10/31/2013 Sector update

Yet another whipsaw.

Real time data appeared to stay in XLK, but the end of day data skipped back to XLB.

The difference is only .04% on my model.

I managed to take advantage of a .8% swap this morning, and if XLB gaps below XLK tomorrow I'll swap again.

Otherwise... (you know the drill)... I'll recalculate toward the close.

10/30/2013 Sector update

Sector model whipsawed back to XLK after the close.

If XLK gaps below XLB, I'll rotate again tomorrow morning.  If not, I'll recalculate toward the close.

10/29/2013 Sector Alert

The end of day data shows XLB with a slight lead on XLK.  If it gaps below XLK in the morning, I'll rotate.  Otherwise I'll recheck before the close.

10/26/2013 BOO!

Sector Model	XLK	4.00%
Large Portfolio	Date	Return	Days
ABX	4/11/2013	-16.57%	198
TTM	5/6/2013	16.60%	173
QCOM	9/3/2013	3.00%	53
NEM	9/30/2013	-0.54%	26
BCR	10/4/2013	17.28%	22
BAX	10/7/2013	0.74%	19
BDX	10/11/2013	4.34%	15
DECK	10/15/2013	13.79%	11
ED	10/18/2013	3.24%	8
ISRG	10/21/2013	-1.96%	5
(Since 5/31/2011)
S&P	Annualized	11.81%
Sector Model	Annualized	24.56%
Large Portfolio	Annualized	32.59%

Rotation: selling TTM; buying EW (Edwards Lifesciences).

It’s been a good week, and the year to date return on the full model is now 34.46%, against the S&P’s 23.39%.  Not super-impressive, but still a good number.   DECK had a comforting gain on Friday.

Of special note is the fact that Edwards Lifesciences is now the FIFTH stock in the same industry.  The hiccups with Obamacare have created an opportunity cluster I could have never predicted.

Keep in mind that news is noise.  The Affordable Healthcare Act is problematic, but not the apocalypse.  People adjust.  Doctors are being driven out of private practice and into corporate groups.  But they still have school debts to pay off and will struggle through.  It isn’t going to be defunded by Cruz and it isn’t going to go away because of a bad website.  NEITHER is it going to avoid delays because of Reid.  The news is noise.  The partisans are noise.

The only thing that matters is the ratio of price to fundamental value.  Occasionally the noise will create a bargain.

EW is a bargain.

Among all of the stocks I survey, the only stock that’s BETTER valued is ISRG, which we picked up last week.

I was intrigued by the Nobel Prizes given to Fama and Shiller.  Fama believes in an efficient market and Shiller believes the opposite.  Some people who manage other people’s money like to convince individuals that there are no true bargains out there and that the market is magically and instantaneously right.  Then they charge their clients money to try to track an index that the clients could do for themselves by simply parking everything into SPY.  Shiller is often quoted by people who try to time the next three months of market investments based on a Cyclically Adjusted PE Ratio that’s really only useful for a ten year holding period.

People who make money don’t measure the “market.”  They measure “stocks” within that market to look for bargains.

So, good for Fama and Shiller.  They are both extremely helpful in scaring my competition into dumping stocks at the bottom.

They get a cash prize, and I get low lying fruit for as long as folks think of a “stock market” instead of a “market of stocks.”

I wish them both a long and prosperous future.

But we know better.  It’s Halloween, and Fama and Shiller are scaring the hell out of people.

All we have to do is pick up the candy everyone drops in their terror.

Tim

 

How to Maximize Federal Revenue

Here we go again in Washington D.C.

The next fight, so we are told, will be over tax policy.  The President wants more “revenue”, and revenue equals taxes, right?

It depends on the time frame.

As I showed some months ago, both the Left and the Right are wrong about taxes.  Republicans want taxes to be too low and Democrats want taxes to be too high.  Typically the argument is framed in terms of fairness.  So I’ll offer a nice fair starting point of 50%:

Is it right to take more money from someone than we leave to his own family?

No, it isn’t.  I don’t deserve MORE of your money than your own children do.  If you decide to adopt me, that’s another matter.  But assuming that you don’t adopt me, your kids should rate at least as well as I do.  That means that I, as a citizen, do not have a moral right to tax you more than 50%.  So then, on a strictly moral level, the combined local, state, and Federal tax burden for any given person should never exceed 50%.

The only exception would be Warren Buffett.  I hear that he doesn’t intend to give the bulk of his fortune to his kids – so he is welcome to give it to me if he so chooses.

In any case, let’s leave that 50% up there as an anchor and take a look at how LONG I can get away with taking 50% of someone’s money before I start getting LESS money:

Now, this is a weird chart, and it will take some explanation.  The vertical axis is the combined tax rate, and the horizontal axis is the number of years you are collecting.

If you want to go full Communist and just tax everyone at 100% rate, you can get away with that nonsense for about 30 years before the government starts getting LESS than it could get at lower rates.

So, 0-30 years, and you can get as much money as possible at 100%.

By 35 years, even 90% is too much.

By 40 years, even 60% is too much.

At 50 years, even 40% is too much.

After that you finally get a permanent long term optimal tax rate of between 30% and 40%.  As I wrote in earlier posts, 35% is the optimal rate.

If you lower it then you collect less money.  If you raise it you ALSO collect less money.  You might get “more” for a few years, but it’s temporary.

We’ve been down this road before.  In the 1940s the maximum Federal income tax rate was a whopping 94%!  They did that to win a world war, and such high rates were justified by the need to survive a global threat.

By the time of John F. Kennedy, the temporary threat of the Axis power was well behind us, and it was time to take a look at how tax rates should be optimized for long term government revenue.  JFK lowered taxes from the 90% range to the 70% range.

Under Reagan the taxes were further lowered until the maximum tax bracket was down to 28% in 1988.

George H. W. Bush was forced to raise rates because they were collecting less money than was needed to fund the programs they neglected to cut.

Under Clinton the maximum rates were higher than now, and he was able to balance the budget before the economy finally blew up.

Under George W. Bush the maximum Federal rate was lowered again to 35%.

We’ve been too high, then too low, then too high, then just right – and now we are too high again and clamoring for more.

Government does this by trial and error, and it’s mostly error.

The problem is that when you raise taxes you DO get more money – in the short term.  Then after a couple of years you realize you need to raise them again, and again you get more money – in the short term.  Then after a couple of years you realize you need to raise them again, and again…

Get the picture?  It’s like a drug habit.  It takes more and more to get less and less of a high – until you are no longer getting high at all, but just feel bad all the time and take a fix to feel semi-normal.

All of which reminds me that I need another cup of coffee…

Ah… now… where was I?

The way to see how tax rates affect revenues, we’ll go back to revenues the government would accumulate off of capital gains taxes on the S&P since 1950.  We’ll look at rates from 1% to 100% based on 10 to 50 year sequences:

The running account starts at 16.66 on 1/3/1950, and is taxed according to the rates on the horizontal axis.  The vertical axis is the amount of money the government could accumulate off of that account if it were taxed for 10 years to 1960 (the orange line).  You can see that for the first thirty years the maximum amount of revenue is accumulated at 100%!

So we should raise taxes at will, right?

Well, no, because by the time we reach 40 years the peak is now at 55%, and by 50 years the peak is at 33%.

As I’ve noted before, the optimal point stabilizes around 35%.  For any given measure past 50 years, it will stay in a tight range between 30% and 40%.

The shock of that graph, however, is the huge difference between 40 and 50 years.  We get that shock because our brains aren’t hard wired to think in terms of compounding returns.  We logarithmically DISCOUNT time as it gets larger, when instead we should do the opposite.  Here is the EXACT SAME graph on a logarithmic scale:

Once again we can see that the first three sequences from 10 to 30 years max out at 100%, while 40 years maxes out at 55%, and 50 years maxes out at 33%.  But now we don’t experience the same shock. 

As far as I can tell, no one has ever graphed this difference in time frames before now – so I’m naming this “The Clontz Curve.”

Politicians, like all humans, think in the short term.  Ordinarily that works out for us, because we don’t live that long anyway.

But COUNTRIES don’t live in terms of months and years.  They live in terms of centuries, and they only come to an end when too much short term thinking gives them unsustainable policies that cause them to collapse.

THAT is what we are facing now – not just in the United States, but in the entire developed world.  If we are Conservatives, we think that lowering taxes will create some kind of instant boom.  It doesn’t happen that way.  Yes, Reagan did the right things by tax and regulation policy, but he also came in at the crest of the baby boom economic wave.  Clinton didn’t owe his boom to his raising taxes (as he ludicrously claimed in the 2012 campaign), but rather he enjoyed the fruits of the elder Bush’s accidentally too LOW rates in the opening year of that decade.

So, sorry Republicans, taxes do NOT have an IMMEDIATE effect.  It takes time for them to help or hinder the economy – time in terms of decades instead of days.

But Democrats are ALSO wrong when they notice no immediate effect and assume the coast is clear.  It isn’t.  Tax policy is a long slow process.  One cigarette won’t kill you.  Ten won’t either.  But ten every day for a few decades WILL.

Tax rates must be set in terms of maximum accumulation calculated over at least 50 years.  Anything less and you are not running a country – at least, not any kind of country your great grandkids will enjoy.

To set optimal tax policy, then, we need to look at the entire tax burden.  The AVERAGE tax burden for local, state, and federal COMBINED should be set at 35%.

That usually breaks down to 15% for local and state taxes and 20% for federal.  A progressive federal rate that gives an average burden of 20% would progress from 0% minimum to 35% maximum income tax rates, as I detailed in earlier posts:

http://market-mousetrap.blogspot.com/2013/01/01132013-arithmetic-limits-of-power.html

and

http://market-mousetrap.blogspot.com/2013/01/01102013-calculating-true-laffer-curve.html

and

http://market-mousetrap.blogspot.com/2012/11/11172012-how-to-really-soak-rich.html

I also gave additional measures of the effect Federal rates had on state rates here:

http://market-mousetrap.blogspot.com/2013/01/01232013-civil-war-first-shot-cuts.html

All of these explored the true Laffer Curve based on actual Federal revenues at different rates.  What is new today is the explanation of how short term thinking prevents policy makers from truly maximizing tax revenues.

The PROBLEM we face is a Federal debt in excess of 17 trillion.  We can no longer afford to collect less than the absolute maximum that can be collected, which is, again:

State and local = 15%

Federal = 20%.

Any more will ultimately get less money.  Wild eyed Republicans have promised trickle down prosperity, and Democrats have promised a Great Society.  Both are wrong.  The economy DOES do better at lower rates, but only in long term calculations.

Tim

10/20/2013 Changing the Pace

Sector Model	XLK	3.20%
Large Portfolio	Date	Return	Days
ABX	4/11/2013	-23.28%	192
TTM	5/6/2013	17.62%	167
VAR	8/2/2013	7.43%	79
QCOM	9/3/2013	3.20%	47
NEM	9/30/2013	-3.79%	20
BCR	10/4/2013	8.52%	16
BAX	10/7/2013	1.52%	13
BDX	10/11/2013	3.61%	9
DECK	10/15/2013	-3.25%	5
ED	10/18/2013	0.19%	2
(Since 5/31/2011)
S&P	Annualized	11.49%
Sector Model	Annualized	25.05%
Large Portfolio	Annualized	30.88%
S&P	Total	29.68%
Sector Model	Total	70.62%
Large Portfolio	Total	90.24%
Sector Model	Advantage	13.56%
Large Portfolio	Advantage	19.39%
	Previous	YTD
S&P	6.02%	22.32%
Sector Model	27.01%	34.33%
Large Portfolio	46.63%	29.74%

 

Rotation: selling VAR; buying ISRG.

This is purely a fundamental exchange.  Both of these companies are in the same industry.

In any case, from time to time I’ll expand the reporting to list all the return metrics.  Since the launch of the model, the S&P has gained a little under 30%, and the Mousetrap has gained a little over 90%.  Basically triple the returns.

Although both the full Mousetrap and the Sector model have undergone some degree of refinement, the Sector model has improved by a greater amount.  Part of the strength of the sector model is the fact that it trades toward the close, rather than trying to navigate gaps on the open.

Trading toward the close would improve the performance of the full model by about 5% a year, but it would be impossible for anyone to follow in real time.  Kind of a Catch-22.  Do I want a blog that averages 35% per year that no one could follow, or one that averages 30% per year that people can. 

Right: better a useful 30% return rate than a useless 35%.

And, with that in mind, I am also planning to back off of intra-week trades on the full model, and set trades for weekend readers.  The blog is for real schlubs like me who work for a living and don’t have time to sit there and watch all the market ticks and tricks.

The sector model will continue to trade in real time, and the full model will trade once a week.   That’s about as easy to follow as possible.

A private fund would trade toward the close, but this isn’t a private fund.  It’s just a blog.

Tim

 

 

10/17/2013 rotation

Sector Model	XLK	1.46%
Large Portfolio	Date	Return	Days
ABX	4/11/2013	-23.36%	189
TTM	5/6/2013	17.06%	164
BTI	7/1/2013	5.58%	108
VAR	8/2/2013	7.31%	76
QCOM	9/3/2013	3.65%	44
NEM	9/30/2013	-3.29%	17
BCR	10/4/2013	6.87%	13
BAX	10/7/2013	3.43%	10
BDX	10/11/2013	2.90%	6
DECK	10/15/2013	-2.50%	2
(Since 5/31/2011)
S&P	Annualized	11.22%
Sector Model	Annualized	24.56%
Large Portfolio	Annualized	31.01%

 

Rotation: selling BTI; buying ED.

When your portfolio has ED, the party’s over…

Tim