Independent Investment Advice Blog

Independent Financial Advice Needed for Bond Market

     Interest rates for the 10 year Treasury have increased from 2.38% to 3.39%, roughly 100BP, since the lows of October 8, 2010. The labor market has improved today based on jobless claims and the ISM's PMI index improved to 56.6%. So does this mean that inflation is coming back and thus bonds will crash? Suppose both inflation and a full employment economy returns. Then the Fed would need to raise interest rates which would hurt the stock market. Also corporate profits are at 55 year record margins, which is an unsustainable statistical outlier. Further, the Schiller 10 year CAPE is 22.7 instead of 15, which implies stocks need to decline by 34% even if corporate profit margin remain unchanged.

     So even if I'm allegedly wrong about bonds that does not mean stocks will go up. Stocks are overpriced. And when they go down then some capital will go into bonds.

     It is possible that stocks will go even higher this year in an irrational move by emotionally charged investors who use stimulus funds to speculate, but that will be a very dangerous short term bubble that would be far too risky to speculate in. To buy stocks now in hopes of making money from a Greater Fool theory with the hope of selling at the exact top during a parabolic up move is a very dangerous short term speculation. It could end up with investors losing big money as they did in the May 6th Flash Crash where stocks went down far below the stop loss order level. It far safer to make a move (that may be a bit too early) and get out of stocks now to avoid being bothered by a crash inconveniently occurring just when you were getting used to a enjoying a stock bubble.

     Getting back to the topic of bonds, Van Hoisington said on Dec. 10, 2010 that the long term average "real" rate for long term 30 year Treasuries is 3% versus 2% now, so rates need to go down. Independent investment advice from obscure advisors has been better than that offered by the Wall Street "sell side" establishment, so I prefer to stick to my bond bull, stock bear forecast.

Can Independent Investment Advice Protect Investors From a Crash?

      Regarding using independent investment advice for investors to protect themselves from a crash, does it work? People are aware that an investment advisor who is not on the "sell side" of the securities industry is more independent and objective than someone on the "sell side". But what about a large independent advisory firm? Can they be objective about making a bearish forecast even though that means losing clients who insist on shopping for a bullish advisor?

     It is not enough to simply seek an advisor who is independent from the manufacturing of securities (the sell side). In addition an investor needs to find an advisor who is independent minded, that is to say, someone who is a contrarian.

   The true "value-added" component of an advisor is someone who can use a contrarian view to find something wrong with the conventional wisdom and use that insight to warn clients to avoid hidden risk, even though such a forecast would be unpopular.        

      Usually avoiding hidden risk means getting out of an investment that offers bigger than normal dividends, interest payments, rent payemnts, oil lease payments, etc. And that means reinvesting the cash from the sale of those assets into lower yielding, more conservative, allegedly less attractive investments. It is like the Titanic's owner thinking they could "save" money by not buying enough lifeboats. In that case one simply must reduce their hoped for profit by spending money to buy lifeboats to be safe, or one will be worse off.

   So investors should seek out an advisor who is truly independent minded, not simply independent of the "sell side" pressures.

Independent Investment Advice: U.S. Equities are 70% Overpriced

China's Bubble: Lending Exceeded Quota by 40%

    In today's Wall Street Journal an editorial said that China's lending exceeded quota by 40%. "Local governments and banks have set up off-balance sheet vehicles to conceal loans and keep the spending boom going."

    This could explain China's overheated bubble economy. The article said it could go on for another year and thus the bubble will get bigger.

   Since China is one of the three pillars of the world economy along with the shaky Eurozone and the U.S., which has a huge unresolved burst housing bubble, then this means all three pillars are unreliable and could get worse. My independent investment advice is that a deflation strategy is correct. This would imply one should do bond investing, and one should examine alternative investment advice for ways to weather the storm.

Has the economy recovered enough to justify the stock market prices?

   The real economy in many ways has recovered since the Lehman crash of September, 2008. So does this mean today's stock prices with SP500 at 1256 are justified and that the bear case is wrong?

    Using the principles of independent investment advice, the best way to judge the market is with the Schiller 10 year average P.E. ratio, which is at 22.7, versus a norm of about 15; also after a bad credit crunch it should have declined to 12, which is a 47% drop to SP at 664. Further the dividend of 2% should be at the historical average of 4.3%, which implies SP must drop 47% to 664.

   The world economy has three main pillars: U.S., China, Europe. In the U.S. the housing crash with a huge oversupply of contingent inventory and delinquent debt still has not been resolved, thus house prices will go down. In Europe even Germany is threatened by the potential for failure in the southern area of the Euro zone. In China there is the risk of a bubble that will end as all bubbles do, in a crash. The best that could happen in China is a growth slowdown instead of a crash which would result in the world economy getting less stimulus during a time when the rest of the world's economy is very weak.

   The only reason for stocks to be so high is because of fear that they are the only haven from inflation (assuming investors don't like commodities, gold, etc.). But if inflation returns it is not a straight pass-through for stocks; on a "real" basis stocks decline during times of inflation. Also, if inflation hits then interest rates will rise which will absolutely hurt the stock market. During times when interest rates are low the bulls say that low rates act as a lever to make stocks go up, but when rates go up the bulls are evasive about that issue. So if we remove the investor's belief that stocks are a hedge against inflation and then a new series of U.S. and Euro area debt crahses occur and China's economy cools down then there will nothing to support an overpriced stock market.

Bond Investing During Holiday Season

     Bond investing during holiday season has been affected by traders going on vacation in last two weeks of December. As a result of holidays some traders have sold off their inventory to protect their profits while they are on vacation.

     To judge how the market behaves we need to wait until January to see what investors do after the holidays are over. Thus bond prices from Dec. 21-31 are not representative of their true potential should be taken with a grain of salt.

David Rosenberg was on CNBC 12-21-2010

David Rosenberg was on CNBC 12-21-2010. http://www.cnbc.com/id/40764859.

     He warned of housing bubble deflation with further price declines and a huge inventory of unsold homes and how this has a potential for a deflationary impact on the economy.

Today’s Bond Market Decline is Not the End of the Great Recession

originally published December 7, 2010 by Don Martin.

    The Long Term Treasury ETF TLT declined 2.14% today because last night a “tax cut” (in reality an extension of a 9 year old tax law, and thus not a cut) will be approved by Congress and the President. There will also be an actual, but temporary, cut in payroll tax rates. One might be tempted to think this will magically cause employment to recover thus igniting inflation and killing the bond market. However, the big picture is that increasingly both China and the Euro zone are looking like a bubble that will (or already has) burst. Also, according to Barron’s two-thirds of the U.S. homes that need to go through the foreclosure process have not yet completed that. With the huge amount of excess debt that Americans need to pay off plus problems in Europe and future problems in China where will growth (which would hurt bond prices) come from?

According to a Dec. 6, 2010 article by Ambrose Evans-Pritchard in www.telegraph.co.uk China has had a 40% increase in its money supply last year which would require monetary tightening. This may cause a hard landing with big falls in commodity prices, EM bonds, EM stock, and Asian growth rates. Homes in China are selling for 20 times income; in Tokyo it is 8x, in U.S. 4.7 x.

The Euro area does not have enough money to bail out its weaker members. Do you think Germany with 85 million people is rich enough to bail out all of the non-British EU part of Europe with 440 million people?

So where is the growth and demand that will make the economy recover (which would thus hurt bond prices)? I think today’s drop in bond prices was a one day panic which may have been exacerbated by a sell-off in Muni bonds. Because new issues of Buy America Bonds won’t be allowed next month municipalities are now in a rush to issue (sell) more bonds this month; this selling makes prices go down because there is too much supply, which in turn can affect Treasury prices.

Financial Planning Ideas For Year End Tax Planning

Originally published Dec. 7, 2010

Here is are some financial planning ideas:

Consider the following strategies on gifting:

Start with the basics: Grandparents – and parents, for that matter – can avoid the gift tax by giving up to $13,000 per recipient per year to each child or grandchild. Above that amount, remember that the gift tax stands at 35 percent in 2010 but is scheduled to rise to 55 percent in 2011.

You can go farther: You can gift an additional $1 million all at once or over an extended period on top of each $13,000 gift by borrowing from the amount you’ll be able to shelter from the estate tax.

Opt to pay medical or tuition bills: If you pay a family member’s school or hospital directly, you may give an unlimited amount. It’s also important to know that you can do that on behalf of anyone, not just family members.

 

 

Don’t forget charity: Charitable giving is not something that’s done only in someone’s will. You can donate assets to a charitable gift fund or community foundation where your investment grows tax-free and you can designate charities you plan to give to before and after you die.

And keep in mind some general last-minute tax planning advice:

Max out your retirement contributions: For 401(k)s, you have until Dec. 31 to make your 2010 contributions. The limit per employee is $16,500 with an extra $5,500 allowed to taxpayers 50 and older. IRAs have later deadlines.

Empty your flexible savings accounts: Flex accounts must be emptied out by yearend (or by the end of your company’s standard grace period) or the money must be forfeited. Double-check the many items that qualify, because that list will get smaller last year – no over-the-counter medicines can qualify for Flex spending without a prescription.

Take advantage of energy credits: The Residential Energy Property Credit expires Dec. 31. Taxpayers spending for qualified improvements ranging from roofs to insulation and water heaters can qualify for a credit up to $1,500.

This article was produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Don Martin, CFP®, a local member of FPA.

China - is it a Bubble?

China - is it a Bubble?

originally published December 6, 2010 by Don Martin.

     Today Reuters has a headline: China’s GDP is “man-made,” unreliable: top leader. My own theory is that China is actually prosperous and growing but the growth may be unduly influenced by a naive handling of monetary policy by a government that is less experienced with finance than developed countries. (Of course our highly sophisticated experts Greenspan and Bernanke were blind to the great Crash of 2007-2008, so maybe Chinese Central bankers are better!) Specifically what worries me about China is that they have a negative “real” rate of 2.4%, which means a business is getting paid to borrow money. This leads to creation of a “crackboom” which ultimately comes to an end with a crash. When rates are artificially low this over-stimulates the economy causing some businesses to do crazy things like build an empty city like Ordos. Instead of real rates of negative 2.4% they should be positive 2 to 3%, which means rates need to rise 5% for the Chinese economy to reach equilibrium. A shock of that much would reduce the growth rate of China’s economy and cause the boom to end or to slow down to a more normal pace. Eventually the truth will come out and the Chinese economy will fall into a slowdown. Just as Americans borrowed too much in the past 20 years and then reduced borrowing since 2008, contributing to a crash, the same can happen in China. Fortunately China uses a lot less debt than America; their bubbles are a cash-based bubble, instead of a credit-based bubble. Cash-based bubbles are like the U.S. Tech bubble of 2000 which only hurt investors, not banks, and only affected one sector in to economy; by contrast credit based bubbles often result in the person who bought at the top of the market being stuck with a huge negative net worth when the debt financed asset falls back down to earth. An example of a credit bubble collapse is Japan in 1990 which has not yet been fixed.

      Once a China crash occurs then Western investors will suffer losses from other EM countries and from commodity investments; couple this loss with the Euro area debt crisis and then the world will be back in another Lehman crash nightmare. This is why my investment allocation is 100% bonds.

    Another concern about China is that the bulls say future growth will come from the lesser developed western areas. My skeptical opinion that when a country is rapidly growing those who have talent will find a way to move to the big city and go to college in the early stage of the boom. So perhaps the people in the rural area who are not college graduates with a professional career are destined to stay that way and thus the less developed areas of China will not grow as fast as the eastern are did.

Why I’m Very Bullish For Long Term

originally published Dec. 6, 2010

The reason for the title “Why I’m Very Bullish” is because I believe eventually the coming huge crash will lead to an ever bigger bull market. My reason for being bearish over the next few years is to avoid overpaying for risk assets before the crash and to wait until the right moment to buy risk assets. Currently my investment allocation is 100% quality bonds. Since most bears hold a little equities, I guess you could call me bearish.

To overlay this current market against the period 1929-1949 we are about halfway through the 1930’s Great Depression. But that does not mean we have reached the absolute bottom yet. Eventually 5, 10, 15 years from now there will be a huge boom. But if the SP needs to go down to 450 to 500 reach the capitulation phase before the true bottom then why buy risk assets now? My reason for expecting a new low is because over-leveraged hedge funds will get make a mistake and get burnt and be forced to panic sell quality assets to meet margin calls. If the price of Puts or margin requirements for hedge funds were to suddenly be increased they would need to sell off assets and only quality assets could be sold during a downturn, not the ones that needed to be sold. This will generate a market crash that won’t respond to offer of easy, cheap Fed money. The prudent thing to do is to hold quality bonds, wait for the stock market to bottom then switch into equities? Ben Graham said wait to buy at a discount for a margin of safety. Today stocks are priced for perfection in a very imperfect and fragile world.

If the SP now at 1200 produces a 7% appreciation starting at a bottom of 500 points in 2015, then in 20 years from then (in 2035) it would be at 3,800 points. This assumes SP goes from 500 points with a 8 P.E. in 2015 to a 16 P.E. 20 years later in 2035. Adding back a 2% dividend would be like the SP going to 5,700 in terms of total return.

The reasons for the mega boom: EM economies in a decade will have become much more sophisticated and professional, much like a developed country. EM countries will have become superior to the developed world in terms of a safe haven that does not irresponsibly have government sponsored credit bubbles, excessive taxes, excessive regulation, etc. Many developed country residents and corporations will emigrate to EM countries for better opportunities to work, to pay more reasonable taxes and Social Security contributions to more solvent governments, etc. It will be similar to the emigration from Europe to the U.S. from 1865-1900. Because EM countries are not saddled with an unaffordable and rapidly growing welfare state they will become the new safe haven for people with quality job skills, for capital, for business. This is in turn will put pressure on Developed countries to compete (by radically reforming the bloated welfare state, protecting capital for excessive taxation and regulation) or they will fail.

The driver of the boom will be a continued need to develop globalization to utilize the labor arbitrage of developed - less developed world. Read Anatole Kaletsky’s Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis. He mentions the Dutch Tulip Bulb Bubble of the 17th century actually had in the background a legitimate reason for markets to become

exuberant due to new opportunities for growth which were due to globalization and freedom. By analogy my opinion is that some of the bubbles in modern times such as Tech, China-EM were actually awkward signals (mixed with huge amounts of noise) by the invisible hand of the market that something really big and good was going to happen.

More confirmation of disinflation

Dec. 5, 2010

More confirmation of disinflation http://economistsview.typepad.com/economistsview/2010/12/frbsf-disinflation-its-not-just-housing.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+EconomistsView+%28Economist%27s+View+%28EconomistsView%29%29&utm_content=Google+Feedfetcher

The three potential sources of inflation are:

Originally published Dec. 5, 2010

 

The three potential sources of inflation are:

1. Increased lending by banks.

2. Monetization of Treasury debt by the Fed.

3. QE2 to the extent that it devalues the dollar.

#1 Can’t happen because only economically healthy corporations and consumers can qualify for a loan and they don’t want to borrow more.

#2 May not happen because if there is a credit quality panic and flight to quality then more investors will get out of corporate bonds and buy Treasuries. In addition the new U.S. Congress may lean towards austerity and not authorize ever larger deficits.

#3 A devaluation is very hard to do because every country, even Switzerland, wants to devalue or else keep their currency from rising against the dollar.

The coming shortage of oil is not inflationary because as consumers spend more on oil they will need to cut back on other purchases and those goods will fall in price as a result of less demand. Imagine the deflationary impact of layoffs in the auto industry when gasoline goes to $8 a gallon and oil is $200 a barrel.

“There are no policy remedies for debt deflation” Hugh Hendry

Originally publsihed Dec. 4, 2010

See Hugh Hendry’s economic commentary at http://www.zerohedge.com/sites/default/files/The%20Eclectica%20Fund%20-%20Manager%20Commentary%20-%20December%202010.pdf

This eloquently demonstrates the global bearish case. Hendry said “There are no policy remedies for debt deflation”.

Fed Made Massive Loans to Hedge Funds in 2008 Crisis

 

Originally published December 3, 2010

$71 billion lent was by Fed via TALF mostly to non-bank entities during the crisis of 2008. Surely this must have helped to prop up the stock market. This may explain why the market did not decline to a “Capitulation Phase” price level with a p.e. ratio of 8 or 9, which would have made the SP500 go to about 450 to 500 points.

Inflation Protected Investments: Overpaying for Insurance?

Orginally published Dec. 2, 2010

When buying inflation protected investments as insurance against inflation you want to avoid overpaying. When trying to insure against the risk of inflation investors buy TIP’s, precious metals, commodities, EM stock, etc. They could overpay and end up losing money for an inflation that either did not occur or occurred so far in the future that the defenses degraded before inflation came.

Currently 1-5 year TIP’s have a negative real rate. Gold mines in the boom of 2008 experienced a 25% annual increase in operating costs that were far higher than the CPI. Commodities may have had a one time boost due to China’s needs plus Chinese speculators in China who have few investment choices. If something goes wrong with China’s economy then the commodities 10 to 17 year secular cycle boom will end with a crash, except for oil. When buying commodity futures investors with long positions overpay due to contango. When investors buy options they take a risk that the option will decay and expire worthless. So the point is that investing to protect from inflation is risky and one could overpay for insurance and loose money. The studies about diversifying by adding commodities to a portfolio over 40 years had results that were mostly attributable to a boom in agricultural commodities in the early-mid-1970’s. If someone bought commodities in the late 1970’s when inflation was at its worst they may have lost money and not protected themselves from inflation. Real estate investing in the 1970’s was profitable because people used fixed rate loans. Today rental properties are often bought with adjustable rate loans, so if inflation hits then mortgage loan interest rates will be very high and this will hurt buyers of real estate so they will not buy and then the price will go down or else not go up enough to compensate for inflation.

Even buying equities of non-commodity companies is not a one-for-one pass through for inflation. During inflation companies cut their margins to avoid losing market share and then earnings decline, hurting share prices.

So if you disagree with my deflationist views and want to load up on inflation hedges please careful because the best hedges are expensively priced and are not guaranteed to correlate with inflation. Tony Boeckh said in the book The Great Reflation that if commodity prices get too high then demand will be reduced making prices go back down. A basic principal of Graham and Dodd investing is to avoid overpaying for investments; buy only at a discount. So they would not buy inflation hedges today.

The one exception to my cautious view on inflation hedges would be oil because the theory of Peak Oil is probably correct, however using the concept of buying at a discount to have a margin of safety it is not now time to buy. Wait for a double dip recession to buy oil stocks.

$9 trillion loss for European banks

Originally published December 2, 2010

     $9 trillion loss for European banks if the Euro breaks up. If those weaker countries break away from the Euro they will devalue their currency and this would create massive losses. See http://blogs.wsj.com/source/2010/12/01/guessing-at-euro-breakup-costs/#

One would think that the contracts require loan repayment in Euros so then a devaluation would not cause the loans to be paid at a less than agreed upon amount. However, the hardship of a devaluation would result in inability to pay and thus a default would occur. So either way European banks don’t look good, and this implies a major source of world wide deflation.

The Effects of QE2 Will be Negated by a Market Crash

Originally published Dec. 1, 2010 by Don Martin

QE2 is thought to be propping up the stock market in an attempt to reflate the economy. If the hedge funds that rely on the cheap cost of borrowed money find that their cost to hedge with Put options or their margin requirements have increased then they will be forced to sell assets. Since it is impractical to sell illiquid assets during a crash then to meet margin calls hedge funds will need to sell good investments, thus those assets will go down more than would be expected during a crash, leading to a market panic. Hedge funds do a significant amount of trading of the total market volume and if they were to have a need for a sudden sell off of assets there would not be enough buyers and thus prices would go down. So the effects of QE2 will be negated by a market crash. This would be similar to what has happened in Japan for 20 years where Central Bank easing lead to temporary bear market rallies that eventually collapsed.

Disclaimer: blog is for education only and is not financial advice

     Originally published 11-22-2010 at the inauguration of this blog which was hosted on a different site.

 

Purpose of this blog is to give general education and information about investing and economics. It is not advice because to obtain advice we require a personalized one-to-one consultation, a written work agreement, payment of fees, etc.

 

Deflation: Future Theme of Investing

Originally published November 23, 2010

The U.S. combined private and public sectors and other developed countries have accumulated a massive amount of debt in terms in proportion to the GNP. It is worse than the 1929 crash. This debt will take years to pay down to manageable levels and during that time the economy will be in a soft depression like that experienced by Japan for 19 years.During the 19 year Japanese depression the rate for Treasury long bonds kept going down and thus the price of bonds went up. The same will happen here. Stocks need to go down to the “capitulation phase” level of a P.E. of 8 to 10, and during the March, 2009 crash they only went down to about 12. So the lows will be retested and we will be stuck in a trading range between SP500 from 1200 to 666 for several years.

Repeat of 1930’s Trade Wars

originally published November 23, 2010

Great article by Robert Skidelsky about trade war leading to deflation at http://www.project-syndicate.org/commentary/skidelsky35/English

Economics of Investing During a Soft Depression

Economics of Investing During a Soft Depression

Originally published November 23, 2010

Today’s investing climate is very difficult not because the economy is depressed but because unprecedented, exotic government stimulation makes it difficult to forecast the consequences of the stimulus. The risk is that stimulus funds will go into speculative investments that will create a new bubble, thus disrupting careful wise investment plans. This will hurt the credibility of the Bears at the time that investors need to listen to their advice, and thus investors will become victimized by a new bubble.

Thanksgiving: Things to be Grateful for

Thanksgiving: Things to be Grateful for

Originally published November 24, 2010 during Thanksgiving week.

    With economic picture looking depressed, let’s keep things in a positive light. Americans can feel grateful their currency is better than the Euro, Yen or the Pound. The U.S. political system is moving, more than other countries, in the direction of fiscal soundness in terms of the possibility of budget cuts, etc. The U.S. labor force is more flexible and sometimes costs less than that of other developed countries, which will help exports. The U.S. government has far more gold than other countries. The U.S. has enormous surpluses of coal and natural gas which can be substituted for oil; the other large developed countries have almost no domestic source of fossil fuel. The U.S. stock market is more honest and transparent than that of other countries. We have Silicon Valley which is doing very well now.

QE2 failing to devalue the Dollar
11-23-2010

Bernanke’s QE2 is failing to devalue the dollar. The dollar has gone up 4% in November, 2010.



 Economics of Investing During a Soft Depression

23. November 2010

     Today’s investing climate is very difficult not because the economy is depressed but because unprecedented, exotic government stimulation makes it difficult to forecast the consequences of the stimulus.

The risk is that stimulus funds will go into speculative investments that will create a new bubble, thus disrupting careful wise investment plans. This will hurt the credibility of the Bears at the time that investors need to listen to their advice, and thus investors will become victimized by a new bubble.

 

Probability of Deflation

Orginally published November 27, 2010

The probability of deflation may seem lower in recent weeks, but one can not use a few weeks of anecdotal information as proof that a major trend has reversed. The book This Time Is Different: Eight Centuries of Financial Folly by Reinhart, and Rogoff, shows that major debt deflations require about seven years to work off the excess debt. It has only been two years since the Lehman crash, so we need more five years  to hit the turnaround point. Since very little has been done to reduce excess consumer debt then how can the stage now be set for a recovery? I think eventually the truth will come out that the recovery is bogus and then consumers will reduce their spending. Because of the huge overhang of excess housing and excess mortgage debt where two-thirds of the homes that need to go into foreclosure have not gone through the process this means there is tremendous deflationary pressure that can not be changed by QE2.


 Reasons For & Against Inflation

24. November 2010

In favor of deflation:

1. China could be a bubble, growth could be exaggerated, or growth could collapse when much needed monetary tightening in China is implemented.

2. The Euro will break up and much of the Continent will go into default.

3. In the U.S. the Austerians are in political ascendancy and will tighten government stimulus and end the Fed’s QE resulting in a slowdown because of termination of stimulus.

4. The developed world’s housing still needs to unwind from the bubble; the majority of distressed real estate still has not gone through the foreclosure and resale process.

5. Japan tried for 20 years to reflate their economy and it did not work

6. Inflation in the U.S. is connected to wars; we had three bad deflation eras (two in the 1800’s, 1929-1941) but only one bad inflation era (1970-1982).

In favor of inflation:

1. All that money printing could create inflation if it leaves the banks and is lent to the public

2. Devaluing the currency creates inflation

3. Governments historically get out of excessive debt, when the situation is very bad, by creating inflation

Ireland Bailout

Orginally published November 28, 2010

Irish banks passed this year’s stress tests and now they need a massive bailout only a few months later. Could this happen to other countries in Europe? The UK, Spain, Holland have more bank debt as a percent of GNP than Ireland.

Deflation Forecast Remains Firm

Deflation Forecast Remains Firm

Originally published December 10, 2010 by Don Martin.

My Deflation Viewpoint Remains Firm

Reasons for my bearish forecast:

David Rosenberg said all advisors surveyed by Bloomberg are bullish. No one is bearish!

China:

     Jim Chanos on CNBC today said he is bearish on China. When their economy slows down that will hurt commodity producing countries in the EM and hurt Europe more than U.S.

    Richard Duncan in Bloomberg, Dec. 9, 2010 “China has the greatest economic bubble in history,” …”There’s a real risk it’s going to collapse in a Great Depression-style scenario.”

      My opinion is that China monetary policy of very high negative “real” rates has created an unsustainable, unnatural boom, unprecedented in history, with too much risk that it will end.

Europe:

       Barry Eichengreen, a UC Berkeley Economist, predicts a European debt write down. He said “The mechanics of debt restructuring are straightforward. Governments can offer a menu of new bonds worth some fraction of the value of their existing obligations.” www.project-syndicate.org/commentary/eichengreen25/English

Macroeconomics and U.S. Treasuries:

SocGen forecast issued Dec., 2010 for 1Q2011 for 10 year Treasury at 2%, however, they think it will be back to 3% in a year.

Aug. 27, 2010: On Thursday, PIMCO’s Mohamed El-Erian said that bonds are not in a bubble. The 10 year Treasury was yielding 2.65% on August 27, 2010.

Van Hoisington and Lacy Hunt on Dec. 9, 2010 said employment / population ratio lowest since 1984, and is a better measure of unemployment than others. They said Treasury bond correlates 70% of the time with inflation, which is now 1%, 30 year Treasury is 4%, so real yield = 3%, average has been 2%, so rates will go down.

“The world is entering a recession that may last up to eight years as the U.S. heads toward a “lost decade” similar to Japan’s slowdown in the 1990s, said Eisuke Sakakibara, formerly Japan’s top currency official.” Bloomberg Dec. 8, 2010.

With Premiums Increasing Should You Get LTC Insurance?

Originally published Dec. 13, 2010

With Premiums Increasing and a Major Carrier Exiting the Market,
Should You Still Consider LTC Insurance?

On Nov. 11, insurance giant MetLife said it would sell no new long-term care (LTC) insurance policies after Dec. 30 though it would continue to service its 600,000 insured customers. The reason? “Financial challenges” in the long-term care insurance industry.
What does that mean?

In short, that long-term care costs have proven unpredictable in the insurance industry, a world that definitely likes predictability. According to Genworth Financial, a marketer of LTC insurance, the cost of assisted living has climbed at an annual rate of 6.7 percent over the past five years and the price for a private room in a nursing home jumped 4.5 percent annually over that timeframe. Insurers have been increasing LTC premiums to combat this cost rise, making recession-battered 2009 one of the worst years for policy sales.

It’s unclear whether other major carriers might join MetLife, but their decision adds some uncertainty to the picture for long-term care planning, one of the most important ways to protect retirement funds.

For some needed perspective, it makes sense to visit a qualified financial planning expert who can look at your complete financial picture and make a recommendation.
Here are some of the questions you need to answer before investing in long-term care insurance or other options:

What resources do you have?  We’re not just talking about money here. While caregiving puts a strain on family, it’s important to consider whether family and friends are truly willing and able to help with your care, which can provide a considerable financial and emotional benefit.  Also, if you live in a community with reliable volunteer resources to help, that’s something to note, though today’s services may not be there tomorrow.

How old are you and your spouse and what’s your health history?  People in good health purchasing long-term care insurance at the age of 55 usually get the most affordable deal in LTC insurance. But an individual’s family health history and current health status are the real determinants of what your LTC insurance policy will cost – or if you’ll qualify for coverage at all.  Also, it’s important to note that 40 percent of long-term care is provided to individuals between the ages of 19 and 65, so the need for care can strike at any time.

Are you a single female? Again, personal and family resources come into play here, but since women typically live longer than men – and they still earn less on average than men – women should take a heightened interest in providing for their long-term care safety net.  Long-term care insurance might be a good solution given their other investments and their health history.

What types of services are covered? Over the course of time, long-term care policies have evolved to place more emphasis on home-based care or assisted living, since most people would choose to recover or live out their last days in a familiar environment.  A basic LTC insurance policy pays for assistance with activities of daily living including eating, dressing, bathing, toileting, incontinence, and transferring (bed to chair, etc.).  Each policy lists the types of services that are covered under nursing home care and under home health care.  Homemaker services are generally covered and other services as listed in the policy.

What triggers coverage? A qualified LTC policy won’t go into effect until the covered individual can’t perform two tasks of daily living for a period, typically 90 days, or when that person needs substantial supervision related to cognitive impairment.  This is where you have to read the fine print since some policies are more restrictive than others. More affordable policies generally take longer to kick in. See if coverage for other physical ailments is available as part of the policy and what per-diem or monthly allowances are offered.

How healthy is the insurance company? While it’s impossible to tell the future – or when a major carrier wants out of a particular line of business – it’s generally better to go with a larger, higher-rated company.

How affordable will the policy be if your premium increases? If you can barely afford LTC coverage now, it’s going to be much tougher to afford premiums if they go up over time. Talk with a planner about other options if that’s the case.

What about an annuity? There are hybrid annuities that also carry long-term care coverage. These products allow policyholders to use the proceeds for LTC coverage, for income or for both. The proceeds that go to pay for long-term care costs for the policyholder would not be subject to federal tax. These long-term care annuities can generate tax-deferred gains, which works particularly well for those in high tax brackets who believe they will be in a lower bracket by the time they would need to draw on that coverage.

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December 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Don Martin, CFP® , a local member of FPA.

What’s Your Risk Tolerance?

Originally published Dec. 13, 2010

Going into a New Year with hopefully better economic and market prospects, it’s a good time to start researching investments. With that, it’s also a good time to review how much risk you’re willing to take on when making those critical decisions. It’s reasonable to assume your risk tolerance has changed in recent years.

Assessing one’s risk tolerance goes beyond your instinctive willingness to say “yes” or “no” on a particular financial move. It goes beyond one’s instincts.  It means re-examining the realities of what you need in life and how you’re going to serve those who depend on you. It also means taking into account the economic turmoil of the past few years to determine what an effect those pressures have had on you.

There’s been plenty of theoretical work done on risk tolerance and what kind of people choose various investments or simply choose not to participate at all. In 2008, TransAmerica released its CURE retirement study (CURE standing for Change, Uncertainty, Risk and Expectations) in which it revealed four basic investing personalities:

•       Venturers take a “nothing ventured, nothing gained” attitude with their money, but their potential pitfall is that they’re overconfident in their level of preparedness.

•       Anchored individuals always “stay on the safe side,” but extreme risk aversion might leave them unprepared.

•       Pursuers will “try anything once” but their continual efforts to grab at new directions might leave them without a clear plan.

•       Adapters take investment situations “as they come” but may not be realizing their full potential as investors.

Whether one of those personalities resonates with you or not, the best way to start planning your finances or to revisit your current financial plan is to meet with a qualified financial expert. If you’ve never worked with a financial planner before, one of the first steps in the process will be reviewing or filling out a risk analysis questionnaire.

Why is risk analysis important before you make decisions with your money? Risk tolerance is an important part of investing – everyone knows that. But the real value of answering a lot of questions about your risk tolerance is to tell you what you don’t know – how the sources of your money, the way you made it, how outside forces have shaped your view of it and how you’re handling it now will inform every decision you make about it in the future.

Here are some of the questions you might be asked as a formal starting point with a planner:

1.    What’s important about money?

2.    What do you do with your money?

3.    If money was absolutely not an issue, what would you do with your life?

4.    Has the way you’ve made your money – through work, marriage or inheritance – affected the way you think about it in a particular way?

5.    How much debt do you have and how do you feel about it?

6.    Are you more concerned about maintaining the value of your initial investment or making a profit from it?

7.    Are you willing to give up that stability for the chance at long-term growth?

8.    What are you most likely to enjoy spending money on?

9.    How would you feel if the value of your investment dropped for several months?

10.  How would you feel if the value of your investment dropped for several years?

11.  If I had to list three things you really wanted to do with my money, what would they be?

12.  What does retirement mean to you? Does it mean quitting work entirely and doing whatever you want to do or working in a new career full- or part-time?

13.  Do you want kids? Do you understand the financial commitment?

14.  If you have kids, do you expect them to pay their own way through college or will you pay all or part of it? What kind of shape are you in to afford their college education?

15.  How does your spouse, fiancé or future partner feel about money and how do those views echo or differ from your own?

16.  Are there other people in your life who might become financially dependent on you? If so, what might their needs be?

17.  How’s your overall health and your health insurance coverage?

18.  What kind of physical and financial shape are your parents in?

Risk tolerance is not so much about dreams and whim as it is about how all the day-to-day lifestyle and money issues affect your perceptions. Some of us need a reality check more than others. A financial professional will understand this challenge and can help you think through your choices. Your resulting portfolio should feel like a perfect fit for you.

However, a planner can help you do much more than control risk on the investment side. You can also work to develop an emergency fund that will support you in case you lose a job or go through a protracted leave of absence due to health or caregiving issues – a significant way to manage risk.

A planner can also make sure you have a disaster plan in place in case you’re disabled or your home is hit by a natural disaster. Financial risk can take many forms, and a planner can help you work through those issues key to your lifestyle.

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December 2010 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Don Martin, CFP® , a local member of FPA.

Western Nations Have Learned Nothing and May Repeat Japan's Mistakes

      Originally published Dec. 16, 2010

      Richard Koo, a Nomura economist said “I therefore have to conclude that the western nations have learned nothing from Japan’s lessons and are likely to repeat its mistakes.”    He thinks the U.S. households have followed a real estate myth for decades since the 1940’s and eventually they will realize they should not hold so much real estate. He believes that during these rare balance sheet recessions like this current on that normal economic measurement standards breakdown and data becomes hard to calculate, taking two years to calculate. This causes people to think that stimulus does not work, but he claims it will work if enough is applied.

See article at http://tinyurl.com/2bdtmew

30 Year Treasuries Expected to Increase in Value

Orginially posted December 17, 2010 by Don Martin.

According to Hong Kong based advisor GaveKal: U.S. 30 year Treasury Bond market back to pricing in “old normal” because the “real” rate using 10 year CPI is at the normal rate of 3.2%. They said the recent rise in rates was not due to inflation. This is similar to advisor Van Hoisington’s December 10, 2010 comment that the “real” rate for the 30 year U.S. Treasury bond is about 1% higher than its historical average and thus he expects it to go down. However GaveKal warned that 30 year U.S. Treasury bond rates could still go up by 50-80 bp. I think Van Hoisington’s opinion is correct.

Forecast for 2011

Forecast for 2011
Originally posted December 17, 2010 by Don Martin.

 

     Stocks could rise solely due to a bubble and not because of fundamentals, but don’t buy them because when the truth comes out stocks will drop faster and further than you may be able to get the courage to sell. Don’t bother buying a bubble stock using the greater fool theory because when everyone panics and runs for the fire exit you could get trampled. Buy only things with a fundamental value above the current price. The 10 year P.E. is 22, should be 15, so that means stocks need to drop 33%, but because of temporary stimulus they may go up more, then people will panic and sell and the market will plummet to the capitulation phase where P. E.’s are 8, 9, or 10 and then SP will trade at 500.

Best performing asset: U.S. Treasuries. U.S. Treasury Bond yields will go down. The long bond has had an average “real” yield of 2% over 100 years and the real yield is now at 3%. We are in the worst recession since the 1930’s with a 17% unemployment rate when discouraged workers are counted. The world needs a safe haven since Euro’s are unreliable and China’s Renminbei is not investible for foreigners. China’s economy could soften leading to global synchronized recession.

U.S. inflation remains close to zero

Renewed foreclosures and more inventory brought to market by desperate sellers and a further drop in home prices

U.S. economy growth rate slows down

U.S. joblessness remains the same

China’s economy slows down. They have a negative real rate of -2% so they need to tighten the money supply by raising rates which will create a slowdown.

Euro area debt crisis continues and results in a bond haircut. The Euro system mistakenly allowed “B” paper countries to become part of an “A” paper world, much like when rating agencies allowed B paper mortgages in the U.S. to be rated AAA because they were in a “wrapper” of Mortgage Backed Securities. These B paper countries need to devalue by 30% but can’t, so the only solution is to take an Argentine style bond haircut where creditors reduce the principal loan balance. Later the Euro will still need to break up or else shrink to only a few strong countries like Germany, Holland, Austria, and Finland.