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.