The Great Recession from December 2007 to June 2009 triggered a remarkable shift in consumer spending.  The “New Consumer,” a household that saves more, spends less and pays down their debt, started to evolve during this time period.  The question is, have the past several years’ economic uncertainty and hardships permanently turned American consumers from spendthrifts to penny pinchers? 

Prior to the Great Recession, personal savings rates in America fell to Depression-Era levels.  Starting in 1992 and leading up to the Great Recession, consumer spending grew at an average annual rate of 3.5%, but real disposable income only grew by 3.1%.  Consequently, consumers borrowed or depleted savings to purchase new cars, homes and other big-ticket items.  This was a nation-wide epidemic that did not discriminate based on income level.  On the whole, we spent more than we could afford in the long run.

With the Great Recession came declines in the housing, stock, and labor markets, which led to decreased American financial confidence.  As a result, the Bureau of Economic Analysis calculates the personal savings rate shifted from lows of 1% to 4% in 2006 and 2007 to 4% to 7% during the recession.  Suddenly, people became more aware of how few assets they had for emergencies and to support increased lifestyles.  As a result, consumer expenditures dropped by approximately 2.8% from 2008 to 2009.  Despite this shift toward savings, household wealth plummeted by over 20% during 2008 to 2009, thanks to the depressed real estate market and volatile stock market.

Over the past year, wages and income are flat, while unemployment is persistently high.  Low mortgage rates and affordable housing are appealing, but the real estate market continues to be depressed.  However, recent reports suggest that consumers are reverting back to their spendthrift habits.  Notably, during September 2011 the nation’s savings rate dropped to 3.6%, its lowest level since the month the recession began.  The data suggests that consumer spending may soon outpace earnings again, resulting in increased consumer debt at a time when many people may not be able to afford even minimal debt payments.

While the nation’s spending and savings data suggests a wholesale shift, it may be true that only a certain percentage of the population is spending more and/or saving less.  Deloitte’s 2011 Annual Holiday Survey, which polls more than 5,000 consumers on their spending habits, suggests that many respondents are hesitant to spend due to a decrease in confidence in the economy.  Regardless of this stated concern, holiday spending is expected to increase 3% from the previous year.  The report suggests that lower and middle income groups will continue to maintain current spending levels during the holidays, while higher income groups will steadily increase spending.

Increased 2011 earnings at luxury goods retailers support survey results with regard to current spending patterns.  As of October 31, 2011, Bloomberg reports that Tiffany & Co. (TIF) saw a 27% increase in sales this year-to-date.  In addition, Nordstrom (JWN) earnings were up 21% and Coach Inc. (COH) increased earnings 20%.  Clearly, some faction of the American consumer is spending more.

Research suggests that the conditions of the macro economy have a strong influence on consumption spending.  Thus as the economy improves there should be a positive upward trend in consumer spending.  Affluent Americans curtailed their spending during the recession, but have slowly come out of their shell in the past year.  For now, it appears that the current increase in consumer expenditures is largely swayed by upper-class households, while lower and middle income class consumers’ spending habits remain unchanged from their recession levels.  As we found after the 2002 downturn and 9-11, the “New Consumer” may be only temporary.

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The Emergency Economic Stabilization Act of 2008 signed into law new requirements for brokers to report cost basis data to investors and the Internal Revenue Service (IRS) for securities purchased on or after January 1, 2011.  These requirements mean changes to the appearance of your 1099 as well as the data it contains.

The new law allows for different types of securities to be phased in over a three-year period (stocks: January 1, 2011 / Mutual Funds and Exchange Traded Funds: January 1, 2012 / All other types of securities: January 1, 2013).  Securities purchased on or after their effective dates are considered “covered.”  Securities purchased prior to their effective dates are considered “non-covered.”

Brokers are only required to report cost basis data for covered securities.  If a non-covered security is sold, cost basis data along with ultimate gain or loss information will be reported to the investor (via the new 1099-B) but will not be reported to the IRS.  Brokers will only report cost basis data to the IRS for covered securities.  The new 1099-B form will note whether a particular transaction is considered covered or non-covered.  This will help in determining what information has been reported to the IRS.

All clients will notice the orientation of the new 1099-B has changed from portrait to landscape to better contain all additional data.  New areas of the 1099-B, for both Charles Schwab and Fidelity Investments accounts, include: acquisition date, adjusted cost basis, disallowed wash sale losses, covered and uncovered securities, and holding period.  The new report also tracks short-term versus long-term gains and subtotals the figures.

Clients with accounts custodied at Charles Schwab will notice a new feature of the report.  A section titled, “Realized Gain/Loss Summary” has been added.  This new section provides a consolidated view of gains and losses, cost basis, and wash sale data.  This means the Year-End Gain/Loss Report you are accustomed to receiving will no longer be sent to you separately.  All of this data is now incorporated into the new year-end summary.  Also included in the year-end report is a summary of fees and expenses.  This area lists any advisor fees debited from your account or margin interest paid, if applicable.

Clients with accounts custodied at Fidelity Investments will notice a change to the supplemental pages included in the Tax Reporting Statement.  Other than variations in the orientation and grouping of data, the information on these pages is the same as in years past with the exception of the realized gain/loss sections.  Fidelity now gives additional data for realized gains/losses on the supplemental pages; however, no data contained on a supplemental page is reported to the IRS.  That data is informational only for the investor.

If you have historically relied on data provided by West Financial Services, Inc. to complete your tax filings, you may continue to do so.  Our annual Realized Gains and Losses Reports will be mailed out in January for all taxable accounts.  If you have any questions while reviewing your new 1099-B or tax packages from your custodian, please feel free to call our office.

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The Internal Revenue Service (IRS) requires that individuals be able to produce records proving any income, deductions or credits claimed on their tax return for at least three years from the date of a return—the statute of limitations for how long the IRS has to assess additional tax if all income was reported correctly. 

In addition, the IRS requires that individuals be able to produce such records for six years if they fail to report income that is more than 25% of their gross income.  If you have filed a claim for a loss from worthless securities, the term is seven years.  There is no statute of limitation for failure to file or tax fraud.

Records to keep for one year or less

Individuals should keep bank and credit card statements for one year or less.  Cancelled checks can be shredded after reconciliation, unless needed for taxes or insurance purposes.  Purchase receipts, online order forms, utility bills, and phone bills can usually be shredded after payment or a minimum of 90 days.  One thing to keep in mind when shredding receipts for purchases is that the time period allowed for challenging payments or other errors, will depend upon the policies of the specific institution, but is usually 60 to 90 days. 

Records to keep permanently or until disposition of property

Certain records must be maintained permanently or until disposition of the property, plus the appropriate time period for IRS audit.  Permanent records include birth and death certificates, estate planning documents (until revised or updated), life insurance policies (until terminated), loan documents (until cancelled or paid), investment purchase documents, year-end transaction statements from mutual fund companies (until sold), marriage and divorce agreements, military discharge papers, pension and retirement plan documents, credit card agreements, home improvement receipts (until sold) and other major purchases (until sold or disposed of).

Individuals preparing their own tax returns should be more cautious in shredding documents.  The records you need, will depend upon the types of deductions that you take on your return: such as calendars for business use of home, logs of mileage deductions, purchase receipts for theft loss purposes, etc. 

IRS Publication 552—Record Keeping for Individuals, is a good source for a detailed description of the proof needed to verify or support various tax deductions.  IRS Publication 529—Miscellaneous Deductions, is another good primer on records that people should keep for documenting various deductions.  If you need to re-create lost records, you can request a copy of your tax return and Form W-2 from the IRS by using Form 4506.

Certain situations occur that require more documentation than might be expected.  These situations include:

•Failure to file, or periodic filing of income tax returns.
•Review of recorded income for Social Security purposes.
•Incorrect cost basis information on mutual fund statements and other investments.
•Adjusted cost basis for a personal residence.
•Cost basis for investments received as a gift.

The responsibility for reporting cost basis information on securities transactions for tax purposes has historically fallen to the investor.  However, that changed on January 1, 2011, when changes enacted in the federal tax law by the 2008 Emergency Economic Stabilization Act went into effect (see the previous article on these changes). 

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We recently attended a presentation by Jeremy Grantham, founder of GMO, a privately held global investment management firm. In this article, we share some of the insights from his presentation.

Market Valuation/Performance

• The year 2000 represented the biggest bubble in U.S. history. The average Price-to-Earnings (P/E, a valuation metric) was 35X. The bubble led to the past decade, where the stock market benchmark has hovered below trend.
• The stock market P/E ratio could potentially go below 9X, which means that stocks may become even cheaper with a potential S&P level of 950.

Economy/Macro Level

• The expectations for GDP growth and inflation are low and stable.
• Grantham believes that the U.S. housing market will not go much lower than its current level.
• The difference between 2008 and 2010/2011—
• 2008 was a U.S.-centric problem.
• 2010/11 is a Europe/China-centric problem and more entangled.
• Watch for early warning indicators of a housing bubble in China.

Corporate Fundamentals

• Companies are lean and mean, as demonstrated by above average profit margins.
• Profits are mainly a result of cutting overhead expenses.

 Other Assets

• Commodities in focus:  Fertilizer demand is on the rise as the world population grows and more people need to be fed.  As a result, the annual use of fertilizer is growing, which may cause a crisis in the production of Phosphates and Potash.

Recommendations/Focus

• High quality stocks win over the long term and trade at a discount to the market.
• Favor non-U.S. stocks over the long term.

Our take is that Grantham is overly negative on the markets as a whole.  However, there are certain aspects upon which we agree and have built into our strategy.  If you have questions, please feel free to give us a call.

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