1st Quarter 2010 Commentary

7/31/2019 1st Quarter 2010 Commentary

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economic overview

The U.S. Economy

The rst quarter o 2010 closes out an incredible year orecovery or the markets, yet other economic indicators

continue to be mixed at best. A year ago we were all

worried that nancial Armageddon was upon us; it is

remarkable that the Dow is up over 70 percent rom

the low o 6,547 set March 9, 2009. However, unemploy-

ment remains at 9.7%, banks are still very picky about to

whom they will lend and the U.S. will have decits or as

ar as the eye can see. On the other hand, manuacturing

is picking up and the housing market seems to have

stabilized, albeit at a much lower level than beore.

We believe that company anecdotes and economicindicators are consistent with a recovery.

GDP(GrossDomesticProduct)wasup5.6%

annualized in the 4th quarter.

TheCase/Shiller10-cityindexofhousingpricesis

unchanged over the last 12 months, whereas in

late 2008 prices were declining 20% per year.

Manyofourindustrialcompaniesarereporting

good news, with solid sequential growth.

Our 111th Congress has passed two hugely expensive

laws, and neither o these seems likely to help oureconomy. The all 2008 nancial bailout worked, and a

more serious economic meltdown was averted. It does

not appear that ARRA, the American Recovery and

Reinvestment Act passed in February 2009, has had

much o an impact. The number o pork barrel projects

in this $787 billion legislation was appalling and its

firSt QUarter 2010QUARTERLYCommentary

Insidethis Issue

economic overview

: : The U.S. Economy

: : Healthcare Legislation

Provisions or Individuals

: : Asset Management

featUred StocK

: : Akamai (AKAM)

internet technologY

trendS

: : Video and Cloud

Computing

wealth management

: : Roth IRA Conversion

Tax Traps

fixed income

: : A Potpourri o Fixed

Income Notes

www.nelsonroberts.com | 650.322.4

eect on job creation has been minimal. Since then, oelected representatives have been consumed by health

care legislation. Many provisions o the new healthcar

bill are costly and have implications or both the overa

economy and individuals. For more inormation, see

the healthcare box at the top o page two. It is our

ervent hope that Congress does not urther interere

with the nascent recovery.

Despite our concerns, we note that in many businesse

orders and backlogs are improving. Same store sales a

up. Even the automakers are reporting good news. W

may be early with this call, but we think the next bigwave o technology advances is upon us. See the artic

on page our about Internet video and cloud computing. W

are undamentally optimistic about the U.S. economy a

we think the stock market will reward prudent investo

index Performance Q110 Ytd

Dow Jones Industrials 4.82 4.82

Standard & Poors 500 5.39 5.39

EAFE (international stocks) 0.98 0.98

Russell 2000 (small stocks) 8.85 8.85

Barclays Interm. Gov/Credit 1.54 1.54

Barclays Municipal 1.25 1.25


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While the frst quarter o 2010 clomarkets, other economic indicators

top

FiFteen Holdings

iShareS intl emerging marketS

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PayChex inC.

iShareS S&P Small CaP

FaStenal Co.

iShareS eaFe index

VolCano CorP.

emerSon eleCtriC

adobe SyStemS

miCroSoFt CorP.

nuCor CorP.

3m ComPany

gilead SCienCeS

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tJx ComPanieS inC.

economic overview (contd)

Healthcare Legislation Provisions or Individuals

With the recent passage o the over 2,700 page Patient Protection and Aordable Care Act and the Health

Care and Education Reconciliation Act, major new taxes and mandates will be imposed. In this issue o the

Commentary we ocus on individuals; we will cover companies in our July issue.

TheMedicarepayrolltaxincreasesto2.35%from1.45%andtheself-employmenttaxincreasesby

0.9% or singles earning more than $200,000 and amilies earning more than $250,000.

ThereisanewMedicaretaxof3.8%onnetinvestmentincomewhichappliestothoseinthe

income categories noted above.

AlsowithregardtoMedicare,thereisanothernew3.8%taxontrustsandestatesleviedonthelesser

ofallundistributednetinvestmentincomeoralladjustedgrossincomeinexcessof$11,200.

Charitable trusts are excluded.

Flexiblespendingaccountlimitdeclinesto$2,500from$5,000.

Deductionofunreimbursedmedicalexpensesislimitedtoamounts>10%ofadjustedgrossincome

vs. the current 7.5%.

These provisions all go into eect on January 1, 2013.

ass m

We had an active rst quarter. Early in January, we took

a loss on Genzyme. Following the all 2008 report o viral

contamination, the company subsequently disclosed

two additional incidents o contamination in their main

manuacturing plant. We concluded that this indicated

management problems and we would look elsewhere.

The 7% dip in the market rom mid-January to early

February provided us with a buying opportunity. Weadded Nucor (NUE), Akamai (AKAM) and Lindsay (LNN).

Nucor is the best-run steel manuacturer in the U.S. It

uses scrap steel as the primary ingredient in its process,

recycling 9 million cars every year. For a complete descrip-

tion o Akamai, see the eatured stock box on page three.

Lindsay is responsible or the beautiul green circles we

see when we fy over the dry western U.S. Their pivot

irrigation equipment allows armers to produce the

same crop yield using 1/3 less water than traditional

drip or food irrigation.

In mid-March, we took our lumps and sold both Gam

stop and Dynamic Materials. Gamestops extensive

retail store network will prove a liability as more vide

games are delivered online (using AKAMs services)

just as Blockbuster has lost out to Netfix. Dynamic

Materials continues to struggle with sales to its end-

markets, particularly the oil reiners, so we elected

to sell it and buy Praxair (PX), which processes anddelivers atmospheric gasses to diverse markets.

The net result is that our equity cash dropped rom an

average o 9% at year end to just over 2%, making u

ully invested. While there are certainly reasons to be

concerned about the stock market, we believe it is th

place to be right now. There is virtually no return on

cash and, in general, bonds are even more expensive

thanstocks.AsWarrenBuffettsays,thestockmark

serves as a relocation center rom the reactive investo

tothepatientinvestor.Weprefertobepatientand

believe that our patience will be rewarded.


3/6

ut an incredible year o recovery or theinue to be mixed at best.

Akamai has created the worlds largest and most widely

used on-demand distributed computing platorm,

comprising more than 61,000 servers in 1,000 networks

in 70 countries. The company provides managed servicesor powering video, dynamic transactions, and enter-

prise applications online.

Akamais business takes advantage o two trends in

technology: cloud computing and video over the Internet.

Most o Akamais clients are businesses or whom access

to their websites or use o the Internet is critical. Clients

include retailers who sell over the Internet, companies

who host applications osite or enterprises that use the

Internet as a mode o product delivery.

The company was ounded in the late 1990s by proessors

and a graduate student at Massachusetts Institute o

Technology. They developed proprietary algorithms to

route and replicate data to more eciently transportInternet trac. Over the last decade Akamai has continued

to grow its business by helping others more eectively

use the Internet. However, the eature-rich content o

video and cloud computing now requires increasingly

intelligentInternetpipeswhichwilldriveanewphase

o demand or Akamais services.

featUred StocK

Akamai (AKAM)

$26.00

$24.00

$22.00

$20.00

$18.00

2010 Bloomberg Finance L. P.

October 1, 2009 March 31, 2010

OCT 15 OCT 30 NOV 16 NOV 30 DEC 15 DEC 31 JAN 15 JAN 29 FEB 26 MAR 15 MAR 31

2009

$30.00

$32.00

DAY SESSIONLAST PRICE

HIGH ON 03/17/10

AVERAGE

LOW ON 10/01/09

31.42

32.08

25.39

18.65

2010

$31.42

FEB 16

PURCHASE PRICE

FEBRUARY 6, 2010

$25.34

AKAMAI TECHNOLOGIES INC.


4/6


Video over the Internet is not new. Victorias Secret

brought down the Internet one night in February, 1999,

ater advertising or their then Internet-only ashion

show during the NFL Super Bowl. In the early days o

the Internet boom, several hundred thousand miles

o ber optic cables were laid across the U.S. The cost

was staggering (billions o dollars) and when actual use

ell well below estimates, several telecommunications

companies went bankrupt. Now, however, eature-rich

applications such as Internet video and cloud computing

are beginning to absorb the glut o excess bandwidth

built ten years ago.

With the heightened demand and high denition quality,

Internet broadcasts are requiring an increasing amounto capacity. Events such as the NCAA tournament, the

U.S. Open and President Obamas inauguration have all

been available real-time over the Internet. Distribution

o video over the Internet will at least augment, i not

replace, video delivery through traditional portals like

cable or satellite.

Today, 700 million video users watch an average o 10

minutes o video every day. These are predominantly

short clips ound on YouTube or news clips rom CNN.

com or other sources. However, the demand or live

sports, ull-length shows and lms is growing as avail-

ability and quality improve.

Netfix launched a partnership with Microsots Xbox

LIVE that enabled users to access a portion o the Netfix

library via the Internet connection on the video game

console. Over 1 million users signed up or this service

in the rst six months. Netfix has since expanded its

platorm beyond the Xbox and now oers more than

12,000 o its titles or streaming, which is just a raction

o the 100,000 total in its library. Other providers have

also added signicant content. For example:

Huluofferscommercial-supportedstreamingvideoof

TV shows and movies rom NBC, Fox, and ABC, as

well as other networks and studios.

MajorLeagueBaseballprovideslivecoverageofout-

o-market baseball games or an annual subscription

ee o $99.95.

CBSSportshaslivecoverageofall63ofthisyears

NCAA tournament games.

Five o our current holdings stand to reap substantial

benetsfromthistrend:Adobe,whoseFlashtech -

nology embeds video in web pages and plays the video

on an end device, Akamai (see Featured Stock box),

Cisco Systems, which sells the equipment necessary to

transport data rom end to end and provides video-

conerencing capabilities, Disney, which own the rights

to a huge amount o content, and Verizon, which owns

InternetpipesandprovidesInternetaccess.

internet technologY trendS

Video and Cloud Computingi

n t e g r i t y

Where do you nd integrity?

It emanates rom tradition, endures market cycles, and sustains long-term

partnerships. Trust lies at the heart o what we do, how we serve and who

we employ.

[in tegr te] n. honesty, sincerity, completeness


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Firm Updates: : Congratulations to Brian and Jennier Roberts on the birth o their third child,

Olivia Reese Roberts, born on March 9th.

Many high-income earners were eagerly anticipating tax-rule eligibility changes in 2010 that would allow

them to convert traditional IRAs to Roth IRAs. However, when it comes to the tax code, the rules are never

straightorward. Here are some tricky pitalls to be aware o:

1. Individuals over 701/2 years old MUST take a required minimum distribution (RMD) beore converting

the balance o their traditional IRA to a Roth, or ace a 50% penalty on the RMD. Further, any RMD

that was mistakenly converted will be subject to a 6% excise charge or each year the money remains

in the Roth account.

2. When there is a partial conversion o IRA assets, a pro-rata amount o ater-tax money is calculated or

each dollar converted. Suppose an individual has $1,000,000 in IRA money o which $100,000 is ater-

tax and $900,000 is pre-tax. The tax-ree percentage is 10% ($100,000/$1,000,000) and the remaining

90% is taxable. I the $100,000 is converted to a Roth, $90,000 will be taxed as ordinary income.

3. Rolling money into an IRA rollover rom a qualied retirement plan the same year an individual converts

to a Roth will make the rollover part o the pro-rata calculation. Because money held in qualied retire-

ment plans is excluded rom the Roth IRA conversion calculation, delaying a rollover to the ollowing year

can reduce tax liability.

4. Ordinarily, a RMD can be taken rom any combination o IRA accounts. However, the rule is dierent or

company plans such as 401(k)s. RMDs must be taken rom EACH plan beore the remaining unds can be

converted to a Roth.

5. Funds rom an inherited IRA are not eligible or a Roth conversion. I money rom an inherited IRA ends

up in a Roth IRA, the money will be subject to the 6% excise tax or excess contributions or each year it

remains there.

This is all very complicated and potentially costly i done incorrectly. Please contact us i you need more

inormation or assistance with Roth conversion.

wealth management

Roth IRA Conversion Tax Traps


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1950 University Avenue, Suite 202

East Palo Alto, CA 94303

650-322-4000

b www.nelsonroberts.com

[email protected]

Past perormance is not necessarily a guide to uture perormance. There are risks involved in investing,

including possible loss o principal. This inormation i s provided or inormational purposes only and does

not constitute a recommendation or any investment strategy, security or product described herein. Please

contact us or a complete list o portolio holdings.

For additional inormation on the services o Nelson Roberts Investment Advisors, or to receive our

Newsletters via e-mail or be removed rom our mailing list, please contact us at 650-322-4000.

2010 Nelson Roberts Investment Advisors

1. Extremely low short-term Treasury rates continue to rustrate investors who are looking or yield. The spread

between high-grade corporate bonds and Treasuries has declined to 1.51%, the narrowest spread since

November, 2007. We do not think that investors are being adequately rewarded or the additional risk at

this level. Municipal bonds are also attracting interest, yet revenues or state and local governments have

declined an average o 4.1% in the ourth quarter o 2009 compared to a year earlier. Again, we questionwhether investors are getting appropriate returns or the added risk in this climate.

The Treasury yield curve has reached historically steep levels as long-term rates have crept upward while

short-term rates (controlled by the Fed) remain steady. A steep yield curve is a positive indicator or economic

growth and an inverted yield curve (long rates are lower than short rates) usually indicates uture economic

contraction. However, it appears the current steepness o the curve is being driven by concern that excess

government borrowing will eventually lead to higher infation. Demand or Treasuries has been weak at recent

auctions. The yield on the 10-year Treasury climbed as high as 3.88% rom a low o 3.5% in February beore

ending the quarter at 3.83%.

2. Beginning in April o 2010, Moodys and Fitch, companies who rate bonds, will modiy the way municipal

debt is rated. The scale will be comparable to how corporate bonds are measured. The changes are expectedto improve municipal debt ratings and lower borrowing costs or issuers.

Historically, both Moodys and Fitch assessed municipal bonds on a separate scale rom corporate issuers,

leading to complaints rom states that municipalities were being held to more stringent standards despite

historically low deault rates. Caliornia, which holds one o the lowest ratings o the ty states, is expected

to see the rating on its General Obligation debt rise three notches, to A1 rom BAA.

3. Are the U.S., France and Germany at risk o losing their AAA credit ratings? Debt is growing in all three

countries, increasing the risk o a uture downgrade. Downgrades would lead to signicantly higher interest

rates, increasing borrowing costs or governments.

All three nations would be well-advised to get their nancial houses in order sooner rather than later.

fixed income

A Potpourri o Fixed Income Notes

Investment Team

Brooks Nelson, CFA

Brian Roberts, CFA, MBA

Steve Philpott, CFP, MBA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

Documents

1st Quarter 2010 Commentary