Monday, April 27, 2009

RB Wants to Tell a Story/VZ/Posts on Tax Issues relating to Equity and Trust Preferred Stock and Deferral of Cumulative Preferred Dividends

The family pictured  above are lineal ancestors who did not have to worry much about the Panic of 1907. The gentlemen at the far left of this family picture is a great uncle who later became a stock investor and stayed with it during the Great Depression (my grandfather is to his right) As a consequence, my great uncle Tom was in a position to afford to buy a graduation dress for my mother. This apparently made her happy as shown in this picture of her taken in 1941. After Tom died, his stock investments kept multiplying and he was able to take care of his wife and his youngest sister, pictured in the lap of their mother, who had contracted Parkinson's disease (both required extensive nursing care). Then after his wife died with TB, and the young sister died many years later, the remainder of the trusts set up for them went to the children  of his brothers and sisters since he was childless. RB thinks in stories, and it is responsible for bringing all of this up to win- in its view -the following argument with LB. I tell myself this kind of story to steel my nerves since I have been pouring money into stocks since late February 2009

(added note: RB=Right Brain; LB=Left Brain)

Once you forget about how you arrived at a place and instead focus where you are and where you want to go, then your perspective changes. The Great Depression would have been bad for an investor who bought stocks on 90% margin before the crash, which was permissible back then, but presented an opportunity to someone with some funds to invest as a result of a steady job. For the Great Uncle Tom, his willingness to step into the fray provided for many good things to a bevy of relatives while he lived and provided for many years after his death. That is RB's point, sort of the big picture rather than the lineal, logical nerdy discussions about Bayesian statistical techniques and other esoteric points that are the staple of LB.    

I mentioned in prior posts that my family has a kind of institutional memory that covers almost 400 years since the original ancestor arrived in Virginia in the early 1600s. As a result, I could tell someone that the mother in this old photo died of the Spanish flu in 1918, as did her oldest daughter Ora pictured third from the left. The poverty evident is  at least partially the result of their not too distant ancestors dissipating the wealth through drink and gambling that was built up during the long life of the young man who first arrived in the U.S. from Bristol England in 1634 and died many decades later after acquiring over 5000 acres of prime Virginia land along the Potomac river in Stafford County. Long Term Bonds in Trust Certificate Form/Grantor Trust Legal Opinion So that is another of RB's story points that means something to it.

The posting of these pictures was caused by a discussion between LB and RB over the their respective perspectives on Mark Hulbert's column in the NYT on Before turning to the discussion, LB will try to put what RB is saying in some logical context, otherwise it would be incomprehensible gibberish. In this post I have mentioned that it took until 1955 for the market to recover from the 1929 crash and the ensuing Great Depression. Hulbert puts the precise date as 11/23/1954  I will generally discuss that statistic in reference to my approach to asset allocation, where I try to recognize that there will be extended periods when the stock market produces no returns and hopefully plan accordingly.

Hulbert accepts that the time period for the recovery in stock prices is correct in nominal terms. He makes several arguments that the nominal time period is not the appropriate one to use. For example, the nominal return does not include the reinvestment of dividends. When stock prices fall 80% and the investor reinvests a dividend to buy additional shares, then more shares will be purchased at the low price which would later be beneficial when the market recovers. This is what started the argument between LB and RB. LB said something like "who could afford to reinvest the dividends during the Great Depression and have the fortitude to hold onto their investments during the plunge to the 1932 lows."

The next adjustment that Hulbert makes is for deflation since the CPI fell 18% by 1936 from 1929.  He claims that failing to adjust for deflation overstates the decline. LB responded that no one probably thought along those lines who actually had to make stock purchase and sell decisions during the Great Depression. The last adjustment is one that I knew but had forgotten about. IBM was taken out of the DJIA in 1939 and then restored in 1979. This made a huge difference in the DJIA return since IBM's heyday as far as gigantic price appreciation moves occurred after 1939. The DJIA may have been twice as high, Hulbert points out relying on some data from Norman Fosback, in 1979 if IBM had stayed in the DJIA index.   


Verizon, a small common stock position and a large bond holding, beat expectations on earnings for its first quarter. Excluding adjustments, VZ earned 63 cents versus estimate of 59 cents. VZ top expectations apparently by adding 1.3 million net wireless customers excluding those acquired from its recent Alltel acquisition. The company continues, however, to suffer erosion in its land line customer base with a decline of 10.4%. The company also added 299,000 FIOS TV customers bringing its total to 2.2 million.  VZ added 298,000  internet customers bringing the total up to 2.8 million.

I am satisfied with the report. 

With my new FeedJit widget, I see some interest in a post about tax issues relating to preferred dividends. I have discussed these issues in several posts and anyone interested in this topic can find earlier discussions by entering search terms in the box at the top left hand corner of the blog. These type of issues do play a role in my investment decisions and even the placement of a preferred stock in a taxable or a retirement account. Some of the posts that I found using the search box include the following:

For the taxation of the dividend a U.S. investor has to figure out whether the preferred stock is an equity preferred (sometimes called by me a traditional preferred) or a debt preferred ( sometimes called Trust Preferred). (REVISED 5/3/09 FOR REIT CUMULATIVE PREFERRED DIVIDENDS, SEE REITs in Barron's/ Clarification on Qualified Dividends & REITS) This is important for wealthy U.S. taxpayers since the dividend paid in connection with ownership of the equity preferred will be a qualified dividend taxed just like a common stock dividend under current rules whereas the debt preferred payments are interest subject to taxation at the highest marginal rates.

So, for example, I own a floating rate equity preferred stock issue from Goldman Sachs, GSPRA, which is in my taxable account, and I just bought a synthetic floater tied to a GS Trust Preferred in a retirement account primarily due to tax issues with that kind of instrument that extends beyond the marginal tax rate on interest payments. Also, if I start to become worried about deferral of a cumulative preferred dividend, I may transition even an equity preferred to a retirement account until that concern about a possible deferral passes. I recently did that with part of my position in a First Industrial cumulative preferred stock. I am currently caught for the first time in my life holding in a taxable account a REIT cumulative preferred in deferral, BEEPRA. I deserve to be caught on that one, but it is starting to recover some from its plunge after the deferral and my exposure was 100 shares at 7 and change with a $25 par value.

Under certain circumstances, I might add a cumulative preferred in deferral in a retirement account as a speculative position when I become more confident the company is likely to survive and ultimately pay the accrued and deferred dividends. All of this can become a  mental exercise for LB that may not make any sense to anyone else. 

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