Fundmastery Blog

Kurt Brouwer April 22nd, 2008

Most of us have heard about high food prices, particularly for commodities such as corn, wheat, rice and other staple foods. Why are they going up and why now?

I first experienced the vagaries of the international food trade when I spent nearly a year in Mexico in 1974. On my way to beautiful and remote Tenacatita Bay (south of Puerto Vallarta), I passed through miles of banana groves, lush with fruit.

Yet, in the little tiendas (stores), bananas were not to be found. Nor was coffee to be found even though it was a huge, local crop. Instead, all the bananas and the coffee beans shipped off somewhere else. Nothing wrong with that, but it illustrated the disparities caused by modern distribution systems. Those farmers knew they could make more producing for export than selling locally. So, they made a wise economic decision.

Now, when it comes to agriculture, we are seeing a similar impact because it’s more lucrative to devote cropland to producing corn for the ethanol market than for food.

Source: Wikipedia Commons - USDA

Food Crisis Shows How Bad Policies Can Be Deadly (Bloomberg, April 21, 2008, Kevin Hassett)

Sometimes, bad economic policies create small annoyances. Sometimes, they lead to catastrophes.

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• Business , Economy , Geopolitics , Money
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Kurt Brouwer April 21st, 2008

This chart from the Wall Street Journal tells an interesting tale about the behavior of investors. It should be no surprise to readers of this blog, that when you change tax rates, investors change their behavior accordingly.

The chart below shows that as capital gains tax rates go up, investors slow down realization of gains. When capital gains tax rates go down, investors speed up realization of gains. Hmmm. Is there a correlation?

It’s important to remember that, as opposed to ordinary income from salaries and bonuses, investors have far more control of when and if they will realize a gain on a sale of stocks, mutual funds, real estate or a business.

And, this is not just an issue for the ‘rich.’ In recent years, most of the households reporting capital gains have been under $100,000 in annual income.

Source: Wall Street Journal

The correlation is not exact because the chart shows realization of capital gains went down in 2002. However, if you remember that 2002 was also a time of recession and a time of falling stock prices, it makes sense. Then, in 2003, the stock market perked up and the 2003 tax cuts kicked in and realizations of gains soared.

I believe that investors take a pragmatic approach to taxes. And, they change their behavior to take full advantage of changing circumstances.

When the tax rate for gains goes up, capital gains realizations go down. And, when investors realize fewer gains, they pay less in taxes. Conversely, when tax rates go down, realization of capital gains surges and tax revenues follow.

Now, in fairness, we have to point out that this effect does not work if you reduce capital gains rates to zero. Realization of gains would go up of course, but tax revenues would not because the rate would be zero. There is a point of diminishing returns from tax reduction and it may be around the current rate of 15%. I don’t know what the point is, but we are probably close.

However, that’s not the issue now. We are not hearing calls for lower capital gains tax rates. Instead, some politicians are calling for much higher capital gains tax rates. Despite decades of evidence to the contrary, they must still think that higher capital gains tax rates will result in higher tax revenues.

Based on what we hear on the campaign trail, the correlation noted in this post and the accompanying chart has not yet sunk in with all of our political leaders. We hope it does.

Via: Steve Janachowski

• Economy , Geopolitics , Money , Personal Finance
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Kurt Brouwer April 19th, 2008

As we all know, financial companies took an earnings hit this quarter as did consumer-oriented companies.

But, plenty of companies in other sectors took home the gold. Companies — from Coke to IBM to Google — made plenty of money this quarter and their prospects look good going forward [emphasis added below]:

Economic Split Seen In Corporate Earnings (Wall Street Journal, April 18, 2008, Tom Lauricella)

As first-quarter corporate earnings reports begin to roll in, a stark picture is emerging of an economy on two tracks.

Banks and companies that sell directly to consumers are grappling with the impact of falling home prices and tightening credit. But many big businesses, especially those that sell to other U.S. companies or to customers abroad, are proving resilient.

On Wednesday, Coca-Cola Co. Chief Executive E. Neville Isdell noted during the company’s conference call that he had taken a recent trip to Chile and Peru. “There’s a vibrancy in Latin America that I don’t think we’ve seen in decades,” he remarked. At International Business Machines Corp., which derives 65% of its business from outside the U.S., Chief Financial Officer Mark Loughridge said the firm posted “very, very solid growth” in emerging markets.

…And late Thursday, Google Inc., which makes 51% of its revenues outside the U.S., reported much stronger than expected results. The company dashed recent concerns that its remarkable growth — based largely on advertising — would be slowed down by the consumer downturn. “We’ve looked at this really carefully and we do not see an impact as of this time,” Google’s CEO, Eric Schmidt, said in a conference call. The market responded by pushing Google’s stock price up 17% in after-hours trading.

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• Business , Economy , Investing , Money , Mutual Funds
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Kurt Brouwer April 18th, 2008

Chinese stocks have taken quite a hit since October, 2007 as this post from the Wall Street Journal’s MarketBeat Blog points out [emphasis in the original]:

China Staggers Around The Track (MarketBeat Blog, April 18, 2008, David Gaffen)

Investors hoping to ride China’s stock market run into the summer Olympics in Beijing have found themselves gasping for oxygen. The most dismaying part is that despite a 50% decline in the country’s major stock index, it may still be overvalued.

The benchmark Shanghai Composite Index ended Friday’s trading down 4%, and has lost 50% from its mid-October record high of 6124.04. Despite this, analysts at Bespoke Investment Group estimate the forward price-to-earnings ratio of the index at 20.90, which ranks second among 13 major world indexes, trailing only the tech-heavy U.S. Nasdaq Composite Index.

Furthermore, the Shanghai index is further from its 52-week high than 21 other major world equity markets. “I don’t know that the froth is still there, but whether it’s inexpensive enough to step back in, well, the Chinese government is still trying to slow the economy to a certain extent,” says Malcolm Polley, president and chief investment officer at Stewart Capital Advisors. “The danger is that it slows a bit too much and in that case, I think you still have to worry about valuation.”

If a stock market falls 50% and valuations are still high, then that’s a problem. But a forward price-earnings ratio of 21 for an economy growing as fast as China seems pretty reasonable. I can only conclude that investors are concerned that economic growth is going to slow way down. Gaffen’s post makes that very point:

Authorities are attempting to curtail growth in the domestic economy to head off inflation, but the Chinese economy grew at a 10.6% rate in the first quarter, a mild moderation from the 11% rate in the fourth quarter. China is dealing with the twin problems of rising inflation and the possibility that demand will slow as a result of the decline in global economic activity.

Still, there is some hope. Inflation moderated in March to an annual rate of 8.3% from 8.7%, near a 12-year high. Analysts at Morgan Stanley believe China is in position to experience a “soft landing,” saying that “external weakness will help to cool the Chinese economy without further aggressive tightening actions through blunt policy instruments by the government.”

Booming economic growth — 10.6% — sounds very good, but inflation is also high at 8.3%. Can China put a dent in inflation without choking off growth? And, as the U.S. economy slows, what happens to China’s export-fueled boom?

• Geopolitics , Investing , Money
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Kurt Brouwer April 18th, 2008

CBS News regularly polls Americans on this question: What is the biggest problem we face?

For a long time, the war in Iraq consistently ranked as the biggest problem, but that all changed as this chart shows:

Source: CBS News (via The Blog & Political Arithmetik Blog)

I don’t think this means that Americans are no longer concerned about Iraq, but rather that worries about the economy have spiked while concerns about Iraq have diminished a bit.

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