The Ups and Downs of Small Business

We often hear that small business is the primary engine of job growth in our country, and to a certain extent that is absolutely true. Small businesses - defined as those with fewer than 50 employees - hired 3 million workers in the second quarter of last year, the Labor Department said yesterday. That's more than half of all new employees, even though small business accounts for just 30 percent of all private sector jobs.

That's the good news, but there's a downside to this as well. Small businesses also accounted for a disproportionate number of layoffs as well - 2.8 million job losses could attributed to that category for the second quarter. The net new number of jobs in small businesses was 158,000.

In the same time frame, mid-sized companies (defined as those with 50 to 249 employees), added just 1.1 million jobs, but they also lost only 900,000 jobs. So the net for that category, 161,000 new jobs, actually exceeded the net job growth for smaller companies.

This Morning's Bad GDP News

There's very disappointing economic news out this morning from the Commerce Department: The American economy actually shrank in the fourth quarter of 2012, by a rate of 0.1 percent. This follows on the heels of relatively strong growth, of 3.1 percent, in the third quarter.

What happened? Commerce cited three primary factors contributing to the downturn:

* Exports fell by 5.7 percent in the quarter, after having increased by 1.9 percent in the third.

* Expenditures by the federal government dropped by 15.0 percent, after having increased by 9.5 percent in the third quarter. Defense spending dropped by 22.2 percent in the fourth quarter.

* Business inventories subtracted 1.3 percentage points from GDP, after they had added 0.73 percentage points in the previous quarter.

It's important to note that this is the first estimate of GDP for the quarter, and subsequent revisions may push the economy into the black. But it still looks like a real setback for the recovery.

Growth in 2013

Where is the economy headed this year? If you believe the latest survey from the National Association for Business Economics, which came out yesterday, it might not be half bad. Half of those polled say the economy will grow at a rate of 2.1 percent pace or better over the next four quarters. Notably, only 36 percent of the group said the same thing last October.

If those economists are correct, it would mean that the economy was about strong in 2013 as it had been in 2012. We won’t have the fourth quarter GDP figure until tomorrow, but through the first three quarters of 2012, the economy grew at a pace of right around that 2.1 percent.

Although the economists weren’t quite as positive about the employment situation, their opinions on the matter are improving. More than a third said that their firms or industries plan to increase hiring in the next six months, up from 28 percent who said that back in October 2012. 

Landmarks for the S&P 500

The Standard & Poor's 500 index crossed a significant milestone on Friday, when it closed above 1500, finishing at 1502.96. It hadn't closed at that level since December 27, 2007. While these numerical thresholds are pretty arbitrary, it's still a nice reminder of how far the market has come in the past few years.

There was another milestone reached on Friday, one that extends even further back: Friday was the eighth consecutive trading day in which the S&P 500 gained. If that doesn't sound so impressive, consider that the S&P hasn't had a winning streak that long since November 2004.

The end of the week also marked the fourth straight week in which the S&P advanced. It's still 4 percent away from its all-time high, though, set back in October 2007.

The Long Years of Retirement

How long do you expect to spend in your retirement years? Maybe longer than you think. According to a new demographic study conducted by BlackRock Investor Watch, if you are a healthy couple entering retirement at the age of 65 today, there is a 50/50 chance that at least one of you will survive to the age of 92.

That's the good news. The bad news is that many investors and retirees underestimate how many years they will spend in retirement. According to the BlackRock survey, 31 percent of the respondents said they expected to be retired for 15 years or less. In reality, the median is more like 27 years.

The upshot is that only half of all workers surveyed knew how much they had to save to account for all those retirement years. That's a difficult state of affairs.

Buybacks Getting Hotter

Share buybacks continue to be one of the hottest forces in all of investing. Consider that for the 12 months that ended in October of last year, the companies in the Standard & Poor's 500 issued $277 billion in dividends. Over that same time frame, those companies spent $375 billion in share buybacks. Buybacks have become the preferred way for corporations to return money to their shareholders.

More than 8 billion shares were retired via buybacks from the S&P 500 companies in the 18 months that ended in  October 2012. That leaves about 300 billion shares outstanding for those 500 companies, which is the lowest that figure has been since 2009.

This might seem like good news for investors, but there's an important caveat. One would expect companies to buy back their shares when stock prices are still rising, but their record of doing so is not impressive. The peak for buybacks by the S&P 500 was in 2007, just before the market collapsed; the low point came in early 2009, just as stocks were going on a four-year bull run.

Earnings Season in High Gear

Earnings seasons is upon us once again, and so far, the results have been pretty mediocre. Of the 54 companies in the Standard & Poor's 500 that had reported their earnings through the end of last week, 65 percent came in above their estimates. That may sound pretty good, but it's actually a bit below the historical returns.

That's the bad news; the good news is that earnings growth is up overall. The companies in the S&P 500 have reported earnings growth of 1.9 percent so far in the fourth quarter, after a decline in earnings growth of 1 percent in the third quarter of 2012.

The strongest earnings growth so far has been shown by the financial sector, up 12.2 percent, and the utilities sector, up 8.9 percent. The laggards have been the industrials, down 4.8 percent, information technology, down 2.9 percent, and health care, down 1.9 percent.

Losses from 401(k)s

Most people manage to leave their 401(k)s untouched until they reach retirement, which is of course their purpose. But a significant number of Americans have found themselves in recent years forced to dip into those savings. According to a study conducted by a company called HelloWallet, one in four 401(k) savers has raided his or her account for preretirement needs.

In 2010, the most recent year for which we have figures, workers took out some $70 billion from their 401(k) accounts prematurely. When you realize that workers contributed $175 billion to their 401(k)s in 2010, and employers made about $120 billion in contributions to their employees' 401(k)s, you can see that this is a very significant concern.

Add those figures together, and the result is that for every dollar that Americans put into a 401(k) in 2010, there was nearly 25 cents taken out. That's a frightening trend.

Fear Strikes Out

We've talked before about the Volatility Index, commonly known as either the VIX or the Fear Index. It's the measure of how much movement - positive or negative - that investors are expecting in the market, as measured by the number of puts and calls they're buying. It made news on Friday, when the Volatility Index reached its lowest point in five and a half years.

The VIX dropped 8 percent on Friday, and has now fallen 45 percent over the past three weeks, basically ever since it became clear that we weren't headed over the fiscal cliff. It closed Friday at 12.46, which is the first time it's been below 13 since April 27, 2007.

These five-year anniversaries are significant because they put us back to a time prior to the meltdown of the financial sector, prior to the onset of the recession. What the lowered VIX is telling us is that investors don't have any more fear or wild expectation from this market than they did in the calm days of early 2007.

Five -Year Highs

The Standard & Poor's 500 Index reached its highest point in five years yesterday. The index closed at 1481, which is the highest close it's seen since December 26, 2007. It's still a bit below it's all-time record high of 1565, set on October 9, 2007.

The Dow Jones Industrial Average is in a similar place: It closed yesterday at its highest point in more than five years, at 13,596. It's still 4 percent below its record close of 14,165, also set back in October of 2007.

If it sounds unusual for the Dow Jones to trade below its all-time high for more than five years, it's really not. Back in September 1929, just before the Black Friday crash the precipitated the Great Depression, the Dow reached a peak of 381. It didn't reach that level again until November 1954 - a span of more than 25 years.

Inflation Quiets Down

According to figures released yesterday by the Labor Department, prices were flat in December. That meant that we ended the year with an annual inflation rate of 1.7 percent. In 2011, by contrast, the core inflation rate averaged 3.0 percent.

What accounts for the difference? In 2012 as a whole, energy prices rose by 0.5 percent, whereas they had increased by a disquieting 6.6 percent in 2011. The increase in the cost of food also slowed: Food prices rose by 1.8 percent in 2012, after rising by 4.7 percent in 2011.

All those recent figures are in line with the long-term trends at this point. Adding in the results from 2012, consumer prices showed an average annual increase of 2.4 percent over the past decade.

The Takeover Premium

You may have heard that Michael Dell, who legendarily founded Dell Computers out of his dorm room at the University of Texas, is now interested in taking the company private again. Dell the company went public in 1988, and after some hard times recently - the stock has declined 43 percent in the past five years - Michael Dell wants to run it himself again.

As soon as he announced the plan to take the company private, Dell's stock rose by 13 percent in one day. That's very common for companies that have announced plans to go private. According to one academic study that looked at such stocks, there was a 26.2 percent premium applied to the pre-takeover stock value of these companies.

And if anything, that number is getting higher. Last year the news service Thomson Reuters calculated that the average premium for takeover companies that were taken private in 2012 approached 30 percent.

Hard Times for Small Business

One area of the economy that has still not reached full recovery is the nation’s small businesses. Economists at Citigroup have found that payrolls at companies with fewer than 500 employees now account for less than 50 percent of the total workforce – the first time that has happened since 2008, in the midst of the recession. Small businesses’ share of America’s GDP has dropped from nearly 50 percent in 2001 to about 45 percent now.

Small business as a force has been declining for some time now. Small businesses were responsible for 61 percent of all new jobs created in the decade from 1998 to 2007. But that number was 65 percent in the ten years prior to that, and 77 percent in the decade that ended in 1987.

Altogether, the total number of small businesses in America had come down to 4.9 million in 2010. In 2007, before the effects of the recession, that number had reached a peak of 5.3 million.

The IRS Says Slow Down

If you're anticipating a refund from the Internal Revenue Service this year, you might be champing at the bit to get your tax return filed. But you'll have to hold on for a little while. The IRS announced last week that because it had to wait until January 2 for the Fiscal Cliff issues to be resolved, it won't be able to begin processing returns this year until January 30. That's about eight days later than normal.

Filers with some complicating factors on their returns will have to wait even longer. If you're claiming such things as residential energy credits, depreciation of property or general business credits, the IRS won't be able to deal with your return until late February or March.

But despite all the IRS's problems, don't expect to get any leeway on the other end. As always, the deadline for sending your return back to the IRS is April 15th. 

The Rise in Inventories

According to figures released by the Commerce Department yesterday, the amount of inventory at U.S wholesalers increased in the month of November, jumping by 0.6 percent. That's the kind of good news that economics watchers are often wary of: While it signals increased economic activity, a growth in inventory often means that manufacturers can scale back in the coming months, so it's not necessarily a positive sign for the future.

But sales for wholesalers actually outpaced the rate at which inventories grew. Sales for wholesalers increased by 2.3 percent in November, which was up from a decrease of 0.9 percent the previous month.

What does that mean? Even with the increased inventory, wholesalers were left with enough goods on hand to last an average of just 1.19 months, which is the lowest that figure has been since last May. So inventories aren't overstocked at all, and thus this doesn't necessarily portend a slowdown in future economic activity. It's probably good news for our economy.

Another January Indicator

We described the other day the effects of the January Indicator, which holds that the direction of the market in January indicates its direction over the course of the year. If you're too impatient to wait for the end of the month, an economist at Goldman Sachs says he has been using an indicator based on just first the five days of January - and it might be an even stronger indicator than the entire month's returns.

For 85 percent of the years since 1950, the first five trading days of January have forecast the overall direction of the Standard & Poor's 500 for the entire year. The only years in that time frame in which the two have failed to track have been 1966, 1973, 1990, 2002 and 2011, although 2011 should come with an asterisk, since the S&P was famously flat for that year.

And the first five days of this year? For the first five trading days of 2013, the S&P 500 was up by about 2 percent. So if you believe in omens, we should be in for a positive year.

The Boomers Did It

As we've mentioned before, one of the paradoxes of the current investing landscape is the, while the stock market has been strong lately, the amount of money flowing into domestic equity funds has continued to drop. Those funds lost about $150 billion in 2012. There's one overwhelming trend that may be largely responsible for this: the aging of the Baby Boomers.

We often hear that as we get older, our assets should move into safer instruments, and the Baby Boom generation has apparently taken this advice to heart. In 2011, according to data compiled by the Investment Company Institute, only 10 percent of households headed by someone aged 65 or older were willing to take above-average or substantial investment risk. Meanwhile, 19 percent of households headed by someone from 50 to 64, and 26 percent of those households headed by someone between the ages of 35 and 49,  were willing to take on that kind of risk.

We can see this show up in the types of assets in people's 401(k)s. In 2010, the most recent year for which the ICI has figures, only 38 percent of 401(k) participants in their sixties had more than three-fifths of their assets in those accounts invested in stocks, but that number rises to 70 percent of 401(k) participants in their forties. As the Baby Boomers continue to move from into their sixties, expect more of their assets to move from stocks to bonds.

The January Indicator

There's an old saw called the January Indicator, which holds that the direction the stock market takes in January will be the direction it moves over the course of the entire year. It sounds like a bit of market legend, but the Wall Street Journal looked into the idea, and found that it holds up. In 82 of the past 112 years, where the Dow Jones Industrial Average went in January was also where it went over the entire year.

Ah, but isn't that statistic a bit loaded? After all, January makes up part of the subsequent year, so it will influence the overall results. So the Journal looked at the following 11 months apart form January's return, and found that the January Indicator still held up in 70 of the 112 years.

What's more remarkable is that no other month shows as strong an effect. The only month that came close to predicting the direction of the following 11 months was November, which correctly forecast the subsequent year in 69 out of the 112 years. Most of the rest of the months were at 60 or fewer.

Value Edges Ahead

Here's one way in which 2012 turned out to be different from the years prior: Value stocks outperformed growth stocks. The Russell 3000 Value Index increased by 16 percent on the year, while the Russell 3000 Growth Index returned 14.7 percent. 

That's not a huge difference, but it reverses the pattern of earlier years. Growth stocks had outpaced value stocks each of of the past three years; in 2009, the growth index returned nearly 40 percent, while the value index returned 20 percent. 

Growth stocks, remember, are those that are expected to increase their earnings in future years, while value stocks are those that are considered undervalued by the market. These shifts in returns between the two categories tend to be cyclical, so we could very well see value outperform for a few years now.

The Last Jobs Report of 2012

December's employment figures, released this morning, show a holding pattern for the jobs market, with everything pretty much the way it has been in recent. months. The economy added 155,000 jobs in December, capping off a year in which we saw an average of 153,000 new jobs per month, so that is right on target. The average was 153,000 jobs per month in 2011 as well.

Superstorm Sandy may have had a positive effect on hiring for December. The construction sector added 30,000 new jobs, which was the second-most behind only the health-care sector at 45,000.

The unemployment rate remained unchanged at 7.8 percent, which may come as a surprise to those of you who follow these things closely. November's unemployment rate was first reported, back in early December, at 7.7 percent. That number was revised upward in today's report, which acknowledges now that the more accurate figure was 7.8 percent all along.

The New Landscape for Roth IRAs

There was another little-noticed aspect of the Fiscal Cliff that passed on New Year's Day that could have a great effect on many people's retirement planning. It will now be much easier for people to transfer assets from a traditional 401(k) into a Roth IRA. Formerly, you couldn't do that until you reached age 59 and a half or when you changed employers, but those restrictions will now be lifted.

Remember, you can put money into a 401(k) tax-free, but that money is taxed when you withdraw it. A Roth IRA is the opposite: You are taxed on the money you put into one, but the withdrawals in your retirement are tax-free.

Of course, if you're making the switch, you pay tax on the money that was in your 401(k) when you move it into a Roth; you don't get to avoid taxes on both ends. If you'd like to discuss how this strategy might fit into your retirement plans, feel free to give me a call.

Estate Taxes and the Fiscal Cliff

Most of the talk over the Fiscal Cliff imbroglio has been about marginal tax rates and cuts to defense and entitlement spending. But one other key part of the negotiations has been the estate tax. The tax rate for estates for last year was set at 35 percent, with an exemption for the first $5.2 million in an estate. But that is now set to change.

In the proposal that the House of Representatives passed late last night, the estate tax rate was raised to 40 percent, with an exemption level of $5 million. The 40 percent rate kicks in for people in the top tax bracket, which is $450,000 for married couples.

And in a crucial provision, and that $5 million exemption threshold will be indexed to inflation. That sort of flexibility indicates that these levels are intended to stick around for a while.

Thoughts for New Year's Day

“All of us every single year, we're a different person. I don't think we're the same person all our lives.” ~ Steven Spielberg

“May all your troubles last as long as your New Year’s resolutions.” ~ Joey Adams

“Let our New Year's resolution be this: we will be there for one another as fellow members of humanity, in the finest sense of the word.” ~ Goran Persson