Falling Earnings… Rising Taxes By Rodney Johnson, Senior Editor, Economy & Markets  Last week the Census Bureau reported retail sales for December, and the numbers weren't pretty. Sales dropped 0.1% overall last month, and were down the same 0.1% when auto sales were excluded. Removing volatile gasoline sales only moved the number to flat. Making matters worse, retail sales increased a paltry 2.1% for all of 2015 – the smallest gain since 2009, and well below the 3.9% growth in 2014.
The report justified our negative view on earnings. Fourth-quarter numbers should be ugly. All of this plays right into our forecast for a general market decline and tough economic conditions in the months ahead.
But it also means something else.
The Numbers Lie All the Time…
If a company wants to cheat investors – it will. And in a market like this… CEOs and CFOs need to keep share prices rising higher. And sometimes, when desperate, they resort to sophisticated – yet perfectly legal – accounting tricks to fool the public. In this exclusive presentation, we reveal how to tell when a company is scamming investors – and what you can do about it. Click here to RSVP now.
Higher taxes.
Over the past five years, the U.S. budget deficit, as well as those of most states, has improved. Through a combination of higher sales tax receipts, higher tax rates in general and higher capital gains taxes, government entities have pulled in a lot of cash. But the days of easy tax revenue growth are over.
Consumers aren't spending more, and in some cases are spending less, as noted by retail sales. This cuts into sales tax growth. Falling markets put the kibosh on capital gains tax revenue, which has been a constant source of cash in California, in particular.
These two trends cramp the spending style of governments large and small, leaving them with few options. They can curb their spending (don't hold your breath for that one), or they can raise tax rates.
As the U.S. economy struggles in the face of a global economic downturn, expect tax rates to move up… and then go even higher.
While falling revenue might cause the federal government and states some short-term pain, the real problem is that their costs keep climbing. It almost doesn't matter what happens in Congress or in state legislatures across the country. Even if they held their spending flat, costs would still jump because they have non-discretionary expenses such as Social Security and pensions, which are zooming out of control.
The case of the federal government and Social Security is well known, and state pension issues surface from time to time, but the issue at the state level is about to get markedly worse, even as the pension managers make the right moves.
Through September of last year, large pension funds held more than 5% of their assets in cash, which is a huge allocation. Clearly, the investment managers of these funds were worried about the markets.
Based on the market action of the last couple of weeks, their caution was warranted. On the face of it, these managers look like investment heroes. Unfortunately, even if they held 100% cash and saved their funds from any losses at all, they would still be losing.
All pension funds have an estimated rate of return. These anticipated gains add to the value of the fund, thereby reducing the contributions required of the plan, participants and employers. Both fund gains and contributions are used to pay benefits. In years where no gains are made, the funds don't grow, but they still have to pay benefits.
In an odd way, investment managers can be great at sidestepping market landmines, but if they can't hit their targeted returns, typically around 7.25%, then they are still failing at their jobs!
This might sound like a problem for state pension fund managers and probably state retirees, but the pain won't end there. Illinois has less than 40% of the money it needs to pay benefits to retirees, and half of all states have 70% or less of the necessary funds.
When these institutions go broke, they won't simply close their doors and tell pensioners "too bad." Many of these states guarantee the benefits in their constitutions, which means the burden will fall squarely on taxpayers.
So, as earnings season kicks into high gear, the global economy slows and the markets suffer, remember that governments will still increase their spending.
They'll just need more of your cash to do it. 
Rodney
Follow me on Twitter @RJHSDent
Market Insight With Adam O'Dell The Weak Get Weaker  I talked yesterday about one of the biggest mistakes most investors make.
That is, thinking that a stock's recent "price discount" must certainly make it a "better value." (A.k.a., a "buy" at a "good price.")
But the sad truth is, buying recently "discounted" stocks is usually a losing strategy. That's because weak stocks usually get weaker, not stronger.
And I have some eye-popping numbers to back up that claim.
Imagine for a minute that you're limited to buying S&P 500 stocks. And that you can choose one of the following two investment strategies.
After sorting all 500 stocks in the S&P 500 index, based on their performance over the last quarter or so… you can either:
- Buy the 50 Best Performing stocks… and hold them for a quarter or so.
- Buy the 50 Worst Performing stocks… and hold them for a quarter or so.
We'll call Option A, "buying the winners," and Option B, "buying the losers."
Although most investors don't think they're buying "losers," they mistakenly think they're buying "a nicely discounted stock." That's what Bill, our fictitious investor from yesterday's story, thought when he decided to buy three stocks in late 2007, at "discounts" of 13%... 17%... and 40%.
Sure enough, the three stocks that Bill bought at a "discount" – Bed Bath & Beyond, American Airlines and E-Trade – were trading at even deeper discounts a few months later, as the stocks dropped a further 17%... 54%... and 65%, respectively, by March of 2008.
Simply put: "cheap" got cheaper (and Bill lost his shirt).
And this concept isn't limited to a few cherry-picked examples. Take a look at three of the research studies I ran, all of which show the same trend: weak stocks get weaker.
Buying the losers (Bottom 50 S&P stocks) in late 2007 would have handed you an average loss of xx% by March 2008. Meanwhile, Top 50 stocks held up much better. Take a look: 
See larger image The same thing happened a few months later.
Buying the losers (Bottom 50 S&P stocks) in early 2008 (while thinking, "the worst must be over") would have handed you an average loss of xx% by August 2008. Meanwhile, Top 50 stocks held their ground. 
See larger image Clearly, buying "recently discounted" stocks in late 2007 and early 2008 was an awful strategy.
Now, fast forward to more recent times. The S&P 500 was trading at an all-time high in late July of last year. Naturally, investors were hesitant to "overpay" and instead looked for "good discounts."
But again, buying recently discounted stocks (Bottom 50 S&P stocks) in late July turned out to be a terrible idea. Those stocks have fallen a further 20% since then… while Top 50 stocks have lost a milder 10%. Take a look: 
See larger image I hope my message is becoming clear now: Weak stocks tend to get weaker, not stronger! That's certainly true when you're making your investment decisions on price alone. Remember, as Warren Buffett says: "Price is what you pay. Value is what you get."
To truly understand what a stock is worth, you need to dig deeper into the company's books.
That's exactly what forensic account John Del Vecchio does – he unravels the "tricks" that companies use to try to fool investors.
And on January 28, he'll show you some of these trade secrets in a special online exclusive that he's prepared just for Dent Research. It's called Earnings Exposed and airs at 4 p.m. (with a rebroadcast at 8 p.m. for those who can't make the earlier showing).
Registration is required to participate though, so make sure to get your name on the VIP list.
You won't want to miss this.
To good profits,
 Adam O'Dell, CMT
Chief Investment Strategist, Dent Research
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