THE MONTH IN BRIEF
December lived up to its promise as one of the better months of the year for stocks, with the S&P 500 gaining 6.53%.¹ It was a strangely quiet time on Wall Street, and the biggest news item of the month was good news for investors. It didn’t take long for President Obama and Congressional Republicans to reach a tax compromise, one with demonstrable benefits for all Americans. In December we learned that the jobless rate had increased; however, by the end of the month, initial claims were at a two-year low. Home sales improved, and so did retail sales. Optimism was back, or at least pessimism did not reign.

DOMESTIC ECONOMIC HEALTH
Two stories dominated the headlines in December: the bipartisan tax accord reached in Washington D.C., and the enthusiasm of shoppers at the malls.

There was no knock-down, drag-out fight on Capitol Hill when it came to resolving federal tax issues. On December 6, President Obama announced a compromise to extend the Bush-era tax cuts for all Americans (including the wealthiest) through 2012. Some of his fellow Democrats howled in protest. Nevertheless, the 2010 Tax Relief Act was signed into law on December 17 after overwhelming passage in the House and Senate. The new tax pact cut (employee) payroll taxes by 2% for 2011 and permitted businesses to expense 100% of their investments in 2011. It extended the college tuition tax credit and federal unemployment insurance; it restored the estate tax at 35% with a $5 million individual exemption. In the estimate of the non-partisan Tax Policy Center, the deal improves the after-tax incomes of the wealthiest 20% of Americans by 5.7% and the poorest 20% of Americans by 3.7% (that is, compared to if the EGTRRA and JGTRRA cuts had lapsed).^2,3

All month, nightly news broadcasts spread the message that consumers were spending freely again. While these accounts were often anecdotal, the numbers on hand were encouraging. The Commerce Department reported a 0.8% gain in retail sales for November – the fifth straight monthly increase. Department store sales were up 2.8% in November, representing the biggest monthly gain in two years. Online sales improved 13.0% this past holiday season, according to Internet tracking firm comScore. At the car lots, J.D. Power & Associates said December auto sales were “significantly beating expectations” and forecast year-over-year sales volume to improve by 11.5% for 2010.^4,5,6

Other consumer signals flashed, hinting that things were looking up. Initial jobless claims fell to a low unseen since July 2008 during the week ending December 25. Consumer spending rose 0.4% and consumer incomes rose 0.3% in November while the federal government’s Consumer Price Index ticked up but 0.1% (as did the core CPI).^7,8,9

There were plenty of other news items. The Labor Department informed us that unemployment had hit 9.8% in November. The Institute for Supply Management’s manufacturing index improved in December to 57.0 from 56.6; its service sector index showed improvement for the month of November, going from 54.3 to 55.0. The Conference Board’s index of leading economic indicators had risen 1.1% in November for its best month since March. The Reuters/University of Michigan consumer sentiment survey improved a bit to 74.6.^{10,11,12,13,14}

GLOBAL ECONOMIC HEALTH
Here’s a news flash: Eurozone inflation leapt 2.2% in December, exceeding the European Central Bank’s inflation target for the first time in two years. (Barclays Capital analysts have forecast the EU inflation rate to reach 2.5% by February.) However, core EU inflation stayed close to 1% and unemployment in the EU’s biggest economy – Germany – stayed near 7%. The Markit Eurozone Purchasing Manufacturers Index climbed to 57.1 in December, close to the 46-month high set last April.^15,16

China’s official PMI dropped to 53.9 for December, while South Korea’s key PMI reached that same mark. Taiwan’s government revised its 2010 GDP estimate in December to 4.8%, much lower than the 10.0% it initially forecast for its export-rooted economy. India’s PMI slipped a bit to 56.7 in December from 58.4 in November, but its November exports increased by 26.5%.^17,18,19

WORLD MARKETS
Assorted benchmarks logged some nice monthly gains. In Europe, Austria’s ATX rose 11.4% last month; Ireland’s ISEQ gained 8.8%, Russia’s RTSI advanced 7.8% and Spain’s IBEX rose 6.4%. The FTSE 100 gained 6.7% in December, while the CAC-40 rose 5.4% and the DAX moved north 3.4%. Turning to the Asia Pacific markets, we see the following December performances: Sensex, +5.1%; Australia All Ordinaries, +3.6%; Nikkei 225, +2.9%; Singapore STI, +1.4%; Hang Seng, +0.1%. Only three indices of consequence went south in December: the Shanghai Composite (-0.4%), the IPSA in Chile (-0.6%) and the Caracas Index in Venezuela (-1.2%).²⁰

The much-watched MSCI World and Emerging Markets Indexes also had healthy gains last month. In U.S. dollar terms, the World advanced 7.25% and the Emerging Markets rose 7.02%.²¹

COMMODITIES MARKETS
Gold cracked the $1,400 ceiling in December, rising 2.61% to settle at $1421.10 per ounce on December 31. Copper posted a 16.13% monthly gain, and silver kept climbing to reach a 30-year high (it gained 83.7% for the year). Crude oil pulled off an 8.64% December advance, with futures finishing 2010 at $91.38 a barrel. The Thomson Reuters/Jefferies CRB index gained 10.0% in December, helped by huge annual gains for silver (see above), cotton (+92%), corn (+52%), and coffee hitting a 13-year peak. The U.S. Dollar Index sank 2.9% for the month.^22,23,24,25

REAL ESTATE
Had the market found a bottom? Was a rebound occurring? Or was a double-dip coming? Commenting on the October S&P/Case-Shiller home price index data, Standard & Poor’s index committee chair David Blitzer said last month with regard to home prices that “[it] looks like a double-dip is pretty much on the way, if not already here.” In the October edition, home prices dropped 1.3% and fell for the third straight month.²⁶

However, there were reasons for optimism. In November, existing home sales were up 5.6%, new home sales up 5.5% and housing starts up 3.9 %. Pending home sales rose by 3.5% in November after a 10.4% leap in October.^27,28,29

Comparing and contrasting mortgage rates in the December 2 and December 30 surveys from Freddie Mac, we see home loans growing more expensive. Average interest rates for 30-year conventional home loans went from 4.46% to 4.86%. Average rates for 15-year FRMs rose from 3.81% to 4.20%. The rates on 5-year ARMs went from 3.49% to 3.77% and rates on 1-year ARMs barely moved, going from 3.25% to 3.26%.³⁰

LOOKING BACK…LOOKING FORWARD
The three major U.S. indices all gained at least 5% last month, and the Russell 2000 ended the year with a 7.79% December advance (it went +25.31% for 2010). Historically, December has often been a good month for stocks – since 1928, the Dow has gained more than 5% in the last month of the year on ten occasions. December 2010 went into the books as the best December for the Dow in seven years.^1,31

Will optimism prevail this month on Wall Street? On the first day of trading in 2011, you had the S&P 500 closing at its highest level since September 3, 2008, the Dow to its highest mark since August 28, 2008 and the NASDAQ at its highest close since December 26, 2007. The December jobs report is shaping up to be the first big challenge to stocks this month; if it shows an improvement, it might convince more investors that the economy is moving in a positive direction. Some Wall Street analysts are looking at 2011 very positively: UBS Wealth Management thinks the S&P 500 will top 1,350 by the end of the year, and Citigroup thinks the index will reach 1,400. (Did you know that last month was the best December for the S&P 500 since 1991?)³⁵

UPCOMING ECONOMIC RELEASES: The schedule for the rest of the month is as follows: the December unemployment report (1/7), November wholesale inventories (1/11), the Federal Reserve’s January Beige Book (1/12), the December PPI (1/13), the December CPI, December retail sales and industrial output, November business inventories and the initial January University of Michigan consumer sentiment survey (1/14), December housing starts and building permits (1/19), the Conference Board’s December leading indicator index and December existing home sales (1/20), the November Case-Shiller home price index and the Conference Board’s latest poll of consumer confidence (1/25), December new home sales and a Fed interest rate decision (1/26), December durable goods orders and November pending home sales (1/27), the final December University of Michigan consumer sentiment survey and the first estimate of 4Q 2010 GDP(1/28), and lastly December personal spending and personal income (1/31).

Monthly Riddle:

Add missing vowels to these three trios of letters to get the six-letter names of three different countries: PNM, MXC, KWT

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Good question. Congress has elected to keep us in suspense.

www.youtube.com/watch?v=o_6CnlAwiPM

0% estate taxes in 2010 … for now, anyway. On January 1, the federal estate tax went away – at least for the time being and perhaps for all of 2010 as envisioned back in 2001. President Obama and Congressional leaders wanted the estate tax to stick around in 2010 at 2009 levels (estate taxes up to 45% with a $3.5 million exemption), but lawmakers were preoccupied with other matters.^1,2

Will Washington really give families million-dollar tax breaks? If no estate tax is imposed in 2010, it could mean a savings of millions for wealthy families. There is talk of bringing the tax back retroactively – after all, the federal government could really use the money. Yet the further we get from January 1, the more difficult reinstating the estate tax for 2010 may become.

As American Institute of Certified Public Accountants vice-president for taxation Tom Ochsenschlager told MarketWatch, “They’re still talking (in Congress) about making something retroactive, but at some point they can’t do that … is it even constitutional? There’s a real question about that.”

The unconstitutional argument goes like this: if Congress moves to retroactively apply the estate tax for 2010, an estate could take the mater to court and point out that Congress had all year to reinstate it but failed to do so.

That argument aside, some estate planners think Congress will get around to a retroactive measure – one that would put the 2009 estate tax levels back into place for 2010.

So, what taxes are in place now? Some taxes still apply to estates in 2010 even if the estate tax doesn’t. People who give away more than $1 million during their life still face federal gift taxes – though in 2010, they max out at 35% instead of 45%.³

Also, all assets with capital gains are to be taxed at 15% above a $1.3 million federal exemption when sold by heirs in 2010. The big news here is that heirs don’t get to use a step-up this year. When they compute the value of an inherited asset, they have to use the basis (the original price paid for the asset) instead of how much that asset was worth when the original owner died. (In addition to the $1.3 million exemption per estate just mentioned, there is another $3 million exemption available for assets inherited from a spouse.)³

What precautions may be wise this year? As a potential heir, you’ll want to document the cost basis of any assets you might receive in 2010. Good recordkeeping is in order.

Additionally, you may want to search a trust or a will for so-called formula clauses anchored by words such as “that portion”, “that amount” or “that fraction”, especially if the will or trust was created some years ago with the presumption of a constantly increasing federal estate tax exemption.

These formula clauses are fundamental to bypass trusts created to defend estate tax exemptions for a couple. However, these clauses assume that there is an estate tax. With no estate tax in place, there is the possibility (depending on how the formula clause is worded) that a deceased spouse’s assets would not be inherited by the surviving spouse, but instead go directly into the family trust – not the most useful result for the surviving spouse.³

What will 2011 bring? Well – if there are no changes – the estate tax and the generation-skipping tax would come back in 2011. Only the first $1 million of an estate would be exempt from estate taxes. Assets above the exemption would be hit with a 55% federal penalty.³ However, the Obama administration had talked of keeping the 2009 estate tax levels in place for 2010 and beyond, which would be better than returning to the pre-EGGTRA levels in 2011.