On the Fed, Stocks, the Election & More on the 1%

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 17, 2012

IN THIS ISSUE:

1. Fed’s Beige Book Shows Economy is Improving

2. The Stock Market in Presidential Election Years

3. Who Are the Richest 1%, Really?

Introduction

Today we visit several interesting topics. We begin with a look at the Fed’s latest Beige Book report that came out last week, which showed that the economy improved at least modestly in all 12 Fed Districts. We also ponder the question of whether the Fed is ramping up to do another round of quantitative easing (QE3).

Next, with everyone wondering if we’re facing another roller coaster ride in the stock market this year, I will bring you some interesting facts about what stocks have historically done in presidential election years.

Finally, we received a great deal of response to last week’s E-Letter that focused on members of Congress and how they fare so much better than the rest of us financially speaking. Given the level of interest in this topic, I dug a little deeper over the last week to find some fascinating information on the so-called “Top 1%” of wealthiest Americans. You’re going to love this!

Housekeeping Note: My writing goal for the New Year is to keep these weekly E-Letters a bit shorter. Internet consultants consistently tell me that shorter is better. We’ll see if I succeed. As always, I would love to get your feedback on this point, or anything else that’s on your mind. Let me know what you like (or don’t like). Click here to give me your thoughts in a quick e-mail.

Fed’s Beige Book Shows Economy is Improving

Every six weeks or so, the Federal Reserve issues an economic and financial progress report based on information provided by its 12 regional Federal Reserve Banks located in major cities across the country. The so-called “Beige Book” (more formally named the “Summary of Commentary on Current Economic Conditions”) is published eight times per year in advance of meetings of the Federal Open Market Committee (FOMC) which sets monetary policy.

The Beige Book is a summary of the change in economic and financial conditions in each of the 12 Fed Districts based on numerous indicators and anecdotal information gleaned from interviews with business leaders and economists in the districts during the previous 6-7 weeks. The Fed has been releasing the Beige Book to the public since 1985.

The latest Fed Beige Book report was released last week and indicated that the overall economy improved at least modestly late last year. Reports from the 12 Federal Reserve Districts suggest that national economic activity expanded at a “modest to moderate pace” during the reporting period of late November through the end of December.

Seven Districts characterized growth as modest (slow); of the remaining five, New York and Chicago noted a pickup in the pace of growth, Dallas and San Francisco reported moderate growth, and Richmond indicated that activity flattened or improved slightly. The Fed summarized the latest Beige Book as follows:

Compared with prior summaries, the reports on balance suggest ongoing improvement in economic conditions in recent months, with most Districts highlighting more favorable conditions than identified in reports from the late spring through early fall.

Consumer spending picked up in most Districts, reflecting significant gains in holiday retail sales compared with last year's season, and activity in the travel and tourism sector expanded in most areas. Demand strengthened further for nonfinancial services, including professional and transportation services.

Manufacturing activity generally continued to expand, although the pace of growth has slowed for selected subsectors such as technology products. Agricultural producers and extractors of natural resources reported generally robust conditions.

Activity stayed sluggish in residential real estate markets, and conditions in commercial real estate markets remained somewhat soft overall but showed signs of ongoing improvement in several Districts. Reports from financial institutions generally indicated a slight uptick in loan demand by businesses, along with improvements in overall credit quality.

If you would like to read the complete Beige Book summary from the Fed, here is the link:
http://www.federalreserve.gov/fomc/beigebook/2012/20120111/default.htm

In short, the latest Beige Book noted that economic activity improved at least modestly in all 12 Districts in the final six weeks of last year. However, the report also noted that there was persistent weakness in the housing sector in almost all Districts. The report suggested that continued weakness in housing could serve as a lid on overall economic growth.

The report also noted strong holiday sales in most Districts (although such sales were up about the same as in 2010). Yet last week’s retail sales report for December was well below expectations. The Commerce Department reported last Thursday that retail sales rose only 0.1% in December versus the pre-report consensus of 0.3%, and well short of the 0.4% rise in November.

Is the Fed Preparing For QE3?

As noted above, the Beige Book provides input for the next Fed Open Market Committee meeting. The next FOMC meeting is set for January 25-26. It appears to me that we have reached the point where the subject of more “quantitative easing” (QE3 in this case) is going to come up before every FOMC meeting. Already I have read analysts suggesting the Fed will vote to implement QE3 at the upcoming meeting.

I don’t agree. You may recall that the October Beige Book was somewhat downbeat as compared to the latest version released last week. Many analysts felt in late October that the Fed was all but certain to vote on QE3 at the November 1-2 FOMC meeting. No such vote was taken.

With the latest Beige Book looking considerably better than the October report, I would not expect the Fed to embark on QE3 at the January 25-26 FOMC meeting. Instead of QE3, I expect the Fed to continue its program of extending the average maturity of its holdings of securities as well as reinvesting principal payments from its holdings of agency debt, as announced in September.

Of course, this is an election year, so anything can happen. It is true that there are more “doves” than “hawks” on the FOMC, and the doves probably favor QE3, but they know that QE1 and QE2 were both very unpopular. For all these reasons, I will be surprised if the Fed votes to implement QE3 later this month.

The Fed has promised to keep short-term interest rates quite low at least until mid-2013, and many analysts believe it will be even longer. Inflation pressures peaked last year, and the Fed believes it will continue to move lower this year. With Europe sinking into recession and continued slow growth in the US, the Fed is probably correct.

One last note on the Fed before we move on. Beginning with the January 25-26 FOMC meeting, the Fed has promised to make public its economic and interest rate forecasts. In previous years, these forecasts have been proprietary.

The Stock Market in Presidential Election Years

The stock market has a history of going UP in presidential election years. In fact, the propensity to rise in presidential years is so strong that there are professional money managers who factor this into their trading programs once every four years.

The table below shows the return of the S&P 500 Index for each election year since 1928. As you can see, in the last 21 election years there have been only three 3 years where the S&P 500 Index had a negative return. Eighteen of the last 21 election years were positive – now that’s strong!

S&P 500 Stock Market Returns During Election Years
Year	Return	Candidates
1928	43.6%	Hoover vs. Smith
1932	8.2%	Roosevelt vs. Hoover
1936	33.9%	Roosevelt vs. Landon
1940	-9.8%	Roosevelt vs. Willkie
1944	19.7%	Roosevelt vs. Dewey
1948	5.5%	Truman vs. Dewey
1952	18.3%	Eisenhower vs. Stevenson
1956	6.5%	Eisenhower vs. Stevenson
1960	.50%	Kennedy vs. Nixon
1964	16.5%	Johnson vs. Goldwater
1968	11.1%	Nixon vs. Humphrey
1972	19.0%	Nixon vs. McGovern
1976	23.8%	Carter vs. Ford
1980	32.4%	Reagan vs. Carter
1984	6.3%	Reagan vs. Mondale
1988	16.8%	Bush vs. Dukakis
1992	7.7%	Clinton vs. Bush
1996	23.1%	Clinton vs. Dole
2000	-9.1%	Bush vs. Gore
2004	10.9%	Bush vs. Kerry
2008	-37%	Obama vs. McCain
2012	?	Obama vs. ?

Source: Wells Fargo, About.com

The average return in presidential election years is just under 12%. If we were to omit the 37.0% loss in 2008 due to the financial crisis, and divide by 20 years, the average presidential year return shoots up to 14.25%. No wonder so many money managers want to be long in presidential election years!

A study conducted by Wells Fargo found that the average market return in the fourth year of a presidential term is twice that of the average return in the first year of a president’s term. This is all quite compelling, especially given the roller coaster ride in 2011 when the S&P 500 narrowly managed to close up less than 3% for the year.

What will be most interesting to watch this year is what the stock markets do if it looks like President Obama is going to win re-election by, say, late August or early September. If Obama is holding a comfortable lead in the polls by then, it would not surprise me if the equity markets go into a decline and 2012 becomes the fourth losing election year since 1928. Just my theory….

Who Are the Richest 1%, Really?

Given the large response to last week’s E-Letter that focused on members of Congress and how they fare so much better than the rest of us financially speaking, I dug a little deeper to find some fascinating information about the so-called “Top 1%.” The question is, who are those Top 1% of wealthiest Americans we’re all supposed to despise?

If you listen to President Obama, the Occupy Wall Street protesters and much of the media, most of the wealthiest 1% are either “trust-fund babies” who inherited their money, or greedy bankers and hedge-fund managers. Certainly, they haven’t worked especially hard, if at all, for their money, critics say.

While the recession has thrown millions of Americans out of work, the Top 1% have been getting even richer. Worse, they don’t even pay their fair share in taxes, according to Obama and the critics. Most millionaires and billionaires – as Warren Buffet claims – are paying a lower tax rate than their secretaries, the critics say. But this is not true as I will explain below.

In reality, each of these stereotypes is largely misleading. Sure, there are some undeserving bad apples among America’s Top 1%, but there are some bad apples in every demographic group. Consider this:

Roughly 80% of millionaires in America are the first generation of their family to be rich according to the Cato Institute. They didn’t inherit their wealth; they earned it. For the most part, the wealthy have worked hard for their money. New York University sociologist Dalton Conley says that “higher-income folks work more hours than lower-wage earners do,” based on several studies.

So who are the Top 1%? According to a recent survey of the Top 1% of wealthiest Americans, less than 14% were involved in banking or finance (including hedge fund managers). Roughly a third were entrepreneurs or managers of non-financial businesses. Nearly 16% were doctors or other medical professionals. Lawyers made up slightly more than 8%, and engineers, scientists and computer professionals another 6.6%. Sports and entertainment figures in the Top 1% composed almost 2%.

The career categories noted above alone represent almost 80% of the Top 1%. And there are members of the Top 1% in other demanding career fields. So much for the notion that most of the Top 1% are trust fund babies, bankers or hedge fund managers!

Much attention has been paid recently to a Congressional Budget Office study that showed incomes for the Top 1% rose far faster from 1980 until 2007 than for the rest of us. Yet because so much of their income is held in investments, the recession and the bear market have hit the rich especially hard. The nonpartisan Tax Foundation has found that since 2007, there has been a 39% decline in the number of American millionaires.

The number of “super-rich” – those earning over $10 million a year – has plunged by 55% since 2007. In 2008, the Top 1% earned 20% of all income in this country, but by 2010, that number declined to 16%. As for not paying their fair share, the Top 1% pay 36.7% of all federal income taxes. Because they earn just 16% of all income, that certainly seems like more than a fair share.

Maybe Warren Buffett is paying a lower tax rate than his secretary, as he claims. But the comparison is misleading because Buffett’s income comes mostly from capital gains, which were already taxed at their origin through the corporate-income tax, and are currently taxed at a rate of 15% at the individual level. Moreover, the Buffetts of the world are clearly an exception. Overall, the rich pay an effective tax rate (after all deductions and exemptions) of roughly 24%. For all taxpayers as a group, the average effective tax rate is only about 11%.

Beyond taxes, the rich also pay in terms of private charity. Households with more than $1 million in income donated more than $150 billion to charity in 2010, roughly half of all US charitable donations. Greedy? It hardly seems so.

And let us not forget the fact that the rich provide the investment capital that funds ventures, creates jobs and spurs innovation. The money that the rich save and invest is a big part of the money that companies use to start or expand businesses, buy machinery and other physical capital and hire workers.

It has become fashionable to ridicule the idea of the rich as “job creators,” but if the rich don’t create jobs, who will? How many workers have been hired recently by the poor?

No doubt dishonest or unscrupulous businessmen have gotten rich by taking advantage of others. No doubt there are trust fund babies, some of which have never worked or worked very little. But the vast majority of the Top 1% worked hard and in the process created jobs for millions of Americans.

Remember this the next time you hear President Obama criticize the wealthy for not paying “their fair share.” And feel free to share the above with others.

Wishing you all the best,

Gary D. Halbert

Gary's latest blog: 2012 Off to a Good Start

Special Articles

The Genius of “One Percenters” (Great read)
http://www.forbes.com/sites/jimpowell/2011/12/29/the-genius-of-one-percenters-is-their-amazing-command-of-the-obvious

Should the Fed print more money? No.
http://news.investors.com/Article/597856/201201131851/fed-ready-to-print-more-money.htm

Govt. showdown brewing over payroll tax cut, etc.
http://tpmdc.talkingpointsmemo.com/2012/01/payroll-tax-cut-negotiations-begin-is-congress-headed-for-another-showdown.php?ref=fpa