2011 Winners & Losers

As a volatile financial year comes to a close, I thought it best to reflect on the large impacts to the financial landscape for 2011.  So I will give you my list of winners and losers for the year.  However, I want to take a different spin on this type of commentary by focusing on winners & losers within 4 major topics affecting the financial universe this year. 

News Networks – Those that read my blog, or work with me on their financial planning have more than likely heard me reference the “creation of crisis” that is created by the 24-hour news networks.  Well, 2011 provided no shortage of crisis.  Financial markets down one week had them proclaiming the return of financial armageddon (a la 2008); with a subsequent rebound rally 2 weeks later.  I often urge people to take headline news with a grain of salt when it comes to personal finance.  Financial reporters are unregulated financial pundits—meaning they can say whatever they want and they are not held to any standard.  This is not the case with those folks who hold any investment license, but reporters fall into an exempt category.  No wonder every week is a new crisis.  Compound that with every other commercial on these networks focused on selling gold to the viewer, and you have networks getting rich on selling fear.

Winners: Network Corporations   Losers: Nervous viewers cashing in their IRAs to buy gold 

Europe – When continental Europe entered into the single currency in 1999, it seemed like a fantastic idea. The prolonged issues in Europe over the last two years continue to revolve around no central decision making body to set fiscal policy for the Union, while the European Central Banks sets monetary policy. The debt crisis in Greece was like a virus that infected the world including Italy, Spain and France, scaring the global economy. On Dec. 5, French President Nicolas Sarkozy and German Chancellor Angela Merkel called for a new European Union treaty to help curb spending in an effort to end Europe's debt crisis and save the continent's euro currency.  As Europe turns (pretty much every week), US financial markets react with polarity.

Winners: Europe (if they can come up with a central policy/treaty)    Losers: US Banks 

Occupiers – Life isn’t fair…let’s put that out there straight away.  But when someone comes through a college graduation to spend the next few years of their life unemployed, it starts to take a toll.  Protracted unemployment has sapped the morale of the working American—and I believe that is what we are seeing in the Occupy protests.  Meanwhile corporate profits have continued to rise. One thing is for sure, companies will not invest in hiring until they have a clearer picture of their expenses to hire for the foreseeable future—and that remains difficult with health care legislation still in question and no long-term agenda for taxes. 

Winners: Are there any?                                  Losers: Everyone (Closing of West Coast ports as the ultimate example)

Polarized Washington – The failure of Congress to come to any swift conclusion on raising the debt ceiling resulted in S&P cutting the US credit rating from AAA.  But with the refusal of policy makers to address a number of issues, it was only a matter of time.  Entitlement reform, out of control deficits, tax reform—“compromise” is not in the vocabulary of any of these politicians.  The recent failure of the “Super-Committee” is just one more example of a year of political brinksmanship.  The leadership vacuum in Washington is quickly becoming a black hole.

Winners: Career politicians                            Losers: The next generation of Americans

It is difficult to isolate the “most important issues” of the year when you write one of these kinds of pieces, but I believe these will have the most lasting effects on us all.  The bright news for the start of 2012 is that the underpinnings of the US economy continue to foreshadow strength.  Cheers to a happy and healthy new year to all.

Asset Location is As Important as Asset Allocation

After a year in which the Euro vacillated between survival & collapse, democracy reached the shores of North Africa, and Wall Street got “occupied”, one thing remained sure & true: VOLATILITY.  As I meet with people every day, it is the ubiquitous item that is keeping people up at night as they prepare to transition to & through retirement.  

A 1991 study conducted by Brinson, Singer & Beebower showed that 91% of an investment portfolio's performance is determined by the allocation of its assets—meaning diversifying (& re-diversifying) your investments between different types of companies is the best way to assure long term performance gains & reduce risk.  More recently though, the increasing complexity of economic forces and the interdependence of global markets have contributed to significantly alter the investment landscape. The current market environment poses new hurdles: unprecedented volatility, economic forces putting pressure on equity markets, the prospect of a resurgence in inflation, & rising interest rates, all compounded by unfavorable demographic trends for most of the developed world. In short, to paraphrase an old saying, in today’s investment landscape, the only certainty is that nothing is certain.

Investors can no longer necessarily rely on traditional strategies to reach their financial goals. As a result, traditional diversification (or Asset Allocation, as it is called) may not be as effective as it once was in serving investors’ needs.  However, the concept of choosing investments based on how they correlate with one another—how their prices change in relation to each other—is still an integral part of investment planning. But asset class diversification alone may not get the job done.

What I call “Asset Location” has become just as (if not more) important as asset allocation.  Asset location is about diversifying across different investment vehicles to take advantage of possible tax advantages, income focus, or non-traditional investment classes.  While traditional asset allocation remains important for a significant portion of your portfolio, asset location can help you to build an infrastructure around your investment plan to help weather times of protracted volatility.

This is how financial planning benefits the investor—more specifically, it structures portfolios by combining different asset classes and investment vehicles in an attempt to provide more effective diversification in order to combat volatility, mitigate risk, overcome inflation and provide income in your retirement years.

Please remember that diversification, asset location and asset allocation do not guarantee profit nor protect against loss in a declining market.  They are methods used to help manage risk.

Super-Failure…

The result of the U.S. debt ceiling’s dysfunctional debate this summer was Congress’s passing of the Budget Control Act of 2011, which created the Joint Committee on Deficit Reduction, more commonly known as the Super Committee. The committee was made up of 12 members of Congress, evenly divided between the House and Senate and both political parties. Their objective by November 23 was to find ways to reduce the deficit by at least $1.2 trillion (to be spread out over 10 years). Unfortunately, they failed to do so.

Failure of the congressional joint committee on deficit reduction likely means little chance to make progress on comprehensive tax or entitlement reform before the November 2012 election.

Now that the economic anchor has dropped, Washington still has to make difficult choices that will likely be a drag on already slow – but recently improving – economic growth. However, given the resiliency in Washington and Congress’s constant focus on electability over sustainability, it would not be surprising if they found a way around the mandatory cuts. After all, the ratings agencies have said that a debt downgrade is not imminent, which could have the political effect of inspiring further inaction.

Failure of the committee may present some economic hurdles, as it reduces the chances of extending recent tax breaks like the payroll tax cuts that are set to expire at the end of this year. Further, we will see mandatory cuts in entitlements and defense to the tune of around $600 billion each. These enforcement mechanisms do not take effect for 14 months, and how those cuts will be enacted is currently a bit unclear. Some members of Congress are already talking about reconfiguring the cuts.  We should have more clarity on where the cuts come from as we move closer to the time they are enacted in 2013. These automatic cuts were supposed to be painful enough that they could force agreement in Washington, but it now appears that our representatives in Congress would prefer to throw out an anchor on economic growth rather than tackle spending. Failure to reach a deal has the potential to decrease GDP growth next year by nearly 1 percent, attributed primarily to the ending of some tax breaks and not extending unemployment benefits.  Failure also kindled fears about Washington’s willingness to overcome political gridlock and take the necessary steps to improve the nation’s fiscal health.

Despite the failure, Standard & Poor’s reaffirmed that it would keep the U.S. credit rating at AA+ after removing its top AAA grade on August 5. Moody’s Investors Service reaffirmed its AAA rating with a negative outlook. In a statement following the super committee’s announcement that it was unable to reach a compromise, Fitch Ratings noted that it said in August that a super committee failure would probably result in a “negative rating action,” (likely a revision of its outlook to negative), and that a review would be concluded by the end of this month. It is worth noting that bond investors have shrugged off the August downgrade, as yields on 10-year U.S. treasuries stood at 2.56 percent on August 5th, the time of the S&P downgrade of U.S. debt, and are now around 2 percent.

With an economy still trying to climb out of one of the worst financial crises in history, I believe more political leadership will be needed to right the economic ship.

How Should We Measure Inflation?

Those readers who have heard me speak at various engagements will note that I devote a significant amount of time focusing on inflation.  My argument is always in finding the correct measure.  While the Bureau of Labor Statistics publishes their monthly change to Consumer Price Index, it remains to be seen how much “trust” should be put into these numbers.

Earlier in the year, the Wall Street Journal Online published a great piece on why the “official” inflation numbers are probably skewed.  All of the adjustments to the calculation of CPI over the last 30 years have made CPI seem “more bearable”.

Two areas that I think are of major concern in the calculation are the principles of substitution and hedonics.  Substitution simply states that when the cost of fresh vegetables creeps to high, the government calculation assumes you buy canned veggies—and thus any additional inflation on vegetables is avoided.  Hedonics attempts to value a product based on the values of its underlying constituent parts—the best example is a piece of technology.  CPI takes into account that if the same technology is the same today as it was three years ago, that the product has experienced negative inflation (deflation) due to the fact that the parts used in today’s model are better or more efficient.  I will let you judge whether that argument has merit or not.

The bottom line is that the calculation of CPI is constantly changing, and at the suggestion of one “rogue” economist John Williams, if we still calculated inflation the way we did when Jimmy Carter was president, the official rate wouldn't be current CPI of 3.7%--it would be closer to 10%.  These factors tell you how central a concern that inflation should be in the financial planning discussion.

The Impact of the “Boomer-ang” Phenomenon

As I write about often in my posts, the Baby-boom Generation are right in the midst of making the transition toward retirement.  As they do so, they must come to grips with the unique risks associated with this transition.  But a recent phenomenon is adding a new complexity to the boomers ability to plan for the retirement financial goal.  One of the realities in the era Post-Great Recession is that more adult children are expecting financial help from their parents.—in the form of a down-payment for a home, tuition payments, or in many cases a roof over their head.

There were some interesting statistics in a recent Harper's magazine article.  85% of this year's college graduates were planning to head back to live with parents for at least some time. Columbia University conducted a study in 2010 that showed 52.8% of 18- to 24-year-olds were living at home, up from 47.3% in 1970.  That means that it is now more common for this age group to be living with their parents.  Some of this can be attributed to the protracted unemployment we are facing on a national level.  Others are trying to super-charge their savings to attempt to get ahead in saving for a home.  Still others help parents in meeting monthly expenses.

The challenge (and danger) to the Boomers, is in the cases where a child living with them (or using funds ) is a significant drain on funds that were earmarked for use in retirement.  While some folks may have a goal to leave a financial legacy, this is not to be focused on at the expense of running out of money in retirement.  This creates a difficult psychological position for parents and is another side-effect of stutter-step recovery to the global financial crisis of 2008.

Be Prepared: Getting Ready to Get Ready for Retirement

If you think about it, you went to school for probably nearly a quarter of your life to prepare you for your career--a big investment of time and money.  But beyond just making sure we do not run out of money, it does not seem that we spend the same proportionate amount of time getting ready for the retirement phase of life.  With that in mind, I thought I would dedicate this week’s blog entry toward creating a checklist of items to prepare for transitioning to retirement.  Here are a few thoughts on getting ready to enter pre-retirement transition years: 

Debt: The 3 “No’s” of Preparing

•  Borrowing from Retirement Accounts—Accessing funds in an IRA comes with the sting of a 10% excise penalty tax, but many company plans allow you to borrow from them and “pay yourself back” over a specified time period.  Sometimes these loans come with record-keeping fees, and you could be missing out on potential appreciation on investment markets.

• Racking up Credit Card Debt—The interest paid to credit card companies is lost leverage in critical pre-retirement years.  Savings rate is quite important as you near pre-retirement years, and carrying balances on credit cards not only serves as impediment to saving, but also drains more money through interest costs.

• Accessing Equity in your Home—Home ownership is a critical key issue for the pre-retiree because your home will either serve as your retirement residence, or as a large piece of re-investable savings if you choose to sell and access built-in equity.  For those people carrying large loans into pre-retirement & early retirement, this key cash-flow item could force the need for more income sooner, or the need to downsize earlier.

Health:

• Not only is it no fun being in poor health in retirement, but it can also be costly.  While much of this may be out of our control due to genetics, having a healthy diet and engaging in reasonable exercise can boost general health. 

 Saving (Tax-Advantaged):

• Pre-Tax Savings Plans—For most of us, the pre-tax retirement savings plan(401k, IRA, etc.) will provide the best tax advantage; reducing taxable income now.  This is the primary place to engage in savings until you hit your limit.  Pre-retirees should aim to put as much in this bucket as their budget can bear because once earned income stops, so does their ability to use these plans.
• Roth IRA Saving—After you have max-funded your pre-tax savings and funded an emergency fund, funding a Roth IRA would allow those assets to compound tax free.  Some people may not be able to save in a Roth due to their income tax situation.
• Tax-Sensitive Savings—Saving in taxable accounts can be different to tax-deferred funds because of the requirement to pay capital gains and income tax “as you go”.  Being tax-sensitive with individual securities sometimes makes sense, as does funding cash value life insurance or annuities.  These choices are highly dependent on the goals set forth for these savings account

 Planning (not just financially):

• Just as having a vague idea about “what you wanted to do with your life” was a decent idea as you entered the working world, having some thoughts on what you want your retirement years to look like is also a good idea.  Whether it’s travel, taking up golf, or volunteering, this will give you some idea of lifestyle, which in turn gives you some idea of income needs.  Also, giving this some serious planning will help you to time your exit from the everyday workforce with what is right for you.

As I have written before, I believe that the retirement transition years are the most important in setting yourself up for the rest of your life.  It is important to be ready to start getting ready to transition.

Within the Volatility: Viewing the Positives?

Sometimes it’s hard to stay positive about the economy as you watch investment markets jerk downwards, upwards, and generally dance with volatility over a protracted period of time.  When almost every headline & television news show tells us that we are headed to recession (based largely on a leadership vacuum in world politics), I think it is important to also look at the economic underpinnings beneath the noise as well. 

A recent research report from Bank Credit Analyst Research – one of the world’s leading providers of global investment research since 1949 – listed a number of positive economic points that are worth noting when trying to determine the direction of the economy:

Oil prices have fallen sharply over the past four months. Oil is down nearly 25% from its high in late April of $113.93. This will provide relief to consumers and, combined with a bottoming in the market when we get there, will be a nice boost to potential economic growth. 

Real bond yields have fallen to extraordinari­ly low levels. Since many home­owners can therefore refinance to take advantage of better interest rates, consum­ers may begin to cash-flow relief.  

The Chinese economy continues to grow, and policymakers there have a lot of ammunition to deal with any slowing that may appear. Ear­lier this year, the fear was that the Chinese economy was trending dangerously, as policymakers at­tempted to give the people what they want in terms of economic growth to support China’s grow­ing middle class. Recent policy action in China suggests that policymakers there are moving away from a “growth at all cost” mentality to a more sustainable growth mentality. 

Treasury yields are low, indicating global confidence in the U.S. as a safe haven, despite the recent S&P “downgrade”. Now is a perfect time to have the political debate on spending and taxes. The difficulty is that, with the 2012 election cycle upon us, answers will probably not be coming forward from our lead­ers in Washington. We are on a low budget in the U.S., but that doesn’t mean that fiscal reform has to be a destroyer of our economy. Sensible spending restraint and some tax adjust­ments can allow the U.S. econo­my to expand at a healthy pace going forward.

Stock prices and interest rates are currently so low that we do not need economic growth to justify the purchase of equities. I do not think that the stellar prof­its many companies reported for the second quarter is a surprise to anyone by now. It is also en­couraging to note that earnings per share can still grow in a low economic growth environment. Firms will likely use the earnings that they do not pay out as divi­dends to repurchase shares since it is not likely that companies will continue to sit on ever-growing cash balances if they are not in­vesting for growth. It is likely this type of earnings growth will add support to the mar­kets. 

The index of leading economic indicators (LEI) rose for a third consecutive month in July. Admittedly, an advance in Au­gust will be a bit more difficult to achieve given the recent market volatility and negative sentiment. However, Fed accommodation still allows for a steep yield curve despite some recent flattening, which should provide some lift to August LEI. Unemployment claims holding in around the 400,000 mark may support LEI, and that level is not indicative of a reces­sion.

·        On Wednesday, August 24, dura­ble goods orders blew away ex­pectations.

o       A monthly surge in new orders for motor vehicles and parts – the best in eight years – headlined a strong durable goods report for July. Another economic measure that implies that the economy may not be what it appears--or at least may not be as bad as re­ported by the talking heads.

·        The Baltic Dry Index – the index measures the price of transport­ing raw materials by sea and is often cited by economists as a bellwether of global economic activity – most recent release revealed that it is now up 21 per­cent from its recent lows. Maybe those of us who think the global economy, while slowing, has not fundamentally changed are not misfits after all. While the index certainly has its critics, in an envi­ronment where investors are be­ginning to price in a global reces­sion, the increase in the Baltic Dry Index is one piece that calls that view into question.

      ·       Unemployment claims holding in around the 400,000 mark may support LEI, and that  

           level  is not indicative of a reces­sion. 

While there are certainly some fundamental issues that need to be addressed in the economy (particularly the level of government debt in Developed countries), not all news is bad news either. 

Revisiting the Efficiency of your Life Insurance Plan

A common issue upon which I revisit with clients on a regular basis is the efficiency of their life insurance.  Typically people will have either an old policy that was taken out when they first started their career and/or a specific amount provided by an employer.  While updating your coverage to a new policy can sometimes lower your costs with greater amounts of coverage because of the changing nature of insurance company mortality tables, often the original intention of the insurance has changed for the person.  For me, the question of reviewing their coverage always starts with the “Why?” question.  Why did you initially set up this coverage?

In my estimation, the main reasons for having life insurance protection in place are as follows:

• Income Replacement—purchasing enough coverage that would provide your heirs or dependents with enough money to replace the income you would have provided during your working years.  From a cost efficiency standpoint, this can often be accomplished through buying a term policy with a term that matches the number of working years remaining before retirement—with the idea that you are using the cost savings to fund retirement plans.

• Estate Tax Mitigation—purchasing permanent insurance coverage (sometimes via an irrevocable life insurance trust) to mitigate estate taxes that will be owed by your beneficiaries upon your passing.  While this type of plan should be orchestrated with an estate planning attorney, it can be helpful when estates are in excess of the government’s estate tax threshold (currently estates valued at $5MM).
• Tax-Favorable Savings Vehicle—For those people who are max funding retirement savings plans, Roth IRAs, personal savings, and emergency funds, a permanent life insurance policy could be a good way to grow cash value in tax-favorable way.  This typically is not a cost-viable plan until these other types of savings vehicles are being maximized.

I believe it is important to be careful with the overall cost of your life insurance plan.  Do not make the premium cost an impediment to other savings vehicles (especially tax-deferred savings potential).  When looking particularly at permanent life policies, be careful not to make it too large of a cash-flow item in the retirement budget.  It is always best to review your life insurance plan to be sure that it fits with the rest of the elements in your financial plan an overall wealth management.

Rollercoaster or Train Track?

I have sat down intently several times over the last 7 days to write an entry that addresses the volatility in the headlines.  First topic was the lack of impact that the debt ceiling deal had on markets.  Next was flight to US Treasuries despite the downgrade of US credit rating by S&P.  And then was the continued influence of the European banking problem that is potentially pouring over into US financial companies.

In the end I decided to shelve all of that to highlight the difference between simply investing versus investing with a plan backed up by infrastructure.  This kind of day to day volatility can definitely churn your stomach like a rollercoaster, as investment managers struggle to sift the data and find a support level in the investment markets.  However your exposure to the volatility should differ based upon your time horizon and overall appetite for risk.

The Phases of Investment Exposure

While the traditional savings paradigm is a simple save/accumulate to distribute illustration (seen to the right), I would argue for several phases along the way:

Distribute, Protect, & Grow—Having a plan for efficient and consistent distribution of assets is critical to meeting your expense needs; however more than likely you will still need some tilt for future growth because of the extended timeframe of retirement

1. Save & Grow--early in saving for a long term goal like retirement, where you may have the ultimate stomach for short-term volatility on a significant portion of your savings.
2. Save, Grow, &  Protect—As you start to amass a significant savings for your goal, beginning to build a protection infrastructure around your savings becomes important.  This may involve using different investment vehicles and alternative asset classes that are not correlated with traditional liquid investments.
3. Protect & Grow—At some point in the cycle, protection trumps growth as you get closer to needing to tap funds for retirement.
4. Distribute, Protect, & Grow—Having a plan for efficient and consistent distribution of assets is critical to meeting your expense needs; however more than likely you will still need some tilt for future growth because of the extended timeframe of retirement.
5. Distribute, Protect, & Transfer—While not the primary concern for retirement planning, efficient wealth transfer should be addressed once you have come through the danger zone of pre-retirement and early retirement years.  This may involve re-checking beneficiaries on retirement accounts, and tending to trust matters for after-tax assets.

Using All of the Asset Classes

When volatility spikes your exposure to alternative asset classes could prove to be a nice anchor for your savings.  While these investments require a suitable income and net worth because of their liquidity & risk profile, vehicles such as non-traded real estate investment trusts, equipment leasing partnerships, and business development companies could provide consistent income that is not correlated to the day to day volatility of investment markets.  For those that this type of planning is suitable for, I recommend that the alternative asset class sit right along with equities, bonds, and cash, and be between 5-20% of your allocation (dependent on which phase of retirement transition you are in).

Consistent Income

Lastly, the biggest worry about the fluctuations in your retirement account ultimately goes back to the accounts ability to produce income for you on a consistent basis in retirement—either through income generating investments or through liquidation of assets.  It is for this reason that you should revisit your income plan on a regular basis during pre-retirement and early retirement years.  This includes looking at Social Security projections, pension plan provisions (and the adjustment to your spouse’s income if something were to happen to you), and then looking at the efficient distribution of your savings so that it lasts through your entire retirement.

Just like a good business plan is written down, your retirement & financial plan should be codified somehow so that you can review it as necessary, but also so that when volatility re-enters investment markets (which it inevitably does) you can feel confident that you have an infrastructure in place to weather the dips.

Alternative investments are subject to significant risks and therefore, are not suitable for all investors. When considering alternative investments, you should consider various risks, including the fact that some products use leverage and other speculative investment practices that may increase the risk of investment loss, can be illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees and in many cases, the underlying investments are not transparent and are known only to the investment manager. With respect to alternative investments in general, you should be aware that returns from some alternative investments can be volatile and you may lose all or a portion of your investment. 

Between the Lines of the Debt Ceiling Agreement

The deal to cut more than $2 trillion in government spending over the next decade and extend the government's ability to borrow until at least 2013 has been signed, sealed, and delivered.  So what was all the fuss about?  And what was really gained by this polarized government brinksmanship?

The debt ceiling debt debate over the last few months achieved one unintended goal.  It surfaced a sleeper issue with the American public to raise the importance of our country’s out of control debt and unsustainable entitlement programs.  Politicians on both sides of the aisle have talked about addressing the problem for a long time, but this has forced the country to face this problem head-on.

The agreed upon bill will cut spending slightly in the early going; which is certainly better for the fragile state of the recovery. The spending cuts will begin with just $25 billion in 2012 and $46 billion in 2013.  This is the tightrope that legislators walked while attempting to form this bill, as economists weighed in that cutting any spending could reduce US GDP (a measure that is already quite low signaling potential sluggish economic growth).

While everyone seems to agree that government debt and spending are out of control, agreement on where to make significant enough cuts to actually impact debt remains unseen.  Major expenditures of Medicare and Social Security, as well as national security seem to be areas that the average American does not want disturbed, but these also remain major weights to the ballooning debt.  It may be clear that we need and want smaller government, but achieving that may be more painful than we want.

The next step in the debt debate will be the appointments made to the bi-partisan super-committee in Congress, and what potential plans can be agreed upon heading into a presidential election year.

The Context for the Debt Debate



History of the U.S. Debt Limit1

 
The last time Congress raised the debt ceiling was in February of 2010. At the time, it was increased by almost $2 trillion.
The fight in Congress over the debt ceiling and fears of a government shutdown are all over the airwaves, so I thought I would touch on a few aspects of the debate, and frame the context for the battle currently being waged in Washington.

History of the Debt Ceiling

The debt ceiling first came into existence in September of 1917. At the time, Congress authorized the issuance of $7.5 billion of bonds and another $4 billion of certificates of indebtedness under the Second Liberty Bond Act.

If we take that $11.5 billion dollars, adjust it for inflation from 1917 through 2011, outstanding debt would have increased to just over $193 billion dollars. The current debt limit exceeds $14 trillion. Washington’s “love affair” with debt has not only grown, it has grown exponentially since 1982.

Looking at the statistics of how US government debt has grown historically, I think it is important to look at two key points:

1. The debt ceiling did not hit the “magic” $1 trillion mark until 1982… less than 30 years ago.

2. Increases in the debt ceiling are quite common. Over this 94 year period since 1917, the debt ceiling was revised 102 times!

Also of interest, Congress has NEVER refused a President’s request to increase the debt ceiling, which is part of the current problem.

A second way to look at the debt ceiling is to look at it in relation to the nation’s Gross Domestic Product (“GDP”); or the market value of all final goods and services produced within a country in a given period. Looking at all available data on this comparison dating back to 1929, we can see that the all-time high for the debt limit to GDP occurred right after WW II when it exceeded 120 % of GDP. If Congress votes to increase the debt ceiling again this year, the debt limit could once again reach 100 percent of GDP. While the U.S. may not be fighting a world war this time around, it is borrowing money like it is.

Options for policy makers to bring debt levels down and cure its addiction to debt-related expenditures are to cut spending, raise taxes, or both.

Why Does the Debt Ceiling Exist?

In a nutshell, the debt ceiling is Congress’s way of setting a limit on how much the U.S. Treasury can borrow. Our Constitution presents Congress with the task of managing both spending and borrowing. When Congress’s appetite for spending exceeds available funds, the government borrows money via U.S. Treasury securities.

While the debt ceiling was proposed with good intentions, it has done little to stop our nation’s exponential rise in debt. More recently, it has become a source of political grandstanding, as policy makers attempt to “stand tall” against a debt problem of their own making.

How Could the U.S. Lose its Aaa/AAA Credit Rating?

According to the credit analysts at Standard and Poor’s, the rating agency would downgrade the quality of U.S. debt for the following reasons:

1. If Congress and the administration fail to come up with a “credible solution” to the U.S. debt and show no signs of agreeing on one in the foreseeable future.

2. If the United States misses any scheduled debt service payments, in which case S&P would issue a “selective default,” meaning a default has occurred on some bonds but not others.

3. If S&P concludes that the debt debate calls into question policy makers willingness and ability to timely honor the U.S. scheduled debt obligations.

How Does the Stalemate Get Addressed?

I think investors and Americans in general, would very much like to see a bold resolution to the current debt debate. In the end, though, a mini deal that satisfies neither side will probably get through and the debt ceiling will be increased. For the optimists, a grand bargain on spending, taxes, and debt will have to wait until after the next election.

From an investment standpoint, for the markets to retain their composure, they do not so much need a solution to the “crisis” as they need more certainty about the direction policy makers will take over the next few years. Stay tuned as the debt debate rages on.


Source 1: U.S. Treasury


Source 2: U.S. Treasury, Bureau of Economic Analysis


Source 3: Jason Geopfert - Sundial Capital Research, Inc.

Slowdown, Meltdown, or Short-term Correction?

Even in times of minor correction, we as individual investors feel the jitters of volatility. I always compare the emotion tied to investment for the individual to the feeling of being on a rollercoaster—markets go up and we have that feeling of anticipation and exhilaration, and as they fall it quickly turns to terror. It can be very hard to divorce one’s self entirely from the emotional side of investing.

While the individual views investment markets like a rollercoaster, institutions look at it like a railroad—with opportunities on one side of the tracks and risks on the other—and they aim to ride right down the middle of the track leaning toward opportunity when they can, and away from risk as needed.

The disciplined approach of the institution can be a tough one for the individual to mimic because of the emotions that play into buying and selling. Typically the euphoric feelings at the height of the market make the individual clamor for more, while the lows trigger emotions towards the exit. This leads to the “buy high, sell low” trap of emotional investing. Institutions take the opposite view; tuning out the noise, and looking for opportunities at the low, and exit strategies at the high.

So, how do we attempt to read through the lines of this current pull-back on the markets?  Let’s look at the economic data in May that potentially foreshadowed a slowdown

“Only 54,000 payroll jobs were added, auto sales declined significantly, retail sales were sluggish even excluding autos, growth in manufacturing slowed sharply, house prices continued to decline to new post-bubble lows (as of March), and home sales slowed.” (according to Calculated Risks Finance & Economics blog). Some of these issues could be attributed to interruptions in supply-chain in Japan following the earthquake (influencing auto sales), & rise in oil prices tied to geopolitics in the Middle East (influencing the price at the pump).

Monetary supply worldwide is on a tightening trend; which isn’t necessarily a bad thing. Responding to high inflation, both the Chinese and Indian banks tightened policy, which may slow growth, but it does not look as though they have gone too far to cut off potential growth completely.

Two political showdowns could play significantly on the continued upward trend of investment markets:

The first being the European Union’s move on Greek debt. If some form of restructuring is not rolled out, Greece could default and exit the Euro—a move that would not be good for any country participating in the single currency.  Domestically, the argument over the debt ceiling continues to be dicey; with one side refusing to cut spending, while the other refuses to raise taxes. Without action, the US government could find itself in technical default—though I do not believe politicians would make that type of dogmatic mistake.

Despite these risks, it bears to keep in mind that we are coming out of a steep recession fueled by a credit crisis, and after almost 2 years of positive growth, a correction at some point is inevitable. The economic data in the next couple of months will be telling as to whether we have a sustained pullback or if some of the shorter-term issues have been resolved—namely the slowdown in manufacturing fueled by supply chain issues. Taking an institutional approach to investment decision-making is not easy, but the ability to stomach normal corrections can prove to be the difference in meeting financial goals.

From an Investor’s Prospective: Understanding the disconnect between Wall St. & Main St.

Many people continue to ask how the stock market can have recovered significantly from the maelstrom of 2008, while the economy and employment still have the feel of “recession” to them.
The short answer is that the stock market is primarily focused on corporate profits. Hence, the stock market has done quite well over the past two years, a period of time when corporate profits have “surged” but the U.S. economy as a whole has merely “firmed up.”

The somewhat longer answer is that there is a very large difference between what drives “Main Street,” (the U.S. economy) and what drives “Wall Street” (the stock market). The table below highlights some of those key differences:

Source: BofA Merrill Lynch U.S. Equity Strategy

While your investment accounts may be enjoying the recovery in corporate prof­its, at the same time you may personally be feeling the effects of recession recovery (sluggish employment, higher than normal inflation, etc.). Hopefully, the above chart will help shed some light on the gap between recession/recovery “feelings” and what Wall Street may be “seeing.”

Separation Boom

While divorce rates over the past 2 decades has decreased, for couples over age 50 (particularly baby-boomers) it has just about doubled according to the National Center for Family & Marriage Research at Bowling Green State University.


The implications for couples divorcing later in life are much deeper for several reasons. Couples typically have accumulated more wealth by age 50, 60 or even 70, and this presents a greater degree of complication in dividing that wealth. Details such as long work history, real estate ownership, retirement account disparity, and life insurance can create a complicated mine-field for equitable division of assets.

Valuing Retirement Accounts at Divorce

One common mistake that is made with retirement accounts is that they are typically over-valued because the taxation is not considered. When looking at an equitable split of assets, the retirement accounts should be factored into the couple’s balance sheet with an after-tax value—sometimes as low as 65% of the current market value of the account.

Protecting Cash-Flow

If a divorcing spouse is awarded an alimony payment to aid in monthly income, the spouse who is set to be receiving alimony should take out a life insurance policy on the paying ex. Trying to plan for payments from an ex-spouse gets more and more risky every year after age 50, as the chance of them becoming ill or passing away prematurely increases with each passing year.

Because couples who are married longer than 10 years are entitled to Social Security benefits from the ex-spouse, divorcing couples will want to pay attention to the Social Security entitlement of their ex-spouse. Someone who earns less than their ex-spouse would want to claim the higher-earning spouse’s Social Security retirement benefit because it will be a higher amount. This is only the case so long as the claiming ex remains unmarried. If a divorcing spouse has a claim to your benefits, you should factor that in to negotiations on the dissolution of the marriage.

Protecting Assets for Heirs

To ensure that assets pass to heirs as originally intended, it sometimes makes sense to set up asset protection trusts upon the division of community property. This type of planning could protect divorcing couple’s children from the complications of remarriage, or from community property claims of their own divorces.



Divorce is a major life transition event, and needs careful consideration. For divorcing boomers, it can have significant impact on retirement feasibility and wealth transfer. Be sure that you understand the future repercussions of any settlement that you are structuring.

Watching the “known unknowns”

Equity markets seem to be struggling with “known unknowns”—that is to say we know there are some things we do not know—ending a volatile stretch of almost daily ups and downs for the market, creating a “risk on-risk off” tennis match for investors.

Here are a few of the questions that the market seems to be grappling with:

Known: Chinese import growth is slowing versus export growth
Unknown: Is this slowdown a sign of greater issues in Chinese growth leading to softer demand for outside goods and commodities? Or, is it indicative of high inventory levels in the country and demand will return?

Known: Commodity prices are softening
Unknown: Is price softening a result of slowing demand in China and other emerging markets, or a slow leak in a commodity price bubble?

Known: U.S. Dollar is rebounding
Unknown: Is it better for U.S. manufacturers to enjoy the benefits of exporting goods with a weaker dollar or for U.S. consumers to experience greater purchasing power with a stronger dollar?

Known: Consumers are feeling the pinch of higher energy and food prices with the April Consumer Price Index (CPI) rising 3.2 percent, the most since October 2008.
Unknown: Does this increase translate into broad long-term inflation across sectors or will consumers adjust to the new environment with little relative pain?


Time will sort out these unknowns and determine market leadership going forward. These unknowns must be factored in to the risk analysis for investors.

6 Items Keeping Boomers up at Night

While you can make the argument that investment markets have returned to normalcy over the last 12 months, there are still major concerns for those who are currently going through or about to go through the transition to retirement. Here are six issues of primary concern for the pre and early retiree

Inflation

According to a labor Department report in December, the cost of living only rose 0.1 percent last year. Looking at the price of various commodities, paints a very different picture. The Federal Reserves current round of quantitative easing has sparked a debate amongst politicians about its longterm affects on inflation. Sustained annual inflation about 3% could have a significant affect on a retiree’s purchasing power.

Parent-Child Sandwich

A prolonged recession has put some established boomers in the position of needing to support aging parents and unemployed children. Reports show many twenty-somethings have moved back in with parents in an effort to curb cost of living. According to 2010 Census Bureau data, 5.5 million Americans aged 25 to 34 live with their parents, up 38 percent from 2000. Last Novembers unemployment rate for people aged 20 to 24 was 14.8 percent.

Statistics show the same at the other side of the generational divide. A 2009 survey by the National Alliance for Caregiving showed 21 percent of caregivers for older adults said the economy had forced them to live together in the previous 12 months. An earlier study by the group found, on average, that families caring for older adults spend 10 percent of their income to do so.

Gold Bubble Bursts

Are Boomers going from bubble to bubble to bubble? Boomer investors irrational exuberance began in the tech sector in the late 1990’s; moved to a more tangible asset class in real estate in the early 2000s; and has poured into commodities (a traditionally volatile asset class) in the last few years. The price of gold is up more than 170 percent since the beginning of 2006 and hit a record of $1,431.25 an ounce last Dec. 7. Billionaire George Soros has predicted that the gold rush can't last, calling the precious metal "the ultimate asset bubble" at the World Economic Forum last January.

Bond Bubble Bursts

Speaking of bubbles, the other asset class that has seen a flood since the financial crisis in 2008 is bonds. Traditionally seen as a more conservative instrument than equities, bonds may be at the center of a perfect storm considering that interest rates are at historic lows. The relationship between interest rates and bonds is such that as rates rise, bond principal values fall.

Not Saving Enough

A 2010 Employee Benefit Research Institute survey shows 13 percent of workers aged 55 or older are "very confident" that they have enough money to live a comfortable retirement--down from 27 percent in 2000. Only 53 percent of older workers have actually tried to calculate how much money they will need in retirement, the survey said. The options for slow-savers are few: They can save more, work longer, or cut back on their spending. The EBRI survey found that 42 percent of older workers don't plan to retire until age 66 or later, up from 20 percent in a 2000 survey. Sticking one’s head in the sand will surely compound the situation. Figure out your capital need and hash out a savings plan sooner rather than later.

Too Much Company Stock

Still a problem I see with prospective clients working for well-established large corporations is the over-weight in company stock in their retirement plans. According to the Profit Sharing/401k Council of America, 18.1 percent of retirement plan assets last year were invested in employer stock. No matter what you think you know about the company you work for, there is still a prudent amount of exposure to have of your employer’s stock.


While this all seems like doom and gloom for the transitioning retiree, these are risks that can all be reduced or eliminated. While the risks and planning principals change during this part of your financial life, you can put an infrastructure in place to get through it.

Thoughts on measuring risk in an investment portfolio

Often when I meet with prospective clients to review their retirement holdings, their portfolio’s risk is measured in a ratio of equities-to-fixed income investments. This has been the traditional way to measure the overall risk of a portfolio, with the weight moving from the equity side to the fixed side as a client ages.

While this may be a simplified way of expressing risk, it may also be just that—too simple. I would make this argument for 2 reasons:

• Some bonds may be more risky that some stocks. It stands to reason that a debt instrument from an emerging market company could conceivably have more risk than an established dividend paying equity investement in the US domestic market

• Risk Changes over time. Volatility in the Emerging Markets asset class certainly is different today than it was 10 years ago, just as the risk of Real Estate or commodities has been an evolving factor over the last couple of years

To account for the changing risk levels regular and consistent analysis should be conducted. This process results in portfolios designed to take advantage of more attractive opportunities for investment while maintaining risk levels established by the analysis. It also allows for a portfolio to adapt as risk changes—of particular value when volatility spikes in the market for the pre-retiree investor.

A portfolio’s stock-to-bond ratio is greatly affected by whether the risk in a portfolio comes from a small allocation to emerging markets, a sizable allocation to high-yield bonds, or a moderate overweight of the equity allocation. However, an adaptive risk analysis can measure these options and determine to what degree a client’s risk tolerance can handle each.

The Dangers of Trading Headlines

In 2007, author Nassim Taleb wrote his very interesting book, "The Black Swan," the theme of which is that the impact of rare events is huge and highly underrated. The idea behind the entire premise of the book is that these events are rare, In previous entries I have opined about the dangers of 24 hours on investment markets. The media have a profound affect on behavioral finance, and it is our individual ability to filter the media which potentially makes us successful investors.
With the recent events in the Middle East, and the earthquake & tsunami in Japan, combined with the financial events/turmoil of the past few years, the term “black swan” is being kicked around more and more, and the label is being placed on many things. I even read an article noting that “black swans were becoming a more common occurance.” This is just irresponsible journalism.

There are geopolitical, natural, social, & financial “events” that happen every year, and it is in the ability to manage those risks that we see financial successes or failures. To name a few of these events over the past several decades:


2000s

• Oil Shocks (2005)
• Corporate Accounting Scandals (2002)
• 9/11 (2001)

1990s

• Tech Bubble Bursts (1999)
• Bosnia-Balkan Crisis (1995)
• War in the Persian Gulf (1990)

1980s

• Savings & Loan Crisis (1989)
• Chernobyl (1986)

1970s

• 3 Mile Island (1979)
• Watergate (1974)
• Vietnam War spreads to Cambodia (1970)

If pressed to, I bet that I could use this loose description of a black swan to name an event every year going all the way back to the 1920s. The point of Mr. Taleb’s book (and it is a great read), is that we cannot mentally grasp or predict the type of event that a black swan is; and therefore cannot plan for it.

As individual investors, it is sometimes difficult to divorce or emotions from our investment decisions. “Media Events” can contribute to these poor decisions. Consequently, we often give in to the emotion of selling low and buying high.

Bull still feels like a Bear—2 years on from the bottom…

On the 2-year anniversary of the current bull market, it may not be a bad time to take a step back and look at where we were not too long ago. What may have felt like financial Armageddon, turned to a sustained market rally, and financial markets are back above the mark they were prior to the crisis.
In probably the most tumultuous time in the market since the start of the Great Depression, it was very difficult to tame emotions for some as a number of investors dumped equities at or near the bottom and shifted to fixed-oriented securities. The reality is that many probably should have never had that much risk exposure anyway.

Over the last 2 years, pundits & money managers have tried to define the “new normal.” Others have declared death to the “buy and hold” investment strategy. The truth is that those who did not panic have recovered much of what they lost—and done so with less volatility. While “buy and hold” may be an okay investment strategy during the accumulation phase of your life, a unique set of risks has always existed during pre-retirement and early post-retirement. This is what necessitates a different investment strategy—not the undefined “new normal.”

Perhaps the reason why this bull market still feels like a bear to many of us is the fact that the 2008 financial crisis was such a trauma, and that some are waiting for another Lehman Brothers to rear its head. Volatility still feels high, though the VIX (the index which measures volatility) has been much lower. The market saw many swings in 2010, which were influenced by headline trading (Euro issues, Gulf oil spill), but they were mildly one way, and then mildly the other…miss one of the mild swings upward and you may have significantly affected your overall success for returns for the year.

While the world gets more complex and economies grow more inter-dependent, the difficulty in staying committed to an investment strategy through emotional ups and downs becomes the biggest challenge to those that need investments growth, but cannot stomach swings.

2011 Oil Shocks on the Way?

The price of oil is up 25% in two weeks, while production is down only 1% due to the Libyan instability issue. So far it seems to be an issue of “the price of oil mirroring headline.” But what will higher oil prices mean for the global economy?

The simplest notion is that higher oil=higher petroleum at the pump= less money for the consumer. Right now, consumer spending is an important part of the domestic economy.

A big questions is what the reaction from government bankers will be. Those at the European Central Bank have hinted that they will raise interest rates in the short term. Bernanke and the Fed have indicated they will keep the status quo for now. This is a real balancing act as inflation worries hang in the balance.

If production does decline due to a protracted unrest in Libya or “contagion” across the Middle East, some have suggested dipping into the country’s oil reserves to ease prices at the tank. It is unclear what real affect this would have on price, because of the emotional affect of using up reserves. If price is already up on a 1% drop in production, what would lowering reserves do to the attitudes toward oil?

Reforming Property Ownership

With 25% of all mortgage holders in the US owing more on their notes than their homes are worth, and distressed transactions account for 66% of sales in CA, it is important to step back and ponder the significant role that emotion plays in the largest segment of most people’s net worth. Do we have a healthy relationship with property ownership in this country?

If you look at the property boom that spawned from the “dotcom bust,” we see the collective heard shunning fantasy business plans and instead opting for “hard assets.” But there are a few inherent issues with investment in real estate that make it a potentially dangerous asset class:

• As mentioned before, Americans have more of their wealth in Real Estate than any other asset 
• Property and debt go hand in hand—and the banks that secure that debt set aside less money for those loans because of the property as a hard asset as collateral for the loans. 
• As property values increase, homeowners have the opportunity to re-leverage debt by accessing equity (There was a doubling of mortgage debt in the US from 2001 to 2007). 
• Property is not only an inefficient market, but also an inefficient asset class—meaning that you cannot offload pieces of it like you could with an equity portfolio (e.g., you cannot sell off your kitchen, but you could dump an underperforming large cap stock); illiquidity can strand owners in their properties even when it is not a negative equity situation; and the market for the same four walls will be different in different locations (arbitrage?)

Given all of the danger, let’s not get the idea that owning a home is a bad idea, however creating government subsidies and programs to promote “irresponsible” home ownership may not be a good one. The systemic issue seems to be the amount of debt that home buyers are allowed to take on. The Swedish government set a maximum loan to value of 85% last year for mortgage ratio; and that is a step in the right direction.

Whether ending the 30-year mortgage device, or phasing out income tax deductions for mortgage interest, or setting more stringent standards for first-time buyers & family businesses (where all household income is reliant on one business) makes the most sense is hard to say.

Baby Boom soon to be Retirement Tsunami

The first of the 78 million Americans of the baby boom generation (individuals born between 1846 & 1964) start turning age 65 in 2011…an age which has been considered “normal” retirement age. As this increases over the coming years, so will the retirement finance burden.

A couple of interesting statistics about entitlement programs:

1. The number people enrolled in Medicare will grow from 47M to 80M in a mere 2 decades.

2. Enrollment in SS will grow from 44M to 73M during same time frame.

At the same time the American workforce will grow more slowly, therefore the taxes to finance these benefits will significantly decrease.

Compounding the baby boomer retirement issue is the findings published in a recent article in the Wall Street Journal. The savings amassed in the 401k plans of boomers falls well-short of their retirement funding needs.

“The median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement, according to data compiled by the Federal Reserve and analyzed by the Center for Retirement Research at Boston College for The Wall Street Journal.” –WSJ

This fact could be easily explained away by saying that boomers simply did not save enough for their retirement years, but I would argue that part of the issue can be found in the design of the typical 401k plan which is a great accumulation tool in early savings years, but may not have protection features as participants near retirement age.

The other retirement threat for boomers that has not been bantered about in the media is the risk of incurring a major medical event in retirement—the cost of which could significantly erode retirement savings. What happens once savings is entirely depleted and you still need long term care/skilled nursing? Medicaid may kick in to cover these costs…another entitlement program which is probably under-funded.

So how should boomers prepare for the coming retirement tsunami? The years immediately preceding retirement need a careful strategic approach that differs from previous accumulation years. Managing investments for protection becomes important. Price out the cost of a long term care insurance policy early, as the cost continues to grow as you get older Find an advisor who can help you manage these issues in concert.

Municipal Securities next?, Maybe Not…

With headlines blazing “Arma¬geddon,” the normally sleepy municipal bond market is finding itself center stage in the current “name that crisis” championship.


In seeing the sovereign debt crisis spread across Europe last summer, many of the talking heads in the media have begun to pick on struggling states and municipalities as the potential next proverbial shoe to drop. But how likely is it that they would default on their debt obligations.

In my recent conversations with a portfolio manager, an interesting tidbit came forward which I found interesting with regard to municipal securities:
“It is important to focus on higher-quality issuers that provide services that are essential to their communities. This “recession-proof” revenue stream from projects that are critical to the state’s progress, such as hospitals, education, transportation, and utilities, is where investors need to concentrate in this environment. This means carefully-selected essential service revenue bonds should currently be the foundation of a municipal portfolio and likely provide the most stability. Government obligations (“GO”) bonds still face significant challenges with budget constraints and public employee benefits producing high price volatility and the potential for downgrades. Finding issuers with little to no underfunded pension obligations and strong reserves will be challenging, but this is where stability will lie in the GO space.”
The take-away here is that not all Munis are created equal and the pros who are good at managing these types of portfolios should still be able to separate the wheat from the chaff.

The 5 Biggest Surprises from 2010

#1 No Rise in Interest Rates


With interest rates at record lows to start the year, most investors probably believed we were in for at least a minor increase. It looked like rates would tick up, but with sovereign debt worries in Europe peaking at mid-year in Greece, the Fed probably kept rates low to avoid a potential double-dip recession. Couple that with another round of Treasury purchases, and rates hit a low at 2.4 %. But overall, it was a decent year for bond investors, with modest gains across most high-quality bond categories, and even larger returns to riskier areas, such as corporate high yield and emerging-market debt.iii

#2 European debt crisis could bring us down

The spring of 2010 brought the potential for a sovereign debt crisis across the Euro zone. Issues kicked off in Greece as government bonds spiked above 13%, causing the currency to lose significant value, and thus raising fear and volatility throughout global financial markets. A $1 trillion rescue fund was created by the European Central Bank to address future similar problems, and the volatility was quelled temporarily. Ireland became the next problem a few months later, and even later in the year further discussion about Portugal and Spain began. Despite the fact the euro is the world’s second most-important currency and the Euro-zone’s economy accounts for 15% of global output, the region’s sovereign debt turmoil did not derail the global economic recovery. European sovereign debt uncertainty may well continue in the year ahead, but the good news in 2010 was the showing of the world economy’s ability to shrug off these types of events.

#3 U.S. stocks remained unloved by mutual-fund investors

With the S&P 500 up nearly 90% from the March 2009 lowiv, history suggests that investors would be flocking to jump into the next potential bull market. The statistics show that through October, mutual fund investors pulled a net $64 billion out of U.S. stock funds during 2010, and continued to feed bond funds instead. Are we also seeing the feeding of another bubble…this time in bonds? Perhaps it is the more conservative mindset of investors, or the aging population seeking income-oriented investments, but I expect interest in the bond market to continue into 2011. With stocks having made a serious comeback from crisis lows, I also expect equity funds to garner some more attention than in 2010.

#4 Ironies abound in “2-speed”, imbalanced world

It is widely acknowledged that developing economies, such as India and China, have grown much faster than developed nations and are expected to do so for some time into the future. In a world full of contrasts and imbalances, that was just the beginning. The Euro-zone dichotomy included a periphery where Spain’s unemployment rose above 20%, and Ireland and Greece slumped back into recession, while Germany’s economy

rode blockbuster export growth to a near-two-decade low in unemployment.vi Commodity markets flourished, with agricultural commodities and copper returning to mid-2008 record levels, while core inflation rates in the U.S. hit 50-year lows. Within the U.S. economy, the residential housing market languished as sales slumped and foreclosures bulged, but corporate capital spending was brisk. Unemployment remained stubbornly high near 10%, but consumer spending picked up steam throughout the year.vii Corporations borrowed at record low rates, but more than 150 banks failed in 2010, and getting a residential mortgage without a high credit score was a futile effort.viii

#5 Gloves come off in currency debate

The Fed’s latest round of Treasury buying called quantitative easing or QE2, had set off some worldwide currency tensions. Some countries finance ministers have argued this as an effort by the US to devalue the dollar. Right now, no major country wants their currency to strengthen in an effort to keep exports of their goods attractive. I expect currency to play an ongoing role, and China’s ongoing valuation of the yuan will be central

Boring…but, a solidly average year

After a calamitous 2008, and a huge rebound in 2009, I picked 2010 to be important for getting us back to a “normal” market. A modest double-digit return on financial markets is a nice average year, and it could not come at a better time after the violent volatility of the previous market cycle. 2010 reaffirmed that you can’t predict market behavior by looking at the daily headlines.
 
 
[i] Greece’s 10-year bond yield hit 13.17% on 5/7/10. Source: Financial Times,

Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[ii] On April 5, 2010, the 10-year Treasury yield hit 4.01%, then fell to 2.41% on
10/6/10. On Dec 2, 2010, the 10-year Treasury backed up to 3.01%. Source: Federal
Reserve Board, Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[iii] All references to asset classes in the article and their respective U.S. dollar
returns (%) for 2010 are as follows (unless otherwise noted): Large Caps – S&P
500 Index (13.4%); Small Caps – Russell 2000 Index (24.9%); Developed Country
Stocks – MSCI EAFE Index (7.4%); Emerging Markets – MSCI Emerging Markets
Index (16.2%); High Yield – Bank of America Merrill Lynch U.S. High Yield Master
II Index (14.3%); Investment-Grade Bonds – Barclays Capital U.S. Aggregate Bond
Index (6.2%); Real Estate – NAREIT Equity-Only Index (22.7%); Commodities – S&P
GSCI Commodity Index (5.7%); Gold – London Gold Bullion, PM Fix US$/Troy Oz.
(28.6%). Source: FactSet, Wall Street Journal, FMRCo. (MARE) as of 12/13/10.
[iv] U.S. Stocks represented by the S&P 500 Index, which appreciated 90.3% from
3/9/09 to 12/13/10. Source: FactSet, FMRCo. (MARE) as of 12/13/10.
[v] Year-to-date net fl ows for U.S. equity and bond funds were -$64 billion and
$223 billion, respectively, through October 2010. Weekly net bond fund fl ows
turned negative the last two weeks of November 2010. Source: Investment Company
Institute, Haver Analytics, FMRCo. (MARE) as of 12/13/10.
[vi] Spain’s unemployment rate was 20.7% in Oct. 2010, while Germany’s was
7.5% in Nov. 2010. Source: Statistical Offi ce of the European Communities, Haver
Analytics, FMRCo. (MARE) as of 11/30/10.
[vii] The High-Grade Copper COMEX spot price ($/lb) reached an all-time high
of $4.20 on 12/13/10. The S&P 500 GSCI Agricultural Commodities Index stood
at 486.22 on 12/13/10, very near its high of 499.25 set on 3/12/08. The U.S. core
infl ation rate was 0.59% year-over-year, an all-time low. The S&P/Case-Shiller
Home Price Index of 20 metro areas is down 0.05% from Jan. 2010 to Sep. 2010.
The number of new consumers with new foreclosures was 457,000 in Q3 2010.
Gross private domestic investment grew 22.4% year-over-year in Q3 2010. The
unemployment rate in Nov. 2010 was 9.8%. Personal consumption expenditures
rose from $10.1 trillion in Q4 2009 to $10.4 trillion in Q3 2010. Source: Standard
and Poor’s, Bureau of Labor Statistics, Bureau of Economic Analysis, Haver Analytics,
FMRCo. (MARE) as of 12/13/10.
[viii] As of 12/10/10, the Federal Deposit Insurance Corporation stated that 151
institutions had failed or been assisted. Source: Federal Deposit Insurance Corporation,
Haver Analytics, FMRCo. (MARE) as of 12/10/10.
[ix] The S&P 500 fell 15.6% from 4/23/10 to 7/2/10, while gold appreciated by 6%.
Source: Standard and Poor’s, Wall Street Journal, Haver Analytics, FMRCo. (MARE)
as of 12/13/10.
[x] Corporate profi ts after taxes with inventory valuation and capital consumption
adjustments stood at an all-time high of $1.2 trillion in Q3 2010. Corporate liquid
assets of non-fi nancial corporations stood at $1.93 trillion as of Q3 2010, which
represented 7.4% of total assets. Source: Bureau of Economic Analysis, Federal
Reserve Board, FMRCo. (MARE) as of 9/30/10.
[xi] The S&P 500’s calendar year average from 1926 through Oct. 2010 is 11.8%.
Investment grade bond’s calendar year average from 1926 through Oct. 2010 is
5.7%. Investment-grade bonds represented by Barclay’s Capital Aggregate Bond
Index from 1976-2010; from 1926-1975 bonds are represented by a weighted composite
of the IA Long-term Corporate Bond Index (34%) and the IA Intermediateterm
Government Bond Index (66%). Source: Ibbotson Associates, FMRCo.
(MARE) as of 10/31/10.
[xii] The range of returns for the major asset classes listed in footnote #3 above
(excl. gold) was 19.2 on a year-to-date basis through Dec.13, 2010, compared to a
historical average range of 51.5 dating back to 1988. Source: Ibbotson Associates,
FMRCo. (MARE) as of 12/13/10.
[xiii]The S&P 500’s standard deviation from 1926 through Nov. 2010 is 21.4%, while
year-to-date through Nov. 2010 it stood at 21.3%. Investment-grade bonds historical
standard deviation is 4.7%, while year-to-date through Nov. 2010 it was 2.6%.
Investment-grade bonds represented by Barclay’s Capital Aggregate Bond Index
from 1976-2010; from 1926-1975 bonds are represented by a weighted composite
of the IA Long-term Corporate Bond Index (34%) and the IA Intermediate-term
Government Bond Index (66%). Source: Ibbotson Associates, FMRCo. (MARE) as
of 10/31/10.