Dwaine van Vuuren: Too Early To Call US Recession

Using a nine composite index consisting of:

• The Philadelphia Fed Aurora-Diebold Scotti Business conditions Index (ADS) 
• The Philadelphia Fed Business Outlook Survey (BOS) 
• The Conference Board Leading Economic Index (LEI) 
• The Conference Board Employment Trends Index (ETI) 
• The e-forecasting.com monthly Leading Index (eLEI) 
• The e-forecasting.com monthly GDP series (eGDP) 
• The Institute for Supply Management ISM Report on Business (PMI) 
• The Chicago Fed National Activity Index three-month average (CFNAI-MA3) 
• The ECRI Weekly Leading Economic Index (WLI) 

Dwaine van Vuuren argues the recession call by ECRI was premature.  Although, ECRI does have a one year time horizon on their call.  Based on his U.S. Economic Growth Super-Indexes, there is only a 15% chance of recession as of December 29, 2011.  He goes on to note the chance of recession has risen quite sharply, but similar spikes were observed in March 2003, September 2005, and July 2006.  None of these periods resulted in an NBER-dated recession.

The difficulty in forecasting a recession is obvious from his charts.  The descent into recession is generally quite abrupt.  Many of the indicators in and of themselves are coincident or short-leading making it difficult to know when the economy has reached the end of cliff.  In other words, a coincident or short-leading index won't tell one much more than the stock market.  Consequently, it won't be helpful in avoiding stock market losses.  He provides a few additional graphs which compare the current recovery to past recoveries noting the current recovery is lackluster, and therefore, potentially more prone to falling into recession.  A recession is generally underway when four or more of the nine indexes are in recession territory.  There are currently two in the doldrums now: ECRI Weekly Leading Economic Index and e-forecasting.com monthly Leading Index.  The other seven indexes are currently well below their respective recession thresholds.  

He concludes with a 4-6 month Leading Superindex which currently shows the economy is susceptible to a recession.  However, the current reading is consistent with other periods in which no recession occurred.  His advice: monitor the leading indexes for continued deterioration or rebound.  If it was easy to read the tea leaves, everyone would be on top of the early warning signs of recession risk.  It does appear that the 4-6 month Leading Superindex lends support to the idea that there is, as John Hussman would say, a syndrome of conditions present that have in the past lead to recession. 

Advisor Perspectives: US Recession - An Opposing View

ETF Screeners

Like search engines, ETF screeners are quick to advertise the total ETF's available for search.  ETFdb lists 1,434, XTF 1,383, and Morningstar 1,374.  All three offer enhanced subscription services.  The subscription services offer ranking systems, model portfolios, research reports, additional statistics such as fund flows and valuation estimates, and enhanced search functionality such as comparison tools (sometimes with additional information) and export to Excel features.  For most ETF research, the important data is offered for free.

The major differences between the sites is the search interface.  All three sites are cumbersome to use at first with none standing out as having a brilliant user interface.  Familiarity will be your best friend.

XTF makes comparing up to six ETF's really easy.  Either enter in the ticker symbols or select up to six ETF's via the ETF explorer.  XTF also provides great pie charts under "Fund Exposure" to graphically show the industry, sector, style, capitalization, and other types of exposure.

ETFdb allows investors to easily locate funds with significant exposure to a particular security.  It really shines if you are looking for an ETF with exposure to a particular country via the "ETF Country Exposure Tool."  This tool makes finding an ETF with the largest exposure to Kazakhstan simple, if you know where to find the country on a map. 

Morningstar didn't stand out other than it was easy to add ETF's to a portfolio, and if you are already familiar with Morningstar, the interface will be easier to use.  In addition, Morningstar offers much more bang for the buck as the monthly subscription fee covers mutual funds, ETF's, CEF's, stocks, and options.       

Site Links:

XTF
ETFdb
Morningstar ETF

New Federal Income Tax Provisions for 2012

While the New Year ushers out a slew of federal tax provisions, a few new provisions also come into effect.

The Usual Inflation Adjustments
Inflation is the taxpayer's friend in 2012.  From Revenue Procedure 2011-52, the taxable income for each tax bracket expands and the personal exemption rises to $3,800.  The standard deduction rises to:

Married Individuals Filing Joint Returns                          
and Surviving Spouses                                                    $11,900

Heads of Households                                                       $8,700

Unmarried Individuals (other than Surviving Spouses
and Heads of Households)                                               $5,950

Married Individuals Filing Separate                                
Returns                                                                            $5,950

Contributions to retirement plans increase as well.  From IR-2011-103, the elective deferral for 401(k), 403(b), most 457 plans, and the Thrift Savings Plan increases to $17,000.  The catch-up contribution for the 50 and over crowd remains at $5,500 for plans other than those described in Section 401(k)(11) or Section 408(p).  The annual compensation limit increases to $250,000 and the defined contribution limit rises to $50,000.

ROTH IRA and Traditional IRA contribution limits remain at the smaller of $5,000 or the amount of one's taxable compensation.  The limit can be split between a traditional and ROTH IRA, but the combined amount cannot exceed $5,000.  The 50 and over crowd can add an additional $1,000 for a maximum contribution of $6,000.

Modified adjusted gross income phase-out ranges for Traditional IRA's are as follows:

IRS.gov: Modified AGI Limits for Traditional IRA contributions if Covered By Retirement Plan at Work

IRS.gov: Modified AGI Limits for Traditional IRA contributions if NOT Covered By Retirement Plan at Work

Modified adjusted gross income phase-out ranges for ROTH IRA's are:

Married filing jointly - $173,000 to 183,000
Single and head of household - $110,000 to $125,000.
Married filing separate covered by retirement plan at work - $0 to $10,000.

The social security wage base rises to $110,100.

See Revenue Procedure 2011-52 for many more items.

Capital Gains and Losses
IRC Section 6045 was amended in 2008 to require brokers to report to the IRS and customers, the customer's adjusted basis in securities sold and to classify the gain or loss as short or long-term.  The basis reporting applies to "covered securities," which basically means any security acquired after its corresponding applicable date.  For 2011, the basis reporting rules covered corporate stock purchases, mutual funds and DRIP purchases will follow in 2012, and other financial instruments in 2013 (commodities, bonds, options, and so on).

Taxpayer's will notice a new form for 2011, Form 8949, "Sales and Other Disposition of Capital Assets," which will aide them in reporting the new Form 1099-B information.  Schedule D will become a summary form with capital gain and loss information flowing from other forms.

Form 8949 will segregate capital gain and loss reporting to three categories:

1) When basis is reported in Box 3 of Form 1099-B
2) When basis is not reported on Form 1099-B (non-covered securities)
3) When no Form 1099-B is received

Veterans Work Opportunity Credits
The Three Percent Withholding Repeal and Job Creation Act, P.L. 112-56, extended the Work Opportunity Tax Credit and enhanced the name to Returning Heroes and Wounded Warriors Work Opportunity Tax Credit (has a more noble ring to it?) for business that hire certain military veterans.  The employer may be eligible for a credit up to $9,600 for each qualified veteran they hire after November 21, 2011 and before January 1, 2013.  There are several layers of credits, with up to a $2,400 credit for hiring a veteran who has been unemployed for at least four weeks, up to $5,600 for hiring a veteran who has been unemployed for more than six months, and up to $9,600 for hiring a veteran with a service-connected disability and who has been unemployed for more than six months.  The last credit amount is up to  $4,800 for hiring a veteran with a service-connected disability who does not meet the Returning Hero credit requirements or who qualifies for food stamps.

More Foreign Asset Reporting
The Foreign Account Tax Compliance Act increased the reporting requirements for individuals holding specified foreign financial assets.  The aggregate value of the assets must be at least $50,000.  The IRS has a page devoted to the specifics.  The information is reported on Form 8938, "Statement of Specified Foreign Financial Assets."  For more on the Foreign Account Tax Compliance Act, see IRS.gov: Foreign Account Tax Compliance Act (FATCA).

Bonus Depreication
While the 100% bonus depreciation expires on December 31, 2011, the 50% bonus depreciation remains for 2012.  The 100% bonus depreciation lives on for longer-lived and transportation property (LLTP).  LLTP property consists of certain property with a recovery period of ten years or more or to transportation property property that has an estimated production period greater than one year and a cost in excess of one million.

EITC Due Diligence
The penalty for failing to comply with IRC Sec. 6695(g) Earned Income Tax credit due diligence requirements increases to $500 for returns filed after December 31, 2011.  The EITC due diligence requirements are broken down into 4 parts.  The final EITC regulations (click here for full text: TD 9570) included the following updates:

1) Form 8867 must now be filed with the tax return.

2) The tax preparer must retain a copy of Form 8867, the completed Earned Income Credit Worksheet, how and when the information used to complete Form 8867 and the Earned Income Credit Worksheet was obtained, including the identity of the person, a copy of any documents provided by the taxpayer on which the tax return preparer relied to complete Form 8867 or the Earned Income Credit Worksheet, e.g. interview questions and answers from the client.

3) The documents above must be retained for three years from the latest of the following dates in either electronic or paper form so long as the IRS can access it, as applicable:

a) The due date of the tax return
b) In the case of an electronically filed return, the date the tax return was filed
c) In the case of a paper filed return, the date the tax return was presented for signature
d) In the case of a nonsigning tax return preparer, the date the nonsigning tax return preparer submitted to the signing tax return preparer that portion of the tax return for which the nonsigning tax return preparer was responsible.

4) A firm may be subject to penalty if one or more members of the principal management of the firm participated in or knew of the failure to comply with the due diligence requirements.  The firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements. The firm disregarded its reasonable and appropriate compliance procedures through willfulness, recklessness, or gross indifference.

5) There is an exception to the preparer or firm penalty if the prepare can demonstrate to the IRS the normal office procedures are reasonably designed and routinely followed and the cause of the penalty was an isolated event.

The previous EITC due diligence rules that were not updated are still in effect.  See the IRS webpage devoted to the new EITC due diligence rules including access to a webinar (45 minutes long).

Voluntary Classification Settlement Program
The IRS introduced a voluntary classification settlement program (VCSP) in September 2011 enabling eligible taxpayers to voluntarily reclassify their workers as employees for federal employment tax purposes for future tax periods while receiving relief for part of the tax liability resulting from past treatment of the workers as nonemployees.  See IRS Announcement 2011-64 for more information.

Expired Individual Income Tax Provisions as of December 31, 2011

Even the most ardent supporter of a simplified tax code would feign excitement over the expiration of the following tax provisions as of December 31, 2011.  The AMT patch will most likely be extended, particularly in an election year.  Many of the provisions are widely used such as the deductibility of state and local sales tax, deduction for certain teacher expenses, and the mortgage insurance premiums deduction.

1) The "AMT patch" will need patching in 2012.  The AMT exemption reverts to its previous statutory amounts.  IRC Sec. 55(d).  Personal credits allowed against regular tax and AMT expires as well.  IRC Sec. 26(a), although certain exceptions apply.  The patch will no doubt be extended as it would subject significantly more taxpayers to the AMT.  The lack of personal credits against the AMT and regular tax would disallow the benefit of some credits for certain taxpayers.

2) The deductibility of state and local sales tax instead of state income tax on Schedule A expires.  IRC Sec. 164(b).  For the few sales tax only states, this will create a noticeable increase in taxes.

3) The deduction of up to $250 for certain elementary and secondary school teacher expenses.  IRC Sec 62(a)(2)(D).  The teacher's unions will no doubt find this annoying.

4) Deductible mortgage insurance premiums as interest.  IRC Sec 163(h).  With many individuals struggling to make payments on homes with little or no equity, this certainly won't help.

5) The tuition and fees deduction (above-the-line) of up to $4,000 for qualified tuition and related expenses.  IRC Sec. 222.  The name and amount of the education credits continue to change, which makes longer term planning more difficult. 

6) Tax free treatment of charitable distributions from IRAs.  IRC Sec. 408(d)(8).  Mitt Romney might want to keep this one around for his supersized IRA.

7) Several other less common provisions including:

a) Transit pass exclusion from income will no longer be equal to the parking benefit exclusion.  IRC Sec. 132(f).  The amount excluded from income falls from $230 per month in 2011 to $125 per month in 2012.

(b) Expanded adoption credit, IRC Sec. 36C, and adoption assistance program IRC Sec. 137 amounts.

(c) District of Columbia first-time homebuyer credit.  IRC Sec. 1400C.

d) Nonbusiness energy property credit.  IRC Sec. 25C.  This provision already took a substantial cut in 2011.  Many of the eligible items are too expensive to justify purchasing them to receive the credit such as furnaces (afu >=95) and hot water heaters (tankless only) for two examples.  It's easier to get a rebate from your local utility company.  The Energy Star websites has an easy to read comparison of the changes from 2011 to 2012.   

e) 100% exclusion of gain on sale of certain small business stock.  IRC sec. 1202(a).

The AMT Sweet Spot for High Income Individuals

With all the negative publicity received by the AMT, it is helpful to note there is a sweet spot for certain high income taxpayers.  It is obviously an unintentional gift from Congress.  Knowing that it exists is the first step toward taking advantage of it. 

Forbes published an easy to read blog post detailing the whereabouts of the sweet spot and how to take advantage of it.  Cutting to the chase, the sweet spot begins, for married couples filing jointly, at $447,800 of AMT taxable income.  At this point, the AMT effective marginal tax rate drops from 35% to 28%.  This is a tax planning opportunity that is best investigated with tax planning software such as BNA Income Tax Planner.  The sweet spot will vary in size depending upon the taxpayer's AMT adjustments and preferences.  These items are shown on Form 6251.

The example used by Forbes is a married couple with no kids whose itemized state, local, and real estate taxes tally $60,000.  The AMT sweet spot in this case stretches from $447,800 to $680,400.  From $447,800 to $680,400 the taxpayer is taxed at 28% on the margin instead of 35%.  A sweet deal, if one can take advantage of it.

Taking advantage of the sweet spot requires the ability to generate additional ordinary income that will be taxed at the 28% rate, but stop right at the point above which the taxpayer returns to the 35% marginal tax rate.  Some ideas to generate this income are ROTH IRA conversions, exercising stock options, accelerating income into the current year or defer expenses to the following year if one has control of business income.

Forbes: The Alternative Minimum Tax Sweet Spot

Bob Farrell 10 Market Rules

Bob Farrell was Merrill Lynch's Chief Market Strategist from 1967-1992.  His market rules provide a simple framework for making investing decisions.  It's a good warm up for Howard Mark's, The Most Important Thing:  Uncommon Sense for the Thoughtful Investor.

1. Markets tend to return to long-run averages over time

2. Excesses in one direction are usually followed by excesses in the opposite direction

3. There are no new eras

4. Exponentially rising or falling markets usually go further than you think, but they do not correct by going sideways

5. The public buys the most at the top and the least at the bottom

6. Fear and greed are stronger than long-term resolve

7. Markets are strongest when they are broad based and weakest when they narrow to a handful of blue-chip names

8. Bear markets have three stages - share down, reflexive rebound, and a drawn-out fundamental downtrend

9. When all the experts agree, something else is going to happen

10. Bull markets are more fun than bear markets

Another great investing rule akin to Bob Farrel's 10 Rules of Investing is the following rule coined by Don Coxe of Cox Advisors, LLC:

"Never invest on the basis of a story on Page One, that is the efficient market.  Invest on the basis of a story on Page Sixteen that is on its way to Page One."

The Taxation of Gold Investments for Individual Investors

Individual investors may experience a substantial difference in the taxation of various investment vehicles used to track the price of gold.  To detail out these differences, let's assume that an investor wishes to compare the tax implications of investing in the SPDR Gold Trust (an exchange traded fund), DB Powershares Gold Fund (an exchange traded fund), PowerShares DB Gold Double Long ETN (an Exchange Traded Note), and gold bullion.


The SPDR Gold Trust, consistent with Internal Revenue Service Chief Counsel Memorandum , is structured as a grantor trust for federal tax purposes and directly invests in gold.  Shareholders are treated as if they own a pro rata share of the underlying assets of the Trust.  The Trust's income and expenses flow through to the shareholder.  Accordingly, the shareholder is subject to the maximum 28% capital gains tax on collectibles when the investment is held for more than one year.  The definition of collectibles is found in Code Section 408(m)(2).  If the holding period is short-term, the usual short-term capital gain rules apply.  More information about the taxation of this ETF, or any ETF for that matter, can be found in the ETF's prospectus.  The SPDR Gold Shares prospectus is located here.


In contrast, the DB Powershares Gold Fund is structured as a partnership for federal tax purposes and invests in actively traded futures contracts.  The investor is purchasing a publicly traded partnership.  Shareholders are taxed on their pro rata share of income, gain, loss, deduction, and other items.  The shareholder will receive a Schedule K-1 each year denoting these amounts.


Because the fund holds futures contracts, six-tenths of the profits will be taxed at long-term capital gains rates and the remaining four-tenths will receive short-term capital gains treatment.  This calculation is done at the partnership level and flows through to the Schedule K-1.  One may also report interest income from the Schedule K-1 from overnight investments and swap agreements entered into by the partnership.  At year-end, regardless of whether gains or losses have been realized, the futures contracts are marked to market.  This causes the partnership to report gain or loss even though nothing was sold.  The partnership is not required to distribute any of these gains, losses or interest to the investor, so the investor may be paying tax, but not receiving any distributions! 


When the investor sell the ETF, he is selling his share of the partnership.  Consequently, he will report a capital gain or loss, short-term or long-term depending upon the holding period, equal to the difference between the proceeds and his adjusted basis in the partnership.  The adjusted basis will most likely be provided to him on a schedule by the partnership, but not always.


The PowerShares DB Gold Double Long ETN is an exchange traded note.  ETN's are long-term, unsecured notes issued by a bank that do not require any interest or principal payments prior to maturity.  The ultimate payment at maturity is equal to the value of the principal payments as if it were invested in the underlying benchmark the ETN was designed to track, less any fees.


ETN's are currently taxed as prepaid financial contracts.  If one reads the prospectus for this ETN, one will find that "significant aspects of the U.S. federal income tax consequences of an investment in the securities are uncertain."  The IRS issued Notice 2008-2 seeking comments on the appropriate tax treatments of instruments decribed as prepaid forward contracts.  If the ETN is treated as a prepaid financial contract, then the gain or loss will be subject to long-term or short-term capital gains tax when the ETN is sold just as if one bought a stock.  However, the prospectus also provides for two alternative tax treatments detailed here in the prospectus.  Until the IRS comes out with definitive guidance, there may be an issue here for investors if the prepaid financial contract position is disallowed by the IRS.


By purchasing gold bullion, one is subject to the maximum capital gains rate on collectibles of 28% if the bullion is held for more than one year and short-term capital gains if held for less than one year.  The primary issues with bullion are storage and insurance costs.


It's important to read the prospectus before you invest in Exchange Traded Funds (ETF) and Exchange Traded Notes (ETN) in order to understand the tax implications.  The option that is best for one's investment portfolio and tax situation varies by investor.  For example, with bullion one can defer gain until one sells it.  With the grantor trust (SPDR Gold Trust) or partnership (DB Powershares Gold Fund), it may be harder to defer gain as the SPDR Gold Trust may sell gold to pay trust expenses and one will be taxed on one's share of partnership income on the DB Powershares Gold Fund whether or not one sells one's investment.  It's important to read up before you leap for the gold.