Weekly Commentary December 30th, 2013

The Markets

Like the mother of a bride reviewing flower arrangements and fretting that a brilliantly sunny day could be marred by dark clouds hidden just beyond the horizon, pundits have been parsing the exceptional year-to-date performance of U.S. stock markets and fussing over the future.

It’s true. U.S. stock markets look like they may be headed toward a fizzy champagne finish even after retreating a bit last Friday. Through Thursday, the Dow Jones Industrial Index had closed at record highs 50 times this year and the Standard & Poor’s 500 Index wasn’t far behind with 44 record high closes, according to NASDAQ.

U.S. stocks aren’t the only markets analysts are stewing over. They’re also pondering the potential effects of higher interest rates. Last week, the yield on benchmark 10-year Treasury notes ascended beyond 3 percent for the first time since 2011. It’s possible higher yields (and a potential drop in bond values) will cause investors to seek out better performing assets next year, but that may not be all bad, according to Barron’s.

“IS TOPPING 3% A BAD THING? Not necessarily, considering the reason for the 10-year yield's march higher: the Federal Reserve's decision to taper $85 billion a month in Treasury purchases, starting with $10 billion less in January. It's a small paring, but sends a big message: Maybe – just maybe – after years of recovery, the U.S. economy is returning to normal.”

Returning to normal in the United States may not prove to be any easier than seeking a new normal in China. Top communist party leaders in China recently implemented policies that give markets a more significant role in the country’s economic development. Concern that high levels of local government debt could pose a risk to ongoing economic growth has the People’s Bank of China (PBOC) employing some unconventional measures to manage interest rates.

Last week, those actions caused China’s seven-day repurchase rate to rise precipitously which triggered the worst case of interbank jitters since June’s liquidity crunch in China. The PBOC “injected fresh money into the markets on Tuesday, easing the pressure on the financial system and quelling fears about a credit crisis.”

As an investor, it’s important to remember that no one knows what the future holds or how central banks and markets will respond.

what’s the difference between a bull and a bubble?  During 2013, stock markets in the United States and Europe generally delivered very attractive returns so it’s not all surprising that talk of market bubbles fills the air. After all, bubbles are not a new phenomenon and they’ve done some damage in the past.

In the 1800s Charles Mackay penned Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. The book chronicled some of the earliest bubbles, including Holland’s Tulipmania of 1624 during which tulip bulbs were valued more highly than gold. He also describes the popularity of the South Seas Corporation whose shares traded higher and higher (on little more than word of mouth) until the stock crashed. More recently, we’ve experienced bubbles in stock markets, real estate, technology stocks, and other types of assets.

So, how do we tell the difference between a bull market and a bubble? According to The Economist, Nobel Laureate Robert Shiller of Yale University, “Describes a bubble as ‘a psycho-economic phenomenon. It’s like a mental illness. It is marked by excessive enthusiasm, participation of the news media, and feelings of regret among people who weren’t in the bubble.’ They are often enlarged by an expansion of credit.”

Shiller measures valuation levels using cyclically-adjusted price-to-earning ratios (CAPEs). According to Barron’s, the Shiller CAPE for the S&P 500 Index was at 21 in January of 2013. That was higher than its long-term average and lower than its recent trend so U.S. equities were somewhere between neutral and significantly over valued. Since January 2013, some U.S. stock markets have delivered returns in the double digits, pushing the Shiller CAPE toward 25. On the face of it, U.S. equities appear to be highly valued.

However, in early December, The Economist reported Shiller was “not yet ready to declare a bubble in American equities… There is nothing like the same excitement about shares that was seen in the late 1990s; net flows into mutual funds only just turned positive this year. Another measure of public indifference is CNBC, a television station that tracks the financial markets, suffered its lowest ratings since 2005 in the third quarter.”

So, is this a bubble or a bull market? The experts aren’t certain. Keep your eyes peeled for signs of irrational exuberance.

 

Weekly Focus – Think About It

Every day of the week, The Economist explains a new topic on its website. The most popular explanations during 2013 included:

• What is the difference between Sunni and Shia Muslims?
• How does copyright work in space?
• Why are your friends more popular than you?
• How did Estonia become a leader in technology?
• Why are there so many tunnels under London?
• Why don't Americans ride trains?
• How might your choice of browser affect your job prospects?

Weekly Commentary December 23rd, 2013

The Markets

To borrow a word from the legendary Gomer Pyle: G-o-l-l-y!

In 1955, just five years before The Andy Griffith Show became a big hit, William McChesney Martin, Jr., then Chairman of the Board of Governors of the Federal Reserve System, made an often-quoted speech in which he said, “The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.”

Last week, Fed Chairman Ben Bernanke didn’t confiscate the punch. He simply modified the recipe by adding a lower proof of spirits when he announced the Fed would begin to taper its bond buying program. Starting in January, the Fed will spend $10 billion a month less on bonds (the amount will be evenly split between Treasuries and mortgage-backed securities). Taking away the punch bowl would have entailed ending all bond purchases and increasing the discount rate. The Fed has indicated it will not change the discount rate for some time.

After an initial dip on the news of impending tapering, many markets around the world moved higher. The Dow Jones Industrial Average and the Standard & Poor’s 500 Indices pushed to record highs. Britain’s FTSE 100, Germany's Dax, and France's CAC indices all pushed higher on Wednesday, as did Japan’s Nikkei 225 Index. In the bond market, U.S. Treasury yields rose and then fell on the day of the announcement.

The beginning of the end of quantitative easing wasn’t the only news that drove markets higher last week. On Friday, the U.S. Commerce Department reported that U.S. gross domestic product (GDP) – a measure of our nation’s productivity – accelerated faster than originally thought during the third quarter. The reasons for the upward revision were increased consumer and business spending.

Life may have been simpler in fictional Mayberry R.F.D. – and they certainly had fewer choices as consumers – but economics and the responsibilities of the Federal Reserve weren’t any less complicated.   

in the EARLY DAYS OF BANKING IN THE wild west, there weren’t too many rules about what banks could and couldn’t do. According to The New York Times, in the early1900s:

“…Commercial banks established security affiliates that floated bond issues and underwrote corporate stock issues. (In underwriting, a bank guarantees to furnish a definite sum of money by a definite date to a business or government entity in return for an issue of bonds or stock.) The expansion of commercial banks into securities underwriting was substantial until the 1929 stock market crash and the subsequent Depression.”

After the crash, thousands of banks failed.

In 1933, Congress passed the Glass-Steagall Act (a.k.a. the Banking Act). The Act defined the difference between commercial and investment banking activities. Commercial banks primarily took deposits and made loans while investment banks helped companies issue stock and invested in securities. The Act prohibited commercial banks from participating in investment banking activities. It also created the Federal Deposit Insurance Corporation (FDIC) whose job was to protect commercial banks’ clients’ deposits up to a certain amount.

In 1999, after years of financial prosperity, Congress changed its mind and passed the Gramm-Leach-Bliley Act (GLBA) which effectively repealed the parts of Glass-Steagall that prevented commercial banks from participating in investment banking activities. Some believe the change in rules played a significant role in the global credit crisis during which commercial banks suffered billions of dollars in losses because of their investment banking activities.

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in response to the global credit crisis and subsequent government bailout. The 953-page Volcker Rule is part of the Act and was passed by regulators in December of this year. It establishes a set of rules that are intended to prevent FDIC-insured banks from making risky bets with customers’ deposits. In particular, banks that rely on taxpayer guarantees are largely prohibited from proprietary trading and hedge fund investments. We’ll know more when regulators decide how the rules will apply and who will enforce them.

George Bernard Shaw said, “We are made wise not by the recollection of our past, but by the responsibility for our future.” Let’s hope when it comes to U.S. banking law, he proves to be right.

 

Weekly Focus – Think About It

“As a child my family's menu consisted of two choices: take it or leave it.”

--Buddy Hackett, American comedian

Weekly Commentary December 16th, 2013

The Markets

You really need to take predictions with a grain of salt. Consider these esteemed opinions:

• "I think there is a world market for maybe five computers." Thomas Watson, Chairman, IBM, 1943
• "Who wants to hear actors talk?" H. M. Warner, Founder, Warner Brothers, 1927
• "Everything that can be invented has been invented." Charles Duell, Commissioner, U.S. Office of Patents, 1899

 

It’s an important to remember the fallibility of experts as we head toward a new year and pundits begin pontificating about the events of the past and predicting what may be ahead.

Barron’s recently pointed out how well U.S. stock markets have performed this year: “Not since 1995, when stocks climbed 34 percent without as much as a 3 percent dip, have we enjoyed a year as agreeable as this. No pain, all gain has turned U.S. stocks into a consensus favorite, the People's Choice award winner, the king of the hill. But, it's no longer the road less traveled.”

The publication tweaked market optimists by pointing out economists’ consensus opinion the U.S. economy will grow by 2.6 percent – admittedly a pretty modest pace for growth – may not seem like a stretch, but it could be. The point was 2014 is almost certain to bring some jarring economic transitions like less monetary support through quantitative easing. Reduced liquidity could negatively affect economic growth (Gross Domestic Product growth in 2013 is projected to be just 1.7 percent).

In a separate article, Barron’s shared insights from 10 strategists – Wall Street professionals who acknowledged 2014 may offer investors a bumpy road. However, their consensus expectation is the Standard & Poor’s 500 will finish 2014 higher. “…Their mean prediction is 1977. The bullish consensus might trouble contrarians, but Wall Street's pros see ample reason for optimism, given their expectations of a stronger economy and rising corporate profits.” 

As you read conflicting opinions about where we’ve been and where we’re going, it’s critical to remember short-term macroeconomic and market predictions should not be given too much weight. You built your investment strategy to meet your long-term investment goals.   

is that a drone? flying through my neighborhood? There may be a new entry on the list of military inventions that have been repurposed for commercial use: Unmanned Aerial Vehicles (a.k.a. UAVs or drones) may soon join global positioning systems (GPS), duct tape, EpiPens, cargo pants, microwaves, and a wealth of other goods Americans rely on in everyday domestic life.

Drones are remote-controlled flying robots. They may be as small as insects or as large as jumbo jets. Today, they’re most known for delivering stealth attacks on selected targets and military service which has included stints on domestic border surveillance and overseas reconnaissance. In the future, they may be thought of as handy tools that help manage a variety of tasks. While no one can be sure which opportunities will pan out and which won’t, there are a lot of potential applications including:

·         Information gathering. Journalism students at the University of Missouri in Columbia are learning to fly drones! They’re gathering pictures, videos, and other news-worthy information. Yes, there are some privacy issues. Already, 42 states are considering bills restricting drone use.

·         Improving agriculture. Students at Oklahoma State University are researching the roles drones could play in increasing yields and monitoring crops for blight and diseases.

·         Disaster relief. The Harvard-MIT Division of Health Sciences and Technology received a grant to develop drones to deliver vaccines and medicines to remote locations and disaster areas.

·         Wildlife research. The U.S. Geological Survey has been using a camera-equipped drone to complete aerial counts of sandhill cranes, and scientists in Indonesia are using drones to study endangered Sumatran orangutans from above the treetops.

·         Shipping goods. American internet retailers are experimenting with using drones to ship goods from fulfilment centers directly to customer’s doors. It may be 2015 before you receive a drone delivery because the Federal Aviation Administration still needs to issue some rules governing drone operations.

So, if you’ve been asking yourself, “What’s the next big thing?,” you might want to read up on drones. They could be it.

 

Weekly Focus – Think About It

“Peace is not absence of conflict, it is the ability to handle conflict by peaceful means.”

--Ronald Reagan, 40^th American President

Weekly Commentary December 9th, 2013

The Markets

If every piece of positive news was a petal, then you might say the American economy was in bloom last week. Moving into the holiday season, consumer confidence was at a five-month high.

Early in the week, manufacturing showed improvement. On Thursday, the U.S. Commerce Department unfurled the news the American economy grew faster than expected during the third quarter of 2013. The next day, it was reported the unemployment rate was at the lowest level since 2008. Hourly earnings increased, as did the length of the work week. Participation in the work force improved slightly, although it remains at historical lows.

There are sound reasons to expect America’s resurgence will continue into 2014, according to The Economist. They reported America’s progress was due, in part, to:

• Policymakers in the U.S. providing direct government support for failing companies and creating liquid capital markets that helped companies recover after the financial crisis.
• Companies benefitting from an increase in domestic energy production. Often the fuel comes from unconventional sources.
• American businesses leading the way in social media. They are expected to blaze the trail when finding ways to profit from Big Data and developing a sharing economy.

There was good news in other parts of the world, too. A global trade agreement – the first major deal in 20 years – was reached that could simplify customs procedures and speed up the flow of goods across the world. CNN Money hailed it as the most significant multilateral trade pact since the World Trade Organization was founded. The agreement has the potential to reduce trade costs by as much as 15 percent, saving developing nations about $445 billion each year, and boost the global economy.

Despite the good economic news, U.S. stock markets slumped through Thursday of last week largely because of investors’ concerns that positive economic news would encourage the Federal Reserve to end quantitative easing sooner rather than later. Those concerns seemed to dissipate with the release of positive employment numbers on Friday and markets surged higher.

Let’s take a stroll down memory lane… In a recent issue, The Economist pointed out during March 2009 the prospects for American companies were pretty sketchy:

“…The Dow Jones Industrial Average closed below 6,627, a 53% decline from its all-time high less than two years earlier. The number of American firms in the global top ten by market capitalization was on its way down from six to three, and America’s share of the top 50 companies from 50% to 40%. Once regarded even in Communist China as the business model for the world, corporate America had lost its crown.”

Oh, the difference just a few years can make! According to an November 18, 2013 article on Economist.com, If we look ahead to 2014, American firms are expected to comprise the majority of the global top ten (when measured by market value) and make up almost two-thirds of the top 50 companies in the world. It’s not all that surprising when you consider the fact, as a headline in Forbes announced, corporate profits are at an all-time record peak making up almost 70 percent of U.S. gross domestic product.

That may have something to do with the way Americans are spending their money. Citing an expert from Bank of America Merrill Lynch, Barron’s reported:

“U.S. import growth has shrunk from 11% to less than 1% between 2010 and 2013, while job growth has repaired from a negative 1.7% to 1.6%... Domestically produced energy now accounts for 87% of what we consume, up from 70% five years ago, and the share of vehicles sold here that are manufactured stateside has risen from 63% to 73%… We're also spending more on domestic goods and services... Nearly 40,000 Americans turn 65 every week, and aging boomers tend to steer more of their disposable income toward services like medical care, accommodation, and recreation that are typically made in America.”

Perhaps what Alexis de Tocqueville, French historian and political thinker, said about America still holds true, “The greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults.”

 

Weekly Focus – Think About It

“When even one American who has done nothing wrong is forced by fear to shut his mind and close his mouth, then all Americans are in peril.”

--Harry S. Truman, American President

Weekly Commentary December 2nd, 2013

The Markets

In 2006, Time Magazine’s Person of the Year was ‘You.’ The magazine declared that 2006 was about:

“…Community and collaboration on a scale never seen before… It's about the many wresting power from the few and helping one another for nothing and how that will not only change the world, but also change the way the world changes.”

Last week, J.P. Morgan named EVERYONE the winner of the "Most Promotional Retailer Award." While communities across America are very interested in Black Friday sales, these events are less about empowerment and more about brawling for consumer goods. It’s a popular activity. In fact, a case could be built that one of the newest Thanksgiving holiday traditions involves the telling of riveting Black Friday (and now Thanksgiving Day) tales that describe retail shopping bravado and adventure.

It may prove to be a short-lived tradition if mobile devices and online sales continue to gain popularity. According to IBM Digital Analytics Benchmark, which collects data from roughly 800 U.S. retail sites in real time, as cited in Barron’s, online sales were up 20 percent on Thanksgiving Day this year as compared to last year. They slowed a bit on Black Friday, up just 9 percent relative to last year by mid-afternoon. Many of the folks who chose to forego shopping in stores made their purchases using mobile devices which accounted for 37 percent of online sales on Friday.

Holiday shoppers and retailers aren’t the only ones who appreciate robust holiday sales, so do state governments. Ron Alt, senior research associate at the Federation of Tax Administrators, was cited by USA Today as saying “about 10 percent of annual state sales taxes come in to state coffers in January from holiday season sales, topping most other months in which about 7 or 8 percent of the taxes are collected.”

We hope your Thanksgiving holiday was filled with wonderful people and adventures.

Pensions around the world… Here’s something a lot of people are thankful for: pensions. There are public pensions, which generally are funded by tax dollars, and private pensions, which generally are funded by companies. Merriam-Webster.com defines pension as, “an amount of money that a company or the government pays to a person who is old or sick and no longer works.” The Economist takes a slightly different view although its focus was on public pensions:

“A pension is a claim on the earnings of future workers. Some countries choose to pay these claims out of future taxes; others set up special funds to invest in financial assets. But these assets (equities, bonds and property) will be able to pay pensions only because future workers generate the income to make them valuable.”

In the late 2000s, tax-financed pensions made up almost 60 percent of gross income on average for people age 65 and older who lived in the 34 countries that comprise the Organization for Economic Co-operation and Development (OECD). Europeans were the most dependent on their governments. Older Belgians and Finns, on average, received about 80 percent of gross income from the state. Older Chileans, Americans, and Canadians were the least reliant. Chileans over age 65 received less than 10 percent of gross income from the government. For Americans and Canadians, government pensions made up about 40 percent of income on average.

In general, public and private pension funds have done pretty well in 2013. They were helped by rising stock prices and higher bond yields. However, the challenges they face, including increasing longevity and volatile markets, are relatively daunting. That’s one reason private pensions have been disappearing in United States. The number of employer-sponsored defined benefit pension plans reached an all-time low of about 22,700 single-employer plans in early 2013. That’s down from just over 112,000 in 1985.

 

Weekly Focus – Think About It

“When you rise in the morning, give thanks for the light, for your life, for your strength. Give thanks for your food and for the joy of living. If you see no reason to give thanks, the fault lies in yourself.”

--Tecumseh, Native American leader of the Shawnee

Weekly Commentary November 25th, 2013

The Markets

Really?!

Okay. Okay. If you’ve been trekking through Siberia or Patagonia for about a year, then maybe it surprised you to hear the minutes from the Federal Reserve Open Market Committee meeting showed it expects to begin tapering Quantitative Easing (QE) in the coming months.

However, since the Fed has been telling anyone who will listen – telling them over and over and over again – that its intent is to slow the pace at which it buys bonds as the U.S. economy strengthens (and since most people haven’t been exploring the hinterlands where the convenience of modern communications may not be readily available), it’s difficult to understand why that information was so surprising that it pushed stock and bond markets significantly lower.

It might have been easier to understand market declines if they had occurred on Tuesday after the Organization for Economic Cooperation and Development (OECD) released its revised economic outlook. In his speech, OECD Secretary-General Angel Gurría said:

“The recovery of the global economy is progressing at a moderate and uneven pace. World GDP growth, which averaged about 4 percent per year in the decade up to the onset of the global crisis, is expected to reach only 2.7% in 2013, the lowest rate since 2009. While we expect global growth rates to move again towards 4 percent in 2015, the world will continue to be affected by the harsh social legacy of the crisis… The recovery itself is exposed to potential downside risks, including fiscal brinkmanship in the United States, unresolved banking problems in the euro area, the high debt burden in Japan, and financial vulnerabilities in some large emerging-market economies.”

Gurría also said, in the OECD’s long-term view, economic weakness was the result of investment remaining anemic, credit growth remaining subdued, trade growth gaining sluggishly, and growth in emerging economies faltering.

Regardless, the markets’ downward foray was short-lived. On Friday, the Standard & Poor’s 500 Index closed above 1800 for the very first time. Other U.S. markets moved higher as well.

an oh-so-brief brief on digital money… If you read or watched the news during the past few months, you may already know this, but there has been an explosion of interest in digital money. That’s the reason you may be hearing and reading about dozens of companies that are rushing to coin virtual currency that has real value. It just seems so 21^st Century, doesn’t it?

Odds are you’ve already used digital money. For example, you used it the last time you purchased something online. Digital money is what we use when we pay or are paid electronically. Think smart phones and credit cards. Digital money is not tangible; however, it is possible to convert digital money that is part of a large centralized banking system into paper money by making a withdrawal from an ATM.

In the United States, the Federal Reserve is responsible for maintaining the integrity of U.S. bills and coins by setting monetary policy. Digital currency companies offer a parallel currency universe; a means of transferring electronic money from one person to another without using traditional banking or money-transfer systems.

Digital money companies appear to be delivering American economist Milton Friedman’s dream, according to The Economist. Years ago, Friedman suggested the Federal Reserve be abolished and replaced by an automated system that would increase money supply at a steady, pre-set rate. He believed such a system would better control inflation, making spending and investment decisions more certain. The Economist article said:

“In theory, then, the system ought to keep a lid on inflation – making it attractive to critics of interventionist monetary policy of the sort practiced since 2008 by America's Federal Reserve under the label quantitative easing… It offers other apparent benefits, too. The currency can be used by anyone (unlike credit cards, for instance), anywhere. Transaction costs are also likely to be lower than those for traditional payment systems, though these are not in fact zero…”

The Economist goes on to point out a key difference between central-bank-controlled currencies (which often offer both bills and coins and digital currencies) and digital currency companies is the former are backed by a country’s regulations and laws; the latter are answerable to online communities using the currencies.

 

Weekly Focus – Think About It

“A business that makes nothing but money is a poor business.”

--Henry Ford, American Industrialist

 

Weekly Commentary November 18th, 2013

The Markets

If you found holiday songs or Beatles tunes humming through your head last week, it may have been your subconscious processing world and market events.

Over the river and through the woods/To Grandmother's house we go… Janet Yellen, current Vice Chairman and nominee to be the next Chairman of the Federal Reserve System, testified at her confirmation hearing before the U.S. Senate’s Committee on Banking, Housing, and Urban Affairs on Thursday. Her comments were widely interpreted as indicating that current stimulus measures will remain in place. This made investors happy and helped push global stock markets higher.

In the United States, the Dow Jones, S&P 500, and NASDAQ, all appear to be headed toward milestones. The Dow is nearing 16,000, the S&P is closing in on 1,800, and the NASDAQ is approaching 4,000.

You say you want a revolution/Well you know/We all want to change the world… China’s third plenum of the 18th Central Committee, which also is being referred to as a blueprint for reform, a reform manifesto, and the Decision on Major Issues Concerning Comprehensively Deepening Reforms, is ambiguously phrased, according to The Economist. However, it appears to encourage:

“…Experimentation in everything from trading rural land to the freeing of controls on interest rates. Barriers to migration will be further broken down and the one-child policy relaxed. A widely resented system of extra-judicial detention, known as laojiao (re-education through labor), will be scrapped.”

China’s leaders also promised to elevate the role of markets in the economy. That news helped push Shanghai Composite Index higher last week.

Have you been offered a lump sum distribution? Not too many employers offer pension plans anymore. You know, pension plans. The kind of retirement plans that employers used to offer; the type where employees generally didn’t contribute and the benefits they received in retirement were determined by their salaries, length of employment, and other factors.

If you’ve ever worked for a company that had one, it’s possible that the offer of a lump sum distribution may be headed your way. If you accept a lump sum distribution, you’re choosing to receive a pile of cash today instead of monthly or annual pension payments in retirement. Basically, you’re agreeing to take responsibility for investing the money and generating a stream of income during retirement so your employer doesn’t have to do those things.

Why are companies offering lump sum distributions? The Pension Protection Act of 2006 (PPA) established new accounting rules. Companies with pension plans must recognize their plans’ funded status on their balance sheets each year. Since balance sheets are scrutinized by analysts and investors, and lots of pension plans are underfunded, companies decided it was time to take action.

How underfunded are these plans? A Wilshire Associates report cited by Reuters found the difference between the amount that S&P 500 companies will owe to retired workers and the amount those companies have set aside to pay retirees is more than $1.5 trillion. How much is that? Well, if you took one trillion one-dollar bills and strung them end-to-end, the chain would stretch further than the distance from the earth to the sun!

Anyway, having an underfunded plan became a corporate finance headache. Two-thirds of companies that have pension plans are trying to limit the effect of those plans on their financial statements (69 percent) and cash flows (58 percent), as well as reduce the overall cost of their plans (41 percent), according to a recent Towers Watson survey. CFO Research in collaboration with Mercer said employers plan to do this by:

• Adopting more conservative investment strategies
• Transferring pension obligations to insurance companies by purchasing annuities
• Offering lump-sum payouts to retired and current employees

In many cases, accepting a lump sum payout rather than having income from a pension may have a significant impact on your retirement.

 

Weekly Focus – Think About It

“The average 401(k) account balance fell 34.8 percent in 2008, then rose from 2009 to 2011. Overall, the average account balance increased at a compound annual average growth rate of 5.4 percent over the 2007-2011 period, to $94,482 at year-end 2011… The median 401(k) account balance (half above, half below) increased at a compound annual average growth rate of 11.5 percent over the period, to $42,082 at year-end 2011.”

-- Employee Benefit Research Institute, June 2013 [12]

Weekly Commentary November 11th, 2013

The Markets

After last week’s surprisingly strong employment report, it’s almost possible to picture Ben Bernanke slapping trail dust from his leg, ducking his head, and saying, “Just doin’ my job.”

After all, running the economy is as laden with complications and unexpected events as a cattle drive. Richard Graboyes, an economist who was once the Director of Education for the Federal Reserve Bank of Richmond, wrote that driving cattle seems “arduous, but simple – walk some cattle from point A to point B. But, the endeavor is fraught with natural and human risks for both rancher and driver.”

Clearly, the head of the Fed and the head of a cattle drive face different challenges. According to The Federal Reserve System: Purposes and Functions publication:

“The Federal Reserve sets the nation's monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates. The challenge for policymakers is that tensions among the goals can arise in the short run and that information about the economy becomes available only with a lag and may be imperfect.”

Last week, the employment numbers seemed to support the idea the economy is gaining steam. According to Forbes, employers added more than 200,000 jobs in October, which was far more than economists had anticipated. The government continued to employ fewer people (employees furloughed during the government shutdown were still counted as being employed). There were 12,000 fewer government jobs in October, and 94,000 fewer for the year. The biggest employment gains were in the hospitality, retail, technical services, manufacturing, and health care sectors.

It’s not time to whoop and holler, though. The New York Times reported the labor force participation rate fell to 62.8 percent, which is a 35-year low. More than 700,000 jobs disappeared during October which was the largest monthly drop since the end of 2009. A smaller labor force can make overall unemployment rate appear to be lower than it is. Let’s hope the labor force isn’t like a herd of cattle that moves too fast and arrives at market a lot skinnier and worth a lot less.

if you were asked to compare teachers’ social status to that of other professions, how would it compare? Are teachers like doctors? Librarians? Social workers? Nurses? Local government officials? Web designers? Lawyers? Policemen? Engineers? Accountants?

Education and training have a profound effect on economies and individuals. In the United States, people who have graduated from college tend to earn more than those who have graduated from high school. Earning an MBA, JD, or MD can translate into significantly higher earnings over a lifetime. Clearly, becoming educated has a significant economic value.

What value, then, do we place on those who provide education? How much respect do we have for the people who teach and train us? As it turns out, the answer varies widely from country to country. According to the Varkey GEMS Foundation’s Global Teacher Status Index survey, which surveyed 21 countries to determine the status of teachers, people in China, Greece, and Turkey have the highest level of respect for teachers and their social standing.

So, how does the teaching profession compare to other professions? In the Czech Republic, Egypt, Switzerland, and many other countries, survey respondents said teachers have the status of social workers. In Brazil, France, Turkey, and the United States, people think teachers are roughly on par with librarians. The Japanese think teachers have the same status as local government managers. More than one-third of Chinese participants said teachers had the same status as doctors. According to the report:

“The U.S. ranked in the middle of the Teacher Status Index with a score of 68.0. Notably, the ranking of primary school teachers is at the higher end of the table and above all the European countries. U.S. respondents scored consistently across the different variables in the study, demonstrating moderate to positive respect for their teachers.”

As you might expect, the more respect a country had for teachers, the more likely people in that country were to encourage their children to enter the profession. Parents in China, South Korea, Turkey, and Egypt were most likely to encourage kids to become teachers.
 

Weekly Focus – Think About It

 “Education is the key to success in life, and teachers make a lasting impact in the lives of their students.”

-- Solomon Ortiz, Former U.S. Representative from Texas

Weekly Commentary November 4th, 2013

The Markets

Exceptional… exceeds expectations… meets expectations… needs improvement… unsatisfactory. It’s a rating system familiar to anyone who has ever received a performance review. Right now, the performance of inflation is not meeting expectations – and that may be a good thing.

Critics of loose monetary policy and rock bottom interest rates have had high expectations for inflation. That is, they have predicted inflation will rise. In March 2012, Martin Feldstein, a professor of economics at Harvard and President of the National Bureau for Economic Research, explained the massive liquidity created in the United States by the Federal Reserve’s easy money policies created a risk of rising inflation. A rapid increase in bank credit would boost the money supply and the rate of inflation unless the Fed raised interest rates in a timely way and on an adequate scale.

So far, low interest rates and unusually aggressive monetary policies haven’t led to higher inflation in the United States or other at-risk regions. The Conference Board’s Harmonized Index of Consumer Prices (HICP), an inflation measure, showed prices in the United States increased by 0.8 percent in September 2013. That’s slower than the 2.1 percent increase reported for 2012.

In the Eurozone, the inflation rate for October fell to 0.7 percent, which was the lowest in almost four years. A recent article in The Economist explained it like this:

“So, why haven't we had the inflation that some predicted in the wake of quantitative easing? The reason is that central banks are not the only, nor indeed the main, money creators. Money is usually created by the private banking system and that has been trying to shrink. If the money supply is a bath, then the central banks may have turned on the taps, but the commercial banks have pulled out the plug.”

That may mean, despite stable and falling inflation rates in some regions, we’re not out of the woods yet. As Mr. Feldstein wrote last March, commercial banks could begin to lend funds to firms and households. If that happens, “Loans could add to deposits and cause the money supply to grow. They would also increase spending by the borrowers, adding directly to inflationary pressure.”

 

how do your state’s taxes stack up? It all depends on who you ask and what types of taxes you’re considering.

The Tax Foundation’s State Business Tax Climate Index for 2014 reported the most tax-friendly states for business were Wyoming, South Dakota, Nevada, Alaska, and Florida. The least tax-friendly were Rhode Island, Minnesota, California, New Jersey, and New York. Every state has property taxes and unemployment insurance taxes, but those in the top ranks tend not to have one or more of the major taxes: corporate income tax, individual income tax, or sales tax. According to the Foundation, “Wyoming, Nevada, and South Dakota have no corporate or individual income tax; Alaska has no individual income or state-level sales tax; Florida has no individual income tax.” It is interesting to note three of the top states are among the least populated in the United States.

Kiplinger’s says that Delaware, Wyoming, Louisiana, Mississippi, and Arizona are some of the most tax-friendly states for individuals because they levy some of the lowest taxes in the country. California, Connecticut, New Jersey, New York, and Hawaii are far less friendly. All have high income tax rates and assess above-average property taxes, which puts them at the bottom of the list of tax-friendly states for individuals. According to state tax policy director for the Institute on Taxation and Economic Policy Meg Wiehe, who was quoted in Kiplinger’s, “Low tax revenues may give a state less money to spend on education, transportation, public safety, and other services important to you and your family... Low taxes don't necessarily lead to a higher quality of life.”

If you’re retiring soon or have already retired, then you may want to consider a move to Alaska, Wyoming, Georgia, Arizona, or Mississippi which have some of the lowest taxes for retirees in the United States. According to Kiplinger’s assessment of state tax laws, retirees may want to avoid Rhode Island, Vermont, Connecticut, Minnesota, and Montana which are some of the least generous with retiree tax credits.

If, after reading this, you’re considering a move to the Equality State (aka the Cowboy State), here are some other things Wyoming has to offer: Yellowstone, the Grand Tetons, Jackson Hole, and about 172 days a year with a temperature below freezing!

  

 

Weekly Focus – Think About It

“A lie gets halfway around the world before the truth has a chance to get its pants on.”

-- Winston Churchill, British Prime Minister

Weekly Commentary October 28th, 2013

The Markets

Contrarians probably are waiting for the other shoe – or, in this case, U.S. stock markets – to drop.

If you’re not familiar with contrarian investing, the theory goes something like this: Consensus opinion is often wrong. When the majority of investors have a bullish outlook and believe stocks are going to move higher, the chances are stock values will drop. Likewise, when the majority has a bearish outlook and believes stocks are going to move lower, the chances are stock values will rise.

Why would Contrarians expect markets to head south? One reason is bullish sentiment is high. On October 23, the American Association of Individual Investors’ Investor Sentiment Survey, which measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months, shows 49.2 percent are bullish and just 17.6 percent are bearish (the rest are neutral). The long-term averages for bullish and bearish sentiment are 39 percent and 30.5 percent, respectively.

Contrarians also are eyeballing the fact that stock markets in the United States have run up for 519 sessions without as much as a 10 percent correction, according to Barron’s. That means markets have weathered bombs at the Boston marathon, chemical weapons in Syria, monetary policy uncertainty, U.S. government shutdown, and Miley Cyrus’ VMA performance. Of course, 519 sessions is not the longest winning streak ever, not even close. In fact, if we assume about 250 trading sessions in a year, then the current rally would have to last until about 2018 to match the record (1,767 sessions) set between October 1990 and October 1997.

Investors aren’t the only bullish faction. Money managers who participated in Barron’s latest big money poll also seem to have adopted Alfred E. Neuman’s motto: What, me worry? Their outlook seems to focus on the Fed’s loose monetary policy. According to Barron’s, “Four of five money managers in our big-money poll expect stocks to be the best-performing asset over the next year, even as 71 percent see U.S. shares as already fairly valued. Thanks to unending central bank support, we all expect above-par stock returns from sub-par economic growth.”

So, what’s going to happen? Only time will tell.

where are interest rates headed? According to the Federal Reserve, economists assume interest rates will move toward equilibrium or a ‘natural’ real rate of interest that takes into account inflation over the long term.

The idea of a natural rate of interest was first introduced by Swedish economist Knut Wicksell.  Recognized as an economist’s economist in the late 1800s and early 1900s, Wicksell is known for his macroeconomic text Interest and Prices which noted the difference between the real rate of return on capital (aka: the natural rate of interest) and the market rate of interest (aka: the rate borrowers pay). According to The Economist:

“If the financial rate is below the natural rate, businesses can reap unlimited profits by borrowing as much as they can and plowing it into high-returning projects. Eventually, though, all that additional spending pushes up prices, money and credit, and, eventually, financial interest rates.

Wicksell saw financial rates as those set by banks competing to make loans. That job is now performed by central banks. They still think in Wicksellian terms: the natural rate prevails when the economy is at full employment. Set the policy rate above the natural rate and the economy tips into depression. Set it below, and inflation results – or, some worry, speculative credit booms.”

So, where are interest rates headed? Apparently, they’re going to move higher. According to the Federal Reserve’s September 2013 economic projections, the federal funds rate (the rate at which banks lend to each other overnight) is expected to reach 2 percent by the end of 2016. Currently, it is at 0.25 percent. (The Fed also expects the United States will be close to full employment at that time with the unemployment rate nearing its long-term average of 5.2 to 5.8 percent.)

 

Weekly Focus – Think About It

“It has always seemed strange to me... the things we admire in men, kindness and generosity, openness, honesty, understanding and feeling, are the concomitants of failure in our system. And those traits we detest, sharpness, greed, acquisitiveness, meanness, egotism and self-interest, are the traits of success. And, while men admire the quality of the first, they love the produce of the second.”

--John Steinbeck, Pulitzer and Nobel Prize-winning American author

Weekly Commentary October 21st, 2013

The Markets

Curse of Chucky, Scream 2, Final Destination 5, Freddy vs. Jason… You know Halloween is nearly upon us when you can’t surf channels without exposing yourself to or relishing in a multitude of horror flick sequels.

Propagating alarming situations seems to be all the rage in Washington, too. Last week, a last-minute deal raised America’s debt ceiling, saving us from a debt default and ending the government shutdown – until next January. In the meantime, hoping to avoid a sequel just three months down the road, the members of Congress agreed to put their heads together and produce a 10-year budget plan by mid-December.

Like the hero or heroine of many a terror-filled fantasy, stock markets generally have proved resilient despite facing formidable challenges. Just last week, the Standard & Poor’s 500 Index hit a new all-time high. According to Barron’s:

“Since the rally began, in March 2009, there has been the flash crash, the Greek default drama, the U.S. debt-ceiling debacle, the Standard & Poor's credit-rating downgrade of the U.S., the sequester, and the great taper scare. Each of these, we were told, could have ushered in a new bear market. Instead, the S&P 500 squirmed out of the traps and headed higher. And, for its latest trick, the market had to avoid the double whammy of a government shutdown and a potential default.”

The short-term resolution of budget and debt-ceiling issues doesn’t mean markets have escaped the (choose one: axe-wielding maniac, flesh-eating demon, Stay-Puffed Marshmallow Man) quite yet. Looking ahead, they’ll have to confront the menace of potentially contentious budget negotiations, the possible end of quantitative easing, and the phantasm of resolute fiscal policy.

it may be the holy grail of investing… If you could accurately predict how share prices would move, you’d probably be quite wealthy. If you could offer insight that helps analysts and investors do a better job predicting such things, you might win the Nobel Prize. That’s what happened last week when American economists Eugene Fama and Lars Peter Hansen from the University of Chicago, and Robert Shiller from Yale University, jointly received the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2013. They were recognized for their empirical analysis of asset prices.

Eugene Fama is best known for his work on the efficient frontier which demonstrated stock prices are extremely difficult to predict over the short term because new information is incorporated into prices very quickly. His research not only influenced future research, many credit the emergence of Index-linked investments to his theories.

Robert Shiller, a student of behavioral economics, challenged Fama’s efficient markets hypothesis with the belief that markets are driven by human psychology which can and does create large and sustained pricing errors. Shiller established when the ratio of prices to dividends for stocks is high, prices tend to fall, and when the ratio is low, prices tend to increase.

Lars Peter Hansen developed the Generalized Method of Moments, or GMM, which proposed a “straightforward way to test the specification of the proposed model… Hansen’s work is instrumental for testing the advanced versions of the propositions of Fama and Shiller… If you want to do serious analysis of whether changing risk premia can help rationalize observed asset price movements, Hansen’s contributions will prove essential.”

According to the Nobel committee, “There is no way to predict the price of stocks and bonds over the next few days or weeks. But, it is quite possible to foresee the broad course of these prices over longer periods, such as the next three to five years… The Laureates have laid the foundation for the current understanding of asset prices. It relies in part on fluctuations in risk and risk attitudes, and in part on behavioral biases and market frictions.”

 

Weekly Focus – Think About It

 “Many men go fishing all of their lives without knowing that it is not fish they are after.”

--Henry David Thoreau, American naturalist and author

Weekly Commentary October 14th, 2013

The Markets

Do world stock markets believe Congress is just offering up some Halloween excitement? 

Last week, they responded to the government shutdown in the United States and the possibility the U.S. might default on its debt for the first time ever with the bravado of teenagers standing in line for a haunted house. Markets around the globe finished the week higher with some notable exceptions that included Chinese and Mexican markets and America’s NASDAQ.

It’s also possible market performance could be attributed to the lack of economic data available since the government shutdown. Even private economic indicators sometimes rely on federal government information to calculate their numbers, so markets may be weighting signs that America’s elected officials are making progress more heavily than they might if other data were accessible.

The positive progress in U.S. stock markets is particularly interesting since a lot of Americans – many of whom may be investors – have negative feelings about the fiscal policy impasse in Washington, according to a new NBC News/Wall Street Journal poll. Sixty percent of Americans polled said “if they had the chance to vote to defeat and replace every single member of Congress, including their own representative, they would.”

That may go a long way toward explaining the recent deterioration of consumer sentiment in America. The Thomson Reuters/University of Michigan's overall index on consumer sentiment declined for the third month straight in October. The change was relatively small, but sentiment reached its lowest level in nine months.

A Federal Reserve System primer… Last Wednesday, vice chair of the Board of Governors of the Federal Reserve Janet Yellen was nominated to take over as Chairman when Ben Bernanke steps down in January. If confirmed, she’ll take the helm of the institution entrusted with safeguarding our country’s monetary and financial system.

Congress established the Federal Reserve System a century ago in response to the financial panic of 1907. According to the Federal Reserve Bank of Boston:

“Financial panics and bank runs were all too common during the 19^th and early 20^th centuries. Some were more severe than others, but most followed the same general pattern. The misfortunes of a prominent speculator would undermine public confidence in the financial system. Panic stricken investors would then scramble to cut their losses. And, because it wasn’t uncommon for speculators to double as bank officials, worried depositors would rush to withdraw their money from any bank associated with a troubled speculator. If a beleaguered bank couldn’t meet its depositors’ demands for cash, panic would quickly spread to other banks. (Remember! There was no federal deposit insurance until 1933. If a bank failed, depositors had little hope of ever seeing their money again.)

The panic of 1907 ended when J.P. Morgan intervened and set up emergency loans for financial institutions. The clamor for reform led to the passage of the Federal Reserve Act (which created the Federal Reserve System (Fed), which became law in 1913.

Today, the Fed includes a Board of Governors in Washington, D.C. and 12 Federal Reserve Banks. The Board of Governors oversees the Fed. Its members are appointed by the President of the United States and confirmed by the Senate. They serve 14-year terms. The Reserve Banks are responsible for the Fed’s day-to-day operations which include “conducting monetary policy, supervising and regulating banks, and providing payment services all help maintain the stability of the financial system.”

Monetary policy is set by the Federal Open Market Committee (FOMC) which is composed of 12 voting members and includes the seven members of the Board of Governors and a rotating group of five Reserve Bank presidents. The chairman of the Board of Governors is also the chairman of the FOMC.

 

Weekly Focus – Think About It

 
“The greatest thing in family life is to take a hint when a hint is intended – and not to take a hint when a hint isn't intended.”

--Robert Frost, American poet