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SUMMER FOG

Well, we can now all enjoy “free” healthcare. Without looking at the pros and cons of the plan, the one certainty about which we are most concerned is the simple fact that U.S. tax payers just received a $600 billion tax increase along with another $2 trillion in debt to add to our already massive deficit. Since many of the taxes don’t commence until 2013 or 2014, the economic pain is not yet evident.

The tax hikes scheduled for 2013 seem to be more certain, as this Supreme Court ruling leaves the President with no incentive to “deal” with Congress. He now has his agenda intact without the need for further legislation. The economic and market effects of the looming financial cliff coupled with the Obamacare taxes and costs are not good. All of these tax hikes will change the after-tax returns to investors in a dramatic and negative way. It stands to reason that sooner or later asset valuations will adjust downward to reflect these lower rates of return. But, that’s a longer-term view, and the markets are telling us that we don’t have to worry about this until next year.

While the longer-term view is clearing, the short-term view becomes even murkier. The recent stock market strength experienced on the heels of the Supreme Court decision has many quite confused. The market has advanced in the face of increasing negative investor sentiment which makes no sense, but after more than four decades in this business, I’ve learned never to “fight the tape,” or at least to respect it.

Signs of economic strength will likely appear over the near term, and typical of Wall Street’s extrapolative tendencies, we expect analysts’ earning projections to be adjusted upward, at least for the next two quarters. It wouldn’t surprise us if stock prices reacted accordingly.

Any temporary strength will likely come from individuals accelerating income into this year, hoping to avoid the stifling tax levels to be heaped upon us by the rapidly arriving Orwellian Society of 2013. As a result, whether taking a bonus, or receiving a higher paycheck, some of the proceeds will certainly “leak” into consumer purchases. In an economy where 71% of GDP is dependent upon consumer spending, any accelerated income is likely to be accompanied by some economic “kicker.”

Looking overseas the picture is even more dire. European economic growth is virtually non-existent. China is teetering as a result, since most of China’s exports are sold to Europe. Japan is still deflating and is trying to solve its problems through bigger tax hikes. The newly elected French President is calling for massive tax hikes on the wealthy. So much for global economic growth… Capital is fleeing into the U.S. leaving us with a temporarily strong currency, low interest rates, and somewhat stronger markets.

Perhaps these short-term dislocations can explain the sanguine state of our markets but, there is still no visible reason to project continuing economic strength and earnings growth into 2013. So, enjoy it while it lasts.

In the meantime, we will busy ourselves looking for special situations which can yield positive returns. There are undervalued companies out there with smart management teams who will be able to swim against the tide, and we will continue to work diligently to find them.

We will also be vigilant in watching government policies and political trends as so much hinges on the November election. We believe more than ever that being deliberate and patient is the key to winning this investment struggle.

About the Author


Harlan J. Cadinha
Founder, Chairman and Chief Strategist
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