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By Mat Johnson "The key to making money in stocks is not to get scared out of them." — Peter Lynch From June to September 2007, the U.S. dollar continued its "freefall," oil prices "skyrocketed" to record highs; financial stocks were "pummeled" by subprime mortgage defaults and a financial liquidity "crunch," the housing market was "cratering," and companies "shed" workers in August as "odds of a recession increased." Pretty ominous stuff. In fact, it's so ominous that cutting and running from the stock market might even have seemed justified. After all, even the Federal Reserve was concerned enough to not only cut short-term interest rates recently, but cut them by a lot. So what happened? Why did the stock market rise yet again in the face of all this doom and gloom? For the just completed quarter, the Dow Jones Industrial Average (DJIA) was up +3.6%, while NASDAQ advanced +3.8%. Even the S&P 500 rose +1.6%, despite more than 20% of the index being in financial stocks (financial stocks were down nearly -6% for the quarter, and -10% since June 1st.) It certainly wasn't lost on most investors that this past quarter wasn't a bed of roses. Six weeks into the quarter, the major market indices had given up all of their impressive year-to-date gains. On August 16th, the DJIA fell by more than 300 points, though recovered by the end of the day. On August 17th the Fed acted, cutting the interest rate that they lend at, as the lender of last resort; more aggressively on September 18th by cutting the bank-to-bank lending rate by half a percentage point. The market has reacted positively ever since and has impressively climbed the "wall of worry" through the quarter-end.  The concern that subprime mortgage defaults and credit "crunch" conditions were spreading into the real economy, as evidenced by the surprise decline in August payroll figures (-4,000), appears to be responsible for the Fed's call to action.
While the conventional view is that Fed rate cuts tend to promote future economic strength, and consequently rising equity prices, another is that they merely turn the tide of sentiment — from excessive fear to measured anxiety. The truth is anxiety is a permanent feature of the stock market, while fear is fleeting. To the extent the Fed was responsible for improved sentiment then they have done well. While the Fed's attempt to forestall economic weakness is admirable, history shows that the intended target of the Fed's aid generally continues to experience problems, while new credit winds up elsewhere. (See Technology Bubble Begets Housing Bubble) The point being the Fed is no elixir. It is businesses that determine the broader fundamentals of the markets and as go businesses so goes the market. As we take a review of the economic fundamentals, it is clear that the growth of the economy has slowed throughout 2007. However, the principal cause driving the slowdown has been in place for quite some time — a weak housing market. The softer housing market has reduced consumer spending for large ticket purchases, particularly those that may have been financed from equity appreciation. All told, this is not such a bad thing. The objective of owning a home is to own the home, not to rely upon the credit available from appreciation as ultimately credit equals debt. Looking forward, we continue to see solid underpinnings for the equity market. Earnings growth continues, though has moderated during 2007. Third quarter earnings growth is expected to slow to just 1.9%, year-over-year, down from 9.6% in the second quarter. Much of the third quarter slowdown is the result of all that has gone wrong recently, particularly with the financial and consumer sectors bearing the brunt of the weakness. As we have noted earlier this year however, the housing market impact has been occurring for quite some time, and going forward it will take little more than a moderation of the recent trends for the fundamental outlook to improve. About the time you receive this commentary, corporate America will be reporting their earnings. The key to the market outlook won't be the backward looking numbers that they report, but rather their assessment of the outlook. Judging by the recent employment data, which largely flew in the face of the originally reported August weakness, companies are confident enough to not only hold on to employees, but continue to add at the same healthy rate prior the bogus August report. Add to this that the Federal Reserve in effect flinched on the originally reported decline in August payrolls (since revised to a gain of +89,000), improved company fundamentals (fourth quarter earnings are expected to rise 11%) combined with improved investor sentiment should be well reflected in the stock market in the periods ahead. Unfortunately, volatility isn't likely to go away overnight, though volatility alone doesn't derail the fundamentals of the equity market; it merely focuses attention on those companies with durable growth prospects at reasonable prices. Given that growth investing is our focus, and wealth management is our discipline, we feel well positioned to continue helping our clients achieve their long-term objectives. Back to TopStrategic Giving: How to Plan Smart Gifts By Scott Whittemore By planning out your gifting strategies, either personal or charitable, you can create more benefits than engendering good feelings about giving. Being smart about gifting provides financial benefits as well. Both personal and charitable gifts remove an asset's future growth from an estate and can reduce estate taxes. Charitable gifts are deductible for income taxes. Understanding the differences in benefits between these two types of gifts can allow you to give in a way that generates the greatest advantages for you as you try to help others. When you give assets to a friend or relative, you transfer future income and growth of those assets to that person. This strategy works best if the recipient is in a lower tax bracket. However, due to recent changes in the age limits of the "Kiddie Tax", this strategy is becoming more difficult to implement. The Kiddie Tax makes a child's unearned income (investment income) taxed at their parent's higher tax rate. Effective beginning tax year 2008, the Kiddie Tax rules have been expanded to include unearned income received by a child:
 Up to tax year 2005, the age limit was 14. Now that the kiddie tax is expanded to include college age kids, it is practically pointless to try to take advantage of your child's or grandchild's tax bracket by transferring investment assets to them as long as they are attending school. Any child in college or graduate school will have their unearned income taxed at their parent's tax rate.
To avoid gift taxation, gifts to loved ones must be below the annual gift exclusion amount. For an individual in 2007, the exclusion amount is up to $12,000. A married couple may give up to $24,000 per year. As long as the total gift value is less than the annual exclusion amount for each recipient, individuals or couples may give to as many people as they wish without any gift tax consequences. Personal gifts will not generate an income tax deduction. Several strategies for making personal gifts are available. The one that is right for you will depend on what you are trying to achieve. If there is no need to put constraints on how the gift is used, an outright gift may be appropriate. If there is a need to control how the gifts are used, trusts can provide limitations. To fund a child's education, Section 529 Plans provide estate planning benefits and allow you to retain some control over how the gift is used. You will know that the funds can only be spent on "qualified educational expenses", not Corvettes or trips to Europe. If your goal is to help build a nest egg for a young person to use as he or she sees fit when reaching the age of majority (18 or 21, depending on state law), you might prefer to establish a Uniform Gifts to Minors Account (UGMA) or Uniform Transfers to Minors Account (UTMA). In these accounts, the beneficiary may use the funds to buy a Corvette, to take a trip to Europe, to start a business or to pursue an alternative education path that cannot be funded from 529 Plans. Please note, with the change in the "Kiddie Tax" ages mentioned above, money in a UGMA or UTMA will likely be taxed at a parent's rate. 529 plans have the very attractive tax advantage that all earnings in the plan are tax deferred and withdrawals for education expenses are tax-free. Overall, 529 plans provide much better control and more tax benefits for education savings than UGMA or UTMA accounts. The main advantage of UGMA and UTMA accounts is they are not limited to education savings. A charitable gift, in addition to reducing the value of your estate, has the extra benefit of being tax-deductible. Using highly appreciated assets, such as securities or real estate held for a long period, can be the most cost efficient means to make a charitable gift. Not only is there an income tax deduction, the capital gains taxes on the asset are avoided. There are limits as to what you can deduct each year, but these limits are generous and excess amounts can be carried over to future years. Several strategies for charitable giving should be considered. Compared to making outright gifts of cash to give highly appreciated assets through donor advised funds or through charitable remainder trusts are financially wise. In the case of donor advised funds, they can be used to help trim taxes on selling a highly appreciated security. Gifting a portion of the asset to a donor advised fund creates an income deduction that offsets the tax liability of selling the remaining position. If you could end up with the same cash in hand, would you rather pay taxes on the gains or donate the tax amount to a charity? Most people would prefer to give. The donor advised fund becomes a source of funding future annual charitable commitments. If you have been making annual gifts to a church, school or community foundation, this future income is freed up from having to fund those gifts as the donor advised fund provides the gifts. A charitable remainder trust is not a well-understood charitable giving vehicle. What is hard to grasp is even though you are giving up control of the assets by putting them in the trust, you can still derive the benefit of the income from the asset for the rest of your life. If managed correctly, the charitable remainder trust can provide an upfront charitable deduction, avoidance of capital gains taxes on selling a highly appreciated asset, and lifetime income at tax-advantaged rates. If you have the opportunity to do strategic gifting this year, Quantum would be happy to provide advice and help you understand your options for making the gift in as smart a manner as possible. For any of your financial planning needs, please contact Scott Whittemore, Director of Financial Planning and Client Relations at (415) 927-8430. Back to TopHousing Crunch? Yes. Economic Meltdown? No. By Howard Aschwald Much has been made of the problems in the residential housing market. We have heard for years how subprime borrowers will default on their mortgages once the adjustable rate loans start resetting. To compound the story, many of the creditors will have to write down the value of their holdings, taking big losses and thereby start a contagion that breaks the economy and the stock market. Those stories reached their peak in August as investors went from fear of the possible truth of the stories (Dow average down 400 points in one day) to a mild euphoria when it looked like the worst wasn't going to be so bad after all (Dow average up 400 points in one day). This only shows how the stock market (or any financial market) is ruled by emotions in the short run. In the longer run, markets always track fundamentals. The fundamentals do show that easy credit terms (no down payment and no document loans) not only led to a flood of high risk home buyers, but rampant speculation in residential real estate. House flippers even have their own TV shows on the cable networks. The easy money that made all of this possible came from a relatively new form of financing called collateralized debt obligations (CDO's). CDO creators pool groups of mortgages, including low quality subprime loans and then slice up the pool into debt securities with various credit ratings and maturities. This allows an investor to buy a security with a two-year maturity and AAA credit backed by the mortgage pool. These investors get their money back and their interest before the investors in the next bracket (with maybe a five-year maturity) get their interest and principal returned. In this way, billions of dollars of loans are repackaged and sold to investors depending on their need for safety versus speculation. Everything works fine until the original assumptions underlying the slicing and dicing of the mortgage pool start to malfunction. When it looked like the default rates on subprime loans were going to be much higher then predicted, buyers of the CDO slices left the market and waited until a real value could be more credibly determined. This put pressure on other forms of credit not related to housing, such as Private Equity (formerly known as "junk bonds") CDO loans. In turn, this added to investor uncertainty for any type of CDO security. Fortunately, since the US is the major creator and seller of CDO paper, the Federal Reserve stepped in to lower the discount rate (the rate that member banks can borrow at) and they cut interest rates as well. This gave investors the needed confidence to start buying CDOs again, but with a much more wary eye and at better interest rates for the lenders. CDOs helped fuel the rise in residential real estate. This rise is out of gas. The residential real estate market is not going to be saved by the Federal Reserve and not by Congressional legislation. However, this does not mean a meltdown of real estate and a crash in the economy. The entire subprime loan market is $500 billion. Even if every subprime loan defaulted, the total damage would be no more than 20% of that value. While undoubtedly painful for losing homeowners and investors holding their mortgages (via CDOs), this $100 billion spread out over a few years will be readily absorbed in the $14 trillion overall economy. In the longer term, real estate will behave like any other investment. We are already seeing new housing construction at 20 year lows as there are fewer qualified buyers and much fewer investors/speculators buying real estate for a quick profit. The natural progression is for rents to rise, as fewer houses are available. As rents go up, investors buy for rental income, not appreciation. There are more forces at work, such as new construction replacement costs via inflation, unemployment, migration, taxes and the cost of borrowing that will impact specific market prices, but these are all part of the fundamentals. Residential real estate will be slow for a number of years until more of these fundamental factors reverse direction to support increased pricing. Back to TopEmployee Spotlight: Stephen A. Bradley, Jr.  Steve Jr. has been working for Quantum part-time since 1999. He graduated from the University of California, Berkeley with a degree in Physical Science with emphasis on Chemistry and Geology. He then went on to study at the University of San Francisco where he completed a Master's degree in Financial Analysis. Upon completing his graduate studies, Steve Jr. joined Quantum full-time as an associate research analyst, also focusing on marketing and client relations. He is also working on his Chartered Financial Analysis designation (CFA). He is currently a CFA Level II candidate. Steve Jr.'s hobbies include reading, basketball, tennis, golf, and snow skiing.
Back to TopQuantum Awarded Paladin's Five Star Designation Quantum has been admitted to the Paladin Registry and awarded Paladin's Five Star quality designation. Planners and advisors must rank in the top 10% of their profession to be admitted to this registry.  The Paladin Registry provides free public services to investors who use the services of financial planners and advisors. The four primary services are investor education, advisor search, advisor ratings, and advisor documentation. Visit their website at www.paladinregistry.com and check out our profile.
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Home | About | Our Team | Services | Investment Strategies | Portfolio Strategies | Contact | Newsroom © 2008 Quantum Capital Management. All Rights Reserved. |
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