Historical Tax Rates Provide Clarity

Includes: DLLR, GLW, JBLU, MYL
by: David Brown

We will definitely face more of the same this week as we have the past week. There seems to be some progress between the President and Congress, but it's anybody's guess what combination of increased revenue and reduced expenses will survive political battle. It will probably be some combination of increased taxes on the top 2% of our wealthiest citizens and some reduction in medical spending. Who knows what else? More on that later.

Last week was an absolutely classic "flight-to-safety." Large-cap value stocks were up nearly 1%. Large- cap growth stocks, on the other hand, were down -0.59%. The top sectors were Financial, Industrial, and Healthcare. However, we would totally avoid the very large banks and investment banks. Pending litigation from governmental units and class actions is at its highest levels since the crash in 2008. Yes, the big banks have large reserves, but many analysts think the reserves are woefully below where they should be. Bank of America (NYSE:BAC) probably has the highest risk due to Countrywide and Merrill Lynch, but Wells Fargo (NYSE:WFC), Barclays (NYSE:BCS), Deutsch (NYSE:DB), JP Morgan (NYSE:JPM) and Citi (NYSE:C) are just a few of the other major targets. Don't go there. Over the past three, six, and twelve months, the best style/cap has been Mid-cap Value. Not a bad place to do some looking.

Our forward-looking SectorCast rates Telecommunication, Healthcare, and Technology as the most likely to outperform over the next 30 to 90 days-although 90 days is an eternity in this market. The recent hit to Technology stocks is most likely overdone, given the tax-related selling in last year's big performers, like Apple (NASDAQ:AAPL).

Here are the Market Stats.

I read with great interest Jack Tilton's Investment Report for December 7, 2012. Mr. Tilton is the former President and Chief Investment Manager of the investment subsidiary of the American National Bank of Chicago (ANB Investment Management and Trust Company). He is also a well-known member of the Investment Analysts Society of Chicago. I was struck by the clarity of his thoughts on the dilemma facing the fiscal cliff deliberators. His careful analysis of the historic record of changes in top tax rates and the level to which it applied demonstrated the enormous variance achieved from the variation of raising maximum tax levels and the income levels where they "kicked in." For example, he pointed out that,

The 1931 increase of the maximum tax rate to 25% [from maximum rates as low as 7% in decades preceding that increase] were applied to levels as low as $100,000 or $1,476, 182 in real terms. In 1932 the maximum tax rate was raised to 63% on incomes over $1,000,000 or $16,378,075 in real terms. But those with incomes of over $100,000 still saw the maximum rate go up from 25% in 1931 to 55% in 1932. It is difficult to argue that this increase was not a significant contributor and cause of the economic downturn in 1932. [Emphasis added by Brown]

These few excerpts don't do complete justice to Jack's work, but he went on to show the reduction of tax rates in 1964 and 1965 and again in the 1980s "even when applied to lower income levels, coincided with stronger and relatively high real economic growth."

Finally, regarding the Clinton era, the maximum federal income tax rate was raised, Tilton says "from 28% to 31% and then in 1993 to 39.6%" although he points out these important numbers:

...the income levels at which these maximum tax rates were applied also rose from only $26,050 ($44,271 real) in 1990 to $70,450 ($116,061 real) in 2000 to $311,950 ($379,509 real), then up more significantly to $250,000 ($388,200 real) in 1993.

Now here is the main point:

So, although maximum rates rose under President Clinton, they were significantly offset by raising the income level at which the maximum rates applied. This was particularly true of the 1993 changes. These changes also coincided with relative high rates of growth in the U.S. economy. [Emphasis added by Brown]

I thank Jack for giving me the privilege of quoting him in my feeble attempt to illustrate his clear thinking on this proposed process, which has numerous historical precedents from which to draw. His paper is much more erudite than I can relate to you with these few passages, but I wish that more in Washington were doing their homework instead of concentrating on political one-upmanship.

4 Stock Ideas for this Market

This week, I selected four highly ranked stocks from Sabrient's universe with great value and exiting growth prospects for you to consider because we think this is what the market wants.

Corning Inc. (NYSE:GLW) - Technology

DFC Global Corp (NASDAQ:DLLR) - Financials

JetBlu Airways Corporation (NASDAQ:JBLU) - Industrials

Mylan, Inc. (NASDAQ:MYL) - Healthcare

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.