Thursday, December 31, 2009

Four Extraordinary Financial Predictions for the Coming Decade

As we leave the year of the "Great Recession" behind, knowing four likely financial outcomes will show us how to position ourselves for financial prosperity in the coming decade.
1) Global growth
Emerging economies were economically superior in the last decade.  Without the effect of the tech and housing bubbles in their past, their demand is not hampered by enormous public (and private) debt.  The better run of these economies will prosper in the coming decade, and provide markets for economies weakened by the lingering effects of the recent recession.
2) Inflation
As we emerge from the Great Recession, the reality of the damage is becoming more clear.  Without government support, we'd be in a Depression.  While the steps taken by G-20 nations were inarguably necessary, it effectively covered old problems with  borrowed dollars, while keeping interest rates artifically low in order to give life to a near-death economy.
As more countries take on huge amounts of debt, the numbers of lenders who have the money and motivation to lend decrease.  It's a simple formula that we all know:  less demand for a commodity causes the price of that commodity to fall.  If nobody is buying the farmer's apples, the farmer lowers her prices.
In the case of our debt (in the form of bonds), when bond prices fall, yields go up.  Here's an example
Maturity Date - One Year.  Price of bond - $1000.  Interest paid by borrower - 4%  Yield to lender - 4%
If the price of that $1000 bond falls to $980,
Maturity Date - One Year.  Price of bond - $980.   Interest paid by borrower - 4%  Yield to lender - 6.1%
Higher interest rates mean higher inflation.  The Fed can't keep rates artificially low forever.
3) The mortgage market
We have just seen the effect of lending to less-than-qualified-borrowers in the recent mortgage meltdown.  You may be able to cut mortgages into little pieces and sell them to Iceland, but in the end, the mortgages will still go bad if the borrower can't pay it back.  Since the crisis, financial reform has stalled.  Mega-banks are repaying taxpayers for the money we spent keeping them alive, and, while lending standards have tightened, the genie has been let out of the bottle.
Investment bankers now operate under commercial bank charters.  Structure finance has diminished the barrier to entry to the mortgage market.  This demand, together with stricter lending practices, will provide additional upward pressure on interest rates.
4) Wealth transfer
Over the last decade, emerging nations have produced good for the insatiable US consumer, who bought with abandon.  Now debt laden, US consumer growth is diminishing.  Emerging nations, however, have newfound wealth.  Those nations now lend money to our government, and have a huge and growing middle class.
China is the most obvious example, but there are others.  These nations, assuming that they avoid the pitfalls of asset bubbles, will provide the majority of global growth in the early part of this decade with their newly acquired wealth.
Before the effects of globalization, all but those who ascribed to "Modern Portfolio Theory" (those who invested a set percentage of their money in various asset classes) were confident in keeping their money largely in US equities and bonds. 
With future diminished US growth prospects, however, this investment strategy is unlikely to be as successful in the next decade.  History has shown that this strategy has not been effective in the past, as well.  Investment veteran Art Cashin, Director of Floor Operations at UBS, recently  reiterated his "theory of the 17.6-year cycle." He pointed out that the periods 1966-1982 and 1929-1947 were "lean cycles," and predicts that we are entering another such cycle at this time.
Consequently, the old benchmark of "Subtract your age from 100, put that percentage of your portfolio in high quality US stocks, and the remainder in bonds" may well be over.
What now?  If you agree with the four assumptions discussed above, Pimco's Emerging Market fund manager (and former Harvard Endowment fund manager) Mohamed Il-Erian proposes the following portfolio:
STOCK  15% US, 15% Non-US Advanced Economies, 12% Emerging Markets, 7% Private Equity.
BONDS  5% US, 9% International, 5% US Treasury Inflation Protection Securities.
REAL ASSETS  6% Real Estate, 11% Commodities, 5% Infrastructure.
With an increasing investment in fast-growing emerging markets, with an emphasis on TIPS and real assets, this portfolio seeks growth with protection against inflation.  If you agree that inflation will cause rates to rise, you'll want to delay your US bond purchases until rates are higher, and wait until gold prices fall before investing in that commodity.  Depressed real estate prices, other than commercial property, show good value now. 
Of course, as we've learned through the painful correction in the last decade, this portfolio does not include cashflow you will need in the next five to ten years.  That is best kept in short-term Treasury issues or insured savings.  Yes, rates are low now.  But, they're likely to rise, as inflation picks up, and for this money, you want return OF capital more than return ON capital.
Have a safe, happy, healthy and prosperous new decade.

Thursday, December 17, 2009

Howard Dean says, "Kill Bill"

You may love that health care reform in any form may be emerging from the Senate.  You may want health care reform, but find so many flaws in this legislation that you hope it doesn't pass.  Why Dr. Dean wants the Bill to die.
It's a Health Insurance Bonanza
It's hard to talk about insurance.  See?  You're already getting bored.  Stick with me.
Not knowing this could cost you.
Health insurers are state regulated.  That means there are 50 hodge-podged different laws.  Insurance companies want it that way.  Why?  Because in a majority of states, two insurers have the majority of business.

Alabama Blue Cross Blue Shield AL 83% Health Choice 5% Total by both insurers 88%
Alaska Premera Blue Cross 60% Aetna Inc. 35% Total by both insurers 95%
Arizona Blue Cross Blue Shield AZ 43% UnitedHealth Group Inc. 22% Total by both insurers 65%
Arkansas Blue Cross Blue Shield AR 75% UnitedHealth Group Inc. 6% Total by both insurers 81%
California Kaiser Permanente 24% WellPoint Inc. (Blue Cross) 20% Total by both insurers 44%
Colorado WellPoint Inc. (BCBS) 29% UnitedHealth Group Inc. 24% Total by both insurers 53%
Connecticut WellPoint Inc. (BCBS) 55% Health Net Inc. 11% Total by both insurers 66%
Delaware CareFirst Blue Cross Blue Shield 42% Coventry Health Care 23% Total by both insurers 65%
Florida Blue Cross Blue Shield FL 30% Aetna Inc. 15% Total by both insurers 45%
Georgia WellPoint Inc. (BCBS) 61% UnitedHealth Group Inc. 8% Total by both insurers 69%
Hawaii Blue Cross Blue Shield HI 78% Kaiser Permanente 20% Total by both insurers 98%
Idaho Blue Cross of ID 46% Regence BS of Idaho 29% Total by both insurers 75%
Illinois HCSC (Blue Cross Blue Shield) 47% WellPoint Inc. (BCBS) 22% Total by both insurers 69%
Indiana WellPoint Inc. (BCBS) 60% M*Plan (HealthCare Group) 15% Total by both insurers 75%
Iowa Wellmark BC and BS 71% UnitedHealth Group Inc. 9% Total by both insurers 80%
Kansas WellPoint Inc. (BCBS) 59% Health Partners 10% Total by both insurers 69%
Kentucky Data Unavailable
Louisiana Blue Cross Blue Shield LA 61% UnitedHealth Group Inc. 13% Total by both insurers 74%
Maine WellPoint Inc. (BCBS) 78% Aetna Inc. 10% Total by both insurers 88%
Maryland CareFirst Blue Cross Blue Shield 52% UnitedHealth Group Inc. 19% Total by both insurers 71%
Massachusetts Blue Cross Blue Shield MA 50% Tufts Health Plan 17% Total by both insurers 67%
Michigan Blue Cross Blue Shield MI 65% Henry Ford Health System 8% Total by both insurers 73%
Minnesota Blue Cross Blue Shield MN 50% Medica 26% Total by both insurers 76%
Mississippi Data Unavailable
Missouri WellPoint Inc. (BCBS) 68% UnitedHealth Group Inc. 11% Total by both insurers 79%
Montana Blue Cross Blue Shield MT 75% New West Health Services 10% Total by both insurers 85%
Nebraska Blue Cross Blue Shield NE 44% UnitedHealth Group Inc. 25% Total by both insurers 69%
Nevada Sierra Health 29% WellPoint Inc. (BCBS) 28% Total by both insurers 57%
New Hampshire WellPoint Inc. (BCBS) 51% CIGNA Corp. 24% Total by both insurers 75%
New Jersey Horizon Blue Cross Blue Shield 34% Aetna Inc. 25% Total by both insurers 59%
New Mexico HCSC (Blue Cross Blue Shield) 35% Presbyterian Hlth 30% Total by both insurers 65%
New York GHI 26% WellPoint Inc. (Empire BCBS) 21% Total by both insurers 47%
North Carolina Blue Cross Blue Shield NC 53% UnitedHealth Group Inc. 20% Total by both insurers 73%
North Dakota Data Unavailable
Ohio WellPoint Inc. (BCBS) 41% Medical Mutual of Ohio 17% Total by both insurers 58%
Oklahoma BCBS OK 45% CommunityCare 26% Total by both insurers 71%
Oregon Providence Health 25% Regence Blue Cross Blue Shield 23% Total by both insurers 48%
Pennsylvania Data Unavailable
Rhode Island Blue Cross Blue Shield RI 79% UnitedHealth Group Inc. 16% Total by both insurers 95%
South Carolina Blue Cross Blue Shield SC 66% CIGNA Corp. 9% Total by both insurers 75%
South Dakota Data Unavailable
Tennessee Blue Cross Blue Shield TN 50% Total Choice 12% Total by both insurers 62%
Texas HCSC (Blue Cross Blue Shield) 39% Aetna Inc. 20% Total by both insurers 59%
Utah Regence Blue Cross Blue Shield 47% Intermountain Healthcare 21% Total by both insurers 68%
Vermont Blue Cross Blue Shield VT 77% CIGNA Corp. 13% Total by both insurers 90%
Virginia WellPoint Inc. (BCBS) 50% Aetna Inc. 11% Total by both insurers 61%
Washington Premera Blue Cross 38% Regence Blue Shield 23% Total by both insurers 61%
West Virginia Data Unavailable
Wisconsin Data Unavailable
Wyoming Blue Cross Blue Shield WY 70% UnitedHealth Group Inc. 15% Total by both insurers 85%
Source: Health Care for America Now

1.  Insurance companies don't even have to compete with themselves.
Let's pretend that the majority of groceries in your state were sold by Kroger and Piggly Wiggly.  There are a few other grocery stores, but they tend to niche (high end, organic, etc) markets, since the combined pricing power of their competitors doesn't allow them to compete directly with the "big two." 
Now let's pretend you go visit your sister, who lives in another state.  There are twice as many major grocery stores in her state, Kroger and Piggly Wiggly, PLUS Safeway and Super Valu.  You notice that the prices at her Kroger are a lot less than yours.  Why?  More competition for your business.
Insurance companies don't even have to compete with their own company across the state line in our current system.  Just by allowing intra-state competition, the cost of insurance would be drastically reduced.  Who benefits from state regulation?
Insurance companies do.  Not you.
2.  The more complex the regulatory process, the more they can get away with.
Every state is different.  In some, you can do this, but not that.  The next state over, you can do that, but not this.  The state to the south allows this and that, but not the other thing.  You see the problem.  One set of rules gives much more protection to the consumer.  We don't often take "insurance regulatory policy" into account when we move to another state.
Again, good for insurance companies.  Bad for people.
3.  But they can't turn you down for pre-existing conditions. . . .
Right.  But they can charge you more.  And, if the government is going to subsidize your extra payment, we'll all be paying in the form of higher taxes.  And, if the government is not going to subsidize your extra payment, we'll all be paying in the form of higher premiums. 
Good for insurance companies.  Bad for people.
4.  How important is this issue to insurance companies?
Some people, like me, measure how much a company wants something by how much they're willing to pay for it.  Let's see where insurance companies rank in lobbying for what they want.
•$3.8 billion has been spent by the insurance and finance lobbyists and
•$3.69 billion, by health industry lobbyists,
according to Open Secrets, a non-partisan group. That's more than any other industry!
They must want things to stay the same very, very much.
Good for them.  Bad for us.
5.  Is this bill better than nothing?
Only you can answer this question.  I will guarantee that health insurers want two things:
a)  For this legislation to die; and
b)  To convince us that we should keep things just as they are.
Good for them.  Bankrupt nation for us.

Friday, December 4, 2009

Can the Nation Afford It? - Part II

There are two sides to everything.  Our previous discussion, that compared the US debtor status with other countries, showed that our GDP is nearly a quarter of the world's, and showed our status in numbers with a few less zeroes with the assumption that trillions are not numbers we throw around all that often.
Our example showed a woman earning $134,540 per year, who owes $125,000 mortgage and $1871 on her car.  Doesn't sound so bad, does it?
Sadly, there is no perfect analogy.  For example
  • The woman in our example will own her home outright 30 years from now, after paying her $125,000 mortgage, and that home will likely appreciate in value over that time.  US National Debt will do no such thing.  It is paying for current programs.  Thirty years from now, many of us will be dead, and that debt will continue to be paid by our children.  Therefore, when considering a policy that increases our debt, the first consideration should be whether it is important enough that we encumber our children with its cost.  For example, health care costs are 16% of the total budget, and that cost is rising at 12% per year.  At that rate, in 10 years, health care costs will be 50% of the US budget. This is an unacceptable situation that must be addressed in a way that cuts cost acceleration significantly, or it will bankrupt the next generation.
  • Lowering the level of national debt is a good thing, but it is the goal of no nation to completely pay off the national debt, as was the goal of the woman in our example to pay off her mortgage.  According to Asia Times, even thrify China has $407.5 billion (3.26 trillion yuan) national debt as of 2005, approximately 18% of its GDP.  Therefore, to quote a figure that each US citizen owes just under $40,000 per citizen is incorrect.  Cutting the debt by 25% would be a more reasonable goal, which would require an average of $10,000 in tax increase per citizen - in addition to balancing the budget.  Clearly, expentidures must be cut and taxes, increased.
  • The primary issue is not the deficit per se; rather it is the direction and trajectory of the deficit.  Right now, it's going up - fast.  That's very bad.  Piling on debt when revenue is flat is a terrible idea.  However, we are just coming out of a recession.  When the unemployment situation improves, revenues will increase.  No increase of revenue, however, will address the current rise in the health care portion of the budget.  That must be addressed through cost containment.
Reasonable people disagree about the particulars in the health care debate.  One thing, however, is certain.  The beneficiaries of non-action are health insurers, who are, by the way, the largest contributors to Congress (who have an excellent lifetime health package).  We must be vigilant that the effect of such lobbying not veil the critical nature of taking immediate, effective and long-term steps to stem the rise of health care costs in this country.  To take no action is to assure bankruptcy for the next generation.

Wednesday, December 2, 2009

Can the Nation Afford It?

An enormous amount of discussion about health care, additional troop deployments, extension of unemployment benefits, etc., begins with opponents saying, "We can't afford it."  Let's take a look at our debt, how it compares with other countries, and weigh the pros and cons of policy decisions based on an educated look at our financial circumstances.
Where would you rank the US among all debtor nations in the world?
1.  Ireland's debt is 1267% of its GDP, or $2.386 trillion as of the second quarter, 2009.  It produces the 35th largest GDP @ $267.579 billion.
2.  Switzerland's debt is 422.7% of its GDP, or $1.338 trillion as of the second quarter, 2009.  It produces the 21st largest GDP @ $500.260 billion.
3.  The UK's debt is  408.3% of its GDP, or $9.087 trillion as of the second quarter, 2009.  It produces the 6th largest GDP @ $2.680 trillion.
4.  The Netherlands' debt is 365% of its GDP, or $2.452 trillion as of the second quarter, 2009. It produces the 16th largest GDP @ $876.970 billion.
5.  Belgium's debt is 320.2% of its GDP, or $1.246 trillion as of the first quarter, 2009.  It produces the 20th largest GDP @ $506.183 billion.
6.  Denmark's debt is 298.3% of GDP, or $607.38 billion as of the second quarter, 2009.  It produces the 28th largest GDP @ $340.029 billion.
7.  Austria's debt is 252.6% of its GDP, or $832.42 billion as of the second quarter, 2009. It produces the 14th largest GDP @ $1.013 billion.
8.  France's debt is 236% of its GDP, or $5.021 trillion as of the second quarter, 2009.  It produces the 5th largest GDP @ $2.867 trillion.
9.  Portugal's debt is 214.4% of its GDP, or $507 billion as of the second quarter, 2009.  It produces the 37th largest GDP @ $244.640 billion.
10. Hong Kong's debt is 205.8% of its GDP, or $631.13 billion as of the second quarter, 2009. While not an independent nation, it produces the 41st largest GDP @ $215.354 billion.
11. Norway's debt is 199% of its GDP, or $548.1 billion as of the second quarter, 2009. It produces the 24th largest GDP @ $451.830 billion.
12. Sweden's debt is 194.3% of its GDP, or $669.1 billion as of the second quarter, 2009. It produces the 22nd largest GDP @ $478.961 billion.
13. Finland's debt is 188.5% of its GDP, or $364.85 billion as of the second quarter, 2009.  It produces the 34th largest GDP, @ $271.867 billion.
14. Germany's debt is 178.5% of its GDP, or $5.208 trillion as of the second quarter, 2009. It produces the
4th largest GDP @ $3.673 trillion.
15. Spain's debt is 171.5% of its GDP, or $2.409 trillion as of the second quarter, 2009. It produces the 9th largest GDP @ $1.602 trillion.
16. Greece's debt is 161.1% of its GDP, or $552.8 billion as of the second quarter, 2009. It produces the 27th largest GDP @ $357.548 billion.
17. Italy's debt is 126.7% of its GDP, or $2.310 trillion as of the first quarter, 2009.  It produces the 7th largest GDP @ $2.314 billion.
18. Australia's debt is 111.3% of its GDP, or $891.26 billion as of the second quarter, 2009.  It produces the 14th largest GDP, @ $1.013 trillion.
19. Hungary's debt is 105.7% of its GDP, or $207.92 billion as of the first quarter, 2009.  It produces the 52nd largest GDP @ $156 billion.
20. USA's debt is 94.3% of GDP, or $13.454 trillion billion as of the first quarter, 2009. It produces the largest GDP @ $14.441 trillion.  The next highest is Japan, at $9.5 trillion less, followed by China, at more than $10 trillion less.  A discussion of the level of US national debt in historic context can be found here.
(GDP ranking source: IMF, Annual GDP  source: CNBC)
Let's put this into context.  Let's move a couple of zeroes and turn the US into a person.  This person earns $134,540 per year.  She owes $125 thousand on a mortgage and $1871 on her car.  Would you consider this person in an unreasonably high debt level?
Next year, she will take out an equity loan on her home for $14,573.  This will increase her level of debt to $141,444 (assuming she pays only the interest on this debt during the prior year).  Now she owes 105% of what she makes.  Do you consider this person in an unreasonably high debt level?
At this point, compared with other nations we are 20th as a debtor.  Historically, in 1944, our debt to GDP was 91.45%, in 1945, 115.95% in 1946, 121.2% in 1946, 105.77% in 1947, 93.72% in 1948, and 94.56% in 1949. 
In 1949, the S&P 500 Index grew 18.79%.  In 1950, it grew 31.71%.  In 1951, it grew 24.02%.  In 1952, it grew 18.37%.  In 1953, it fell by .99%, and rose 52.62% in 1954.  Not only have we been at these debt levels before, but we grew handsomely after that period.
I'm not saying that I think debt is a good thing.  I don't.  But, I do think that the "we can't afford it" manta must be put into perspective.  If the policy issue is critically important, we can afford it.
The question should be whether the policy issue is critically important.

Monday, November 16, 2009

Mid-November Economic Outlook

Some very smart women I know noted recently that some women financial columnists, not unlike some of their male counterparts, sway their commentary toward a political point of view.  In my opinion, that does justice to neither financial analysis, which one would hope would lead where the data follow, nor politics, which one would hope to be policy-driven.  Whatever our point of view, data show both parties have contributed to the deficits we currently have. 
In this column, I endeavor to give financial information as it is, and put it into some historical context, in order that we might understand our best individual financial strategies and which governmental policy decisions one would support which are consistent with a given outcome.
I.  Unemployment
The unemployment rate rose to 10.2% last month.  Anyone who read the July 13 column was expecting this rise, when comparing the recent recession to that in the early 1980's, wherein I noted "the average unemployment rate in the last five months of the recession ended Nov, 1982 was 10.18%, and it averaged 9.8% for the year after that recession was over." 
Although this was expected, it is not good news.  Coupled with the fact that consumer confidence is trending lower, it does not bode well for any sector of the ecomony reliant on discretionary spending.
II.  Other Economic Indicators
Here, the outlook is inconsistent. 
  • Housing is trending upward
  • Manufacturing is improving
  • Non-manufacturing sectors look questionable
  • Car sales have slowed after the "cash for clunkers" program ended
  • Discount and luxury retail sales are moving slightly upward
  • Corporate profits are improving
III.  Conclusion
Economy as a Whole
Given these general economic conditions, it is unlikely that the US Gross Domestic Product will match previous 3.5% growth in the fourth quater.  Given current data and trends, it appears that the year will close with a 2% - 2.5% quarter, and possible decline to 2% at the beginning of 2010.  As the year progresses, if pos-recession employment trends hold true, growth will likely rise to 3% as 2011 approaches.
Investor sentiment has been very positive of late.  My macroeconomic analysis includes 22 indicators, and of all of them, I think sentiment is most predictive.  It is, however, a negative corollary, i.e., the higher the sentiment, the worse the outcome.  It's not the bargain it was before it rose 50%, and I'll quote Warren Buffett, "Be fearful when others are greedy: be greedy when others are fearful." 
I've started hearing, "Get in before you miss the boat."  That always makes me want to jump ship.

Greed and Fear

I was just looking over a list of the cities where the highest percentage of homes was "under water," i.e., the mortgage is higher than the house is worth. 
And a light went on in my head.
I used to manage money.  I heard people throw around the words "greed and fear" almost every day.  When markets were expensive, EVERYBODY wanted to buy.  When they crashed, you couldn't give stock away.
So, back to mortgages, more than half of the people in these cities owe more on their houses than they can get from a buyer.
  • Bakersfield, CA
  • Riverside, CA
  • Fort Meyers, FL
  • Fairfield, CA
  • Orlando, FL
  • Reno, NV
  • Port St. Lucie, FL
  • Phoenix, AZ
  • Stockton, CA
  • Modesto, CA
  • Merced, CA
  • Las Vegas, NV
That's over 1.8 million households, with houses worth about what they were sometime between 1998 and 2003.  Some of these people had to buy their homes for a new job, etc.  But most, I imagine, saw housing prices go straight up during that period and bought or refinanced, thinking they could make money when they sold.  Now, unfortunately, the majority of people in these cities are on the "fear" side of "greed and fear."
The return on investment for investors in the stock and real estate market, over the long term, is very similar.  Apparently, so is the motivation to buy.  We know, as investors, we should strive to "buy low and sell high," or as Warren Buffett says, "Be greedy when others are fearful: be fearful when others are greedy."  But that's not what we do.
Back to the stock market, you may have noticed it's going up.  A lot.  Let's take a look at that for a moment.
First of all, it's up about 50% from its low.  It came down 50% from its high.  So, does that mean we're back where we started?  Far from it.
Since we're near Thanksgiving, let's use the example of pie.  If we put a pie on the table, and the kids eat half of it, it's easy to visualize what's left: half a pie.  If we increase that half a pie by 50%, we add a quarter of a pie.  We've got 3/4 of a pie, or 25% less than the full pie that we put on the table.
So, if the market is down 25% from its high, does that mean that it's cheap?
If we look at history, the average price investors pay for every dollar the S&P 500 earns is $15.82.  Right now, you'll pay about $21 for next year's earnings.  At the market low, you'd have paid under $11.  So, it's more expensive than its average price, but that's not surprising, since it's roared back over 50% from last March.  Does that make you feel greedy (I've got to get in before I miss the boat) or fearful (I should have bought when it was down, and now it's probably due for a correction).
The best way to feel, in my opinion is emotionless.  Being rational, rather than greedy or fearful, is the best strategy.  One very good strategy is to review your spending, put some money aside every month and invest it no matter where the market is, making sure, of course that what you invest is long term money.  That means you won't be using it for ten years or so.
This constant investing strategy is called "dollar cost averaging," and will result in you buying sometimes when the market is low, and sometimes when it's high.  Overall, you'll average out the peaks and valleys and invest rationally - for the long term.
Then you can leave greed and fear for the drama queens.

Saturday, November 7, 2009

Straight Talk About Debt

No issue is more politicized than deficit spending.  Blame abounds, but little insight is given into the components of our deficit, and what reasonable action must be taken.
For a history of US deficit spending, click here.  For an estimate of our current national debt, click here.


The stimulus package comprises approximately 10% of our current deficit. 
The majority of the deficit spending is comprised of:
  1. Unfunded liabilities from tax cuts made by Jobs and Growth Tax Relief Reconciliation Act of 2003.  When enacted, the Congressional Budget Office estimated that the tax cuts would increase budget deficits by $340 billion by 2008.  That effect has been exacerbated by the just ended recession (see 3. below).
  2. Unfunded liabilities from Medicare Drug Program.  When enacted, Medicare chief Mark B. McClellan said the drug package would cost $1.2 trillion between 2006 and 2015.
  3. The opportunity cost in GDP lost because of the recent recession which began in 2008.  Generally, annualized GDP grows just under 3%.  For the 18 months ended June 30, 2009, annualized GDP contracted just under 2% - or 4.6% less than average.   From the last quarter in 2008 to the second quarter of 2009, our $12 trillion economy shrank an aggregate of nearly $400 billion - representing a huge loss of tax revenue, loss of employment, etc.,
No credible economist would argue that the stimulus package was unnecessary.  It was begun by necessity in the previous administration and continued into the current one.  It is not the source of our economic problems, and allegations to the contrary are clearly false.

Growth of health care costs is unsustainable.

Left unchecked, growth in health care costs, currently about 17% of our GDP, will bankrupt the US.  That is not overstated to create alarm.  It is a fact.
Those who take the position that we cannot afford to pass comprehensive health care reform are wrong. 
Health care costs are increasing 6.2% per year.  At that rate, in 25 years health care cost will be almost 30% of GDP.  In 50 years, it will be almost 50%. 
It's the biggest problem we have, and we must solve it in order to address deficit spending in any meaningful way. 
To counteract any effort to address this problem which may threaten their profits,
  • $3.8 billion has been spent by the insurance and finance lobbyists and
  • $3.69 billion, by health industry lobbyists,
according to Open Secrets, a non-partisan group referenced recently in an article by the Wall St. Journal.  No industries have contributed more, by the way.

Medicare first.

Only one group represents more clout than the two lobby groups discussed above.  Retired persons.  Grey panthers.  AARP.  Lots of boomers with time to spare, and raised during a time where the promise of Medicare (enacted in 1965) was sacred.  Prior to the aforementioned unfunded drug program in 2006,
  • the number of Medicare recipients increased 2 times - from 20.4 million to 42.6 million 
  • the economy grew 12 times - from $1 trillion to $12 trillion
  • Medicare spending grew 47 times - from $7 billion to $339 billion
Big problem.  Anyone can see that costs are rising too fast.  So where should we start?
  1. Increasing information technology for patients
  2. Containing drug costs via use of generics
  3. Limiting malpractice judgements (thereby limiting doctor's insurance premiums)
  4. Opening group insurance rates to small business
  5. Providing equal tax benefits to private insurance as employer-provided insurance
  6. Lowering the deductible and raising the contribution limits on Health Savings Accounts
These policies would assure that the goal of cost containment would be foremost in the minds of legislators.  If we don't get this right, we go broke. 
It's as simple as that.

Wednesday, November 4, 2009

Economic Highs and Lows

After a third quarter that dazzled like a diamond in the pile of coal our economy had been for the prior year and a half, we seem to be standing at a crossroads.  The stock market seems economically cheery, but most of us are not.  What's the best action to take in times like these?

I.  Define your goal in dollars

This sounds simple, but is not.  As a matter of fact, if it's done properly, it requires soul searching.  What is your economic goal?  Not your neighbors', not your friends', not your colleagues'.  Yours.
To know that answer is to define what makes you happy.  If you're doing the things that make you happy, then all you need to do is write down how much you spend on your happy life, and ensure you have the means to live it.
If you're not doing the things that bring you joy, however, this is a big job.  You need to visualize yourself in your fulfilled state, and calculate its economic cost.  That may take some time.
But, it's an investment well worth your effort.

II.  Identify your financial challenges
  • DEBT
Now, we're going to do the things that will get you to, or maintain your happy life.   If you're paying off debt, especially credit cards, your first step is easy.  Keep paying them down.  This is the singularly most treacherous obstacle to financial health.
But, what if you were on the verge of retirement, and all of a sudden, BOOM!  You heard the sound of your crashing 401(k).  Or, what about any of us that are on the path toward financial security, but not there yet?  What is the best course of action to take now?
First of all, as you have seen from the stock market's 60% rise since March, selling in a panic is a very bad idea.  If you did, you learned a valuable, if expensive lesson.  You sold when you should have been buying.  You learned why billionaire investor Warren Buffett says, "Be greedy when others are fearful, and fearful when others are greedy."
If you didn't sell, you're down 30% from the highs, and wish you'd invested more earlier in the year. I advised moving back into the markets slowly last November in order to "buy low."  The price of stocks is not as cheap as it was then.  So what do you do?
First, you put nothing into the market you need within the next five years.  You NEVER put money into the stock market that you need in the next five years.  The last year is a perfect example of why that is true.
Next, you realize that, at the last market top the price (or P/E) was 19.7, and at the last low, it was 10.3.  We're at 16.9 - not cheap.  So, it's very important that you think very carefully about buying stocks that have gone up in price very quickly, like Apple, Google and AIG.  A safer strategy right now is quality value stocks, like Microsoft, GE and Bank of America, whose prices have risen less quickly.
Finally, be judicious, but keep investing.  You're not buying on sale, so don't buy all at once.  Buy more when the market is down, and less on days when it's risen quickly, and put in a little every month rather than a lot all at once. 
But, keep in mind this is where your investments return more than inflation, and don't be deterred in saving for your goals.

III.  Watch your personal sentiment
The positive outlook for the US investor is very high right now.  Warren Buffett's advice is worth repeating here, "Be fearful when others are greedy."  Yet, the sentiment outside of Wall St. is decidedly more somber.
Here, we are discussing your personal sentiment.
No one is advocating a Pollyanna attitude.  Things are tough.
But, it is under our complete control how to face our tough situation.  One of my favorite stories about Thomas Edison included his reaction to a devastating fire that destroyed much of his expensive equipment and scientific notes.  Surveying the damage, he noted that, with "all the mistakes destroyed," he could begin anew with a fresh perspective.
Like him many women welcome less spending over the holidays, making gifts instead of buying them, focusing on spending time, rather than money on loved ones.  Some intend to keep these new rituals as part of their lives even after our financial challenges are behind us.
There is much to be gained by seeing obstacles as opportunities.

Tuesday, October 27, 2009

A Woman's World Economic View

I. The United States
You know we've been in a recession. If you're employed, you're probably nervous about keeping your job. And if you're unemployed, you know we've been in recession better than I could ever tell you.

It's up to the National Bureau of Economic Research to provide the official beginning and ending dates for recessions, and if you're interested in how they do it, you can read about it here. For the rest of us, we saw a banking crisis start late last year, and while we may not have known the details of how it happened, we certainly knew why.

We saw every Jane, Jean and Judy buying houses they couldn't afford, getting a mortgage based on her ability to fog a mirror, and saw real estate prices zoom upward - like the Internet stock prices did in the late 1990's. A familiar pattern, with a familiar "pop" end the end of the bubble, accompanied by falling housing prices.

Then we really saw the force of this nasty recession.

Unlike the past, though, it is not the US that is leading the world out of recession. We're mired in debt and have failed to pass even one piece of financial reform legislation more than a year after causing a worldwide economic downturn. Although we appear to have stopped our economy from shrinking, we expect anemic growth at best for the next year or so.

II. Our Place in the World Economy

From the end of WWII through the remainder twentieth century, the US was the world's economic powerhouse. A significant reason for that was attributable to "good old Yankee ingenuity." During the war, we focused our best and brightest toward the war effort. Because military technology at that time had civilian application, our best minds transitioned easily from the war effort to consumer technology.

In the latter part of the 1900s, the US voted with our pocketbooks to stop looking for the union label and outsourced much of our manufacturing to countries who could produce our goods with lower employment costs. As a result, we became less a manufacturer and more a service provider to the world. Our techies were golden, and Wal-Mart, our merchant.

We imported much more than we exported, and became a debtor nation to our manufacturers, especially China. Thus, a great wealth transfer took place in the so-called "third world," where manufacturing jobs expanded feverishly. The Chinese built an enormous middle class from their export business.

Now, they finance about 25% of our national debt, which is the sum of all the deficits, or overspending we have accumulated every year - plus interest. For a look at our historic debt levels, read my July 15 article.

III. Popular Misconception

There is no doubt that our deficit is high. Without mitigating the seriousness of that situation, though, understanding China's reliance on the US as a major buyer of their manufactured goods is critically important as we evaluate our status as a debtor nation. Their population has accepted Communist rule with an unspoken financial contract that it expects to reap the benefits of newly acquired wealth. Should China stop buying our debt, which continues to be the highest quality in the world, it will also assist in further lessening the value of our dollar and likely fuel an inflationary fall into another recession.

Smart sellers don't bankrupt their main customers, and China is not stupid.

Further, while anyone can see that both China and India have been growing rapidly, we are not on the verge of losing our position as the primary financial powerhouse in the world. Much has been made of the meager savings rate in the States as compared with the thrifty Chinese. Upon closer look, however, it's apparent that the Chinese are thrifty largely because they cannot rely on their government to care for them. For example, the Chinese social security system currently has $94 per retiree, according to Steven Roach, head of Asian Operations at Morgan Stanley. Yes, our system also has problems, as the Social Security trust fund remains an IOU by Congress, but ours does have a long, unbroken history of payment. The Chinese are accustomed to caring for themselves during disasters, both natural and financial, and therefore tend to put more aside.

Last, while we attempt to once again define ourselves as the technological leader in such growth industries as "green technology," we have, without question, both the best institutions of higher learning that are necessary for cutting edge research and development, and an open door to the best minds in the world.

Having taught math-based analysis courses at UCLA, I can attest to the great difficulty I had during roll call in our first sessions. These unpronounceable names were from every corner of the world, and the university was delighted to have them.

Once again, a combination of our open door to great world minds, with Silicon Valley innovation may be our economic savior, moving from high technology to green energy, and selling it to the world.

IV. Future Course

Once we have economic stability and a health care policy that will not bankrupt our country, our next priority must be to get our financial house in order. Let's look what high debt does to the country by personalizing it a bit. Let's say you earn $60,000 per year. After taxes, you net $4,000 per month. Your mortgage payment is $1,500 per month, you have a second mortgage of $500 for major home repairs, your car payment is $600, and you have eight credit cards on which you pay an aggregate monthly payment of $850. That leaves you only $550 every month for food, clothes, medical, utilities, gasoline and car repairs, movies, and all other incidental expenses. You're in trouble. You're probably increasing your credit card debt every month, paying for necessities you couldn't afford after paying your debt. So, your credit card debt is growing, and you're barely hanging on.

Magnify that situation, and you have our Federal government. Yes, we had to pass the stimulus package to save ourselves from financial ruin. Yes, we have to address the unsustainably high cost of health care. But once that's done, we must cut expenses and pay down our debt, just like the person in our example, or risk the future of our economy.

We must also acknowledge that, within the next century, the US will be one of the world financial powerhouses, but not the only one. If China learns to cooperate with the rule of international trade, and if India streamlines its impossibly difficult tangle of red tape, than a less indebted US will share its position with them.

V. What We Do

What we do matters. We shopped at Wal-Mart. By doing so, we exported manufacturing jobs.

Now, we must demand that our deficits be reduced and focus on educating our young people to work in a much more competitive and complex world.

Education has always been a women's issue. We know that the answer to education is not primarily money. It's a contract between teachers, parents and children that excellence is expected, and failure is failure on a world order.

What we do matters.

Friday, October 23, 2009

The Female Retirement Dilemma

Issues involved with planning for retirement are different for women than they are for men.  And understanding them can be the difference between comfort and poverty in our old age.

I.  By Saving the Same Percentage, We Retire with Less Than Half Than Men

Let's look at the result of both men and women putting aside 10% of their earnings for retirement.

First, women current earn, on average $.80 for every dollar men earn.  So now, for every $.10 in men's retirement accounts, women have $.08 - 20% less.

Next, women spend an average of eleven years of their productive working lives as an unpaid caregiver for a family member.  Assuming a work life from college graduation at 22 to retirement at 65, that unpaid absence lessens our earning years by another 25%.  That reduction in lifetime earnings, added to the fact that we lower salaries, results in us having $.06 for every $.10 men save for retirement - or 40% less.

So, if we assume average annual earnings of $60,000 during their careers, men will save $258,000 and women, $154,800, assuming that those savings are invested in assets that keep up with inflation. 

At 65, a man will need ten years of retirement income from savings of $258,000.  Invested in assets that keep up with inflation and taxes, he will have $25,800 per year for ten years. 

A woman, because of her additional life expectancy will have a sixteen year retirement with savings of $154,800.  Invested in assets that keep up with inflation and taxes, she will have $9,675 per year.

No wonder twice as many women than men live in poverty.

II.  What To Do

First, homemakers who care for children or parents should have Spousal IRA accounts funded on their behalf every year.  Considering that replacing all the functions provided would total approximately $30 thousand per year (Source:, it is only reasonable that your retirement is funded while you provide these services at no charge.

Second, women must learn to invest their retirement assets in a way that will maximize growth without taking an inordinate amount of risk.  The two long term investments that provide the highest return are stocks and real estate.

In the last few years, we have witnessed the volatility both these investments have.  But, let's put this into perspective.  The stock market high was in August, 2007.  Just over two years later, the market is down about 30% from its high.  There are two considerations we must make:
  • These are long term investments, intended for use in ten years or more.  In the 30+ years since I've been in the business, I've witnessed a years-long 50%+ correction in the 70's, a heart-stopping drop in the '80's, a precipitous fall in the 90's, the dot com bubble bursting in the early part of this decade and the current correction.  These are predictable, and those who have made wise stock investments and held them have fared far better, even at this point, from those who put their money in so-called "safe" investments, like money market accounts, Treasury Bills and insured savings accounts, which fail to stay ahead of inflation and taxes.  Note that there were two times billionaire investor Warren Buffett publicly admitted to buying stock in US companies:  once, during the correction in the 1970's; and the other, from March to year end, 2008.
  • Even at retirement, we have life expectancies that mandate we stay ahead of inflation and taxes, and therefore advise consideration of keeping at least a portion of our long term portfolios in capital markets.
  • Conversely, our short term (five years or less) cash flow needs must be kept in safe investments, so that our expenses are met and we are not tempted to sell our long term investments during market lows. 
Third, we've seen the outcome of abdicating responsibility for our financial lives with the likes of Madoff, Stanford, Enron, WorldCom and others.  There is no one who will take more of an interest in our financial health that ourselves.

It requires only that we gain the knowledge to take action and the willingness to provide for our future.

Sunday, October 18, 2009

Why Inflation is Worse for Women

Inflation is one of those vagaries of economics that most people hear enough to have an idea of what it means, without being able to define it precisely. Why it's important to know exactly what it is - particularly for women.

I. What It Is

Inflation is simply the measurement of how much prices rise every year. The most dramatic example of inflation is the price of houses. When I was about six years old, my parents bought a house in a suburb north of Los Angeles for $35,000. Even with the dramatic downward adjustment of house prices in that area within the last few years, that house is worth over $750,000. Over that time, the price of that home has grown at an annual rate of over 6.25%.

The way an annual growth rate works is

Price multiplied by Growth Rate equals New Price.

For example, the first year would be $35,000 X 6.25% = $2,187.50. New Price is $35,000 + $2,187.50 = $37,187.50.

The second year would be $37,187.50 X 6.25 = $2,324.22. $37,187.50 + $2,324.22 = $39,411.72. As you can see, the amount of growth in the second year is higher, because the New Price in the second year is higher.

This additional growth happens every year, and is called the effect of compounding.

II. Inflation and Women

Women live longer than men. Consequently, their investments have to last longer than men's do, in order for women to last for their longer lifespan. When you add to our longevity the fact that we earn less than men (currently about $.80 to the dollar) and average eleven years outside the workforce as non-paid caregivers for family members, it's easy to see that we start with less money, and need to make our money do more, or risk facing poverty in our old age.

III. The Risk of No Risk

The recent correction has been a stark reminder that short term volatility is a fact of life in the stock market. Many have said, "I'm never putting money into the market again. I'm sticking with safe investments." While it is certainly an understandable reaction, it is one that could risk women's long-term financial well being. Here's why.

The common economic barometer for a "no risk" investment is the one year Treasury Bill. Safety is assured, as repayment by the United States Treasury is considered certain. As of October 16, the one year Treasury Bill is paying .36%.

You must pay Federal taxes on the interest earned on your Treasury Bill. Married people earning less than $137,050 have a marginal tax rate of 25%.

Inflation over the last year has run about .31%.

So, your actual return for this "safe" investment is

.36%, Interest Rate, minus

.09% Tax Rate (25% tax on .36%), minus

.31% Inflation (the rise in costs over one year), equals


After inflation and taxes (called "real return") you are behind where you started.

As a long term investment, this safe investment is a guaranteed loser.

IV. Some Other Types of Investments

We saw that the type of safety provided by Treasury Bills will actually lose ground over the long term. So, what's a girl to do?

A. Bonds

Bonds are loans. Treasury Bills are loans to the US government.

You can also loan money to corporations, who will pay you back, with interest. Corporate bonds are rated as to the certainty of repayment. "Investment grade" bonds are considered safe, and "junk bonds" are just what they sound like. High interest and low probability of repayment.

An investment grade bond is currently paying 5.62% for eight years.

5.62% Interest Rate, minus

1.41% Tax Rate (25% of 5.62%), minus

0.31% Inflation equals


Your risk is that inflation will rise (as virtually every economist agrees it will) over the next eight years, and cut further into your return. But, at least you're staying ahead of inflation.

B. Stocks

Owning stock is owning a piece of a company. Owning stock in just one company is very risky, because if that company has financial problems you can lose some, or in cases like Enron and WorldCom, even all of your money.

Most people diversify their investments by owning many companies. One way of doing that is to invest in an index, like the Dow Jones Industrial Average or the Standard and Poor's 500 Average. Since the Dow has 30 stocks and the Standard and Poor's Index has 500, the latter is a more diversified investment, and is the measurement against which most fund managers base their performance.

Over very long periods of time, the stock market's return is about 9.8%, about 3.5% of which is dividend payments.

9.80% Return, minus

0.85% Tax Rate (3.5% dividend payment times 25%), minus

0.31% Inflation, equals


There are a thousand provisos here. The growth in your investment (besides dividends) is taxable when you sell it. Current inflation rates are extraordinarily low, so your normalized return is more like 6.5% than 8.64%. But, in general, you get the point. Your money grows much faster in the market - EXCEPT there are predictable and certain big price fluctuations. You just saw one.

I've seen one in the 70's that took half the value of the market away in a long, grueling grind downward that lasted years. I saw one in 1987 that dropped far and fast. I saw one in the 90's. And there is this one.

So, short term money does not belong here. If you need it in five years, it doesn't belong here.

C. Real Estate

Real estate investments (not your home) have returns that are very similar to stocks. As you have seen, this too is a volatile enterprise. It's also highly specialized and takes a very large initial investment.

V. Risk and Return

If you know the risk, it is lessened. If you have a long term horizon, know that the stock market is VERY volatile and NEVER either sell in a panic - or invest money you need within five years - than you won't be spooked when the inevitable happens.

For those of us who are 50 and older, adding more bonds and lessening stock exposure is smart, as older women have less tolerance for price fluctuations than younger women. Some use the simple equation of subtracting their age from 100, and putting that amount in diversified stocks, and the rest in bonds.

VI. The Bottom Line

Let's say you're saving $7,500 a year for the next ten years for your retirement.  Using the examples provided above:

In a Treasury Bill, you'll end up with $74,865 (less than your original investment).
With Corporate Bonds, you'll have $89,628

With Stocks, you'll have $112,008.

Yes, there will be volatility in the stock market. But, with your long term horizon, you'll know better than to panic and sell, and help yourself not be one of the 13% of women living in poverty at age 75.

Tuesday, October 13, 2009

Who Can You Trust?

Loss of Trust

Bernard Madoff defied the odds by returning a consistent 12% annual return to his investors. 
Stanford Financial assured its clients that they were investing in safe, insured certificates of deposit.
WorldCom's balance sheet was remarkable in its ability to grow profitably.

All were lies.  Investors in each of these enterprises lost billions of dollars.

Market Volatility

Even those women who were fortunate enough to invest with honest advisers see their retirement savings cut by 1/3.  We are understandably very hesitant to assume risk in this environment.

Disadvantages for Women Investors

Adding to those challenges, women also face the facts that we:
  • Earn $.80 for every dollar men earn;
  • On average, are out of the work force for eleven productive years as an unpaid care giver for a family member; and
  • Women live longer than men.
So, what do we do? 

Last October, I discussed this situation using an example of a woman I called Sarah.  While she had saved almost $32 thousand, collected $2000 per month in Social Security payments and owns her $335 thousand house free and clear, she was unable to maintain even basic living expenses.  Why?

Sarah invested 70% of her money in so-called "safe" investments like insured Money Market Funds and Bonds.  While her investments grew slowly and predictably, after deducting the loss of spending power due to inflation, her investments barely kept up during the time she was saving.  To make matters worse, she has a long life expectency after retirement that will damage her spending power with these investments even further.

That's what not to do.

While, as we've seen lately, the stock market and real estate investments can be wildly volatile in the short term, over the long term they are the investments that are most likely to grow in excess of inflation.

Stocks?  Now?

Last November, I advised getting back into the stock market  If you had followed that advice and bought the S&P 500 index, that investment would have grown by 11.3%.  A combination of money market funds and bonds would have grown by 2.5%.  Inflation would cut your return on the S&P 500 to 11%, and 2.2% on your bonds.

That could be the difference between a comfortable retirement and one where you can barely pay your bills.

Women and Poverty

According the Center for American Progress, "elderly women are far more likely to be poor than elderly men."  More than twice the number of women over 75 are poor compared to men.  Those are the facts.  We need to face them.

The Real Risk

The real risk we take is not taking risk.  We know that, over time, the stock market and the real estate market are the two investments that grow in excess of inflation over time.  We know that both can be volatile over the short term.

The Ten Commandments for Investing

1.  Buy low.  Sell high.
That means buy when nobody else wants to.  That means buy on sale.
2.  Diversify
The Standard & Poor's 500 Index can be purchased for a little over $1000 per share right now.  It gives you a stake in 500 large companies, mostly based in the US.
3.  The market is volatile.
Don't sell in a panic.  (See #1.)
4.  You have an 81 year life expectency.
Even when you're retired you need investments that will outperform inflation.  One simple rule of thumb?  Subtract your age from 100.  Put that percentage of your investments in stock.
5.  It's not too late.
Maybe you waited until now to start investing, and you think it's too late to start.  It's not.
6.  It's not too complicated.
You're smart.  You can do this.
7.  Don't be afraid of risk.
Be afraid of being old and poor instead.
8.  Debt is bad.
Pay it off.  That's a good initial investment, if you're just getting started.
9.  Pay low commissions.
They diminish your return on investment.  Use a discount broker, like ScotTrade or TD Ameritrade.
10.  Keep investing.
Put money aside for yourself, and invest regularly.  Putting yourself first is not selfish.  It's smart.

Friday, October 9, 2009

It's Up! It's Down! It's Cheap! It's Expensive!

If you listen to the business news, a myriad of market pundits are shouting,
  • "Beware!  The market has gotten ahead of itself!"
  • "If you don't get in now, you'll miss this upturn!"
  • "The market is getting very expensive here!"
  • "The market is historically very cheap!"
  • "Buy gold!"
Who's right?

Well, as always, I think the best judge of that is you.  All you need is some information, and you're likely to make a much better decision with your money than anyone who has an agenda.

I.  What do we mean when we say "the market?"

Many of you have heard of the Dow Jones Industrial Average, often called the "Dow."  The Dow is thirty companies (3M, AT&T, Alcoa, American Express, B of A, Boeing, Caterpillar, Chevron, Cisco, Coke, Disney, DuPont, Exxon, GE, HP, Home Depot, IBM, Johnson & Johnson, Kraft, McDonalds, Merck, Microsoft, JP Morgan, Pfizer, P&G, Travelers, United Tech, Verizon and Wal-Mart.)  Since there are about 5000 publicly traded companies, so this is a rather small snapshot.

A much better measurement of the market is the Standard & Poor's 500 (S&P 500), which are 500 large publicly traded stocks, most of which are based in the US.  Let's use this much broader index when we refer to the market.

II.  What is a P/E?

A P/E is a fraction which consists of
  • The Price of the index as the numerator, and
  • The Earnings for that index as the denominator. 
The S& P 500 index is now trading at 1067.59.  That's the P.  It is projected (by Standard & Poor's) to earn $69.20 next year.  That's the E.  1067.59 divided by 69.20 is 15.42.  The P/E of the market is 15.42.  That means that for every dollar the market earns, you are paying $15.42 when you buy the index at this price.

Last year, the P/E was 28.37.  The market was trading at 1099.23, and it earned $38.74 over the last twelve months.  The market is cheaper than it was last year, but you knew that. 

The real question is what is a "normal" P/E?  The historic long term average for the S&P 500 is 15.82.  So, this index is cheaper than its long term average.

III.  The Market is Ahead of Itself

Let's see if people who say this are right.  At its low last March, the S&P 500 traded at 666.79.  It is now
  • Up 60% from its low of 666.79 last March, and
  • Down 30% from its high of 1564.74 in October, 2007
It's trading very near a "normal" P/E of 15.82.  People who think the market is ahead of itself think that times are not normal.  We have a huge deficit.  We have high unemployment.  We are coming out of the worst recession since the Great Depression.

These people may be right, except for one thing.  The market is a discounting mechanism.  That means it is priced for events about 6 - 9 months in the future.

Do you think things are getting better?  Do you think we're on the road to economic recovery?  If so, the market may be fairly priced (but not the bargain in was in March).  If not, you probably think it's come too far too fast.  Your opinion is as good as any.

IV.  If you don't get in now, you'll miss this upturn.

If the best reason you can give for doing something now is that prices will go to the moon if you don't, then you're using the same reasoning that people used to buy Internet stocks in the late 1990's and houses in this decade.  It's not a good reason to buy.

V.  Buy gold

Gold is, historically, a TERRIBLE investment.  What it is, however, is a hedge, and insurance policy against disaster.  If currencies lose value (like our dollar has in the recent economic meltdown), people rush to gold as an internationally accepted commodity. 

If you think the US economy is going to hell in a hand basket, buy gold.  Otherwise, it's ridiculously expensive (an all time hight of $1050 per ounce), and is much more likely to go down over the long term than it is to go up.

So, there you have it.  You have all the information you need to be a pundit.  Draw your conclusions based on the facts, and act accordingly.

Wednesday, October 7, 2009

What If We Had A Financial Meltdown - And Did Nothing

I.  What Financial Reform Says

Earlier this year, we discussed the Obama Administration's financial regulation proposals in detail, breaking the discussion into a four part series.  Here is the full text of the proposal

If you didn't have a chance to read that discussion, here it is.

Given the severity of the recent recession, not to mention its causes, the one issue I did not discuss was the possibility that Congress would take no action at all. 

So, of course, that's exactly what our elected representatives did.  Or, did NOT do, to be more precise.

II.  What does Financial Reform have in common with Health Care Reform?
Last month, we saw how financial reform is inextricably entwined with health care reform.  As you know, an integral part of health care reform addresses insurance reform,e.g., mandatory covering of pre-existing conditions, the much-discussed "public option" and so on.

Since we, as taxpayer/owners of insurance bohemoth American International Group ("AIG"), have paid $1400 per family to date for its bailout, after it took extraordinary unregulated risk in the housing market, you'd think this issue would demand resolution.

Think again.

Whether you support the "public option," a government-run program that will compete with insurance companies, or the insurance "co-op," designed to provide a more competitive environment for health insurance, know this.  Insurance is regulated by each state - not the Federal government - and in many states, as much as 85% of health insurance is held by one insurer. 

If this were true for Microsoft, the company would be sued for having a monopoly in that state.   Yet, it is okay for insurance companies, because each state operates with different rules.

This is unnecessarily complicated, non-competitive and does absolutely nothing for anyone except insurance companies.

III.  Dare we ask that two things be done at once?

If you think it's too much to address financial reform and health care reform in one Congressional session, then be prepared for more of the same. 

If not, you may want to drop a quick note to your elected representatives, with whom, by the way, financial lobbyists have spent $3.4 billion to ensure their support. 

Here's where to find them.

Saturday, October 3, 2009

Important Pricey Leather Handbag Information

I.  Gender Marketing says. . .

Men identify deeply with their jobs.  They're hardwired for task orientation.  When they lose their jobs, they tend to lose their identity.

"Women are . . . worried about their jobs, but not to the extent that they feel their . . .existence is being threatened, and so they are in the mood to buy despite the crisis," gender marketing expert Diana Jaffe told Reuters recently. 

So, do we conclude that men face the current economic slump by questioning their identity and cutting back on spending, and women make themselves feel better by shopping for pricey leather handbags?

II.  Why do we buy?

Maybe watching "Madmen" has hurled us back in time and made us behave as though we were living in far less liberated 1960's.  Maybe we are taking the ostrich approach to managing our money, and, like Nero, are fiddling while Rome burns.  Maybe, in this particular case, we should behave more like men - but for very different reasons.

We need not define ourselves by the way we earn a living in order to face our current economic situation.  We can continue to be well-rounded human beings who know that our net worth and our self worth are very different.  But in order to pursue the things that bring us happiness, we'd best ensure we have a roof over our head and food on our table in our old age before we buy "pricey leather handbags."

Yet, the fashion industry send us messages - four times a year, via preposterously thin teen-age girls - that we "need" what they offer.  Do we?  Does spending money on handbags and shoes really make us feel good enough to forego providing for our long term needs?

III.  Put Yourself First

If you have put aside enough for yourself to live comfortably for the rest of your life and you need a handbag, by all means buy one, as long as you have the money.  But if you have not provided for your long term security, exactly what do you accomplish by buying something that you truly cannot afford? 

The appearance of wealth is nothing.  It is for someone else.  It speaks to others - not you.

IV.  You Say

Times are difficult.  Current times are more difficult than the grueling recession that took place in the 1970's, when I began working in finance.  It was a time when wealth was lost in a grinding market correction that took place over years and cut portfolios in half.  Inflation was out of control and job losses made the national mood grim.  It was also the time when Warren Buffett invested heavily in the stock market and earned wealth that is measured only slightly less than that of Microsoft founder Bill Gates.

It is your right to buy whatever you want, whenever you want.  You can be tempted by the fashion industry to buy gladiator shoes, designer bags or whatever it is - as long as it speaks to your authentic self.

You can also decide to put that money aside in investments that will outperform the ravages of inflation, like stocks and real estate, which will provide for you for the rest of your life. 

One in four of us will live to age 95.  Elderly and destitute with a pricey handbag in my closet, is not the choice I make for myself.  I invite you to join me in defying gender marketing research, and investing your time and resources in investing in your future.

Thursday, September 24, 2009

Happiness Is. . .

"Happiness is," said a song that was popular when I was a girl, "different things to different people."

A few days ago, New York Times columnist Maurine Dowd noted that the General Social Survey, "which has tracked America's mood since 1972," found that men are getting happier and women are "getting gloomier." Ms. Dowd quotes Marcus Buckingham, a former Gallup researcher and current Huffington Post blogger, as noting that "women begin their lives more fulfilled than men, as they age, they gradually become less happy."

From the women of The View to moms on the playground, opinions about why this state of mid-life malaise abound.
  • Our lives are more crowded with our increased options of family, work, friends
  • Our biology makes us more sensitive, and therefore vulnerable
  • Our culture is youth obsessed, especially as it relates to women

Stretched too thin, feeling responsible for far too many things for time to allow, becoming less and less culturally attractive, who would NOT feel unhappy? In every discussion I've heard, reasons are many, but, as Ms. Dowd concludes, the answer is a paradox.

Perhaps. But, maybe our answer is the fact that we simply do not take time, individually and as a group, to address our unhappiness. Perhaps we have invested our time, energy and resources in others and have left ourselves feeling impoverished. As a person who has earned her living in advising others how to invest their wealth, I now wonder whether the same structure that one uses to develop a portfolio can address this problem. Here is a general example of how this process works.

  • What is your goal? In investment terms, the answer is a number. In life terms, the answer is your response to "What makes you happy?" Answering that question requires enough time to consider what it is that brings you true joy. It's much easier to say, "I don't have time to think about that," than "I don't know what makes me happy." The latter statement is a symptom of not having nurtured oneself. And, over time, that lack of nurturing will likely result in deep unhappiness.
  • What must you do to achieve your goal? In investment terms, this answer requires both sacrifice and risk. Sacrifice involves putting money aside for the future, and risk involves investing in assets which can, as we have all seen lately, fluctuate wildly in short term price, but, over the long term, earn more than inflation. In life terms, we must also be willing to make sacrifices and take risk to get what we want. We must develop a strategy to acquire those things that bring us great joy, whether they be experiences or self expression. We must surround ourselves with those who will help us, and rid ourselves of those who will not. We must cease to think of providing for ourselves as "selfish," and begin to treat ourselves as the valuable beings that we are.
  • What must you do to stay on course? In investment terms, this requires a minimum of an annual check-up to measure progress. In life terms, we must also constantly monitor our progress, and ensure that we do not allow ourselves to feel guilty, unappreciated, dismissed, or any other negative emotion about achieving what it is that we want.

By following this investment structure, we will find that our lives cannot become too crowded for ourselves, because we will filter out that which is not fulfilling our life goal. We will expand our sensitivity to ourselves by putting ourselves first, without a moment's thought that we are being selfish. We are merely nurturing ourselves in order that we can be more nurturing to others. Finally, we will dismiss any assertion that we are not attractive people. We will value ourselves much too highly to think we must look any certain way in order to be attractive. We will define ourselves by our own standards.

Then, we may give our daughters, nieces and young women friends the priceless gift of valuing themselves on their own terms. And, perhaps, like us, they will use their options to achieve happiness as they define it.

Friday, September 11, 2009

Health Care Reform Meets Financial Reform

I. Health Care Reform - and Insurance

In response to President Obama's Health Care Reform address this week to a joint session of Congress, the Cato Institute recommended that, in order to help achieve the goal of cost control in comprehensive health care, "(p)eople should be allowed to purchase health insurance across state lines," noting that "(o)ne study estimated that that adjustment alone could cover 17 million uninsured Americans without costing taxpayers a dime."

Unfortunately, the insurance industry is regulated on a State level, so such across-state-lines purchase of health insurance is currently not possible.

II. Financial Reform - and Insurance

As I mentioned recently in the first of a four part Financial Reform legislative review series, State regulation of insurance companies makes regulatory oversight very difficult. That difficulty in regulating this industry contributed in large part to the financial meltdown that began last year, and continues today.

III. Health Care Reform Meets Financial Reform - with Insurance

Insurance regulation is again brought to the forefront as we discuss means to achieving bi-partisan support for the adoption of comprehensive health care reform in the United States, just as it was when financial regulation was being discussed. And, as this reemerges, we find Morgan Stanley CEO John Mack, who guided that institution through the recent financial meltdown, saying:

"I'm somewhat disappointed that we've lost a little of the steam about getting financial reform. We do need system-risk management." Risk management, by the way, is just another way of saying 'insurance.'

These are complex times. There are complex domestic issues that require consideration on many fronts.

IV. Can We Do More Than One Thing At a Time?

It is not appropriate to say, "Since we've avoided the seizing up of the financial markets, now we can concentrate on health care." We cannot discuss the health care without discussing the insurance industry - and a large part of financial meltdown involved abuses from industry.

To date, no financial regulation reform has passed. Every US woman and man has a stake in this. It was with $180 billion of your money that insurance giant American International Group ("AIG") was bailed out, after having issued innumerable credit default swaps. What were those? They were unregulated promises by AIG to guarantee mortgage payments - for which they had no way of paying when the mortgages defaulted. In other words, AIG (and many others) collected fees for promises they made, but could not keep.

Thus, the insurance industry is at the heart of both the financial crisis and the health care debate. We must accept that both are critical components of our economic survival.

I have heard no compelling argument for keeping the insurance industry regulated at the State level. That is too complex from a regulatory perspective, and non-competitive from a health insurance perspective. Both sides of the political aisle seem to agree on that.

V. What Action Can You Take?

First, become acquainted with the issues. The administration's financial reform proposal is referenced and discussed at the link provided above in Section II. Whatever your opinion with respect to the version of health care legislation you support, it is likely, unless you own or lobby for an insurance company, that you support the free market competition that will result from the ability to purchase health insurance across state lines.

If you refer to Open Secrets, a non-partisan group referenced recently in an article by the Wall St. Journal you will see that the two top industries spending the highest number of lobbying dollars to influence legislation are:

  • Finance, Insurance & Real Estate $3.7 billion
  • Health $3.55 billion

Remember that your Congressional representatives work for you, not lobbyists, and that it is you who pays for their health insurance, which is likely far superior to yours. To voice your opinion on Federal regulation of the insurance industry, here is a list of your representatives, with their email addresses

As always, your comments and suggestions are most welcome.

Tuesday, September 8, 2009

How Much Will YOU Earn?

As I mentioned six days ago , I look to Standard & Poor's for earnings projections. I had mentioned that, in the next twelve months, projections for S&P 500 earnings are $48.67. Note that the next twelve months are September, 2009 - August, 2010.

Last Saturday, Barron's magazine published projections for 2010 by ten strategists, who charge dearly for their advice. These projections are for January, 2010 - December, 2010. Let's take a look.

I. Next Year's Earnings for the S&P 500

Since I'm writing this column, I'll go first.
  1. Standard & Poor's projects S&P 500 earnings to be $72.99 in 2010.
  2. The optimist of the Barron's group is Prudential International, which predicts $80 - 9.6% more than S&P.
  3. Three (BlackRock, Goldman Sachs and JP Morgan Chase) predict $75 - 2.75% more than the S&P.
  4. Two strategists (Deutsche Bank Private Wealth Management and Morgan Stanley Investment Management) predict $72 - 1.4% less than S&P.
  5. US Trust projects $70.50, and and RBC Capital Markets, $70 (about 3.5% - 4%) less than S&P.
  6. Citigroup predicts $68 - 6.8% less than S&P.
  7. Gloomy Barclay's Capital? $60 - almost 18% less than S&P.

So, one of the statistical methods you may have slept through in Stats Class, was to throw out the highest and lowest numbers and average the rest. Doing so gives us $72.19 - 1% difference between S&P's projection and that of esteemed (and expensive) strategists. That's not much.

II. The S&P 500 Index - Left Alone vs. Sliced Up

If you buy the S&P 500 Index, it looks like this:

  • Technology - 18.6%
  • Financials - 15%
  • Health Care - 13.5%
  • Energy - 11.7%
  • Consumer Staples - 11.6%
  • Industrial - 10%
  • Consumer Discretionary - 9.1%
  • Utilities - 3.8%
  • Materials - 3.4%
  • Telecommunications - 3.2%

Our esteemed strategists, on the other hand, want you to buy individual sectors of the index that look like this

  • Technology - 22.2% (3.6% more than the index)
  • Energy - 19.4% (7.7% more than the index)
  • Materials - 19.4% (7.7% more than the index)
  • Industrial - 16.7% (6.7% more than the index)
  • Financials - 13.9% (1.1% less than the index)
  • Health Care - 5.5% (8% less than the index)
  • Consumer Discretionary 2.8% (6.3% less than the index).

They don't want you to buy any

  • Consumer Staples (11.6% of the index)
  • Utilities (3.8% of the index), or
  • Telecommunications (3.2% of the index)

III. The Cost of Buying the S&P 500 Index vs A La Carte

So, basically, this is the deal. You'll be paying a big fat fee to strategists in order to slice up the sectors of the S&P 500, ignoring about 20% of it, and whittling the remaining 80% + up or down by an average of about 5%. They're suggesting that, by doing this, you will see earnings increases on your investments of an average of about 24.5% - less their big fat fee.

You'll pay nothing to me to recommend the S&P, which is predicting earnings increases of 34.5%. And neither S&P nor I care whether you buy or not.

Strategists, on the other hand, stake their livelihood on whether you pay them for their opinion.

Which do YOU think is the better deal? Just for fun, let's keep track of the difference between buying the S&P 500 index in 2010, and doing what strategists suggests throughout 2010. Then, we'll subtract their average big fat fee from their returns and nothing from mine, and see who wins.

It's one woman versus ten men. I'm comfortable with those odds.

Wednesday, September 2, 2009

Is the Stock Market Cheap?

If the answer were "yes" or "no", this would be a short column.
I don't write short columns.
First of all, we have to decide what we mean by "cheap".
I. Ancient History
Going back to the last quarter of 1936, you would have paid an average of $15.82 for every dollar of earnings for the Standard and Poor's 500 Index (more diverse than the better known Dow Jones Industrial Average, which consists of 30, as compared with 500 companies). That average price is the numerator (top number in the fraction) of the Price/Earnings, or P/E ratio. The denominator (bottom number in the fraction) is the amount the S&P 500 earns. So, the average P/E (or amount you pay for every dollar of earnings you're buying) has been 15.82
Last Friday, the S&P 500 average was $1028.93. That's the price. S&P projects the next twelve months' earnings to be $48.67.
1028.93/48.67 = 21.14 Right now, you're paying $21.14 for every dollar the S&P 500 is projected to earn for the next year. That's 25% more than the average price has been since 1936. So, using that measurement, no, the market is not cheap.
II. Last Year
A year ago last Friday, the S&P 500 average was 1282.83. Earnings over the last year were $33.60.
1282.83/33.60 = 38.18. $33.18 is 80% more than $21.14, so the market is a lot cheaper than it was last year. You may have heard something about this. The market is down a lot.
III. Forward vs. Trailing Earnings
Many of you are racing to your Wall St. Journals and saying, "Hey, Kitty, what gives? Their P/E ratio is different from yours!"
You're right.
Some financial publications do the math this way:
Right Now Price divided by Last Year's Earnings
I do my math like this:
Right Now Price divided by NEXT YEAR'S EARNINGS
Why do I do that? Last year's earning were earned by people who bought the market last year. When I talk about earnings, I am talking about now - not last year. I get my earnings projections from Standard & Poor's - not some Wall St. schlub who's trying to talk me into buying or selling. Standard & Poor's doesn't care if I buy or not, so I trust their projections more than I trust those who have a stake in how the answer looks.
My preference.
IV. Comparable Yields
The Federal Reserve, and a lot of other really smart people determine the value of the market by comparing it with what you'd get if you invested someplace else.
Since you're much too smart an investor to jump in and out of the market, paying short term capital gains taxes on all your sales, you are a long term investor. Short term investors don't belong in the stock market. Stock markets can correct, as you've seen recently, and short term investors can get their heads handed to them in corrections.
So, the long term investor compares the price they pay for the market to another long term investment - the 10 year Treasury Note. That's a loan to the US Treasury for that collection of deficits we've been running up lately.
The ten year Treasury Note is paying 3.48%. So, what is the market paying?
It's the reverse of the P/E, it's E/P. Again, the projected earnings are $48.67 and the market is trading at 1028.93.
48.67/1028.93 = 4.73%
4.73% is 26% more than the 3.48% Treasury Note yield, so your return on the stock market looks a lot better than your return on a 10 year bond. And it should.
Those stock market earnings aren't guaranteed. Something bad could happen. There's risk in the market. That's why you should get paid more.
But 26% more is pretty good under anybody's measurement.
V. So, is the market cheap?
Historically cheap? No
Cheap compared to last year? Yes
Cheap compared to comparable yields? Yes
More yes than no.
If this stuff were easy, everybody would be rich.

Tuesday, September 1, 2009

A September Snapshot

September 2009 looks much better than September 2008.
We've certainly heard everyone and her mother say we're climbing out of recession. Shall we take a look and see whether everyone is actually right?
For the purposes of comparison, we'll compare the data available thus far in 2009 with the full year of 2008.
I. Manufacturing
Industrial output has averaged 97.4 over the first seven months of this year, with July actually showing upward movement for the first time this year, probably due in large part to the "cash for clunkers" program. 2008 industrial output averaged 109.6, however, so we're still down over 11% year-over-year.
The percentage of manufacturing capacity we are using has averaged 69.4% this year through July. (Full capacity is generally thought to be 84%.) Last year's was 78.3%, so here again we're down over 11%. The good news, however, is that capacity utilization has been climbing upward for five straight months.
II. Gross Domestic Product
It is generally thought that an economy our size can grow at 2.8% per year at full employment without causing inflation. In 2007, the US economy grew at 2.5%. In 2008, our economy contracted by 1.8%. In the first two quarters of 2009, GDP was -6.4% and -1%, respectively. Most economists predict flat to 2% growth in the third quarter of this year.
III. Unemployment
Last July, we looked at historic unemployment data and saw that unemployment generally begins to improve about one year after a recession ends. 2008 unemployment levels averaged 5.76% and this year, 8.77%. We can conclude, based on these data, that unemployment will begin to improve in the third quarter of 2010.
2010, however, is a mid-term election year, and this issue has already begun to be politicized. For that reason, the current Congress may approve an additional stimulus package aimed at improving the unemployment outlook, and, in doing so, their re-election prospects. From a strictly economic perspective, this seemingly unnecessary expenditure, and additional deficit to be added to the burgeoning national debt, would seem to be a mistake.
But, I never underestimate the lengths to which our esteemed members of Congress will go to be re-elected, so I consider an additional stimulus to be a needless, but likely event.
IV. Consumer Confidence
As you have undoubtedly heard, 2/3 of US GDP is consumer spending. As you have undoubtedly experienced, consumers are somewhat less confident than they were before this recession. To validate your feelings, consumer confidence was 103.49 in 2007, 56.76 in 2008 and, thus far in 2009, is 39.89.
Before we assume that all is lost for any potential growth in GDP owing to our cautious consumers, please take a look at the often ignored export situation, discussed recently
Should the hypothesis that newly enriched emerging markets will spend their dough on our exports, we may have a growth engine that could replace our previous non-stop, debt-riddled spending spree with something more sustainable.
V. Inflation
From 1973 to 1995, inflation averaged 2.8%. Most economists believe that 2.5% inflation allows sustainable economic growth and full employment. In 2007, inflation averaged 2.87%. In 2007, inflation rose to 3.85%. This year, with falling energy prices due to lessening demand, as well as consumer entrenchment in nearly all categories, inflation is .33%.
This is undeniably good news, which, of course, I will turn into something scary. At no time in history has the government printed money to the extent it has now and NOT caused inflation. History tells us it is coming, but it's not here yet.
VI. Business Inventories
When businesses are humming along, inventories used to build up in anticipation of happy consumers. Those days are over, for two reasons. The first, and most obvious, is that consumers are scared. So scared, in fact, that they're SAVING money. Weird.
Second, businesses have gotten smart. They operate as close to a build on demand model as possible, i.e., they don't build your thingamabob until you order it.
That said, however, inventories have fallen by over 6% - after building up for six straight years. They are low, and falling. When demand does return, which I believe it will through exports, then inventory buildup will help boost economic growth.
VII. Conclusion
All these indicators are pointing positive. It's been so long since we've had good economic news, we hardly recognize it when it shows up, but there it is.
The worst is over. Let's hope we keep our heads on straight and stay the course without succumbing to political pressure that will cause us to make poor economic decisions.