Bob’s Journal for 12/2/21
Profit Margins Keep Soaring
The major question for stock investors is: Can profit margins continue to increase faster than the economy?
For most of the 2000s, profit margins of nonfinancial businesses have increased faster most quarters than the post-war average. Lately, they’ve increased faster than at any point since the early 1950s. Profit margins also have increased at a higher rate than the economy.
This historic growth in profit margins is a major reason why stock prices consistently increased faster than the economy.
The issue for investors is whether profit margins can continue to grow at historic rates.
Long-term secular trends and government policies were favorable to profit growth. But some of those trends and policies are starting to reverse.
Wages and salaries are rising at their highest rates in decades. The labor shortage means businesses are likely to have to continue increasing compensation.
There’s a global movement to increase taxes and regulations on businesses. More aggressive antitrust actions seem likely. Commodity and supply shortages also increase the cost of doing business and have the potential to reduce profit margins.
Global trade is decreasing after decades of increasing.
Now, it looks like the Fed and other central banks are becoming more concerned about inflation than about stimulating growth.
In recent earnings calls, many businesses cited these and other factors as potential pressures on future earnings and margins.
But so far businesses have been able to raise prices at least as much as their costs increased. That’s maintained profit margins for many of them while contributing to the surge in inflation.
Surveys of business owners indicate they are able to increase prices to their customers and plan to increase prices in the coming months.
For now, there seems to be a sustainable cycle of high consumer spending causing businesses to expand to meet that demand, including by raising compensation.
The higher compensation gives consumers more money to spend so they can pay the higher prices businesses charge to maintain their profit margins.
The cycle is likely to continue until either consumers decide they won’t pay the higher prices or the Federal Reserve decides inflation is too high and takes actions to reduce economic growth.
Tax Court Shows a Peril of Holding Gold in Self-Directed IRAs
A true self-directed IRA allows taxpayers to invest in non-traditional assets, such as real estate, mortgages, small businesses and precious metals. But the IRA rules are detailed, and the IRS and Tax Court expect IRA owners to follow them to the letter.
Most IRA custodians restrict investments to publicly traded assets such as stocks, bonds, mutual funds, options and futures. But custodians of true self-directed IRAs allow the IRAs to be invested in almost anything. These custodians charge higher fees than more traditional IRA custodians.
A popular strategy is the Checkbook IRA, or LLC IRA. In this strategy, an LLC is created and a true self-directed IRA buys all the ownership interests in the LLC. The LLC establishes a financial account or checking account.
Then, the LLC can buy or invest in anything the tax code allows. The transactions are conducted using the LLC’s checkbook. This saves transaction fees since the IRA custodian isn’t making the transactions.
But the LLC must follow all the IRA rules, because the IRA is considered to have engaged in any of the transactions the LLC undertakes and to own any assets the LLC owns.
In a recent Tax Court case, the taxpayer engaged in the Checkbook IRA strategy and had the IRA buy American Eagle gold coins. The taxpayer, as a managing member of the LLC, took physical possession of the coins.
Generally, gold bullion and coins (as well as other precious metals) are considered collectibles in the tax code. An IRA isn’t allowed to own collectibles. But exceptions are allowed for certain types of bullion and coins, the American Eagle coins being among the exceptions.
The dispute concerned whether the taxpayer could take physical possession of the coins. The tax code says specified precious metals aren’t considered collectibles when they are in the physical possession of the IRA custodian.
The taxpayer argued that the physical possession requirement applies only to bullion and not to coins. But both the IRS and the Tax Court disagreed. The court ruled that the physical possession requirement clearly applies to both bullion and coins.
As a result, the purchase of the coins by the IRA was treated as a distribution to the taxpayer. She had to include the value of the coins in her gross income for the year she took possession of the coins. McNulty v. Commissioner, 157 T.C. No. 10 (20210).
When to Let Charities Cash in Your Investment Gains
When deciding how to rebalance your portfolio or take some investment gains, don’t forget to consider including charities in your strategy.
After the last few years, many people are sitting on substantial investment gains, especially in stocks. They might want to take some of those profits. Or they might want to reduce the percentage of their portfolios that are in stocks or other highly appreciated investments.
Of course, you could sell some of the investments. But you’d have to pay capital gains taxes on the profits. If you’re in a higher income bracket, that also could trigger some of the Stealth Taxes, such as taxes on Social Security benefits, the Medicare premium surtax and the 3.8% tax on net investment income.
An alternative is to donate some stocks or mutual funds to charity.
When you itemize expenses, you take a charitable contribution deduction equal to the fair market value of the asset on the date of the transfer to charity. You owe no taxes on the appreciation that occurred while you held the investment.
If you haven’t identified the charities to which you want to give or don’t want to give a large amount at one time, you could transfer the investment to a donor-advised fund account. That allows you to take the tax deduction in 2021 but wait until later to dole money out to individual charities.
In the meantime, the donor-advised fund account is invested so the value can increase. Unlike an IRA, you don’t have to contribute cash. You can transfer the investment so that it continues to appreciate uninterrupted.
Many donor-advised funds now accept contributions of a wide array of assets, including cryptocurrencies. A spokesman for the Schwab Charitable Fund recently told The Wall Street Journal that the fund has accepted land, grain, race cars, quarter horses and a stake in a National Football League team.
Many charitably inclined people find they maximize after-tax income by integrating charitable giving with investment and tax strategies.
The Data
Personal Income increased by 0.5% in October from September’s level.
Spending, as measured by Personal Consumption Expenditures (PCE), again increased more than income, rising by 1.3% in October.
The Fed’s preferred measure of inflation, the PCE Price Index, increased 0.6% in October, compared to 0.4% in September. The 12-month increase for the index was 5.0% in October, compared to 4.4% in September.
Excluding food and energy, the PCE Price Index increased 0.4% in October and 4.1% over the previous 12 months.
Home prices rose at a slightly slower rate in September, according to the S&P Corelogic Case-Shiller Home Price Index. The index increased 1.0% in September, down from a 1.2% increase in August.
Over the previous 12 months, the index increased 19.1%, compared to 19.6% as of August. That’s the first decline in the 12-month number since May 2020.
The FHFA House Price Index for September reported a 0.9% increase, compared to 1.0% in August. Over 12 months, the index increased 17.7%, compared to 18.5% as of August.
Pending home sales increased 7.5% in October from September’s level, according to the National Association of Realtors (NAR). But October’s pending sales were 1.4% lower than 12 months earlier.
New home sales in October were 0.4% higher than September’s sales but were 23.1% lower than 12 months earlier.
In addition, new home sales estimates for the three previous months were revised to levels significantly lower than the initial estimates.
Manufacturing activity in Texas increased in November, according to the Dallas Fed Manufacturing Survey.
The Production Index derived from the survey increased to 27.4 from 18.3 in October. The Dallas Fed reported this level indicates “robust growth.”
But the Chicago PMI took a big drop in November. The index declined to 61.8 from 68.4 in October.
The ISM Manufacturing Index increased to 61.1 in November from 60.8 in October. That’s the 18th consecutive month of growth in manufacturing, according to the survey.
New orders and production increased, but price increases slowed from October.
But manufacturing activity slowed a little in November, according to the PMI Manufacturing Index. The index was reported at 58.3 for November, compared to 59.1 in October.
The ADP Employment Report estimated another month of solid private sector job gains in November. The report estimated 534,000 new jobs were created in November, down from the 570,000 created in October but still a solid number.
The Consumer Confidence Index from The Conference Board was 109.5 in November. That’s down from a revised 111.6 in October, which is lower than the initial reading of 113.8. The November level is a nine-month low.
Consumer Sentiment, as measured by the University of Michigan, also declined. The index was 67.4 in November, compared to 71.7 in October. The Consumer Sentiment Index is down 12.4% over 12 months.
The survey found that consumer optimism is at its lowest level in the past decade, and inflation concerns were the major reason.
The Markets
The S&P 500 fell 2.70% for the week ended with Tuesday’s close. The Dow Jones Industrial Average declined 3.66%. The Russell 2000 lost 5.69%. The All-Country World Index (excluding U.S. stocks) retreated 3.43%. Emerging market equities dropped 3.21%.
Long-term treasuries rose 4.92% for the week. Investment-grade bonds increased 1.59%. Treasury Inflation-Protected Securities (TIPS) added 0.67%. High-yield bonds fell 0.55%.
In the currency arena, the U.S. dollar declined 0.66%.
Energy-based commodities lost 9.98%. Broader-based commodities declined 8.39%. Gold dropped 1.14%.
Bob’s News & Updates
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