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." http://www.cato-at-liberty.org/2009/09/08/mr-president-here-is-our-answer/

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, http://womensfinancialplanning.blogspot.com/2009/07/obama-administration-financial.html 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." http://www.cnbc.com/id/32799393 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 http://www.opensecrets.org/lobby/top.php?indexType=c 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 http://www.visi.com/juan/congress/

As always, your comments and suggestions are most welcome.

How Much Will YOU Earn?

As I mentioned six days ago http://womensfinancialplanning.blogspot.com/2009/09/is-stock-market-cheap.html , 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.

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.

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 http://womensfinancialplanning.blogspot.com/2009/07/unemployment.html 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 http://womensfinancialplanning.blogspot.com/2009/07/wuvl-shape-of-our-upcoming-recovery.html
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.

A Disturbing Trend

As the discussion about health care reform drones on, the current emphasis seems to be focused on how we pay doctors, and whether that pay structure is an incentive to our long term health care goals. Before you stop reading, by the way, this is NOT a discussion of health care. It is a discussion of payment for services, how we structure those payments, and whether that structure pays people to do what we value most.
It seems we pay surgeons an average of about $600,000 per year, and doctors who practice family medicine about $160,000 per year. In other words, we think the doctors who perform lap band surgery to shrink our stomachs after we're morbidly obese are more valuable than the ones who tell us to eat healthier diets.
I'm not in medicine, but that seems weird.
I do, however, have some experience in the world of money management, and can point to an interesting commonality with the medical field. We pay stock brokers a fee every time they buy or sell a security for us, yet countless studies - particulary those in the field of "value" investment (that philosophy practiced by Warren Buffett as a desciple of Benjamin Graham) - show that a "buy and hold" strategy is more appropriate for the investor than buying-and-selling-all-the-time.
Yet, if a broker practices the latter philosophy, she will be paid far less than those who are hopping in and out of stocks, racking up high commissions, and leaving clients with additional short term capital gain payments. That's higher taxes, in plain English.
Why are we paying higher fees to doctors who operate on us than those who keep us healthy, and higher commissions to brokers who buy and sell all the time rather than buy and hold, which, in the case of the vast, vast majority of clients, will result in a higher return on investments?
Hmmmmm. It seems we value people who give us short term solutions to our problems more than those who act in a way that address our long term goals.
We certainly pay them more.
Well, that's all for now. I'm going back to being angry with the current administration for not solving our problems in seven months. What's taking them so long? I want long term solutions -and I want them NOW. Who CARES how much it costs?
Oh, I see now. When I think that way, doctors fees and broker commissions make much more sense.

Late Summer Economy

Summer is generally a time when capital markets languish, brokers vacation in the Hamptons, and there is little economic news. That is not the case in the Summer of 2009.
A fierce battle is being fought between the economic interests of those who have monetized health care - the pharmaceutical companies, the health insurers and health care providers like doctors and nurses - and millions of Americans who are teetering on the edge of economic insolvency because of our country's unsustainable rise in the cost of health care. The stakes are undeniably high, as are the emotions of those who argue both sides of the issue.
On one thing we can all agree. To fail to address this issue is to destroy the long term health of our economy.
In addition to that issue, however, we are also emerging from the worst recession since the Great Depression. Because financial markets ceased to function at the end of last year, an enormous amount of money was provided to commercial banks (and investment banks who changed their charters to avail themselves of this money) in order to prevent a financial disaster. This disaster was caused by securitizing and selling the risk of poorly underwritten mortgages, and the sales - and disastrous effects - were worldwide.
This problem began in the late 1990s, with the dissolution of the Glass-Steagall Act, that separated commercial and investment banking. It appears that we expect, however, that this decade long problem-in-the-making is solved immediately.
"What is taking so long?" is the predominant economic question.
We have, apparently, become a nation convinced that there are simple, quick solutions to everything.
We continue to face declines in manufacturing, rising unemployment, plummeting housing prices and a distinct lack of consumer confidence. On the bright side, inflation is almost non-existent, interest rates are at decade lows, and capital markets show unmistakable signs of predicting an end to our recession. We are working on financial reform and the excesses of the past seem, at least for the present, to have subsided.
It's a mixed bag. We will not suddenly pop out of this quagmire in a month or two. That is clear.
It is also clear that we will politicize economic issues. We will criticize the Economic Team, point to rising deficits, scream about banker's bonuses and wonder why we're not back to normal seven months from the inauguration of the new administration.
Yet, not one of these issues is directly relevant.
Rising deficits? Yes. Was there an alternative to a huge cash infusion into the economy? No.
Banker's bonuses? Yes. Are they a significant percentage of the "bailout money?" No.
What, then, should we be discussing?

1. Financial Regulation - Plug up the holes that caused excesses without unduly burdening the financial system
2. Long Term Employment Growth Policy - Some jobs, including much manufacturing, are gone forever. Reeducating the work force for long term employment is vital
3. Deficit Reduction and National Debt Repayment - Once we've stabilized the economy and gotten back to work (in about a year), we need to raise taxes. Yes, we all need to pay more taxes to reduce the current deficit and repay the national debt. It is as big a security issue as reliance on foreign oil.

There you have it. It's not a pretty story, but at least we're talking about the real issues.

As always, your comments are most welcome.

Stagflation and Its Potential to Derail Economic Recovery

Unemployment

We've previously discussed the fact that the current unemployment rate, while high, is not at the level it was in some previous recessions. We've also discussed that unemployment tends to last longer than recession, and is therefore called a "lagging" indicator.

But that's not the whole story. Further research shows that unemployment may actually be behaving differently than it has in past economic recoveries.

In the statistical measurement called "standard deviation," the US is deviating from the standard behavior of unemployment as measured by Arthur Okun, a prominent economist in the 1960s. The relationship he discovered was that between the degree to which the economy contracted and the concurrent rise in unemployment. This relationship, called Okun's Law, had been reasonably reliable - until now. At the current rate of decline in our economy, his calculations show that we should have a current unemployment rate of 8% - not 9.5%. We have lost almost 5% of all jobs - far surpassing the 3% we lost in the 1980s recession when unemployment last reached over 10%.

We previously discussed the fact that, during a recession, employers tend to keep employees at a level that will accommodate the return of growth after the recession ends. It is that "buffer" that results in a delay in hiring, as these employees increase their productivity during the growth phase, eliminating the necessity to add workers until the economic growth trajectory is well under way.

In this recession, however, further examination of employment patterns show that this "buffer" has not been kept. Does this mean that employers, jarred by inability to obtain credit by the frozen financial system, panicked and cut employment more than usual? Perhaps.

But, that does not explain the additional fact that, since 2001, overall hiring has been contracting. During the 1990s, employment expansion was at a rate of 8 workers for every 100 on staff. That expansion dropped to 7 workers per 100 during the 2001 recession. Hiring, however, stayed at that level after the recession was over, and has now fallen to 6/100.

Perhaps a part of this failure to hire can be attributed to

• A permanent loss of manufacturing and other jobs "outsourced" to countries who can produce goods at a lower cost than the US


• Less innovation = fewer new businesses. During war time, technology tends to be focused on the war effort as opposed to innovations in the private sector.


• As aging baby boomers leaving the work force, the total number of workers lessens and unemployment rates appear larger. As an example, with a total work force of 100, if 5 people are unemployed, the unemployment rate is 5%. With a total work force of 90, if 5 people are unemployed, the unemployment rate is 5.5%

Whatever the explanation, there is a big difference between a sustained decrease in hiring, as there has been since the 2001 recession and thereafter, and job losses due to a recession. Jobs lost in economic downturns have historically returned, but only when confidence that economic recovery was well in force.

Stimulus

Some argue that the unemployment problem is partially addressed by the stimulus program. This is only partially true, because government programs aimed at repairing the infrastructure, e.g., roads, bridges, etc., are temporary in nature.

Confidence

Jobs lost in economic downturns have historically returned only when economic confidence returned to the private sector. Certainly, no employer wants to add workers unless she feels that a sustained recovery is under way.

Sustainable Jobs

The Obama administration has opined that new job growth be in technological advances in green energy, which will address the national security issues of oil imports, the international need to reduce greenhouse gases, and provide a cost effective alternative to depleting international sources of fossil fuels. With the current lack of emphasis in math and science in the educational system, this goal will be difficult to achieve in the short run. Regardless of the source of so-called sustainable jobs, however, it is crucial that job growth be achieved - and soon.

Falling Wages

One need only look at the economic problems in the State of California and publishers like the Boston Globe to see that we are experiencing a period of falling wages. Wages, expected to be flat during periods of recession, are in danger of falling as businesses and municipalities cut expenditures to the bone.

Additional Stimulus

Should unemployment rates continue to fall precipitously, and wages fall as businesses try to survive, the government may be tempted to provide additional stimulus. That, in my opinion, would result in the disastrous recipe for stagflation. Stagflation = Stagnant (or falling) Wages + Inflation.

But, inflation is very low, you may argue. True, but the national debt, approaching $10 trillion dollars, must be repaid. And, as debt is piled on, higher and higher rates must be paid to borrowers who lend us money. Higher rates mean higher cost of borrowing in the public and private sector, which result in higher costs. Higher costs plus stagnant wages = Stagflation.

What Now

The goal of sustainable job growth is an absolutely critical part of the answer. That means that we will need

• An immediate retooling of our workforce in skills necessary for sustainable jobs


• Education emphasis on math and science


• Accommodative policies to encourage investment in sustainable business


• Immediate policies enacted to reduce deficits


• Bi-partisan support for such policies to encourage confidence.

The last issue is critical. Without confidence, business will stay stagnant. It's a tall order, and there's an immense economic outcome at stake. Failure to achieve sustainable job growth will result in a more serious long term economic problem than has faced our country to date. It is up to every one of us to voice our opinion to our representatives and demand that action be taken immediately, or accept a generation of economic decline.