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.
FOUR FINANCIAL PREDICTIONS
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.
A SHIFT IN THE PORTFOLIO PARADIGM
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.
SPECIAL OPPORTUNITIES 8%
 
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)
Surprised?
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.