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Today’s Tax Market And The European Financial Crisis | Sean Barron

Sean Barron, Portfolio Manager with Delta Trust & Bank, sat down with Roby Brock of Talk Business to discuss today’s tax market and the financial crisis occurring in Europe. In an interview, time is always critical, so Sean has provided his full thoughts each question presented to him by Roby below. To watch the interview, click here.

Q: In your business, it’s incumbent to be able to predict “surprises”. Europe, the economy, inflation – these aren’t surprises but they’re impacting investments and the financial markets. What are some “predictable surprises” on the horizon?

A: I love this question! After the financial crisis and Nassim Taleb’s book “The Black Swan”, this term has become the go to phrase to describe anything on a large scale that is a rare event. When originally the term was meant to be a call to plan for the unexpected, it has turned out to be an excuse to lack of planning and a catch phrase for the major news outlets. This goes back to a blog post I made after listening to James Montier at the CFA Annual conference. He reminded us that black swans are unpredictable, have a massive impact, and there is ex-post rationalization. On the other hand, predicable surprises are where at least some people were aware of the problem, the problem gets worse over time, and eventually the problem explodes into a crisis.

Currently, the situation in Europe would definitely fit the definition of a predictable surprise. In my view, the following events would not be black swans as they more aptly fit the definition of a predictable surprise:

• Greece leaves the Euro.

• The Eurozone jointly and severally guarantee all debt issues by each country (including other steps to fiscal union) – although the real problem is a competitive dis-advantage by the PIIGS that will take longer to fix. Without an exchange rate to act as the fulcrum, this imbalance will remain in the short term.

Murakami will be the best new author you read this year.

• Bonds will not be considered “safe” and stocks “risky” 20 years from now. We have enjoyed a 30 year bull market in bonds that leads everyone to conclude that bonds are “safe”, as reversals in interest rate trends have been few and short in duration. This will not be the case in the next 20 years.

• The upcoming elections won’t elect any “leader” strong enough to make the changes the country needs long-term.

• Negative real interest rates will cause a bubble.

• Arkansas will win CWS.

• I will be wrong on at least one of these predictions. ;) 


Q: Everyone is worried about the debt crisis in Europe. Is there a way to “Euro-proof” investments?

A: In terms of volatility, no. Volatility in almost all markets will remain high, given political uncertainty and Europe continuing to plug the dam with bubble gum.

In terms of a permanent loss of capital, yes. In every era where there is great uncertainty, there is great opportunity. The key will be to stay liquid. Do not invest in investments that have lock-up periods, use leverage, or can require capital calls. There will be great opportunities to find value in the Euro crisis. Or, you could always take Jim Rogers advice, buy a farm and learn Mandarin.

Q: We have been watching a debate in Washington D.C. regarding the extension of the Bush-era tax cuts. What are the scenarios if they’re extended or if they aren’t for clients you’re working with?

A: The usual disclaimer: I am not an accountant. Please contact your CPA with your specific situation.

Income tax:

If modified adjusted gross income is over 200,000 for individuals and 250,000 for married couples, you may want to pull income into 2012 (regardless of what happens, as a result of 3.8% Medicare surtax). Also, you may want to delay charitable contributions to 2013 to the extent possible.

Capital gains:

The government has basically given you an interest free loan using your stock as collateral. If you die, the loan is forgiven and the collateral is freed up. If you ever need to spend the collateral, you must pay off the loan.

There are two additional “catches”:

One, any future gains or losses on the collateral is shared pro-rata by the loan. In effect, the government is sharing some of the risk with you. Two, the government can change the principal value of your loan (and its pro-rata share).

Now, if I made that deal with a company or friend (instead of the government) and I knew that party’s balance sheet had eroded and was spending more than it earned, I think that I would pay this party off before they unilaterally modified the terms of the deal.

Estate tax:

The annual exclusion amount for the estate tax is set to go from $5.12 million in 2012 to $1 million in 2013. While we don’t believe the $1 million will actually go into effect, there is no guarantee that it will remain at 2012 levels. You should definitely talk with your estate planner to determine if gifting to future generations in 2012 makes sense for you, as you can use the $5.12 million exclusion and pass to grandchildren with no generation skipping tax.

Click here to read a blog post from June 5 that discusses a breakdown of the effect of the tax increases on stock market valuation.

Q: A high-profile event with Arkansas ties is the controversy surrounding the alleged Mexican bribery scandal involving Walmart. This has led to investigations, shareholder lawsuits, yet the stock continues to perform well, I’d argue due to the retailer’s strong quarterly performance. Is it safe to say that the markets are pretty forgiving when you’re winning?

A: I think that Charlie Munger said it best, “You’ve got a complex system and it spews out a lot of wonderful numbers that enable you to measure some factors. But there are other factors that are terribly important, yet there’s no precise numbering you can put to these factors. You know they’re important, but you don’t have the numbers. Well practically everybody (1) overweighs the stuff that can be numbered, because it yields to the statistical techniques they’re taught in academia, and (2) doesn’t mix in the hard-to-measure stuff that may be more important. That is a mistake I’ve tried all my life to avoid, and I have no regrets for having done that.”

This brings to mind John Bogle’s comment that we are all “renters” of stock and not “owners”. This means the owners of the stock are transitory and take little interest in oversight. He also expounded on this in his excellent book “Enough”, where he explores how businesses today have become so much about the bottom line.

I think it is pretty obvious from the events at the large investment banks that greed trumps morals more often than we want to think. Ultimately, I do believe there is a discount applied by the market when issues of integrity or managements grasp of company complexity are called into question. You definitely see this in Chesapeake Energy and the previously mentioned large investment banks.

I do not follow Walmart closely though, so I cannot comment as to valuation. We focus on the qualitative aspect of a company first and they have never made it through those filters. To me, they had a huge competitive advantage as a result of an economy of scale and distribution system that no retailer could match. The wide distribution of the internet has eliminated that advantage. I personally can’t tell you the last time I went to Walmart. Amazon delivers all my “Walmart” type products to my door either monthly, bi-monthly, etc. I don’t have to take the time to drive to Walmart, I save gas money, and it is less expensive. Who wants to take the entire family 10 miles out of the way, listen to the kids ask to buy everything they see, spend twice as long and twice as much money as intended, when they can just have it delivered to their door?

I see Walmart where Microsoft was a few years ago. Early on, they killed their cash cow, DOS, and replaced it with Windows. Since then, they have been hesitant to embrace the internet, in fear of killing their Windows cash cow and now have given competitors a head start and are playing catch-up. I have more faith that Microsoft now understands the new reality than I do Walmart does.

Sean Barron
Portfolio Manager
Delta Trust & Bank

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