Six Charts That Prove The Tax Code Was Written For The Rich

Reuters

There's an outstanding new report from the Congressional Budget Office analyzing which income sectors receive the most benefits from tax expenditures. 

One thing is completely obvious after the report: The U.S. tax code is designed to turn the screws on the middle class, while granting huge tax breaks to the rich and and tax credits to the lowest income quintile. 

The CBO calls these "tax expenditures" because "they resemble federal spending by providing financial assistance to specific activities, entities, or groups of people. Tax expenditures, like traditional forms of federal spending, contribute to the federal budget deficit."

The report looked at four kinds of tax expenditures:

Exclusions from taxable income - Roughly evenly distributed among the quintiles. Deductions - Benefits of itemized deductions "rise sharply with income," benefiting the rich the most. Preferential tax rates - The low tax rates on dividends and capital gains "provide almost no benefits to households in the bottom four quintiles" but are a huge benefit to the upper fifth.Tax credits - The credits provide large benefits to households in the lowest income quintile by design, with decreasing upward benefits. Notice how none of those are really targeted at the middle three quintiles? Check out the charts to see just how bad it is. 

Read the whole report here >

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We Have Been In The Grip Of A Treacherous Sideways Moving Stock Market

Vitaliy Katsenelson is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley, 2007) and The Little Book of Sideways Markets (Wiley, December 2010). He writes a monthly column for Institutional Investor

I started writing my first book, Active Value Investing: Making Money in Range-Bound Markets, in 2005; finished it in 2007; and published the second, an abridged version of the first (The Little Book of Sideways Markets), in 2010. In both books I made the case that there is a very high probability that we are in the midst of a secular sideways market – a market that goes up and down, with a lot of cyclical volatility, but ends up going nowhere for a long time.

Sideways markets happen not because stock market gods play an unkind joke on gullible humans but because of human emotions. Historically, sideways markets have always followed secular bull markets. At the end of secular bull markets stocks become very expensive – their valuations (P/Es) get very high. Sideways markets are just a payback for all the fun and returns stock investors received during secular bull markets.

In 1999, after 17 years of incredible returns, the mother of all secular bull markets ended at valuations we'd never seen before. For this reason, in my first book I argued that the present sideways market, which started then, might last longer than past ones. In the Little Book I want a step farther with the benefit of hindsight – it was written post-Great Recession. I argued that the economic growth rate going forward will be lower than it was in the past, and thus this sideways market may even last longer than I originally suspected.
Every so often I get an email from a reader with the question, “Are we there yet?” Are we still in the grip of a treacherous sideways market, or we are now entering into a secular bull market? I will try to answer that question as best I can in this writeup.

The Sideways View of The World

In early May I had the pleasure of attending and speaking at the Value Investing Congress in Las Vegas. The last time I spoke there it was May 2008 and the market was just coming off its top. (Here is a PDF of the '08 presentation, and the new presentation is here.) The S&P was at 18x trailing earnings. Profit margins were at a modern-day high. They subsequently collapsed but came back to set an even higher high.

The market was not cheap in 2008. It is not cheap now, either.

Before I dive into my argument I need to introduce you to a very simple calculation that is at the core of my sideways argument:

E + Change in P/E + Dividends = Total Return

Stock price movements are driven by two variables: earnings growth and changes in the price-to-earnings ratio. Add dividends, and you have total stock returns. The dividend yield of an average stock today is 2% – it is all yours to keep, so my discussion here will focus on the direction of “E” and “P/E.”

If you were to normalize profits for high margins and look at 10-year trailing earnings, in 2008 stocks were trading 66% above their historical average. They were at 30 times 10-year trailing earnings (see next chart).

Vitaliy Katsenelson

In all honesty, I could make the same presentation today as I did five years ago (in fact I borrowed and updated a few slides from that presentation – see next chart). Market valuation is not dramatically different now from what it was then. A cyclical bear and a cyclical bull market later, the S&P 500 is still at the same 18 times trailing earnings and 26 times 10-year trailing P/E, or 41% above average. (It was 60% above average in 2008.)

Vitaliy Katsenelson

(See footnote at end for a detailed explanation of the above chart.)

Investors who were on the sidelines over the last few years and who are now pouring money into stocks, expecting that we are in the midst of a secular bull market, will likely be disappointed

The previous sideways market of 1966-1982 had four cyclical bull markets and five cyclical bear markets packed inside it. From 1970 to 1973 the Dow went from 700 to 1,000, just to drop again, this time to 600. Four times, investors thought that a cyclical bull market had turned into a secular (long-term, 1982-1999 type of ) bull market, but their hopes were dashed as they discovered that these were just head fakes toward the next cyclical bear market (see next chart).

Vitaliy Katsenelson

It is when nobody wants to own stocks ever again, when valuations are below their historical average, that a secular sideways market finally dies (actually more like goes into hibernation) and the next secular bull market is born.

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Homeowners Are Thinking Twice Before Walking Away From Their Underwater Mortgages

Foreclosure and bank owned sales fell 18% in the first quarter to 190,121, according to RealtyTrac's latest report.  This is down 22% from Q1 2012.

Foreclosure and short sales accounted for 21% of all residential sales in Q1, down form 25% in Q1 2012, and a peak of 45% in Q1 2009. 

Meanwhile, non-foreclosure short sales were down 10% from Q4 2012, and down 35% from Q1 2012. 

Including non-foreclosure short sales, the share of distressed sales came to 36%.

The decline in foreclosure related sales is in large part because of  a decline in foreclosure activity. But the decline in non-foreclosure short sales was "surprising" according to RaltyTrac vice president Daren Blomquist, given that 11 million homeowners are in negative equity. 

"Rising home prices in many markets are stunting the continued growth of short sales by reducing incentive for both underwater homeowners and lenders.

"Underwater homeowners may be willing to stick it out a few more months or even years in the hope that they will be able to walk away with money at the closing table and without a hit to their credit rating, and for lenders a failed short sale may no longer translate into bigger losses down the road given that average prices of bank-owned homes are rising — at a faster pace than non-distressed home prices in many markets."

Here are some details from the report:

The average price of a foreclosure related sale declined 1% quarter-over-quarter in Q1 to $167,095.At 35% Georgia had the biggest percentage of foreclosure related sales. Meanwhile, in Massachusetts, New York, and New Jersey foreclosure-related sales account for less than 10% of sales.  The average price of a foreclosed home was 30% below the average price of a non-foreclosure property.

Here's a look at foreclosure sales against average foreclosure sale price:

RealtyTrac

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KEITH JUROW: The Government's Plan To Save Housing Will Cause People To Default Over And Over Again

Keith Jurow has been a regular contributor to BUSINESS INSIDER for three years.  His new real estate subscription report – Capital Preservation Real Estate Report – launches at the end of May.

Here We Go Again

On March 27, 2013, the Federal Housing Finance Administration (FHFA) announced the introduction of still another mortgage modification program.  Entitled the Streamlined Modification Program, it was intended to enable distressed borrowers to more easily qualify for a modification.

Unlike the HAMP modification program, borrowers will not have to show any financial hardship whatsoever in order to qualify.  If their first lien is owned or guaranteed by either Fannie Mae or Freddie Mac, the only requirement is that they be delinquent for 90 days or more and complete a 3-month trial period.  Also – they cannot be delinquent for more than two years and cannot have had two or more previous modifications.

Nice deal, huh?  The obvious criticism is that it will only encourage borrowers to default in order to qualify.  FHFA’s answer is that it will minimize losses to Fannie and Freddie by reducing foreclosures.  Really?

The program was supposed to begin on July 1.  But on May 12, FHFA announced that the program would become effective immediately.  Servicers are required to send modification offers to all eligible borrowers.

The Failure of HAMP

The government’s HAMP mortgage modification program was begun in the spring of 2009 at the height of the credit crisis.  Although they had expected it to help as many as 3 - 4 million distressed borrowers, only 816,000 permanent modifications were still outstanding at the end of March 2013.

According to the latest report from the TARP Inspector General, more than 26% of all permanent modifications had already re-defaulted.  Over 1 million trial modifications had been canceled due to non-fulfillment of the terms by the borrower.

As early as April 2010, the Congressional Oversight Panel reported that more than half of borrowers who had received a permanent modification under HAMP were seriously underwater.  Their average loan-to-value ratio (LTV) was 145%.

Even worse, this percentage included only first mortgages.  The Obama Administration had estimated that roughly half of all at-risk borrowers were also saddled with second liens on their property.  So the true LTV for borrowers under HAMP was clearly much higher.

Then in March of 2011, this same panel reported that recipients of permanent modifications were still badly underwater.  They also emphasized another serious problem.  After the modification, borrowers still had an average debt-to-income ratio (DTI) of 60%.  This meant that 60% of their total income was being spent on servicing their debts.  That debt burden was unsustainable for most homeowners.

Mortgage Modification Problem Goes Well Beyond HAMP

In June 2012, the credit reporting firm Trans Union issued the results of a study based on an examination of 600,000 borrowers from its enormous database who had received a mortgage modification between January 2008 and July 2011.  It found that nearly 6 out of every 10 borrowers had re-defaulted within 18 months after receiving the modification.

The problem of re-defaults goes well beyond HAMP modifications.  There are roughly $900 billion securitized mortgages outstanding which are not guaranteed by Fannie or Freddie.  Take a good look at this shocking graph from TCW showing the re-default rate for loans modified in different years.

TCW

You can see that in the early years of modifications, nearly 80% have re-defaulted.  For the most recent years of 2010 – 2011, the percentage is already approaching 40% and headed higher.

According to mortgage modification data provider HOPE NOW, more than 18 million mortgages have been either modified or provided with some so-called “workout solution.”  You can imagine what the percentage of mortgages considered seriously delinquent would be had these not occurred.

Why Should This Time Be Different?

The obvious question is why should the new streamlined modification program have results much different than the HAMP program or any of the others?  It will focus on the same pool of homebuyers who bought or refinanced during the bubble years of 2004 – 2007.  More than half of them own properties which are badly underwater and nearly half have second liens as well. 

Is there any plausible reason to expect that borrowers who receive a modification under this program will re-default less than those with permanent HAMP modifications?  Perhaps those who dreamed up this new program really believe that the economy is strengthening.  As they see it, homeowners with a reduced mortgage burden will be less likely to default in an improving economic climate.

Unfortunately, we have overwhelming evidence that underwater homeowners are much more likely to default than those who have equity remaining in the property.  As I have repeatedly shown, the number of homeowners who purchased or refinanced during the bubble years boggles the mind.  Take a look at this chart on refinancing originations during the bubble years of 2004 – 2006.

Mortgagedataweb.com

In these three years, 27 million mortgages were refinanced.  Regardless of whether the refinanced loan was a first mortgage or a second lien, the overwhelming majority of these properties are underwater.  That is the main pool of distressed borrowers whom the new modification will attempt to save. 

The Terrible Burden of Second Mortgages

To get a sense of the enormity of the problem with which this new modification program will try to grapple, you must begin to understand the second lien disaster.  In numerous articles, I have written about the burden of home equity lines of credit which has gone largely unreported by the media.  Let me briefly explain the problem. 

During the crazy bubble years of 2004 – 2006, millions of homeowners took out second liens to tap the growing equity in their home.  Most were home equity lines of credit (HELOC).  In California, it was not uncommon for banks to provide HELOCs of $200,000 and up.   Some owners refinanced these HELOCs one or more times to pull still more cash out of their property. 

In its 2004 report, the FDIC listed the ways in which banks were encouraging borrowers to open new HELOCs including providing automatic credit limit increases as the property increased in value.  To increase the use of existing HELOCs, banks were actually charging “nonuse fees” on lines that were open but inactive.

Because qualifying standards were based primarily on the equity in the home, HELOCs were most attractive in those states where prices were rising rapidly – California, Nevada, Arizona and Florida.  Homes had become a money tree which their owners could shake almost at will.

Homeowners opened an incredible number of HELOCs.  Take a look at this chart from Equifax showing the total HELOCs outstanding from March 2008 through March 2013.
The green line shows that there were almost 15.5 million HELOCs outstanding in the nation at the peak.

Equifax

The green line shows that there were almost 15.5 million HELOCs outstanding in the nation at the peak.

The lunacy of HELOC borrowing was most apparent in California.  During 2004 and 2005, a total of more than 1.4 million HELOCs were originated in California just for the purchase of homes according to figures I received from CoreLogic. 

In those two years, borrowers in California would take out a HELOC to buy investment properties in other hot markets such as Las Vegas and Phoenix.  While the loans were recorded as California HELOCs because the borrower’s property was in California, the purchased home was actually in another state. 

When the housing market finally began to decline in 2007, banks were very reluctant to accept this change.  They continued to shovel out millions of HELOCs.  Equifax reported that a total of 4.6 million new HELOCs were originated in 2007 and 2008. 

As late as the fall of 2009, a study published by Equifax Capital Markets found that 45% of prime borrowers with securitized first mortgage loans that were still current in July 2009 also had a HELOC.  Worse yet, the average outstanding balance on these HELOCs increased steadily from roughly $83,000 in mid-2005 to $118,000 four years later.

If you add in installment second liens, there are a total of roughly 15 million second mortgages still outstanding on homes throughout the nation.  I estimate that at least 90% of these properties are now underwater.  This situation is rarely discussed in the media but presents a problem that no modification program can solve.

Moral Hazard

Allowing or encouraging borrowers to become seriously delinquent in order to qualify for a mortgage modification has become known as moral hazard.  What sensible reason is there to eliminate the requirement that borrowers must show some financial hardship to qualify for a modification? 

Doesn’t common sense tell us that some borrowers who can afford to pay their mortgage will strategically default so they can use this new program to obtain a better deal on the terms of their mortgage?  Apparently common sense does not play a role with the policy makers at FHFA.

I have talked more than once to spokespersons for Fannie Mae on this moral hazard question.  Their answer is simply to give me the party line:  We are trying to help delinquent homeowners stay in their homes and avoid foreclosure.  Those investors who own these mortgages do not elicit the same concern by FHFA to get paid back what they are owed.

Note: You can learn more about Keith’s new Capital Preservation Real Estate Report by clicking here.

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GOLDMAN: Here The 2 Reasons Why US Solar Stocks Have Been On An Insane Tear (FSLR, SPWR, SCTY)

China's extreme manufacturing of solar panels caused a massive supply glut, and a lot of American solar companies had it rough in 2012.

This year, however, has been a different story.  SunPower, First Solar, and Elon Musk's Solar City have been on a tear lately, with their stock prices surging 50% - 300%.

Here's their chart YTD:

Yahoo

In a research note today, Goldman Sachs' Brian Lee, Thomas Daniels and Britt Boril explain why: they're focusing more on projects rather than parts, and they've pulled out of Europe: 

The key change within US solars, in our view, has been an evolution of business models to downstream, project businesses. As fundamentals have shifted away from manufacturing, supply-demand and component ASP debates toward backlog and pipelines, we believe earnings have stabilized, with visibility now firm over the next 12-18 months. Also, a geographic mix shift away from Europe toward North America and emerging markets such as Japan, India, South America, and the M. East has reduced policy risk. 

Here's the evolution in sales data...

Goldman Sachs

And here's the new geographic breakdown...

Goldman Sachs

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Video Shows How Insane Trading Goes Right Before Important Data Drops

Two days ago there was some strange trading activity before the May Consumer Confidence number came out. There was an explosion in SPY (the SPDR Sector S&P ETF), the eMini (electronically traded futures) and hundreds of other stocks 1/4 second before the number came out.

In trading time, that's forever.

Eric Hunsader the CEO of market research firm Nanex, told Business Insider that the strange activity was most likely a case of 'banging the beehive.' That's the phrase traders use to describe what happens when a high frequency trader sends out a barrage of orders before right before a key event (like a report), impacting price and forcing everyone in the market to move their positions.

It's wild stuff, and seeing it in action is even wilder. Today, Nanex posted a video of trading in the SPY ahead of the Consumer Confidence number. You can check it out below. It shows a half second before the 10:00 am announcement, slowed down for 5:39.

You'll note activity explodes at 9:59:59.755.

Also, just FYI, the little colorful bars are exchanges.

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BofA On Treasuries: 'Key Support Levels Have Broken ... STAY BEARISH'

U.S. Treasury bonds have sold off sharply in recent weeks, sending bond yields soaring upward.

In recent days, the yield on the 10-year Treasury yield reached 2.17% – its highest levels in over a year – and is now trading near 2.12%.

That puts the bonds in a bit of a "technical vacuum area" for traders charting yields, which just means it's been a while since the last time bonds were here, and there's not a lot of past experience to go off of in terms of recent action at these levels.

In a note to clients, BofA Merrill Lynch technical analyst MacNeil Curry suggests traders should "STAY BEARISH" following the recent sharp move upward in yields.

Curry writes:

Across the US Treasury Curve, key support levels have broken. STAY BEARISH & watch the monthly closes

Across the US Treasury curve, 2yr, 5yr, 10yr and 30yr yields have broken key support levels, pointing to further upside in the sessions and weeks ahead. While allowing for a near-term consolidation, as 2s could struggle with 31.6bps/32bps area support, 10s are threatening to post a potential Shooting Star (warning of near-term stalling) and 30s are struggling with retracement support around 3.337%, any pullback/pause should prove temporary and corrective. Indeed, we look for the sell-off to continue, with 2s targeting 41bps, 5s to test 1.182%/1.257%, 10s to probe 2.292%/2.242% and 30s to take a run at 3.461%/3.504%. HOWEVER, the risks to this view are to the topside, as the monthly candlesticks warn that Treasuries are on the cusp of long-term/cyclical turns in trend. Indeed, all points on the curve are poised to complete Bearish Outside Months (watch the Friday close – see charts for levels), while 5s, 10s, and 30s are also on the verge of completing monthly head and shoulders bases, which would point to a return to levels not seen since 2011.

The chart below shows the 10-year Treasury yield's recent break above the upward channel it has been trending in for the past several months.

BofA Merrill Lynch Global Research, CQG

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