A Word From The Advisor

Can the powerful rally that captured the market since mid-March be sustained? Several trends have converged to fuel the rally: healthier-than-expected first-quarter earnings, a quick resolution to the Iraq war, continued interest-rate easing by the Federal Reserve and lower energy prices. Tax cuts on capital gains and dividends have spurred the more recent gains. These factors all point to a stronger economy, with healthier corporate profits and more disposable income for the individual.

Investors have learned a great deal from the three years of a bear market in stocks, now tempering their investment decisions with wise caution. As painful as the decline may have been for some, the real issue is how to best take advantage of the positive stimuli the economy is receiving and be ready for the recovery. We at Oakwood, as your professional money manager, have well positioned our client portfolios through our thoughtful, researched and ongoing investment management style to advantageously capture the benefits of a recovering economy.

Historical precedents are encouraging. There have been ten sharp reversals similar to the one from this year’s market lows in the past 46 years. When they did occur, the market rallied 23.6% on average in the next 12 months and 37.3% on average in the next 24 months.

Many investors have begun to dip their toes back into the equity market. The three consecutive months of inflows ending with a May inflow of $219 billion continued in June. These inflows show an increase in investor confidence and a willingness to expand their level of risk associated with high quality US equities. It is crucial to assess one’s own risk tolerance, as the ability to maintain a commitment to a mix of stocks and bonds is proportionate to the level of comfort with the type of stocks and bonds within these broader asset classes.

Whatever combination of stocks and bonds your investment objectives and risk tolerance lead you to, an understanding of the latest Federal tax cuts will broaden the perspective on your portfolio choices. Here are some Frequently Asked Questions to help make sense of some of the changes, along with a comment on how they might affect investment decisions.

Implications for Investors
One implication from the new tax proposals is that the tax shelter provided by qualified retirement plans becomes less compelling. While the main advantage of retirement accounts is tax deferral, they continue to be attractive to investors, utilizing tax-deferred accounts such as 401(k)s and IRAs which postpone taxes until retirement, and their proceeds are taxed as ordinary income when withdrawn. For many taxpayers, particularly in the top brackets, it will now be cheaper to pay taxes each year on earnings at the low 15% rate. An examination of your taxable and tax-deferred strategies is needed in order to advantageously determine which type of assets to own in each respective account. Specifically, a shift too more equities in the taxable account (taking advantage of the lower rates on capital gains and dividends) and more taxable bonds in your tax-advantaged accounts (deferring tax payments on those accounts until withdrawal) may be beneficial. Tax-free municipal bonds, of course, would remain in your taxable account.

Beyond that exercise, in general, we see no real advantages in skewing your portfolio toward one asset class or another to take advantage of the new tax provisions. For example, a swap from a taxable bond to a stock with a similar yield might look tempting in light of the lowered rates on dividends, but there is risk involved in such a swap. Stocks in seemingly safe dividend paying sectors like utilities can experience price drops. That may not be worth the marginal excess return in after-tax yield.

As your investment advisor, we will continue to work with you to select the best type of investments for your specific situation. Our responsiveness through active management ensures that we continually monitor market events, such as the new tax proposals, and changing economic conditions, to maximize investment results. We believe the overall effect of the fiscal stimuli and tax cuts will lead the economy to slowly pick up steam. A more robust economy will lead to better margins for corporate America, which in turn leads to better returns in the stock market.