volatility levels, and 2) the elimination of the “up-tick rule.” The stock market has been rather passive over the past three years with little daily fluctuation. This made people forget the volatility of the past, especially during trying times such as 1987, 1990 or 1998, to name a few. We believe that the impetus to this increased volatility was the elimination of the “up-tick rule” on July 6th.
The “up-tick rule” was established in 1938 as a way to reduce wild swings in the stock market. The “up-tick rule” required traders to wait for an upward move in the price of the stock before it could be sold short (short selling = selling a stock that one does not own in anticipation of the stock falling further. You make money buying the stock back at a lower price in the future). This rule was changed at the behest of Wall Street and hedge fund managers. We believe that the elimination of the rule will only increase volatility on both down and up days. On the downside, traders can sell stock short when the market is falling without waiting for an up move. This will exacerbate downward moves in the market. On the upside, all the stock that is shorted has to be bought back sometime in the future. Short sellers feel pressure to buy back that stock when the market moves higher. We believe that the 300+ point move when the Fed cut interest rates had quite a number of short sellers buying back stock they shorted. Stock market volatility is back.
Year-End Tax Planning
We can hardly believe that three quarters of 2007 have come and gone. Now that we are heading into the last quarter of the year, the topic of year-end tax planning invariably comes up. As such, here are a few items to think about as you prepare for year-end:
- For those of you over the age of 70 ½ who own Individual Retirement accounts, you are required to take a distribution out of your IRA before year-end. For those clients that have yet to take your distribution, we will be contacting you in late November/ early December. If you have any questions prior to our call, please don’t hesitate to contact us.
- Consider manipulating your income and expenses for 2007. The most basic form of year-end planning involves deferring income into the next year and accelerating deductions into the current year. If you are having a particularly good 2007, you may consider pushing income into 2008 and accelerating deductible expenses into 2007. On the other hand, if 2007 has not been a particularly good year, you may want to consider taking income in 2007 and deferring deductions into 2008.
- If you have realized capital gains for the year from selling investments during 2007, we will consider selling any investments that would generate a loss to offset your realized gains. You can use your realized losses to offset all of your realized capital gain plus up to $3,000 of regular income. If you have any gains/losses that we are not aware of from other investments, please provide this information so we can do our best to minimize your taxes.
- If you have a retirement plan at work and have not been maximizing your contributions for the year, you should consider doing so before year-end. For those of you under the age of fifty, you can contribute up to $15,500 into your retirement plan. For those of you over the age of 50, you can contribute $20,500 into your retirement plan.
- Charitable contributions must be made by December 31, 2007. Remember for those of you over the age of 70 ½, you can contribute up to $100,000 to charity from your Individual Retirement account. These contributions are not considered taxable income to you, the donor.
- Consider a gift to a Roth IRA for a child or grandchild. If you have a high school or college student that has earned income, you can make a gift to a Roth IRA of up to $4,000. This is lifelong gift that offers the unique benefit of tax-deferred growth and tax exempt withdrawals at retirement. You have until April 15th, 2008, to establish such an account.
Newsletter Topics
The purpose of the newsletter is to help educate and inform our clients on matters we think are important to them. However, we might be overlooking some topics that may be of interest to you. If there is a topic that you would like us to cover, please e-mail Jim at jgore@thorinvestment.com.