Never Waste a Crisis

tax documents

Weekly Market Commentary 5-14-12

Tim Phillips, CEO – Phillips and Company

Myron F. Weiner wrote an article in the Journal of Medical Economics entitled, “Don’t Waste a Crisis — Your Patient’s or Your Own.” While many people want to take credit for this quote, its exact form can be traced back to Mr. Weiner. It simply means, you should take advantage of a patient’s critical health condition by using it to bring about a change in their behavior. I know the last time I was sick I promised myself to change some behavior that would improve my health.

I am hopeful this quote will come into play before the end of 2012 or very early 2013 to address the coming, “Taxmageddon” crisis. As it stands today, the Bush Tax cuts will expire at the end of 2012 and tax rates are expected to increase substantially for everyone on January 1st, 2013.

tax rate by inome

These will have a major effect on the dividend and interest payments you receive from your investments. The table below illustrates the impact of the change in tax rates on a hypothetical investment that yields $10,000 annually.

tax rates

If the tax rates we currently enjoy expire, we would need our gross yield to go from $10,000 to $14,120 (36% tax bracket) and $15,020 (39.6% tax bracket) respectively, to maintain the same after-tax return in 2013. The only way for yields to increase is for prices to fall.

In this hypothetical situation, prices would have to fall by 29% to provide someone in the 36% tax bracket with the equivalent after tax yield. That’s assuming we are efficient evaluators of returns and completely optimize our expected rates of return. This is a fairly big assumption, but none the less, wiping out 29%+ of the assets for American’s is a crisis.

That's why I believe we will see one of three things happen before the end of Q1 2013:

  1. A complete extension of the Bush tax cuts (not well liked by the current administration).
  2. A partial extension of the Bush tax cuts on those under $250,000 in income (not well liked by Republicans in the house).
  3. Another game of chicken and brinkmanship, similar to what we saw with the debt ceiling circus of last summer when we were stripped of our AAA credit rating. Ultimately leading to another full, but temporary extension.

Any scenario suggests we should continue to look for cash flows out of equity positions and take some reasonable risks when buying debt. We should prepare for more volatility in the capital markets and continue to expect our economy to improve at only a very modest pace as we kick the can down the road. Remember, anytime you have uncertainty with tax policy, decision makers tend to postpone big decisions unless they are absolutely necessary.

American consumerism is based on the absolutely unnecessary – and an uncertain tax policy could hurt.

I've often said, “It only takes one clown to make a circus.” So what happens when you have 536 clowns and 311 million spectators that want to consume? You have a crisis and my bet is the circus clowns will be forced to make a pragmatic decision.

If you have questions or comments please let us know as we always appreciate your feedback. You can get in touch with us via Twitter, Facebook, or you can Email me directly.

Tim Phillips, CEO – Phillips & Company

Research supported by:
Adam Gulledge, Associate – Phillips & Company
Alex Cook, Associate – Phillips and Company