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Less than 50 days until Fiscal Cliff : Who blinks first?

Posted by Abigail M. Huffman, CFA on November 13, 2012 at 2:34 am

I have recently returned from post-election meetings in Washington, D.C. where universal attention is now focused on the “fiscal cliff”, the automatic tax increases expected to kick in at the beginning of the year due to the expiration of Bush tax cuts and other provisions.  Lawmakers are once again preoccupied with breaking the impasse that has hamstrung policy advancement since the days of the debt ceiling crisis (May through August 2011), rejection of Obama’s bipartisan deficit committee proposal (also know as Simpson Bowles) and subsequent alternative proposals.   Time to resolve a large hit to the economy is of the essence, with less than fifty days until the deadline, and the consequences are sobering.


Last week, The Congressional Budget Office published a report that reiterates the difficult scenarios of either maintaining scheduled tax raises or extending Bush tax cuts:

1)                   If all provisions are allowed to expire, the debt to gdp ratio will come down over ten years but the economy will face a probable recession in 2013 or,

2)                   Extending tax cuts would maintain positive economic growth but increase long-term debt to unsustainable levels.

While it is debatable how much can be achieved by a “lame duck” Congress in 21 days of sessions until the end of the year, here are some of the things that lawmakers and pundits are saying inside the beltway:

  • Both parties are claiming a “mandate.”  The Republicans base their assertion on the very close popular tally for the Presidential race.  The Democrats, of course, point to Obama’s electoral victory (and 49.4% of the popular vote versus Romney’s 49.1%.)  It looks to me as though Americans hedged their bets:  voting  progressively on social policies for Obama, but conservatively on spending policies since the Republican Congress controls spending.  The American electorate wants many things – universal healthcare, maintenance of Social Security and Medicare, and does not want to pay for it!
  • Some lawmakers claim that going over the fiscal cliff could easily be reversed and that while uncertainty would prevail in the meantime, policy and tax reform cannot be hurried.  This argument could also be used to support a temporary solution and would be analogous to the last three years of continuing resolutions to enact annual budgets.  And while both sides may be using rhetoric, this writer asks, have any of these folks seen the stock market reaction to status quo politics when the stock market sold off almost 3% after the election?  Could lawmakers really be so deaf to financial markets, corporate CEOs, foreign leaders, credit agencies and the IMF?  
  • Present lawmakers are likely to take an approach that buys time (until the more cantankerous newly elected Congress arrives in Washington) and avoids the automatic cuts in defense and discretionary spending.  The prevailing assumption is that the real deal will take some time. 
  • Some numbers:  The US Treasury collects almost $1.3 trillion in revenues from individuals, while $1.1 trillion is lost to loopholes and deductions.  “Lowering rates and broadening the base” is probably intuitively attractive to any taxpayer because the verbiage seems to promise that those who are already paying will pay less at lower rates.  I expect, however, that all of us will be paying more in the long run despite any attempt by either party to protect a particular constituency.  Potential targets include homebuilders (save the mortgage interest deduction) or charitable organizations (save the deduction for charitable donations).  On the spending side,  entitlements could be tweaked with Social Security cost of living increases adoption of “chained CPI”.[1]

It remains to be seen if things are going to get better, or get worse before they get better, or just get worse.  As of Friday, both Boehner (who does not want to go down in history as a political hack) and Obama (also considering his legacy) have made conciliatory remarks, a dim positive if not yet substantiated by any agreement.  In any event, the Huffman Broadsheet promises to keep you up-to-date on how policy impacts financial markets and the economy and who blinks first.





While the S&P 500, Nasdaq (CCMP or orange line), and Dow Jones (INDU or yellow line) are up nicely for the year, the market accelerated its retreat last week after peaking in September.  Source: 

[1] “Chained CPI” lowers cost of living increases due to adapting the basket of goods to new products and services.  See Investopedia

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With consumers becoming more confident, is it time for a positive feedback loop?

Posted by Abigail M. Huffman, CFA on November 2, 2012 at 4:15 pm

Last week I highlighted the positive implications of a stronger real estate market.  Confirming this view are reports this week showing that residential construction rose smartly in September, by 2.8% and average home prices by 2% compared to last year[1].  Residential real estate improvement implies the positive spillover effects of increased durable consumption (think washing machines, refrigerators etc.,).  It is time for a positive feedback loop – that is consumers spend more, demand increases , businesses hire and the economy grows!  Consumers are feeling better off and more confident now that their net worth has increased.  Could this positive sentiment translate to a stronger economy and stock market?

Here are the economic positives:

  • Today the Labor department reported that payrolls increased better than forecast with 171,000 jobs added in October.
  • On Nov. 1,  ADP reported that 150,000 jobs, also better than expected, were created in the private sector.[2]
  • Also on Nov. 1, unemployment claims were lower than predicted at 363,000
  • Consumer sentiment is the highest since September 2007 when the recession started. (See chart below)
  • Oil prices are receding putting more discretionary spending in consumers’ pockets.
  • Consumer debt has decreased after several years of paying down debt.[3]  So consumers are starting to spend and as a consequence, retail sales are up more than 5% versus a year ago.[4]
  • Household net worth is up more than 17% compared to a low in 2008.
  • Economy is growing at a moderate 2% pace.

Could these positives affect future stock market performance?

Assuming a snap back to historical averages, the market is poised to go higher once investors return to owning stock ownership at their usual 60% allocation (instead of the current 50% levels).  Currently both individual and institutional investors shun stocks and prefer bonds.  According to ICI, the Investment Company Institute, investors have withdrawn money out of equity funds four years in a row with $100 billion pulled out in 2011, for example.  This year through September, investors have sold $83 billion of equity funds and channeled roughly 3x that amount into bond funds over the same period.[5]  It appears that investors are preparing for the last Global Financial Crisis instead of a future bull equity market!

Additional supportive factors for stock ownership are low inflation (with the Federal Reserve promising to keep interest rates low for the foreseeable future), decent profits reported this earnings season (despite some challenged revenues for multinational companies), and increased productivity at American companies.  All of these factors argue for a higher stock market once some of the uncertainties are cleared away such as the election and fiscal cliff.

Caveat:  Hurricane Sandy’s destruction is a big negative whose effects and costs are still being measured.  In fact, your author is writing these words at her New York gym due to Sandy’s effects!  Long term, nevertheless, it looks like consumers are getting ready to spend, demonstrating their dominant portion (about 70%) of the gross domestic product.




Chart Source: St. Louis Federal Reserve

[1] See Case Shiller report on October 30th.

[2] Click ADP for full report details

[3] Mortgage balances are lower than in 2006 as reported by the Federal Reserve

[4] See Oct 15 report by the Census Bureau

[5] See historical flow data at ICI.org

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Will Housing provide growth we are looking for?

Posted by Abigail M. Huffman, CFA on October 25, 2012 at 4:52 pm

Looking for growth – Will housing provide it? 

Recent data show that the housing market, while still a lower than historical norm at 2.2% of the economy, is on the mend.  Historically (from 1980-2007), the housing industry’s share of gross domestic product (a measurement of all goods and services produced in a year) averaged 4.5%.[1]  During the housing bubble leading up to 2007, housing accounted for up to 6% for several years.  It has taken almost 5 years to absorb the excess inventory accumulated during the boom years and home prices are finally rising.   Chart 1 shows that economists surveyed were too conservative in their estimates.

Data (numbers in thousands) Survey  Actual


Housing Starts Month vs prior Month



Housing Starts



Building Permits



Building Permits Month vs prior Month




New Home Sales



New Home Sales Month vs prior Month



Mortgage Applications          –


Housing starts, building permits and new home sales have been higher than expected as shown in the table.  Note the difference between “survey” and “actual”.  Source:  Bloomberg

Positive Implications of a resurgent housing sector – jobs, spending, and consumer spending! 

It is reasonable to expect that housing will revert to its average contribution to the economy and has finally started on that path.  How much is an additional 2.3% of our $15 trillion economy?  The Bipartisan Policy Center estimates that the missing 2.3% is roughly equal to $350 billion.  Moreover, the additional jobs that could be created to meet estimated housing needs is almost 3 million jobs.

All this bodes well for a stressed US economy that is seeing decreasing demand for exports due to a slowdown overseas.  Housing could make up for some of the lost revenue. Assuming the housing recovery is sustainable, the ripple through the economy should help stimulate demand for other goods.  And consumers will spend!

Chart 2 shows the upward trend for new home sales.  Source:  National Association of Home Builders

[1] Gross Domestic Product is equal to GDP = C + G + I + NX 

Note: Housing is part of “C


C” is equal to all private consumption, or consumer spending, in a nation’s economy

G” is the sum of government spending

I” is the sum of all the country’s businesses spending on capital

NX” is the nation’s total net exports, calculated as total exports minus total imports. (NX = Exports – Imports)


Read more at Investopedia


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Simpson Bowles – Part 2: How it affects you

Posted by Abigail M. Huffman, CFA on October 18, 2012 at 1:53 am

Simpson Bowles – Part 2 – How it affects you

Last week I discussed the goals of Simpson Bowles and the comprehensiveness of the proposal.  While the appointed bipartisan commission ultimately rejected its own plan in December 2010, this road map for cutting the long-term debt and deficits continues to resonate in political debates.

Most notably, the proposal calls for shared sacrifice by taxpayers and government employees.  And what makes the plan unique – compared to subsequent plans – is that it addresses both the revenue (taxes) and spending (outlay) sides of government in every sphere.  Even entitlement costs, which are growing at more than twice the rate of the economy, are reigned in to solve long-term funding gaps.   

My goal here with The Huffman Broadsheet is to give you, dear reader, useful information as you contemplate your verdict within this political maelstrom.  The politicians can haggle over spurious details during debates and avoid the full and total analysis involving painful choices that we, as a responsible citizens and taxpayers cannot ignore.

What are the Main Components of the Simpson Bowles Plan?

There are six main parts to “the Moment of Truth” plan. (Click on the title for full document)  Highlights are listed by category.

1)   Discretionary spending cuts

The commission notes that forecasting and controlling discretionary spending was how the government balanced its books in the 1990s.  Members suggest there be enforceable spending caps, realistic disaster budgeting, and that total government employees be reduced through attrition.

2)  Tax reform (click here for quick summary)  

  • For individuals: the commission suggests lowering rates and broadening the base of payers through the elimination or curtailment of many deductions. Mortgage interest deduction and charitable donations are two examples.
  • Reduce the deficit by ensuring that revenues reach 21% of gross domestic product by 2022.
  • Simplify the tax code.
  • For companies:  Establish a single corporate rate and lower it to between 23% and 29%.
  • Align US tax system with international trading partners by moving to a territorial system whereby income earned overseas is not subject to domestic taxes.

3)   Health Policies

  • Reform or repeal those parts of Medicare that are subject to fraud or are inadequately budgeted for such as long-term care insurance.
  • Pay for the Medicare “doc fix”, a sustainable growth-rate formula aimed to control Medicare spending, which now equals more than $200 billion.
  • Reduce Medicare fraud.
  • Address Medicaid funding and state implementation.
  • Adequately budget for health care programs.

4)   Other Mandatory Policies

  • Protect the disadvantaged.
  • End wasteful spending.
  • Review and reform federal workforce retirement programs.
  • Reduce agricultural programs.
  • Give post office greater management autonomy. 

5)   Social Security

  • Make retirement benefit formula more progressive.
  • Reduce poverty by providing an enhanced minimum benefit for low-wage workers.
  • Gradually increase retirement ages based on increases in life expectancy.
  • Gradually increase the taxable maximum to cover 90% of wages by 2050.
  • Adopt an improved inflation measure to calculate Cost of Living Adjustment.

6)   Process Reform

  • Establish a debt stabilization process to enforce deficit reduction targets.
  • Design effective automatic triggers for extended unemployment benefits.

Fast-forward 2 years later: Facing the Fiscal Cliff and how it affects you – or “What, me worry?[1]

Almost two years have passed since the Simpson Bowles plan was rejected.  The economy now faces a potential recession if numerous short-term provisions are allowed to expire.  For individuals, the tax code remains needlessly complex and outdated.  (Refer to charts 1 and 2 to see how you may be affected.[2])

The good news is that:  tax receipts are rebounding and the government operating deficits are shrinking. (See the Congressional Budget Office  October report.)

The bad news it that:  the US cannot continue to “kick the can down the road” forever.


Chart #1:  Federal tax rates for individuals would increase roughly 5% if all provisions in the fiscal cliff are allowed to expire.  Source: Tax policy center

[1] Attributed to Alfred E. Neuman, the fictional mascot from Mad Magazine.

[2] The Tax Policy center aims to provide independent and bipartisan analysis of the tax code.  See Tax Policy Center


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Simpson Bowles: Worth a visit? Part 1

Posted by Abigail M. Huffman, CFA on October 10, 2012 at 11:23 pm

The first presidential debate covered tax policy and the economy. Since the candidates brought up Simpson Bowles several times, I picked up my copy to review. If you would like to read the entire 65-page proposal, titled “The Moment of Truth” click on the title.

Otherwise, I’ll summarize the main points here – since you will be hearing a lot about it in the coming weeks.

First, what is it?

The report was published December 2010 by the National Commission on Fiscal Responsibility and Reform. This 18-member bipartisan commission, appointed by President Obama, devised a blueprint to reduce the national deficit by $4 trillion by 2020, reduce the deficit and put the nation on a better, more sustainable footing. While the “Mission and Goals” continue to be laudable almost two years later and almost unanimously agreed upon, the implementation of these objectives is the sticking point.

Where there is universal agreement…

The goals of the plan are wide ranging, comprehensive and ambitious. The “guiding principles and values” underlie the difficult choices and compromises made by the group. Here are the core principles:

1. A commitment to make America better off tomorrow than it is today.

2. Don’t disrupt the fragile economic recovery.

3. Cut and invest to promote economic growth and keep America competitive. This means cutting waste in government but at the same time investing in education, infrastructure, and establishing policies to augment economic growth and keep the US globally competitive.

4. Protect the truly disadvantaged.

5. Cut spending “we cannot afford – no exceptions” in the federal government, the tax code, entitlement spending.

6. Demand productivity and effectiveness from Washington.

7. Reform and simplify the tax code (by lowering rates and broadening the base of taxpayers).

8. Don’t make promises that we can’t keep.

9. The problem is real, and the solution will be painful requiring shared sacrifice (interest payments on the debt may reach $1 trillion annually by 2020).

10. Keep America sound over the long run.

The sticking points: Shared sacrifice — or something for everyone to hate.

The last fifty pages of the plan detail how the commission would implement these values. And they really spread the pain around, so much so that by the time Obama was presented with the final plan, not enough commission members were supportive to take the plan to Congress. The plan died, only to be resurrected repeatedly as other legislators have tried to develop a plan with less pain. Voters are also unenthusiastic given the potential limitations on beloved deductions such as the mortgage interest rate deduction or proposed increase in retirement age. (For more history, see my previous blog “Tough Choices“).

Over the next few weeks, look to The Huffman Broadsheet for discussions about specific components of Simpson Bowles that look like they’ll survive.

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Tax policy update:
Keeping your head when all about you are losing theirs1

Posted by Abigail M. Huffman, CFA on September 25, 2012 at 9:44 am

The 2012 presidential election brings a renewed emphasis on US fiscal health and its long-term future.  A candidate asks: “Are you better off?” But I suggest two more important questions:  What fiscal policies will provide you with a better future?  And what role do you want government to play in that future? 

Where to start searching for an objective viewpoint?

The choices are complex and the ideological divide between the two political parties have led to stalemate in Congress-so what’s an ordinary citizen to do?  I suggest seeking objective information that outlines the possible consequences of specific policies. Read the rest of this entry »

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