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2014: Year of the merger

by Community Manager

‎06-18-2014 01:15 PM

market commentary

By Bob Landry, executive director portfolio manager


2014 is shaping up to be a year defined by mergers and acquisitions on Wall Street. Reported corporate combinations through the middle of May were worth more than $575 billion, up about 35 percent from the same period in 2013. There have been a number of high-profile deals since then, and it seems evident that more are on the way.


An upswing in M&A makes some sense when you consider that profitability during the current bull market, now well into its sixth year, has not been led by an increase in revenue. To improve their bottom lines, companies have instead focused on cutting costs, raising productivity, refinancing debt and buying back shares. Turning to M&A is a logical next step — a way to buy more revenue when growth is hard to come by organically.


Some of the M&A activity, however, appears to be influenced by U.S. tax considerations by firms with considerable quantities of cash generated and held outside the country. This week’s proposed $43 billion buyout of Covidien by Medtronic is identified as the latest of these so-called “tax-inversion” deals, whereby a company based in the U.S. (in this case, Medtronic) buys a foreign-based overseas-domiciled company (Covidien) and then the combined company establishes its official headquarters overseas.


The change of domicile would enable Medtronic to use the amassed profits from its overseas operations without first paying U.S. corporate income taxes. The U.S. has by far the developed world’s highest corporate taxes, with the marginal rate set at 35 percent. Adding in state taxes can push the overall burden above 40 percent. Our tax structure is also unique in that U.S. taxes are levied on global earnings.


Tax-inversion deals are adding some immediacy to a long-running debate about how taxes should be applied to the estimated $2 trillion in cash held overseas by U.S. companies. For some perspective, $2 trillion is more than the GDP of all but nine countries on the planet. It’s half of what the U.S. government is expected to spend in the next fiscal year. At current prices, it’s about a third of the value of all of the gold mined in human history. It’s a lot of money.


There are obvious advantages for the U.S. if this overseas cash were able to be repatriated. It would be available for investment in modernizing aging plants and equipment and for new operations and new products, all of which could create needed jobs. The current recovery has seen less aggressive capital spending than in previous economic recoveries, so this cash could be an especially valuable source of investment as corporate borrowing costs rise along with interest rates, as we expect to occur in the coming years. Some of the cash could also be returned to shareholders in the form of higher dividends or stock repurchases.


We are not among those calling for a one-time tax holiday that would allow U.S. companies to bring their overseas cash home free and clear or at ultra-low rates. All we are suggesting is that the U.S. might be better served in the long run if our corporate tax structure was more globally competitive.


Former banker Walter Wriston once said, “Capital goes where it is welcome and stays where it is well treated.” As a place to do business, the U.S. offers a number of pluses — among them, a skilled and educated workforce, advanced technology and an embrace of the entrepreneurial spirit. Adding more capital would only stand to enhance these advantages and, in doing so, bring long-term benefits to the country as a whole.


USAA Investments Managed Portfolio Outlook

Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. While signs point to continued recovery of the U.S. economy, valuations are no longer cheap and profit margins are near record highs. The USAA Income Stock Fund seeks dividends and dividend growth as contributors to total return.


We are tactically underweight fixed income, primarily to fund a deployable cash position. Within fixed income, we prefer areas of the market that are more credit-sensitive and less sensitive to changes in interest rates, such as investment-grade corporate bonds and high-yield bonds. The USAA Intermediate-Term Bond Fund and the USAA High Income Fund fit this profile.


We are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund provides potential protection against the risks of long-term inflation.


We are overweight non-U.S. developed markets and emerging markets based on relative valuations. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. Along with compelling valuations, they offer an interesting long-term prospect for growth. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.


As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for your individual goals, objectives, risk tolerance and time horizon.


This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.


Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Contact us at 1-800-531-8910 for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.


Investing in securities products involves risk, including possible loss of principal.


Past performance is no guarantee of future results.


Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.


As interest rates rise, existing bond prices fall.


Non-investment grade securities are considered speculative and are subject to significant credit risk. They are sometimes referred to as junk bonds since they represent a greater risk of default than more creditworthy investment-grade securities. 


Some income may be subject to state or local taxes or the federal alternative minimum tax.


Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Emerging market countries are most volatile. Emerging market countries are less diverse and mature than other countries and tend to be politically less stable.


The S&P 500 Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange.


Standard & Poor’s 500 Index and S&P are registered trademarks. The S&P 500 Index is an unmanaged index of 500 stocks. The S&P 500 focuses on the large cap segment of the market, covering 75% of the U.S. equities market. S&P 500 is a trademark of the McGraw-Hill Companies, Inc.


The Russell 2000® Index is an unmanaged index which consists of the 2,000 smallest companies in the Russell 3,000 Index, and is a widely recognized small cap index.


USAA or its affiliates do not provide tax advice. Taxpayers should seek advice based upon their own particular circumstances from an independent tax advisor.


High double digit returns are attributable, in part, to unusually favorable market conditions and may not be repeated or consistently achieved in the future.


Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.


The Real Return Fund may be subject to stock market risk and is non-diversified which means that it may invest a greater percentage of its assets in a single issuer. Individual stocks will fluctuate in response to the activities of individual companies, general market, and economic conditions domestically and abroad. When redeemed or sold, may be worth more or less than the original cost.


Managed Accounts is a service of USAA Investment Management Company (USAA), a registered investment adviser and broker dealer.


Diversification does not guarantee a profit or prevent a loss.



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