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CALLING A SPADE

In the face of numerous interest rate hikes and higher oil prices, we have held to the view that an underlying secular bullish trend was in place for American stock markets. This belief stemmed from a well-publicized Bush Economic Agenda featuring permanent tax cuts (not temporary) and a re-do of our convoluted and stifling tax code.

With the President’s second term victory came a Republican majority in both houses of the legislative branch of government. This seemed to increase the probability that the President would be successful in cementing his key economic building blocks in place before the next election.

To support the President’s agenda was absolute proof that the tax cuts worked: $100 billion in increased tax collections, rendering last year’s “budget deficits as far as the eye can see” crowd to the dustbin. The tax cuts have actually increased government revenues well beyond those predicted by the Congressional Budget Office (CBO) of the Office of Management and Budgets (OMB).

The stage was set for the Bush economic agenda and the by-products of higher profits for corporations and stockholders.

Hurricane Katrina’s arrival couldn’t have come at a worse time for policy makers. On the day of a scheduled vote to abolish the estate tax, the nation’s news cameras all turned to the ugly spectacle in New Orleans. Accordingly, all scheduled business in the U.S. Senate and House of Representatives gave way to finger pointing between local, state, and federal officials. Politicians began bidding up the price of aid in an effort to look good to voters. To make matters worse, the President’s reaction to the national disaster seemed to acknowledge fault and take responsibility for the hurricane. Now we have a runaway spending train with no apparent leadership or voice of reason calling for proper national priorities and adherence to a long-term agenda, which we deem to be absolutely necessary. Frankly, without it, the outlook is quite bearish. Without it, we can all look for increased taxes on dividends, capital gains and income. Without it, we can expect the after-tax rate of return on all asset classes in the United States to drop.

The tax commission, appointed to study our tax code and render recommendations for its improvement, has been asked (for the second time) to delay recommendations until the end of October. Will there be time to debate and implement change or permanency this legislative term? If not, we will probably have to table the discussion until 2007. After all, 2006 is an election year (when, as in the story of Cinderella, legislators turn into pumpkins).

Last week, it was Tom DeLay, the Republican House Majority Leader, who made the news. A Travis County District Attorney had indicted him for a campaign spending violation. A few days prior it was Senate Majority Leader, Frist, who made news because of a questionable stock sale. Whether these charges carry any merit is not the important issue; what is important is that the legislative point men for the Administration have been “taken out”.

These events have taken place in only two weeks, but they are coincidentally (or otherwise) all poised to inflict damage for years to come unless someone takes the leadership reins. Our sense is that it is time for George Bush to step up and lead or lose all of his initiatives, including the war.

Our sources in Washington tell us that extensions to the current tax cuts are still in the mill through the budget reconciliation bill, and tax reform is still on the President’s radar screen. Accordingly, we are staying the course in spite of the intensifying negative environment.

We have identified Japan and Australia as new investment opportunities and are beginning to build exposure to both markets. With elections behind them, the direction for both is more free market initiatives and lower taxes. As you know, economic rates of growth increase with such initiatives and we like to invest with this type of wind in our sails.

The price of oil–which factors in hurricane-caused shortages, hoarding, speculation, and every possible emotion– has reached a point of elasticity where we can expect consumer behavior to change. Accordingly, there is now a “braking” factor in place over the economy to complement the already evident braking caused by the Greenspanled interest rate hikes. We can expect lower economic profits as a result of both. We hope that both negatives are near an end, but the earnings risk has clearly increased for cyclical companies.

So there you have it…a growth stock orientation through a continuing normal exposure in U.S. stocks; bond exposure slightly lower than normal with maturities shorter than normal; some new foreign exposure in Australia and Japan, along with ample cash awaiting the next opportunity. Needless to say, we will be watching Washington very closely.

Enclosed is an article written by ex-Speaker of the House, Newt Gingrich, which explains much of the disinformation surrounding tax and budget policies. It’s worth reading… Happy Halloween!

About the Author


Harlan J. Cadinha
Founder, Chairman and Chief Strategist
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