Market and Economic Update – June 21, 2013

  • Another Potentially Larger Issue
  • What’s The Incentive?
  • Could This Be The Next Shoe to Drop?
  • The Nature of Sequels
  • It Makes Sense – Doesn’t It?

Please note that Moving Markets is now going to be published on a monthly basis.

China: Economic Growth Slowest in 13 Years

A Reuters News Service story reported that China is experiencing the slowest growth in well over a decade.[i] This from the article (emphasis added):

Interview of the Week

This week I interviewed frequent guest expert Dr. A. Gary Shilling.  Dr. Shilling is the president of the A. Gary Shilling & Co., an investment advisory company.  He has served on the staffs of the Federal Reserve Bank of San Francisco and the Bank of America.  Dr. Shilling shares his take on de-leveraging, debt levels & economic growth. You’ll want to catch this interview at www.everythingfinancialradio.com

Risks are rising that China’s economic growth will slide further in the second quarter after weekend data showed unexpected weakness in May trade and domestic activity struggling to pick up.

Evidence has mounted in recent weeks that China’s economic growth is fast losing momentum but Premier Li Keqiang tried to strike a reassuring note, saying the economy was generally stable and that growth was within a “relatively high and reasonable range”.

China’s economy grew at its slowest pace for 13 years in 2012 and so far this year economic data has surprised on the downside, bringing warnings from some analysts that the country could miss its growth target of 7.5 percent for this year.

“Growth remains unconvincing and the momentum seems to have lost pace in May,” Louis Kuijs, an economist at RBS, said in a note. “The short-term growth outlook remains subject to risks and we may well end up revising down our growth forecast for 2013 further.”

Exports posted their lowest annual growth rate in almost a year in May at 1 percent, exposing a more realistic picture of trade following a crackdown by authorities on currency speculation disguised as export trades to skirt capital controls, which had created double-digit rises in export growth every month this year even as world growth stuttered.

May exports to both the United States and the European Union – China’s top two markets – both fell from a year earlier for the third month running.

Imports fell 0.3 percent against expectations for a 6 percent rise as the volume of many commodity shipments fell from a year earlier.

The volume of major metals imports, including copper and alumina, fell at double-digit rates. Coal imports fell sharply.

“The trade data reflects the sluggish domestic and overseas demand, signaling a slower-than-expected recovery in the second quarter,” said Shen Lan, an economist at Standard Chartered bank in Shanghai.

A government factory survey of purchasing managers and a similar poll sponsored by HSBC, both issued earlier this month, showed export orders falling in May, suggesting the outlook remained grim.

Inflation, bank-lending growth and investment were below expectations in May, while factory output and retail sales rose around the same pace as in April.

Consumer inflation in China slowed to the slowest pace in three months; perhaps an early sign of deflation entering the picture.

This economic slowdown that China and the rest of the world is experiencing is quite predictable.  In the case of China, municipalities have humongous debt levels which will tend to be deflationary.  China also has a demographic problem: an aging population.[ii] CNBC reported recently (emphasis added):

China, the manufacturing hub of the world, is in danger of losing that title.

Its population is aging fast as its one-child policy, begun in the 1970s, begins to bite. This, in turn, could lead to a huge labor shortfall by 2050, according to experts.

China’s workforce, those between the ages of 15 and 64, is expected to start contracting beginning in 2015. The number of new entrants into the workforce is already falling and will decline by 30 percent in 2020 compared to 2010, according to Beijing-based research firm GK Dragonomics.

“In the case of China, you have a shrinking number of people in the young adult workforce, shrinking numbers of children feeding into this force, and a growing number of the aging workforce,” Judith Banister, senior demographer at Javelin Investments in Beijing, said.

In 2010, there were 110 million people 65 and above in China; by 2030, the number will increase by more than 100 million, according to the United Nations. By 2050, more than a quarter of the population will be over 65.

In an article published in the China Economic Quarterly earlier this year, Wang Feng, director of Brookings-Tsinghua Center for Public Policy in Beijing, likens China’s demographic structure to a bullet train racing into the unknown.

“Profound demographic changes in China are redrawing the parameters of the country’s future,” Wang wrote.

Over the past two decades, China has experienced what experts call “a demographic window of opportunity.” UN data show the country’s working age population grew from 66 percent of China’s total population in 1990 to more than 72 percent in 2010 — fueling the nation’s economic rise, when it grew at an average rate of nearly 10 percent annually.

China’s working age population is expected to decline to 61 percent of the total population by 2050, according to the UN.

A one-child policy introduced in 1977 and rolled out nationwide two years later has contributed to falling birth rates, while life expectancy has gone up.

China’s labor force will soon begin a significant contraction.  That will increase the cost of labor and make China a less competitive location for manufacturing.  But, there’s another potentially larger issue here.  An older population consumes less.

While that is not as detrimental to China as it is to the US, it’s still a significant factor.  According to The World Bank, 34% of China’s GDP is from household consumption as compared to 72% in the U.S.[iii] As China’s population ages and as labor costs increase, China’s GDP growth will slow.

But it’s important to keep these factors in context.  The growth rate of the Chinese economy is slowing from double digit percentage increases annually to single digits.

Will New IRA or 401(k) Rules Affect You? Part One

While I have written about President Obama’s proposed limits on the amount that you can contribute to an IRA or other retirement account in the past, I wanted to expand on this thought.  Recently, I have had conversations with many, many folks who are concerned about the rules regarding IRA’s or other retirement account changing.  As you might expect, all these folks were concerned about the rules changing so they were not as favorable to the taxpayer.

I am republishing what I wrote previously here:

President Obama’s budget, according to a Bloomberg article published recently, will limit investment levels in IRA’s and other retirement accounts to $3 million.  To be fair, the details of the proposal are not clear, but the fact that the idea of retirement account investment limits are even being discussed should be very alarming to everyone.[iv] This from the article:

President Barack Obama’s budget proposal would cap multimillion-dollar tax-favored retirement accounts like the one held by Mitt Romney, his Republican rival in 2012.

Obama’s budget plan, to be unveiled April 10, would prohibit taxpayers from accumulating more than $3 million in an individual retirement account. That proposal would generate $9 billion in revenue for the Treasury over the next decade, according to a White House statement released today.

“Under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving,” the statement said.

The most prominent taxpayer with a multimillion-dollar IRA is Romney, the 2012 Republican presidential nominee and co- founder of Bain Capital LLC. Romney disclosed in public filings during the campaign that his retirement account held between $18.1 million and $87.4 million. At one point, the maximum exceeded $100 million.

IRAs have evolved from a retirement-planning technique into an estate-planning tool for some wealthy families because tax laws allow the accounts to be passed on to heirs, said Ed Slott, an IRA specialist and certified public accountant based in Rockville Centre, New York.

“Over the last election it hit a critical mass when a lot of people found out that Romney had $100 million in his IRA,” Slott said. “People thought, how on earth did that happen? I think that was the tipping point.”

The Romney campaign didn’t explain how he amassed that much money in an IRA when contribution limits are much lower. Most taxpayers can contribute a maximum of $5,500 for 2013. Older workers, self-employed workers and those who save through 401(k)-style plans have higher caps and can roll those accounts into IRAs.

One possibility is that Romney included Bain investments valued at close to nothing that later grew exponentially. The value would increase tax-free in the retirement account and would be subject to taxation at ordinary income tax rates when taken out.

Democratic lawmakers, including Representatives Sander Levin of Michigan and George Miller of California, asked the Treasury Department last August to answer questions about large IRAs and to make policy recommendations.

The administration’s statement didn’t explain in detail how the proposal would work. The cap would apply to the total of all of an individual’s tax-favored retirement accounts.

First, let me talk about how Mr. Romney could accumulate that much money in a retirement account.  As the article states, contribution limits to a retirement account are determined by the IRS and may increase year to year.  While the article correctly states that IRA contribution limits are $5,500 this year, it fails to point out the other types of retirement accounts that allow much larger contributions.  For example, a plan like a defined benefit plan allows for contributions large enough to fund a specific level of pension income at retirement.  If a company were to adopt one of these types of plans, contributions to the plan are made for each plan participant with older participants potentially getting a larger contribution than a younger plan participant due to the fact that the contribution will have a shorter time in which to grow.  For example, a 50 year old who will be collecting $2,000 per month at retirement might require a larger plan contribution than a 30 year old who will be collecting the same $2,000 per month at the same retirement age.  Presumably, the contribution made for the 30 year old will have longer to grow than the contribution made for the 50 year old.  If these plans are terminated, the plan balance allocated to a plan participant can be rolled to an IRA account.  It’s likely that Mr. Romney had a plan along these lines and, as the article states, it’s also almost a certainty that the investments in the plan grew exponentially.

Here is what the article doesn’t state.  The IRS owns about 40% Mr. Romney’s retirement account.  In spite of the fact that during the election much hype surrounded the fact that Mr. Romney paid a tax rate on his income in the 15% range due to much of the income being from capital gains and dividends, that will all change for Mr. Romney when he reached the age of 70 ½.  At that point, Mr. Romney will be required to take required minimum distributions from his retirement plan.  Assuming a balance of $100 million in his IRA at that point, Mr. Romney’s required minimum distribution from the plan would be between $3.5 and $4 million.  That distribution would be taxed at ordinary income tax rates, currently 39.6%.

The very important point here is that as an IRA account grows for the investor, it also grows for the IRS.  And, assuming tax rates in the future are higher, the IRS’ share can even grow disproportionately to the share of the investor.

Second, the CPA quoted in the article states that IRA’s are an estate planning tool because tax law allows the accounts to be passed to heirs.  While that is true, when the heir inherits an IRA, required minimum distributions begin IMMEDIATEY based on the heir’s age and remaining life expectancy at that time.  In this case, as in the case of an IRA owner reaching the age of 70 ½, income taxes are paid on distributions and are taxed at ordinary income tax rates.  In the case of wealthy families, that tax rate is once again 39.6% under current law; and that’s before state income taxes if applicable.  While heirs inheriting IRA’s can further defer the income taxes due, the income taxes can’t be avoided.  Assuming the inherited IRA continues to grow, total taxes paid on the IRA may actually be significantly higher over time than if taxes were paid on the account at the death of the original IRA owner.

This idea of capping retirement account investments will, in my view, ultimately REDUCE the total tax revenue generated by IRA’s and other retirement accounts.  As a retirement account grows for the investor, it also grows for the IRS.  Distributions from an IRA are taxed at the highest income tax rates in the code.  That being the case, why would the government want to limit the level of investment in an IRA?  It’s certainly not for tax reasons; more tax revenue is ultimately generated by a large growing IRA than one that is smaller.  My view is that this proposal is purely political, intended to create another reason for the have not’s to hate the haves.

Third, the article states that the proposal would generate $9 billion in tax revenues over the next decade.  The accountant that made that calculation would probably have to take his shoes off to count to 20.  This will be a net tax revenue loser for reasons that I’ve already stated.

Fourth, note the White House statement quoted in the article, “Under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving.”  This is simply farcical.  Here we go again, the government helping us determine what is reasonable.

Finally, if this IRA limit becomes law, it will have unintended consequences.  Charitable contributions will decline.  Wealthy individuals with charitable intent typically leave their IRA’s to charity rather than their heirs.  An IRA is the least efficient asset to own from a tax perspective and when an IRA is left to charity, the entire balance goes to the charity and no income taxes are paid.  I can cite many, many times through the years that both wealthy and middle class clients have left their IRA’s to their church or charity for this fact alone.

Another unintended consequence of this notion should it become law is that retirement plans at employers may cease to exist in the same numbers that they do today making it harder for the ever-shrinking middle class to conveniently save for retirement.  A business owner who sponsors a retirement plan may terminate the plan when her IRA limit is reached making a company sponsored plan unavailable to many workers.  After all, if the business owner can’t contribute, what is the incentive to keep the plan?

Prior to this article being published, I was of the opinion that folks saving for retirement should consider accumulating assets outside a retirement account.  Given the current tax trends and fiscal condition of the US, why would anyone want a joint account with the IRS considering that if future tax rates are higher than today, the IRS’ share grows?

Will New IRA or 401(k) Rules Affect You? Part Two

The recently established Consumer Financial Protection Bureau has been kicking around whether it has the authority to “help” Americans manage the money they’ve collectively accumulated in a retirement account.[v] This from an article published by Bloomberg (emphasis added):

The U.S. Consumer Financial Protection Bureau is weighing whether it should take on a role in helping Americans manage the $19.4 trillion they have put into retirement savings, a move that would be the agency’s first foray into consumer investments.

“That’s one of the things we’ve been exploring and are interested in in terms of whether and what authority we have,” bureau director Richard Cordray said in an interview. He didn’t provide additional details.

While it is unclear as to how this ‘help’ would manifest itself, it may make many IRA or 401(k) account holders nervous.  I talked about this in my book of two years ago “Economic Consequences.”[vi] Here is an excerpt:

In some cases, it may even make sense to use retirement account assets to eliminate your debt, although you should look at the consequences of doing so with a qualified professional before making any decision.

Why might I suggest you consider such a thing?

I believe that it’s possible that at some point, given the unfunded liabilities of Social Security and the many underfunded pensions around the country that the entire retirement income system gets a major overhaul.  That overhaul could potentially include government takeover or control of individual retirement accounts.  Before you dismiss my thought as being radical or not possible, consider what has already occurred around the world.

In December of 2010, the country of Hungary effectively confiscated $14 billion in private pensions.  The Hungarian citizens had a choice; either remit your retirement savings account to the state or be disqualified for a public pension but still be required to make the required contribution for the pension.

The Bulgarian government had a similar idea to gain control over $300 billion of private retirement savings.  After some of the unions protested, the government implemented only 20% of the original plan but still effectively confiscated private retirement savings accounts.

The country of Poland had a less dramatic development.  The country’s plan allowed savers to keep the retirement savings accumulated so far but require that a percentage of future private savings go to the state run Social Security program.

In the country of Ireland, in 2001, the country established the National Pension Reserve Fund to support the pensions of Irish retirees in the years 2025 through 20503.  Problem is in March of 2009, the Irish government seized 4 billion Euros from the fund to bailout the Irish banks and in November 2010, the 2.5 billion Euros remaining in the fund was used to help fund the bailout of the rest of the country.

In November of 2010, the French Parliament voted to earmark 33 billion Euros from the National Reserve Pension Fund to reduce short term pension deficits.  This move uses retirement savings intended to be used in the years 2020 – 2040 in the years 2011 – 2024.

In 2001, the country of Argentina confiscated $2.3 billion of retirement savings by forcing private pensions to transfer assets to a state bank in exchange for treasury bills.

You may be thinking that nothing similar could ever happen here, after all those countries are not the USA.  If you’re thinking that, to be fair, you may be right.

But, to quote an old cliché’, I would never say never.

Who ever thought that the bondholders of General Motors would have had to take junior positions to the union during GM’s bankruptcy?  10 years ago, every analyst would have said not possible, yet it happened.

Who would have every thought that the US Government would have shelled out $182.5 billion for an 80% share in AIG when the total value of the outstanding stock at the time was less than $4 billion?  It happened.

An article in “Investor’s Business Daily” on February 17, 2010 written by Newt Gingrich and Peter Ferrara reported that the Treasury and Labor Departments were seeking public comment on the conversion of 401(k) and IRA accounts into annuities or other steady payment streams7.  In other words, according to the article, “the idea is for the government to take your retirement savings in return for a promise to pay you some monthly benefit during your retirement years.”

“US News and World Report” reported in 2008 that Theresa Ghilarducci, a professor at the New School of Social Research, was invited to testify about her idea to eliminate the preferential tax treatment of 401(k), IRA and other retirement accounts before a subcommittee8.  Ms. Ghilarducci’s plan would replace 401(k) plans with government sponsored “guaranteed retirement accounts” for every worker.  The government would deposit $600 every year, indexed for inflation, into the guaranteed retirement account.  Each worker would have to save 5% of pay into the accounts and the government would pay the worker a 3% return on the investment account.  Congressman Jim McDermott commented at the time that “the savings rate isn’t going up for the investment of $80 billion [in 401(k) tax breaks], we have to start to think about whether or not we want to continue to invest that $80 billion for a policy that’s not generating what we now say it should.”

Ghilarducci was featured in a “Money” magazine article in 2008.  In the article she makes some comments that should scare anyone who is using a 401(k) or IRA to save for retirement, “People aren’t saving any more because of them; those who use 401(k)s and IRAs are moving money they’d already be saving from taxed to nontaxable accounts. The 401(k) doesn’t even make top-paid people save consistently. The only answer, and this is after 25 years of looking at it, is to make people save: a mandatory, universal savings plan on top of Social Security.”

Could this be the next shoe to drop?  Could we have a new politician run retirement system on top of a financially strapped Social Security system?

Maybe not.  But, when you look at the level of the “official” national debt, it’s at about $14.3 trillion10.  Considering that according to the Investment Company Institute there were total assets in IRA’s and 401(k)’s of about $6 trillion at the end of 200811 and total retirement account assets of $15.6 trillion at the end of the third quarter of 2009 (this total includes 401(k)’s, IRA’s and all other retirement plans); that may be a target that’s too tempting for some politicians to resist.

After mandating that everyone buy health insurance or face a government penalty in the recently passed healthcare package, will the government mandate retirement savings next for the entire population and in the process take over the existing, private retirement savings plans?

Again, maybe not.  But, I believe that the possibility exists.

We’ve discussed, the current unfunded liabilities of the Social Security system are significant but what we have not yet discussed is that just last year, in 2010, the cash flows from the Social Security system went negative for the first time meaning that the payroll taxes collected for the program were not enough to cover the benefits paid out.    While I can’t guarantee or accurately predict what might happen in the future, I think, based on the evidence, it makes sense to at least consider using retirement account balances to eliminate debt even though there will be tax consequences.

To quote another old cliché’, a bird in the hand might be worth two in the bush.

I’d add this one thought for your consideration.

An article in the PPG Gazette, reported on a news release issued by the US Department of Labor on August 26, 2010.  The news release issued an agenda for hearings that the Department of Labor was having with The Department of Treasury.  These hearings took place September 14 and 15 and were innocuously titled, “Lifetime Income Options for Retirement Plans”.  Admittedly, this article is more of an op-ed than article, but it raises some thought-provoking points.  One of them being that in congressional hearings held in 2008 on the same topic an idea was discussed that would replace seized retirement account assets with something called Treasury Retirement Bonds.  These Treasury Retirement Bonds would be worth more than the assets that were in the retirement account at the time the assets in the retirement account were seized in order to make the process more tolerable for investors.  The article also points out that should this occur, you’ll never hear terms like seizure used, instead the policymakers would probably use terms like retirement protection legislation in order to sell the program to the public and, like many things that the government implements, a plan like this would likely be incremental as well.  The article also states that these retirement accounts would potentially pay an income at retirement to the retiree with that income stopping at the retirees’ death possible leaving nothing for the retiree’s heirs similar to the way that Social Security accounts now function.

Housing Bubble Take Two?

The housing bubble and subsequent bust of 7 years ago might seem like a distant memory given the stories of rapidly increasing housing prices and bidding wars and fights over properties.  Is the housing market fully recovered?  Or, is this just a repeat of the last bubble?

“The New York Times” ran a story that discussed this.[vii] Here’s an excerpt (emphasis added):

Bidding wars sound almost quaint. These days, the only way for would-be buyers to secure a home, it often seems, is to offer all cash and be ready to do so within hours, not days.

The bursting of last decade’s housing bubble feels like ancient history here, where first-time home buyers are competing with investors to get into single-family homes with prices approaching $1 million.

“It’s everyone from a kid out of law school to an investor from China, walking around with thousands to spend,” said Kameron Eliassian, a Los Angeles real estate agent. “I don’t know where it’s coming from, and I don’t care. Just show me proof that it’s there, and we’re good.”

After saving money for years, waiting for the residential real estate market to hit bottom, buyers all over the country appear eager to get back in, lured by low interest rates and the prospect of a good deal.

But with the number of homes for sale at historically low levels and large investors purchasing thousands of properties, buyers are facing a radically changed market and prices are quickly rising.

The percentage of homes bought with cash has shot up in many markets across the nation. Nearly a third of all homes purchased in Los Angeles during the first quarter of this year went for all cash, compared with just 7 percent in 2007. In Miami, 65 percent of homes sold were for cash deals, compared with 16 percent six years ago.

The prices on all-cash deals are also rising significantly. In Los Angeles, the median price on an all-cash home this year is about $351,000, compared with $230,000 in 2009. Over the same period, the median price over all increased to $410,000, up $85,000. In fact, last month, home prices in Southern California hit their highest level in the last five years.

All-cash buyers, typically investors eager to renovate and quickly resell or rent out homes, are making it more difficult for first-time buyers, who typically rely on mortgage loans that can take weeks or months to materialize. More California homes have been flipped in the last year than in any year since 2005.

Bubbles can be identified when irrational activity exists.  This article describes prices increases and bidding wars that could only be described as irrational in my opinion.

While shadow inventory is falling and houses in many parts of the country are selling like beer at a NASCAR race, I’d proceed with caution.  It’s probably a good time to sell a house but not such a great time to buy one.  If the Federal Reserve stopped buying mortgage backed securities each month at their current frantic pace and the US Government was suddenly not involved in the mortgage business, I believe the housing market would look a lot different than it does presently.

Look for a sequel to the first housing collapse in the future.  The only good news is that the sequel will probably be less dramatic and less interesting than the first.  But, that’s the nature of sequels.

Trash Collectors in Charge of Public Safety?

In an economic winter season, events occur that might have seemed to be downright ridiculous during any other economic season, in particular garbage men and letter carriers helping to patrol neighborhoods.[viii] This from CBS News San Francisco (emphasis added):

The shorthanded Antioch Police Department is enlisting the help of local garbage collectors and letter carriers to spot crime on city streets.

Employees of the local trash collector, Republic Services Inc., as well as U.S. Postal Service employees have been given tips on how to act as effective witnesses to crimes. The program, dubbed “We’re Looking Out For You” aims to add some experience eyeballs looking out for the city’s 105,000 residents.

As part of the training, drivers received a list of questions designed to help them identity criminal activity, as well as a laminated copy of the police department’s non-emergency phone number.

“It’s a huge resource multiplier for us,” said Lt. T. Brooks of the Antioch Police Department. “These are people who are actively engaged in the community and are actively participating in making Antioch a safer place.”

The police department isn’t encouraging anyone to take crime fighting into their own hands, but simply to keep an eye out for activities that seem out of the ordinary along their route.

When you think about this idea, it makes sense doesn’t it?

Too bad it takes an economic winter season to help local politicians gain perspective.


Core Economic Beliefs Driving Investment Philosophy

Economic Cycles

In 1925, a Russian economist by the name of Nikolai Kondratieff published a book titled “The Major Economic Cycles”. In it Mr. Kondratieff stated his view that capitalist economies move in boom and bust cycles with each full cycle repeating itself every 60 to 80 years. Some present day economists building on Kondratieff’s work have defined these “Kondratieff Waves” as 4 sub cycles, naming the sub cycles after the 4 seasons of the year; spring, summer, autumn and winter. We believe, after a study of economic history, that Mr. Kondratieff’s cycle theory is accurate.

The Spring Cycle

During spring, an economy experiences a gradual increase in business and employment. Consumer confidence gradually increases. Consumer prices begin a gradual increase compared to levels seen during the previous cycle (the winter cycle). Stock prices rise and reach a peak at the end of the spring cycle. Interest rates begin to rise from historically low levels and credit gradually expands. At the beginning of the spring cycle overall debt levels are low. (In our view, this most recently represents the time frame of 1949-1966)

The Summer Cycle

During summer, an economy sees an increase in the money supply which leads to inflation. Gold prices reach a significant peak at the end of the summer period. Interest rates rise rapidly and peak at the end of the summer. Stocks are under pressure and decline through the period reaching a low at the end of the summer cycle. (In our view, this most recently represents the time frame of 1967-1982)

The Autumn Cycle

During autumn, money is plentiful and gold prices fall reaching a gold bear market low by the end of the autumn season. During autumn there is a massive stock bull market and much speculation. Financial fraud is prevalent and real estate prices rise significantly due to speculation. Debt levels are astronomical. Consumer confidence is at an all time high due to high stock prices, high real estate prices and plentiful jobs. (In our view, this most recently represents the time frame of 1983 – 2000)

The Winter Cycle

During winter, an economy experiences a crippling credit crisis and money becomes scarce. Financial institutions are in trouble. Unprecedented levels of bankruptcy at the personal, corporate and government levels. There is a credit crunch and interest rates rise. There is an international monetary crisis. There are pension funding problems and the price of gold and gold related equities rise. (In our view, we have been in the winter cycle since 2001)

Investing Overview and Premise

In 1999, economist and financial commentator, Harry Browne, wrote a book titled “Fail Safe Investing”. In his book, Browne presented his idea as to what an ideal portfolio should look like given that economic conditions cycle and as these cycles occur, certain asset classes can be adversely affected while other asset classes might benefit.

In his book, Browne concluded that the best kept secret in the investing world is that almost nothing turns out as expected. We agree. While each season of the economic cycle may be easy to see from an historical perspective, it may be difficult to determine with precision the beginning of one cycle ‘season’ and the end of the prior cycle ‘season’.

Browne designed a very simple portfolio strategy designed to protect and grow assets in each of the four economic cycles:

  • 25% invested in Cash. In a tight money environment, cash can be a profitable asset to own. In periods of deflation, cash can gain in purchasing power as prices fall.
  • 25% invested in Growth Stocks. In prosperous times, growth stocks can perform nicely while stocks may not perform as well in periods of inflation, deflation and tight money.
  • 25% invested in Gold. In an inflationary environment, gold can protect purchasing power.
  • 25% invested in Government Bonds. In a deflationary environment, as interest rates fall, bonds can perform nicely. In more prosperous times, bonds can also perform well.

Our Approach

While we agree with Browne’s approach given our belief that evidence suggests that economies cycle, we have modified Browne’s approach due to our belief in the use of exit strategies and our interpretation of current world macro-economic conditions. We believe that our modification of Browne’s original strategy will produce enhanced results. For thoughts on incorporating this strategy into your portfolio or your 401(k) plan, request an Exit Strategy Analysis below.


Exit Strategy Analysis™ Evaluation

If you would like to receive a complimentary Exit Strategy Analysis™ on each of the holdings in your portfolio, visit www.ExitStrategyAnalysis.com and complete the form there. An Exit Strategy Analysis™ is a second opinion on the holdings in your portfolio; however, unlike many second opinions, you will learn at what price you may wish to exit your holding in order to potentially protect profits or limit losses

Additionally, at your option, your Exit Strategy Analysis™ could include the following:

  • How to potentially maximize your retirement income
  • How to potentially diversify currencies
  • A complimentary copy of the book Economic Consequences: Can You Survive, Even Prosper from the Results of 100 Years of Bad Money Decisions?

After obtaining some preliminary information from you, you will receive your completed Exit Strategy Analysis™.

Request your complimentary Exit Strategy Analysis™ now by visiting www.ExitStrategyAnalysis.com!

Advisory services offered through USA Wealth Management. Any information obtained from third party resources is believed to be reliable but the accuracy cannot be guaranteed. This entry may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Therefore, no forecast should be considered a guarantee. No investment strategy can guarantee a profit. Investing in market related securities involves a risk of principal loss. Prior to making any investment decision, the services of an appropriate professionals should be obtained in order to understand the risks, costs, and benefits associated with a particular investment.

[i] Langi Chiang and Jonathan Standing. “China’s economy stumbles in May, growth seen sliding in Q2.” www.Reuters.com June 9, 2013. http://www.reuters.com/article/2013/06/09/us-china-economy-idUSBRE9580GE20130609
[ii] Deirdre Wang Morris. “China’s Aging Populations Threatens Its Manufacturing Might.” www.CNBC.com October 24, 2012. http://www.cnbc.com/id/49498720
[iii] Source: http://data.worldbank.org/indicator/NE.CON.PETC.ZS
[iv] Richard Rubin and Margaret Collins. “Obama’s budge would cap Romney-sized retirement accounts.” Bloomberg. April 5, 2013. http://www.bloomberg.com/news/2013-04-05/obama-budget-calls-for-cap-on-romney-sized-iras.html
[v] Carter Dougherty. “Retirement Savings Accounts Draw U.S. Consumer Bureau Attention.” Bloomberg. January 18, 2013. http://www.bloomberg.com/news/2013-01-18/retirement-savings-accounts-draw-u-s-consumer-bureau-attention.html
[vi] Dennis Tubbergen. Economic Consequences: Can you survive, even prosper, from results of 100 years of bad money decisions? Grand Rapids, Michigan: Dennis Tubbergen, 2011. Print.
[vii] Jennifer Medina and Katharine Q. Seelye. “As Home Sales Heat Up Again, Buyers Must Resort to Cold Cash.” The New York Times. June 8, 2013. http://www.nytimes.com/2013/06/09/us/cash-is-fueling-quick-home-sales.html?_r=1&
[viii] Anonymous. “Shorthanded Antioch Police Ask Mail Carriers, Garbage Collectors to Help Spot Crime.” CBS San Francisco Bay Area. June 10, 2013. http://sanfrancisco.cbslocal.com/2013/06/10/shorthanded-antioch-police-ask-mail-carriers-garbage-collectors-to-help-spot-crime/

 

Market and Economic Update – June 14, 2013

  • Ticket Prices Go Up
  • ‘Abenomics’ Bubble is Bursting
  • Monster Debt Levels
  • “Common European Debt”
  • The Hindenburg Omen

Wishing on a Star Just Got More Expensive

Disney recently announced that ticket prices would be increasing.  Fox News New York ran an Associated Press story on the company’s decision to raise prices.[i] This from the article:

Interview of the Week

This week I interviewed frequent guest expert Jim Babka. Mr. Babka is president of DownsizeDC.org. Mr. Babka shares his take on what is currently happening in Washington DC and the current IRS Scandal. You’ll want to catch this interview at www.everythingfinancialradio.com

When you wish upon a star, be sure to bring your wallet. Disneyland and Disney World have raised their ticket prices.

Disney said in a statement that starting Sunday, a one-day adult ticket to one park at Disneyland will cost $92, a $5 increase. Kids’ tickets also jumped $5, to $87.

The prices apply to either Disneyland Park or Disney California Adventure Park. Buyers of annual passes will see similar increases.

The Disneyland statement says the price hikes were brought on by a variety of factors, but the tickets represent a great value given the breadth and quality of attractions and entertainment its parks offer.

California does not charge taxes on their tickets.

That’s not the cast in Florida.  Prices also changed at Disney World in Florida.  Tickets there are now $95 a day according to the Walt Disney World site.  With tax, the ticket jumps to $101.18, according to MouseSavers.com.

Unemployment is not improving.  Record numbers are receiving government assistance and yet Disney is raising prices.  A family of four spending the day at Disney World will spend more than $400 just to get in the park not to mention all the extra spending for food, drink and mouse ear souvenirs.  Add those expenses in and that same family might spend another $200 or so.

How can we square this?

In spite of a less-than-robust economy, Disney is raising prices.  The executives at Disney who made this decision are bright; presumably they know what they’re doing.

The answer lies in an often ignored factor that influences economic activity – demographics.  At certain ages, spending patterns are quite predictable.  Not only is the amount of spending quite foreseeable, the areas of spending are as well.

While the baby boomers are reaching their retirement years and are spending less, their children, the echo boomers, are beginning to marry and have children.  Naturally, these parents want their children to wish upon a star at a Disney resort.

“Barrons” recently ran a story about this seldom-heard, but very important economic factor.[ii] Echo boomers, also referred to as Millennials or Generation Y, are those age 18 to 34.  This segment of the population accounts for 86 million people and is 7% larger than the Baby Boomer segment.  This group already accounts for $1.3 trillion of consumer spending, 21% of total US consumer spending.  As this group gets closer to their peak spending years (age 46 to 50 years old), they will have a big impact on the economy.

Presently though, the leading edge of the Millennials is getting married and having children who want to go to Disney.  That might explain why Disneyland had to turn away new potential customers during the holiday season while other businesses like Sears and JC Penney are closing stores.[iii][iv] Baby boomers who used to spend a lot more money are reaching the years during which they don’t spend as much.  That hurts Sears and JC Penney.

While I am bearish on the stock market shorter term during this economic winter season, due to the echo boomers, once we get through this economic winter period, I believe that we will once again see a bull market.

How long will that take?

My guess is another 8 years or so.  Until then, depending on your time frame and age, you may want to consider nest egg management strategies that could help you avoid the effects of a stock market decline.

U.S. and China Manufacturing Contracts

An article published by “The Telegraph” reported that manufacturing in both China and the U.S. contracted and manufacturing is at the lowest level since the 2008 and 2009 crisis.[v] This from the article (italicized) and my thoughts (non-italicized):

The closely-watched ISM index of US factories tumbled through the “boom-bust line” of 50 to 49, far below expectations. It is the lowest since the depths of the crisis in mid-2009 and a clear sign that US budget cuts are starting to squeeze the economy. New orders plunged 3.5 to 48.8 on weak foreign demand and reduced federal contracts.

GDP, or Gross Domestic Product is a simple mathematical formula.  Consumption + Investment + Government Spending + or – net exports.  When government spending declines so does GDP and the economy contracts.

According to the US Treasury, total outlays for the first four months of calendar year 2012 were $1,225,878,000 versus $1,182,077,000 for the first four months of 2013.  While actual outlays are down, they declined by only 3.6%.  When comparing government spending from October, the beginning of the fiscal year, through April government spending declined only .58%.[vi]

While this slight pullback in spending of less than $44 million may be a slight factor, in the context of a $15.7 trillion economy it’s a gnat on an elephant’s back and not a significant contributing factor to the sudden decline in manufacturing.

The news came hours after HSBC said its index for China also fell below 50, a major inflexion point for the world’s industrial workshop.

“This is not a good moment for the world economy,” said David Bloom, currency chief at HSBC. “The manufacturing indices came in weaker than expected in China, Korea, India and Russia, and then we got America’s ISM.

“We thought we had a clear picture that the US was recovering, Japan was printing money and were we’re back to happy days, and now suddenly a huge spanner has been thrown in the works.”

Amazing to me that someone thinks we’ve returned to “happy days” when countries are printing money to prop up their anemic economies.  Debt levels worldwide exist whether money is printed or money is not printed.  Debt still has to be dealt with and excessive debt levels are deflationary and cause economic contraction.

The OECD says the US is tightening fiscal policy by 3.2pc of GDP this year, the biggest squeeze in half a century. Consumers spent their way through the initial shock in the first quarter by slashing the national savings rate to 2.5pc.

“People have been living in a psychological bubble,” said Charles Dumas from Lombard Street Research. “They ignored the cuts but now they are starting to feel it.”

Feeling the effects of less than $44 million in cuts?  Pah-leeze.

The ISM quoted a string of gloomy comments from different sectors, such as “government spending has tightened” (computers), “over the past 20 days we have seen the trend flatten” (furniture), or “downturn in European and Chinese markets is having a negative effect on our business” (machinery).

Wall Street reacted calmly to the ISM shock, betting that the US Federal Reserve will delay plans to taper its monthly bond purchases of $85bn (£55.5bn). Stephen Lewis from Monument Securities said this may be a misjudgement. The latest minutes of the Federal Advisor Council, which advises the Fed on markets, are packed with warnings over the side-effects of quantitative easing.

The council said it is “not clear” that QE is boosting the economy, and warned that zero rates are pushing pension funds underwater on their liabilities, and may be causing firms to defer investment on the grounds that rates will remain low.

QE, or money printing, cannot boost the economy.  QE is the economic equivalent of crack – it produces short term effects and then once it wears off, you’re in worse shape than when you started.

They also said Fed purchases of mortgage bonds was depriving banks of “bread and butter” business, pushing them into riskier corporate and emerging market debt, and blowing a “bubble” in fixed income and equity markets.

Mr. Bloom said a sharp strengthening of the Japanese yen on safe-haven flows and the 16pc fall of the Nikkei index from its peak are disturbing. “People are asking whether the ‘Abenomics’ bubble is bursting.”

Of course the ‘Abenomics’ bubble is bursting.  If it’s not bursting presently it will in the future.  You can’t print money at a maniacal rate without creating a bubble like Abe has done.  One need only look at a chart of the Nikkei, the Japanese stock market index, to see that a bubble has formed.  The near parabolic chart pattern up is almost always followed by a similarly spectacular decline.

This decline in manufacturing is predictable given demographic trends, debt levels and policy response.  Look for this trend to continue and intensify.
Eurozone Sinks Into Deepest Recession Ever

In the Eurozone, economic activity contracted for the sixth consecutive quarter.[vii] An article published in “The Guardian” explained (emphasis added):

The eurozone has slumped into its longest recession ever, after economic activity across the region fell for the sixth quarter in a row.

Economic output across the single currency area fell by 0.2% in the first three months of 2013, statistics body Eurostat reported on Wednesday. France, Spain, Italy and the Netherlands all saw their economies shrink as the economic crisis in the eurozone continued to hit its largest economies.

Eurostat’s figures showed that the eurozone economy has contracted by 1% over the last year, putting further pressure on leaders as unemployment climbs to new record highs. The 0.2% contraction in the first quarter was an improvement on the 0.6% drop recorded between October and December, but analysts warned that the eurozone’s economic outlook is darkening.

“What seems incontrovertible, on this evidence, is that the member-states of the euro zone are on the wrong track,” commented Stephen Lewis, chief economist at Monument Securities. “The costs of the zone’s one-size-fits-all strategy are becoming brutally apparent.”

France was dragged back into recession by a 0.2% drop in GDP, announced on the first anniversary of François Hollande being sworn in as president.

Pierre Moscovici, French finance minister, denied Paris’s forecast of 0.1% growth this year was too optimistic. “I’m sticking to the figures,” Moscovici told reporters, adding that the EU must prioritise growth over tackling budget deficits.

There was also disappointment that Germany eked out growth of just 0.1%, worse than economists had expected. The Dutch economy shrank by 0.1%.

“The bottom line is that both the German and French economies, which together account for half of the eurozone’s output, are in the doldrums,” said Nick Spiro of Spiro Sovereign Strategy. “Add in the persistent recession in the Netherlands, which accounts for a further 6.5% of eurozone GDP, and the core and semi-core of the eurozone are in significantly worse shape than a year ago.”

Italy’s new prime minister, Enrico Letta, was given an early reminder of the challenge he faces with the news that Italian GDP fell by 0.5%. Italy’s economy has been shrinking for the last seven quarters, its longest recession since at least 1970.

Beyond the eurozone, the Czech Republic suffered a 0.8% decline in GDP during the quarter.

The data came a day after the Washington-based Pew Research Centre reported that public support for the European Union had fallen over the last year, from 60% to 45%. Pew warned that the ongoing financial crisis means the European project was “in disrepute” in some countries, with many Europeans losing faith in closer integration.

The recession in the Eurozone has stretched to 1 ½ years.  Given that monster debt levels in Europe still exist, this recession will continue long term and intensify.  I believe a study of history confirms this.  With worldwide debt levels at nosebleed levels, the only possible outcome is recession and deflation.

German Finance Minister Fears Revolution from Your Unemployment Rate

The German Finance Minister, Wolfgang Schauble, warned that the Eurozone needs to do more to alleviate the pain being experienced by European youth who are unemployed.  Interestingly, the Finance Minister used the word revolution to describe what would happen in the event that welfare standards were toughened.[viii] Reuters news service reported (emphasis added):

German Finance Minister Wolfgang Schaeuble warned on Tuesday that failure to win the battle against youth unemployment could tear Europe apart, and dropping the continent’s welfare model in favor of tougher U.S. standards would spark a revolution.

Germany, along with France, Spain and Italy, backed urgent action to rescue a generation of young Europeans who fear they will not find jobs, with youth unemployment in the EU standing at nearly one in four, more than twice the adult rate.

“We need to be more successful in our fight against youth unemployment, otherwise we will lose the battle for Europe’s unity,” Germany’s Schaeuble said.

While Germany insists on the importance of budget consolidation, Schaeuble spoke of the need to preserve Europe’s welfare model.

If U.S. welfare standards were introduced in Europe, “we would have revolution, not tomorrow, but on the very same day,” Schaeuble told a conference in Paris.

The Finance Minister is right.  If welfare benefits were reduced for young, unemployed Europeans, a revolution would occur.  Historically speaking, economic winter seasons are prime time for revolutions.  And when one takes a look at some of the economic statistics relating to Europe, the outlook is not optimistic.  Here is a bit more from the article1 (emphasis again added):

Prime Minister Mariano Rajoy of Spain, where youth unemployment is among the highest in Europe, called for the euro zone to triple aid to small businesses and allow governments to subsidize the hiring of younger workers without sanctions for overspending.

In recent weeks Germany, wary of a backlash as many in crisis-hit European countries blame it for austerity, has taken steps to tackle unemployment in the bloc, striking bilateral deals with Spain and Portugal.

“We have to rescue an entire generation of young people who are scared. We have the best-educated generation and we are putting them on hold. This is not acceptable,” Italian Labour Minister Enrico Giovannini said.

Rajoy said both the European Investment Bank and European Central Bank should do more to help credit flow to small firms.

Small and medium-sized companies in Spain and much of southern Europe pay much higher rates for loans than their counterparts in the north. Youth unemployment in Spain is above 57 percent as layoffs continue in a deep recession.

“With all respect for its independence, I believe the ECB can and should do more,” Rajoy said in a speech at the end of the conference, also saying funds channeled to small firms via the EIB should be boosted to 30 billion euros ($38 billion) a year.

He called for “some kind of common European debt” and said Europe should temporarily exclude social security subsidies for youth hiring from its calculation of member states’ budget deficits, a proposal that will likely meet resistance.

“Common European debt” has been suggested by many.  But, mark my words, it will never happen.  That would require stronger European economies like Germany to help with the debt load of weaker economies.  The German electorate will not stand for that.

Calls to expand credit will also go unheeded.  Extending credit to someone who is not credit worthy is no solution it’s only a temporary band aid.  Meanwhile youth unemployment is expanding.

Even without tougher welfare standards, Mr. Schauble’s concerns are valid.

Is the Clock Ticking? Hindenburg Omen Appears

If you’re not a technical analysis geek, the term Hindenburg Omen probably means nothing to you; however, if you have money invested in the stock market, you might want to learn about this indicator.  Dr. Robert McCugh, a past guest on my radio program, “The Everything Financial Radio Show”, recently explained[ix]:

So what is a Hindenburg Omen? It is the alignment of several technical factors that measure the underlying condition of the stock market — specifically the NYSE — such that the probability that a stock market crash occurs is higher than normal, and the probability of a severe decline is quite high. This Omen has appeared before all of the stock market crashes, or panic events, of the past 29 years except one, except the mini-crash of July/August 2011. Except for that one crash, no stock market crash (a decline greater than 15 percent) occurred over the past 29 years without the presence of a Hindenburg Omen. Another way of looking at it is, without an official confirmed Hindenburg Omen, we are pretty safe. On the other hand, if we have an official Hindenburg Omen, then a critical set of market conditions necessary for a stock market crash exists. As of May 31st, 2013, we have such a condition in the market, as we have a new official Hindenburg Omen.

We got a first Hindenburg Omen observation on Wednesday, May 29th, 2013, and a second official confirming Hindenburg Omen observation Friday, May 31st, 2013, meaning we are now on the clock watching for a stock market crash, and at the very least a significant decline. There is a much higher-than-random probability of a stock market crash starting sometime over the next four months. All criteria were met Wednesday May 29th and Friday, May 31st, 2013. May 29th’s observation saw 74 NYSE New 52 Week Highs, and 131 NYSE New 52 Week Lows according to the Wall Street Journal, the lower of the two coming in at 2.33 percent, above the 2.2 percent threshold required for a Hindenburg Omen observation. Total NYSE issues traded were 3,175. New Highs were not more than twice New Lows, the McClellan Oscillator was negative at negative -192.60, and the 10 Week Moving Average (50 Day Moving Average) was higher than it was ten weeks earlier. The second observation on May 31st, 2013 has occurred within the required 36 day period necessary for a cluster (two or more observations) to occur. Friday May 31st’s observation saw 98 NYSE New 52 Week Highs, and 162 NYSE New 52 Week Lows according to the Wall Street Journal, the lower of the two coming in at 3.09 percent, above the 2.2 percent threshold required for a Hindenburg Omen observation. Total NYSE issues traded were 3,165. New Highs were not more than twice New Lows, the McClellan Oscillator was negative at negative -251.41, and the 10 Week Moving Average (50 Day Moving Average) was higher than it was 10 weeks earlier.

Now that we have a second observation, we have an official confirmed Hindenburg Omen. This is the first Hindenburg Omen since November 12th, 2012, and only the fifth since 2008, the 2008 signal which of course led to the massive stock market crash in the autumn 2008, and the seventh since the Bear Market started in 2007 (we got one in 2007, one in 2008, two in 2010, two in 2012, and now one in 2013). We got crashes after both the October 2007 and June 2008 Hindenburg Omens.

While this article may just be technospeak to you, there are many other factors that should have many stock market investors taking another look at the level of risk they’re assuming in their portfolio.  There is a bearish price-volume divergence as well as negative seasonal bias in addition to this recent Hindenburg Omen.

Depending on your individual facts and circumstances, you may want to reassess your nest egg allocations.


Core Economic Beliefs Driving Investment Philosophy

Economic Cycles

In 1925, a Russian economist by the name of Nikolai Kondratieff published a book titled “The Major Economic Cycles”. In it Mr. Kondratieff stated his view that capitalist economies move in boom and bust cycles with each full cycle repeating itself every 60 to 80 years. Some present day economists building on Kondratieff’s work have defined these “Kondratieff Waves” as 4 sub cycles, naming the sub cycles after the 4 seasons of the year; spring, summer, autumn and winter. We believe, after a study of economic history, that Mr. Kondratieff’s cycle theory is accurate.

The Spring Cycle

During spring, an economy experiences a gradual increase in business and employment. Consumer confidence gradually increases. Consumer prices begin a gradual increase compared to levels seen during the previous cycle (the winter cycle). Stock prices rise and reach a peak at the end of the spring cycle. Interest rates begin to rise from historically low levels and credit gradually expands. At the beginning of the spring cycle overall debt levels are low. (In our view, this most recently represents the time frame of 1949-1966)

The Summer Cycle

During summer, an economy sees an increase in the money supply which leads to inflation. Gold prices reach a significant peak at the end of the summer period. Interest rates rise rapidly and peak at the end of the summer. Stocks are under pressure and decline through the period reaching a low at the end of the summer cycle. (In our view, this most recently represents the time frame of 1967-1982)

The Autumn Cycle

During autumn, money is plentiful and gold prices fall reaching a gold bear market low by the end of the autumn season. During autumn there is a massive stock bull market and much speculation. Financial fraud is prevalent and real estate prices rise significantly due to speculation. Debt levels are astronomical. Consumer confidence is at an all time high due to high stock prices, high real estate prices and plentiful jobs. (In our view, this most recently represents the time frame of 1983 – 2000)

The Winter Cycle

During winter, an economy experiences a crippling credit crisis and money becomes scarce. Financial institutions are in trouble. Unprecedented levels of bankruptcy at the personal, corporate and government levels. There is a credit crunch and interest rates rise. There is an international monetary crisis. There are pension funding problems and the price of gold and gold related equities rise. (In our view, we have been in the winter cycle since 2001)

Investing Overview and Premise

In 1999, economist and financial commentator, Harry Browne, wrote a book titled “Fail Safe Investing”. In his book, Browne presented his idea as to what an ideal portfolio should look like given that economic conditions cycle and as these cycles occur, certain asset classes can be adversely affected while other asset classes might benefit.

In his book, Browne concluded that the best kept secret in the investing world is that almost nothing turns out as expected. We agree. While each season of the economic cycle may be easy to see from an historical perspective, it may be difficult to determine with precision the beginning of one cycle ‘season’ and the end of the prior cycle ‘season’.

Browne designed a very simple portfolio strategy designed to protect and grow assets in each of the four economic cycles:

  • 25% invested in Cash. In a tight money environment, cash can be a profitable asset to own. In periods of deflation, cash can gain in purchasing power as prices fall.
  • 25% invested in Growth Stocks. In prosperous times, growth stocks can perform nicely while stocks may not perform as well in periods of inflation, deflation and tight money.
  • 25% invested in Gold. In an inflationary environment, gold can protect purchasing power.
  • 25% invested in Government Bonds. In a deflationary environment, as interest rates fall, bonds can perform nicely. In more prosperous times, bonds can also perform well.

Our Approach

While we agree with Browne’s approach given our belief that evidence suggests that economies cycle, we have modified Browne’s approach due to our belief in the use of exit strategies and our interpretation of current world macro-economic conditions. We believe that our modification of Browne’s original strategy will produce enhanced results. For thoughts on incorporating this strategy into your portfolio or your 401(k) plan, request an Exit Strategy Analysis below.


Exit Strategy Analysis™ Evaluation

If you would like to receive a complimentary Exit Strategy Analysis™ on each of the holdings in your portfolio, visit www.ExitStrategyAnalysis.com and complete the form there. An Exit Strategy Analysis™ is a second opinion on the holdings in your portfolio; however, unlike many second opinions, you will learn at what price you may wish to exit your holding in order to potentially protect profits or limit losses

Additionally, at your option, your Exit Strategy Analysis™ could include the following:

  • How to potentially maximize your retirement income
  • How to potentially diversify currencies
  • A complimentary copy of the book Economic Consequences: Can You Survive, Even Prosper from the Results of 100 Years of Bad Money Decisions?

After obtaining some preliminary information from you, you will receive your completed Exit Strategy Analysis™.

Request your complimentary Exit Strategy Analysis™ now by visiting www.ExitStrategyAnalysis.com!

Advisory services offered through USA Wealth Management. Any information obtained from third party resources is believed to be reliable but the accuracy cannot be guaranteed. This entry may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Therefore, no forecast should be considered a guarantee. No investment strategy can guarantee a profit. Investing in market related securities involves a risk of principal loss. Prior to making any investment decision, the services of an appropriate professionals should be obtained in order to understand the risks, costs, and benefits associated with a particular investment.

[i] Author Unknown. “Day at Disneyland now $92; Disney World tops $100.” www.MyFoxNY.com via The Associated Press. June 3, 2013. http://www.myfoxny.com/story/22488499/day-at-disneyland-now-more-than-90
[ii] Jacqueline Doherty. “On the Rise.” Barron’s. April 29, 2013. http://online.barrons.com/article/SB50001424052748703889404578440972842742076.html#articleTabs_article%3D1
[iii] Mark Eades. “Disney parks reach capacity with holiday crowds.” Orange County Register. December 28, 2010. http://ocresort.ocregister.com/2010/12/28/disney-parks-reach-capacity-with-holiday-crowds/65192/
[iv] Before its News Staff. “J.C. Penney, Sears, Best Buy top retail store closings in 2013.” www.BeforeItsNews.com via USA Today. February 12, 2013. http://beforeitsnews.com/opinion-conservative/2013/02/j-c-penney-sears-best-buy-top-retail-store-closings-in-2013-2575946.html
[v] Ambrose Evans-Pritchard. “Global shock as manufacturing contracts in US and China.” The Telegraph. June 3, 2013. http://www.telegraph.co.uk/finance/economics/10096951/Global-shock-as-manufacturing-contracts-in-US-and-China.html=
[vi] Source: Department of the Treasury Financial Management Services. http://www.fms.treas.gov/mts/mts0413.pdf
[vii]Graeme Wearden. “Eurozone now in its longest recession.” The Guardian. May 15, 2013. http://www.guardian.co.uk/business/2013/may/15/eurozone-recession-deepens
[viii] Ingrid Melander and Nicholas Vinocur. “Germany fears revolution if Europe scraps welfare model.” Reuters. May 28, 2013. http://www.reuters.com/article/2013/05/28/us-europe-unemployment-idUSBRE94R0D320130528
[ix] Robert McHugh. “We got an official confirmed Hindenburg Omen on May 31, 2013.” www.SafeHaven.com June 3, 2013. http://www.safehaven.com/article/30019/we-got-an-official-confirmed-hindenburg-omen-on-may-31st-2013

 

Market and Economic Update – June 7, 2013

  • Evolution of World Reserve Currencies
  • Money Printing
  • Only Getting Started
  • An Old Market Adage Comes to Mind
  • Who Implodes First?

New Zealand and China Looking to Bypass the US Dollar

Only a few weeks ago, I wrote about Australia and China putting together a deal to allow direct trade between the two countries effectively bypassing the US Dollar in trade between the two countries.  Now, Australia’s neighbor is getting into the act.  The Country of New Zealand is now looking to put the same deal in in place.[i] This from “The Wall Street Journal” (emphasis added):

Interview of the Week

This week I interviewed frequent guest expert Professor Laurence Kotlikoff. Prof. Kotlikoff is a Professor of Economics at Brown University and President of Economic Security Planning, Inc., a company specializing in financial planning software. Mr. Kotlikoff shares some tips how you can maximize your Social Security and how to avoid some common mistakes. You’ll want to catch this interview at www.everythingfinancialradio.com

Seeking to help its exporters, New Zealand is negotiating with China to make their currencies directly convertible, a spokeswoman for Prime Minister John Key said.

Wellington’s push is aimed at driving down costs for companies that do business with China, which is close to overtaking Australia as New Zealand’s No. 1 trading partner.

Talks are in the “very early stages” and “progressing,” the spokeswoman said, adding that the issue had been brought up during Mr. Key’s visit to China last month.

Officials at the People’s Bank of China didn’t return calls seeking comment.

Direct convertibility between the Chinese yuan and New Zealand dollar would end the need for New Zealand’s companies and currency traders to convert New Zealand dollars or yuan into U.S. dollars when making or receiving payments.

New Zealand’s two-way trade with China totaled 15.3 billion New Zealand dollars (US$12.4 billion) in the year ended April 30, compared with NZ$16.8 billion with Australia, government data showed last week. Most of New Zealand’s exports to China are agricultural products—particularly milk powder, meat and wool—while most of its imports from there are computers, mobile phones and clothes.

Trade relations took a knock earlier this month when China temporarily blocked millions of dollars of New Zealand meat from entering the country, as it bolstered scrutiny of imports after a spate of mainly homegrown food-safety scandals.

Beijing is undertaking a long, gradual campaign to establish the yuan as a more market-oriented, international currency. China’s State Council, or cabinet, said in a statement this month that the country would draft a plan to allow the yuan to become fully convertible. Meanwhile, the People’s Bank of China is guiding the currency higher and set the median point of its permitted daily trading band last week at the strongest level ever.

Where this goes from here is fully predictable.  Historically speaking, the world’s reserve currency has been the currency of the largest creditor nation in the world.  At one time that described the British Sterling which was overtaken by the US Dollar since the US was the largest creditor nation in the world.  Today, the US has become the largest debtor nation in the world while China is the world’s largest creditor nation.

The move away from the US Dollar has begun and is picking up steam.  While it will take some time for the Chinese Yuan to overtake the US Dollar as the world reserve currency, I believe that it will ultimately.

Short term, look for US Dollar strength as Japan and Europe become bigger problems; however, long term you’d have to bet on the Yuan.

The chart above illustrates the evolution of world reserve currencies.  Notice that the last four currencies have enjoyed dominance for about 100 years.  Doesn’t look like that trend will be broken with the US Dollar from where I sit.  That’s why I like some precious metals in a portfolio.

Can the Money Printing Stop?

An article in “The Telegraph” recently offered some interesting perspective on the money printing in which many of the world’s central banks are engaged.[ii] Here is a bit from the article (emphasis added):

Wednesday night’s panic in Tokyo, where the Nikkei dropped a stomach churning 7pc, kicking off a global chain-reaction that saw the FTSE fall 143.48 points, demonstrates just how difficult it is going to be for the world’s central banks to exit their loose money policies.

It’s not even as if Ben Bernanke, chairman of the Fed, said he was planning to exit; in fact, initially he said the reverse, in testimony to Congress. It was only in the Q&A, and in minutes to the last meeting of the Fed’s Open Markets Committee, that a clear bias emerged to slow the pace of asset purchases “in the next few meetings”, so long as the economic data were strong enough.

What the subsequent violent gyrations in markets indicate is that any hint of applying the brakes risks generating a fresh financial crisis, which, in turn, would render the economic recovery still-born.

Both financial markets and the real economy have become addicted to “quantitative easing”. So much so that they cannot do without it.

The upshot is that we are going to see financial repression of the type being practised in virtually all the major advanced economies – including, if only to a more limited extent, the eurozone – continue into the indefinite future.

There are only three ways to deal with a big debt overhang. The hard way is to try to work your way out of it, or to cut your cloth according to your circumstances. More often than not, this proves self-defeating. The austerity required ends up shrinking the economy, thereby further increasing the size of the debt burden.

You can also default, but it will take years, even decades, to win back the confidence of capital markets after such an event, or you can do what Britain, and now Japan, are attempting, and inflate your way out of it.

Central bankers dream of getting back to “normal” – normal interest rates, a normal balance sheet and so on – but that point isn’t going to come any time soon. They are stuck on a money printing treadmill and there appears no way off.

In order to fully understand this, one has to understand the primary problem which is debt excesses.  As this article correctly states there are only three ways to deal with debt.

One, pay it down a little at a time.  This creates a miserable deflationary environment and an economic cycle that feeds on itself causing economic contraction at a rate that is ever-increasing.

Two, you can just decide not to pay the debt and leave your creditors hanging.  This default on the debt makes it go away but it closes the door to any future credit for quite some time.  If you don’t pay your debts, you don’t get more credit.

Three, you can attempt to get rid of the debt by printing money.  While this tactic sounds good theoretically speaking it can’t work long term.  At some point, people wake up and figure out that trading something intangible like paper money (fiat currency) for something tangible is a bad idea.  That’s when the economic crash occurs.

Dutch Pensions Cut for Existing Recipients

“The Telegraph” reported that Dutch pension recipients recently had their benefits cut due to not enough funding.[iii] Sounds a lot like news stories regarding many US municipalities like Detroit, Philadelphia, Stockton and others.  The economic winter symptoms are far reaching and extend worldwide.   This from the story (emphasis added):

Millions of Dutch pensioners – held up as the envy of their British counterparts by campaigners three years ago – have been forced to endure cuts to their pensions because of funding shortfalls in some of their schemes.

A total of 66 Dutch pension funds have been forced to cut pensions because of funding gaps, figures from the Dutch central bank show. The cuts average 1.9pc.

In all, 2 million active pension scheme members face cuts, on top of 1.1 million who are already receiving their pensions and 2.5 million “sleepers” (members who have changed jobs without taking their pension rights with them), European Pension News reported.

The development has sparked a lively debate among British pension experts about the merits of the Dutch scheme.

In 2010, David Pitt-Watson, a former chairman of Hermes Focus Asset Management, said British pensions “should go Dutch”. In an article for The Daily Telegraph, he wrote: “If a typical British and a typical Dutch person save the same amount of money for their pension, the Dutch person will end up receiving at least 50pc more income in their retirement than the Briton. There is no trick here. It’s just that the Dutch have an efficient architecture for their savings. We do not.”

He said the Dutch system enjoyed economies of scale thanks to large schemes that covered a number of firms. These schemes can pay pensions from investment income instead of relying on annuities.

But responding to the recent cuts, John Lawson of Aviva said: “Dutch charges are not cheaper, nor are equities a one-way bet.”

Henry Tapper of First Actuarial said the cuts should be put in “a little perspective”. He said: “The Dutch system works rather like the with-profits system. Current Dutch pensions have been shown by David Pitt-Watson and others to be producing about 39pc more than our ‘guaranteed pensions’ [from annuities] in the UK.”

One of the big issues facing pensions is the actuarial assumptions used to calculate the current level of funding needed to fully fund future pension benefits.  While I’m not familiar with these rules as they relate to Dutch pensions, I do know that many actuaries who calculate required funding levels for many US pensions can use an anticipated rate of return for stock assets and bond assets that is much higher than the rates of return that have actually been experienced by pension plans.

The Dutch plans operate much the same way.  Mr. Lawson, quoted in the article, is with the large British insurance company, Aviva.  While he has a vested interest in the use of annuities to provide pension income, his statement is spot on.  Equities are not a one way bet.  Equities don’t just go up, they fall as well.

In today’s world, due to the money printing in which central banks have engaged, stock prices are artificially high in my view.  When the deflationary forces of debt overtake stimulus actions, the Dutch pensions may be cut yet again.

Over two years ago, I began writing about the underfunded pension problems, warning that this story would get bigger and bigger as time passes.  That’s happening and we’re only getting started.

James Chief Investment Strategist: This Hasn’t Happened in 50 Years

“King World News” interviewed a gentleman named James Saut who happens to be the Chief Investment Strategist for Raymond James, a $360 billion brokerage company.[iv] His comments from the interview follow (emphasis added):

“We are currently involved in the longest buying stampede chronicled in my notes, and my notes run a little over 50 years.  I first discovered ‘buying stampedes’ and coined that phrase back in the 1970s.  They typically run 17 to 25 sessions, with only 1 to 3 session pauses or pullbacks before they keep going.

This one has lasted 102 sessions as of today….

“There have been some that have lasted 25 to 30 sessions, but it is rare, I repeat rare, to have one go for more than 30 sessions.

There was a 38 session buying stampede into the 1987 peak in August, which proceeded the Dow Theory sell signal of October 15th of 1987. We all know what happened on October 19th, we got the stock market crash.  Then, in 2010 you had a 53 session buying stampede.

But the one we are in right now is the longest one I’ve ever seen in my career.  As I said, today marks the 102nd trading session of this buying stampede.  That’s 102 sessions of a buying stampede, and remarkably we still haven’t had 3 consecutive days down in the Dow since this buying stampede started.

I think this rally is going to continue into the end of the quarter because portfolio managers are still underinvested and underperforming.  They not only have performance risk, but they also now have bonus risk, and ultimately job risk.  So I think we are to remain strong into the end of the quarter and then my timing work shows that sometime in July or August we are vulnerable to the first potential for a serious (double-digit percentage) pullback.”

Mr. Saut makes an interesting point.  The last time the Dow Jones Industrial Average finished with 5 consecutive down days was in December of 2012, ending on December 28, 2012.  Since that time, the Dow has only seen two consecutive down days; unprecedented as Mr. Saut states.

So how should we interpret this?

In my view, nothing more than an after effect of the Federal Reserve’s money printing policies.  As money is printed and a currency is devalued, inflation occurs and prices rise.  That includes the price of stocks.

I believe that this is far from a new paradigm for equities.  It’s simply a result of a monetary policy that is unsustainable.  I’m fond of using a quote from the late economist Herbert Stein to explain such policies.  Mr. Stein stated, “If something cannot go on forever, it will stop.”

This monetary policy, largely responsible for the “buying stampede” in stocks will stop and when it does I believe that a significant correction in stocks will follow.  The old market adage, “sell in May and go away” comes to mind.

Mauldin: Japan is on the Brink of Disaster

In spite of many of the financial talk show talking heads proclaiming Japan has it figured out economically speaking, I have been adamant about the fact that the massive level of money printing in which Japan is engaged will come to an end and there will be no happy ending.  Japan has too much debt for any real economic growth to occur and their population is aging which is another drag on the Japanese economy.  John Mauldin, whose newsletter “Thoughts from the Frontline” is a must read, recently commented.[v] A few excerpts from his letter on Japan follow (emphasis added):

The recent volatility in Japanese markets is breathtaking but characteristic of what one should come to expect from a country that is on the brink of fiscal and economic disaster. I don’t mean to be trite, from a global perspective; Japan is not Greece: Japan is the third-largest economy in the world. Its biggest banks are on a par with those of the US. It is a global power in trade and trade finance. Its currency has reserve status. It has two of the world’s six largest corporations and 71 of the largest 500, surpassed only by the US and comfortably ahead of China, with 46. Even with the rest of Asia’s big companies combined with China’s, the total barely surpasses Japan’s (CNN).

In short, when Japan embarks on a very risky fiscal and monetary strategy, it delivers a serious impact on the rest of the world. And doubly so because global growth is now driven by Asia.

Japan has fired the first real shot in what future historians will record as the most significant global currency war since the 1930s and the first in a world dominated by true fiat money.

Japan has painted itself into the mother all corners. There will be no clean or easy exit. There is going to be massive economic pain as they the Japanese try and find a way out of their problems, and sadly, the pain will not be confined to Japan. This will be the true test of the theories of neo-Keynesianism writ large. Japan is going to print and monetize and spend more than almost any observer can currently imagine. You like what Paul Krugman prescribes? You think he makes sense? You (we all!) are going to be participants in a real-world experiment on how that works out.

After the collapse of what might still be the largest economic bubble in history, in 1989, Japan is still mired in a 24-year non-recovery. Nominal GDP in 2011 was almost exactly what it was 20 years earlier, in 1991

That lack of growth takes on special importance because when we measure national debt-to-GDP we use nominal GDP as the denominator. If debt is growing and the economy is not, that debt-to-GDP ratio can grow very rapidly. From the Financial Times at the end of March:

Japan’s central bank governor has told parliament that the government’s vast and growing debt is “not sustainable,” and that a loss of confidence in state finances could “have a very negative impact” on the entire economy. The warning comes as Shinzo Abe’s administration attempts to drag Japan out of more than a decade of deflation with aggressive monetary and fiscal stimulus.

In January, weeks after taking office, the government unveiled a Y10.3tn ($109bn) spending package while leaning on the Bank of Japan to buy more of its bonds – a strategy described by Morgan Stanley MUFG Securities as “print and spend”. Speaking to lawmakers on Thursday, BoJ governor Haruhiko Kuroda noted that, while the government bond market has been “stable,” Japan’s gross debt to GDP ratio – expected to top 245 per cent this year, according to estimates by the International Monetary Fund – is “extremely high” and “abnormal”.

Japanese households and corporations are saving even as the government runs deficits close to 10%. As a way to compare, a 10% deficit in the US would be $1.6 trillion.

There are two and only two ways to grow an economy in real terms. You can grow your working population, or you can increase your productivity. That’s it. Japan does not have the option of growing its population (or has not chosen to), and it is actually quite difficult for an industrial economy to grow its productivity. If your population is actually shrinking (see chart below) and productivity growth is less than 1%, then real GDP growth is just not possible.

I would encourage you to read Mauldin’s entire piece.

The problem that Japan has, as Mauldin points out, is that they CANNOT grow their economy.  There are two major enemies when it comes to economic growth: the first is debt and the second is demographics.  Japan has a big problem on both counts.

Mauldin states that Japan’s debt to Gross Domestic Product (the commonly used measure of economic output) will top 245% this year.  That’s simply monstrous.  And, as I noted previously, the bond market may be ready to keep Japan honest as the interest rates on Japanese bonds, once thought to be risk free, spiked above a multi-year declining trend line.

The only way that Japan could possibly solve its debt problem is to have the economy produce more.  Growing the economy would allow Japan to maintain the same debt level but if the economy was producing more, the debt would become more manageable.  It’s no different than you getting a raise and now having more income to use to retire your debt.

Trouble is, in order to make the economy grow, you need to have a well-balanced population from an age perspective, or as Mauldin states, you have to grow your working age population.  Japan has an aging population and as we know from demographic studies, an aging population works less and consumes less than a younger population.

When the Japanese fallout occurs, it will be worldwide.  The only question is does Japan implode first or does Europe?


Core Economic Beliefs Driving Investment Philosophy

Economic Cycles

In 1925, a Russian economist by the name of Nikolai Kondratieff published a book titled “The Major Economic Cycles”. In it Mr. Kondratieff stated his view that capitalist economies move in boom and bust cycles with each full cycle repeating itself every 60 to 80 years. Some present day economists building on Kondratieff’s work have defined these “Kondratieff Waves” as 4 sub cycles, naming the sub cycles after the 4 seasons of the year; spring, summer, autumn and winter. We believe, after a study of economic history, that Mr. Kondratieff’s cycle theory is accurate.

The Spring Cycle

During spring, an economy experiences a gradual increase in business and employment. Consumer confidence gradually increases. Consumer prices begin a gradual increase compared to levels seen during the previous cycle (the winter cycle). Stock prices rise and reach a peak at the end of the spring cycle. Interest rates begin to rise from historically low levels and credit gradually expands. At the beginning of the spring cycle overall debt levels are low. (In our view, this most recently represents the time frame of 1949-1966)

The Summer Cycle

During summer, an economy sees an increase in the money supply which leads to inflation. Gold prices reach a significant peak at the end of the summer period. Interest rates rise rapidly and peak at the end of the summer. Stocks are under pressure and decline through the period reaching a low at the end of the summer cycle. (In our view, this most recently represents the time frame of 1967-1982)

The Autumn Cycle

During autumn, money is plentiful and gold prices fall reaching a gold bear market low by the end of the autumn season. During autumn there is a massive stock bull market and much speculation. Financial fraud is prevalent and real estate prices rise significantly due to speculation. Debt levels are astronomical. Consumer confidence is at an all time high due to high stock prices, high real estate prices and plentiful jobs. (In our view, this most recently represents the time frame of 1983 – 2000)

The Winter Cycle

During winter, an economy experiences a crippling credit crisis and money becomes scarce. Financial institutions are in trouble. Unprecedented levels of bankruptcy at the personal, corporate and government levels. There is a credit crunch and interest rates rise. There is an international monetary crisis. There are pension funding problems and the price of gold and gold related equities rise. (In our view, we have been in the winter cycle since 2001)

Investing Overview and Premise

In 1999, economist and financial commentator, Harry Browne, wrote a book titled “Fail Safe Investing”. In his book, Browne presented his idea as to what an ideal portfolio should look like given that economic conditions cycle and as these cycles occur, certain asset classes can be adversely affected while other asset classes might benefit.

In his book, Browne concluded that the best kept secret in the investing world is that almost nothing turns out as expected. We agree. While each season of the economic cycle may be easy to see from an historical perspective, it may be difficult to determine with precision the beginning of one cycle ‘season’ and the end of the prior cycle ‘season’.

Browne designed a very simple portfolio strategy designed to protect and grow assets in each of the four economic cycles:

  • 25% invested in Cash. In a tight money environment, cash can be a profitable asset to own. In periods of deflation, cash can gain in purchasing power as prices fall.
  • 25% invested in Growth Stocks. In prosperous times, growth stocks can perform nicely while stocks may not perform as well in periods of inflation, deflation and tight money.
  • 25% invested in Gold. In an inflationary environment, gold can protect purchasing power.
  • 25% invested in Government Bonds. In a deflationary environment, as interest rates fall, bonds can perform nicely. In more prosperous times, bonds can also perform well.

Our Approach

While we agree with Browne’s approach given our belief that evidence suggests that economies cycle, we have modified Browne’s approach due to our belief in the use of exit strategies and our interpretation of current world macro-economic conditions. We believe that our modification of Browne’s original strategy will produce enhanced results. For thoughts on incorporating this strategy into your portfolio or your 401(k) plan, request an Exit Strategy Analysis below.


Exit Strategy Analysis™ Evaluation

If you would like to receive a complimentary Exit Strategy Analysis™ on each of the holdings in your portfolio, visit www.ExitStrategyAnalysis.com and complete the form there. An Exit Strategy Analysis™ is a second opinion on the holdings in your portfolio; however, unlike many second opinions, you will learn at what price you may wish to exit your holding in order to potentially protect profits or limit losses

Additionally, at your option, your Exit Strategy Analysis™ could include the following:

  • How to potentially maximize your retirement income
  • How to potentially diversify currencies
  • A complimentary copy of the book Economic Consequences: Can You Survive, Even Prosper from the Results of 100 Years of Bad Money Decisions?

After obtaining some preliminary information from you, you will receive your completed Exit Strategy Analysis™.

Request your complimentary Exit Strategy Analysis™ now by visiting www.ExitStrategyAnalysis.com!

Advisory services offered through USA Wealth Management. Any information obtained from third party resources is believed to be reliable but the accuracy cannot be guaranteed. This entry may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Therefore, no forecast should be considered a guarantee. No investment strategy can guarantee a profit. Investing in market related securities involves a risk of principal loss. Prior to making any investment decision, the services of an appropriate professionals should be obtained in order to understand the risks, costs, and benefits associated with a particular investment.

[i] Rebecca Howard and James Glynn. “New Zealand, China in talks on convertibility of currencies.” The Wall Street Journal. May 26, 2013. http://online.wsj.com/article/SB10001424127887323855804578506383781598470.html?mod=WSJ_hp_LEFTWhatsNewsCollection
[ii] Telegraph Staff. “Central banks are stuck on a money printing treadmill.” The Telegraph. May 23, 2013. http://www.telegraph.co.uk/finance/comment/telegraph-view/10077227/Central-banks-are-stuck-on-a-money-printing-treadmill.html
[iii] Richard Evans. “Superiority of Dutch pensions called into question.” The Telegraph. May 11, 2013. http://www.telegraph.co.uk/finance/personalfinance/pensions/10050061/Superiority-of-Dutch-pensions-called-into-question.html
[iv] Eric King. “This is stunning, I haven’t seen anything like this in 50 years.” Blog: King World News. May 28, 2013. http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/5/28_This_Is_Stunning,_I_Havent_Seen_Anything_Like_This_In_50_Years.html
[v] John Mauldin. “Mauldin: Japan is on the brink of disaster.” www.BusinessInsider.com May 26, 2013. http://www.businessinsider.com/japan-economy-disaster-2013-5

 

Market and Economic Update – May 31, 2013

  • The Facts Become Clear
  • A Step In The Right Direction
  • Bubble Territory
  • A Very Deep Hole
  • Be Ready

Bernanke: Premature Withdrawal of Stimulus Could Endanger Economic Recovery

“Bloomberg” reported that Federal Reserve Chairman Ben Bernanke stated that premature monetary tightening could compromise economic recovery.[i] This from the article (emphasis added):

Interview of the Week

This week I interviewed guest expert Congressman Justin Amash. Mr. Amash represents Michigan’s Third District in the 113th United States Congress. Mr. Amash shares his view on what is going on in Washington and his views on and US economic & tax policy. You’ll want to catch this interview at www.everythingfinancialradio.com

Federal Reserve Chairman Ben S. Bernanke said the U.S. economy remains hampered by high unemployment and government spending cuts, and raising interest rates or reducing asset purchases too soon would endanger the recovery.

“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,” Bernanke said today in testimony to the Joint Economic Committee of Congress in Washington. Monetary policy is providing “significant benefits,” he said.

Bernanke is leading the most aggressive economic stimulus in the Fed’s 100-year history in an effort to spur growth and reduce an unemployment rate that stands at 7.5 percent almost four years into a recovery from the longest and deepest recession since the Great Depression.

While the labor market has shown “some improvement,” the Fed chairman said “high rates of unemployment and underemployment are extraordinarily costly.”

“Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers’ skills and — particularly relevant during this commencement season — by preventing many young people from gaining workplace skills and experience in the first place,” he said.

Stocks extended gains after the comments. The Standard & Poor’s 500 Index climbed 0.7 percent to 1,680.15 at 11:31 a.m. in New York.

William Dudley, president of the Federal Reserve Bank of New York, also signaled that it’s too soon to tighten policy.

“Three or four months from now I think you’re going to have a much better sense of, is the economy healthy enough to overcome the fiscal drag or not,” Dudley said in an interview with Michael McKee on Bloomberg Television that aired today.

Translation:  if we stop printing money now and pumping it into the economy, the deflationary forces of debt will take over and the stock market may decline.

As has happened so many times in the past after the Fed Chairman’s testimony, the stock market rallied.  Money printing is good for stocks but hasn’t been helpful in reducing the unemployment rate.  That’s because money printing benefits those closest to the printing press.  The farther you are from the printing press, the less you derive in benefits from the money printing process.

This fact becomes clear when you analyze the facts.

“CNN Money” recently reported that the rich are getting richer while everyone else is losing ground.[ii] This from the story (emphasis added):

The net worth of American households grew by $5 trillion in the first two years of the economic recovery, but not everyone shared in the riches.

The top 7% of American families saw their wealth grow to $25.4 trillion in 2011, up from $19.8 trillion two years earlier. The remaining 93% of Americans experienced a decline in net worth to $14.8 trillion, down from $15.4 trillion, according to a new analysis by the Pew Research Center.

The dividing line between the two sides is $836,033 in 2011. The 8 million U.S. households with a net worth at or above that point got richer as America pulled out of its recession: Their average net worth rose by 28% from 2009 to 2011. Meanwhile, the 111 million remaining American households saw their wealth decline by 4%.

Why such a difference in fortunes? It’s because the rich are much more heavily invested in the stock and bond markets, which rallied during the recovery. Less affluent households typically have their wealth tied up in their homes, and the housing market remained flat between 2009 and 2011.

By 2011, the average wealth of the top tier was almost 24 times that of the rest of Americans. Two years earlier, the ratio stood at less than 18-to-1.

While wealthy Americans are benefiting from the Fed’s policies, Main Street isn’t.

In an economic winter season, debt is purged from the system.  Only after debt is purged from the system can real economic recovery occur.  That is when the economic season changes from winter to spring.

That day is still a way off.

US Budget Deficit Less Than Projected

The Congressional Budget Office, a non-partisan organization, reported recently that the US Government’s budget deficit will fall to $642 billion, down from the $845 billion that was originally projected.[iii] This from a piece published by U.P.I. (emphasis added):

The U.S. budget deficit is shrinking faster than thought, falling to $642 billion from the $845 billion projected in February, number-crunchers said Tuesday.

The Congressional Budget Office said the unanticipated $203 billion cut to the current-year shortfall — a 24 percent drop from just three months ago — comes from higher-than-expected individual and corporate tax payments and $95 billion in expected dividend payments from mortgage-finance companies Fannie Mae and Freddie Mac.

Both private companies were bailed out by taxpayers in 2008 and have been under temporary government control since.

The shrinking budget deficit has nothing to do with $85 billion in mandatory, across-the-board budget cuts, known as sequestration, that went into effect March 1 or with tax increases Congress passed in the winter to avoid the so-called fiscal cliff, the non-partisan CB O, which provides economic data to Congress, said.

Those policy changes were already worked into the February forecast, it said.

The $845 billion in red ink in February would have put the deficit at 5.4 percent of economic output. The new projection would put the deficit at 4 percent of gross domestic production.

The deficit was 7 percent of the budget in 2012 and 10.1 percent in 2009.

The improving deficit picture will likely continue until 2016, when spending picks up as a share of the economy and revenue levels off, the CBO said.

At that point, Medicare and Social Security are expected to start taking an even larger share of the budget, with Social Security and government healthcare spending hitting an expected $3 trillion, or half the budget, by 2023, the office said.

This is good news at least in the short term.

However, the long term picture is still bleak largely due to entitlement spending on Medicare and Social Security.  To the President’s credit, in his proposed budget he did propose that the growth of the Social Security program be slowed.

It’s a step in the right direction but a long way from where we need to be.  Moody’s Investor Services, a rating agency agrees.  Unless the US addresses long term debt levels, the agency has stated the country risks a credit rating cut.[iv]

Short term however, given the state of much of the rest of the world, this is likely bullish for the US Dollar.

Two Money Printing Bubbles?

The Japanese Stock Market

Japanese Prime Minister Abe’s money printing binge has been good for Japanese stocks.  Note the chart below of the Nikkei index.[v] Since late last year, the Nikkei has risen by more than 77% from a low of 8661 to a recent high of 15360.  That level of increase in 6 months is a parabolic rise and, in my view, likely a bubble in the making.

The US Housing Market

The Coachella Valley area of California (Palm Springs area) along with other areas around the country are experiencing real estate values that are quickly appreciating.  According to an article published by the Gannett Company, desert.com, the median sale price of a single family home in the area increased 15.8% on a year over year basis.[vi]

South Florida’s housing market continued its impressive rebound in April.  The median resale price for a single family home in the Miami-Dade area increased 23.7% from a year earlier.  The median price for a condo jumped by 17.1% on a year-over-year basis.  Sales of single-family homes were up 15.2 percent and sales of existing condos rose 18.7% year-over-year.[vii]

In Phoenix, single family home prices were up almost 30 percent in price year-over-year.[viii] In Las Vegas, the price of a single family home increased 30.6% year-to-year.[ix]

The US Stock Market

When reviewing Price–Earnings ratios for the S&P 500, the historical mean is 15.89.  Currently, the S&P 500 PE is at 24.48 (see chart below), putting the index at a premium of 54% of the historical mean.

When central banks engage in money printing, the easy money has to go somewhere.  In Japan, the easing is pumping the stock market.  In the US the real estate market and arguably the stock market are in bubble territory as well.

Global Debt Levels Massive: ‘The Wall Street Journal’

“The Wall Street Journal” ran a story recently that reported on the massive levels of debt that exist worldwide.[x] Here is an excerpt from the article (emphasis added):

$223.3 trillion: The total indebtedness of the world, including all parts of the public and private sectors, amounting to 313% of global gross domestic product.

Advanced economies tend to draw attention for their debt at the government and household levels. But emerging markets are gathering debt at an increasing pace to drive their economic development.

In a comprehensive report on global indebtedness, economists at ING found that debt in developed economies amounted to $157 trillion, or 376% of GDP. Emerging-market debt totaled $66.3 trillion at the end of last year, or 224% of GDP.

The $223.3 trillion in total global debt includes public-sector debt of $55.7 trillion, financial-sector debt of $75.3 trillion and household or corporate debt of $92.3 trillion. (The figures exclude China’s shadow finance and off-balance-sheet financing.)

“Increasingly, ‘debt’ is seen as a dirty word,” the ING research team said in a report released this week. “But in most cases, it should not be. Perhaps it is no coincidence that the rise of U.S. indebtedness coincided with improvements in technology and the globalization of trade, human labor and finance. Computers allowed for speedier processing and better and more transparent access to credit risk data.”

“Debt can become dirty when the rise of debt service costs exceeds income and a borrower’s long-term ability to make payments and often when rapid growth of debt and/or lack of adequate transparency disguises creditworthiness issues,” they write.

Global trade has played a leading role in driving debt dynamics as emerging markets increasingly supplied low-cost labor and raw materials in recent decades. But emerging-market debt has grown only slightly faster than economies. A decade ago, total emerging-market debt was $18.8 trillion, or 214% of GDP. (Now it’s $66.3 trillion, or 224% of GDP.)

Per-capita indebtedness is still just $11,621 in emerging economies (and rises to $12,808 if you exclude the two largest populations, China and India). For developed economies, it’s $170,401. The U.S. alone has total per-capita indebtedness of $176,833, including all public and private debt.

The article correctly states that debt can become a dirty word when the rise of debt service costs exceeds a borrower’s long-term ability to make payments on the debt.

Funny the author of the article didn’t automatically come to that conclusion especially when the author quotes the fact the U.S. alone has per-capita indebtedness of $176,833.  Given that the US Census Bureau has reported that the per capita income annually is $27,915; that leaves a ratio of indebtedness to income of 6.33.[xi] That means that total debt in the US is $6.33 for every dollar earned.

It’s a very deep hole and would make any rational observer come to the conclusion that debt at these levels is indeed a dirty word.

You Can’t Fool the Market – Japanese Bonds About to Implode?

While Prime Minister Abe in Japan has vowed to continue to print money until a 2% inflation target is reached, perhaps he forgot to consider the reaction of the bond market?  Given that for a long time Japanese Government bonds were considered to be risk free, the recent spike in interest rates in Japanese Government bonds should be concerning to everyone around the world, not just those holding Japanese Government debt.  A recent spike in interest rates in Japanese Government bonds may indicate that the end of low interest rates for the Japanese Government is at hand with investors demanding a higher return on their investment to compensate them for their increased investment risk.  An op-ed published by “The Market Oracle” explains[xii] (emphasis added):

Japan has fueled much of this latest rally in stocks, driving the marketing first with promises of money printing by the Prime Minister in November 2012, and then a massive $1.2 trillion QE program announced by the Bank of Japan last month.

The result of this has been a collapse in the Yen and a 70%+ rally in the Nikkei in the last six months.

This has been the fundamental driver of this latest risk on rally. Remember that the US Federal Reserve has begun changing its language regarding QE and has even hinted at tapering QE before the year-end. So it’s the Bank of Japan who’s in the driver’s seat for asset prices today.

If Japan has been bad for the Yen and good for stocks… it’s been an absolute disaster for Japanese bonds. Since the Bank of Japan announced its latest QE program, Japanese Government bonds have triggered circuit breaks no less than four times due to incredible volatility.

And last week, they briefly violated their multi-year trendline.

Many investors are probably looking at this chart and thinking, “who cares what happens to Japanese bonds… why does a trendline violation matter here?”

First and foremost, Japan is the second largest bond market in the world. If Japan’s sovereign bonds continue to fall, pushing rates higher, then there has been a tectonic shift in the global financial system. Remember the impact that Greece had on asset prices? Greece’s bond market is less than 3% of Japan’s in size.

For multiple decades, Japanese bonds have been considered “risk free.” As a result of this, investors have been willing to lend money to Japan at extremely low rates. This has allowed Japan’s economy, the second largest in the world, to putter along marginally.

So if Japanese bonds begin to implode, this means that:

1)   The second largest bond market in the world is entering a bear market (along with commensurate liquidations and redemptions by institutional investors around the globe).

2)   The second largest economy in the world will collapse (along with the impact on global exports).

Both of these are truly epic problems for the financial system. But even worse than any of them is the following:

If Japan’s bond market implodes, then global Central Bank efforts to hold the system together will have proven a failure.

Japan is truly the leader amongst global Central Banks when it comes to progressive and accommodating policy. The Bank of Japan has kept interest rates at ZERO for nearly two decades. It’s also launched NINE QE plans adding up to an amount equal to nearly 25% of Japanese GDP. So far it’s managed to do this with minimal consequences.

Central Bankers around the world have monitored these efforts and believed that they can implement similar plans. So if Japan’s bond market begins to collapse, then it’s Game, Set, and Match for Central Banker policy. And what follows will make Lehman look like a joke.

Investors, take note… the financial system is sending us major warnings…

Be ready.


Core Economic Beliefs Driving Investment Philosophy

Economic Cycles

In 1925, a Russian economist by the name of Nikolai Kondratieff published a book titled “The Major Economic Cycles”. In it Mr. Kondratieff stated his view that capitalist economies move in boom and bust cycles with each full cycle repeating itself every 60 to 80 years. Some present day economists building on Kondratieff’s work have defined these “Kondratieff Waves” as 4 sub cycles, naming the sub cycles after the 4 seasons of the year; spring, summer, autumn and winter. We believe, after a study of economic history, that Mr. Kondratieff’s cycle theory is accurate.

The Spring Cycle

During spring, an economy experiences a gradual increase in business and employment. Consumer confidence gradually increases. Consumer prices begin a gradual increase compared to levels seen during the previous cycle (the winter cycle). Stock prices rise and reach a peak at the end of the spring cycle. Interest rates begin to rise from historically low levels and credit gradually expands. At the beginning of the spring cycle overall debt levels are low. (In our view, this most recently represents the time frame of 1949-1966)

The Summer Cycle

During summer, an economy sees an increase in the money supply which leads to inflation. Gold prices reach a significant peak at the end of the summer period. Interest rates rise rapidly and peak at the end of the summer. Stocks are under pressure and decline through the period reaching a low at the end of the summer cycle. (In our view, this most recently represents the time frame of 1967-1982)

The Autumn Cycle

During autumn, money is plentiful and gold prices fall reaching a gold bear market low by the end of the autumn season. During autumn there is a massive stock bull market and much speculation. Financial fraud is prevalent and real estate prices rise significantly due to speculation. Debt levels are astronomical. Consumer confidence is at an all time high due to high stock prices, high real estate prices and plentiful jobs. (In our view, this most recently represents the time frame of 1983 – 2000)

The Winter Cycle

During winter, an economy experiences a crippling credit crisis and money becomes scarce. Financial institutions are in trouble. Unprecedented levels of bankruptcy at the personal, corporate and government levels. There is a credit crunch and interest rates rise. There is an international monetary crisis. There are pension funding problems and the price of gold and gold related equities rise. (In our view, we have been in the winter cycle since 2001)

Investing Overview and Premise

In 1999, economist and financial commentator, Harry Browne, wrote a book titled “Fail Safe Investing”. In his book, Browne presented his idea as to what an ideal portfolio should look like given that economic conditions cycle and as these cycles occur, certain asset classes can be adversely affected while other asset classes might benefit.

In his book, Browne concluded that the best kept secret in the investing world is that almost nothing turns out as expected. We agree. While each season of the economic cycle may be easy to see from an historical perspective, it may be difficult to determine with precision the beginning of one cycle ‘season’ and the end of the prior cycle ‘season’.

Browne designed a very simple portfolio strategy designed to protect and grow assets in each of the four economic cycles:

  • 25% invested in Cash. In a tight money environment, cash can be a profitable asset to own. In periods of deflation, cash can gain in purchasing power as prices fall.
  • 25% invested in Growth Stocks. In prosperous times, growth stocks can perform nicely while stocks may not perform as well in periods of inflation, deflation and tight money.
  • 25% invested in Gold. In an inflationary environment, gold can protect purchasing power.
  • 25% invested in Government Bonds. In a deflationary environment, as interest rates fall, bonds can perform nicely. In more prosperous times, bonds can also perform well.

Our Approach

While we agree with Browne’s approach given our belief that evidence suggests that economies cycle, we have modified Browne’s approach due to our belief in the use of exit strategies and our interpretation of current world macro-economic conditions. We believe that our modification of Browne’s original strategy will produce enhanced results. For thoughts on incorporating this strategy into your portfolio or your 401(k) plan, request an Exit Strategy Analysis below.


Exit Strategy Analysis™ Evaluation

If you would like to receive a complimentary Exit Strategy Analysis™ on each of the holdings in your portfolio, visit www.ExitStrategyAnalysis.com and complete the form there. An Exit Strategy Analysis™ is a second opinion on the holdings in your portfolio; however, unlike many second opinions, you will learn at what price you may wish to exit your holding in order to potentially protect profits or limit losses

Additionally, at your option, your Exit Strategy Analysis™ could include the following:

  • How to potentially maximize your retirement income
  • How to potentially diversify currencies
  • A complimentary copy of the book Economic Consequences: Can You Survive, Even Prosper from the Results of 100 Years of Bad Money Decisions?

After obtaining some preliminary information from you, you will receive your completed Exit Strategy Analysis™.

Request your complimentary Exit Strategy Analysis™ now by visiting www.ExitStrategyAnalysis.com!

Advisory services offered through USA Wealth Management. Any information obtained from third party resources is believed to be reliable but the accuracy cannot be guaranteed. This entry may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Therefore, no forecast should be considered a guarantee. No investment strategy can guarantee a profit. Investing in market related securities involves a risk of principal loss. Prior to making any investment decision, the services of an appropriate professionals should be obtained in order to understand the risks, costs, and benefits associated with a particular investment.

[i] Craig Torres. “Bernanke Says Premature Tightening Would Endanger Recovery.” www.Bloomberg.com May 22, 2013. http://www.bloomberg.com/news/2013-05-22/bernanke-says-premature-fed-tightening-would-endanger-recovery.html
[ii] Tami Luhby. “The rich are getting richer, while the rest lose ground.” www.CNNMoney.com April 24, 2013. http://economy.money.cnn.com/2013/04/24/american-household-wealth/
[iii] United Press International. “U.S. budget deficit shrinks faster than expected.” www.UPI.com May 14, 2013. http://www.upi.com/Business_News/2013/05/14/US-budget-deficit-shrinks-faster-than-expected/UPI-74261368580294/
[iv] Daniel Bases. “Moody’s says more steps needed to save U.S. credit rating.” www.Reuters.com January 2, 2013. http://www.reuters.com/article/2013/01/02/us-usa-ratings-moodys-idUSBRE9010ML20130102
[v] Source: http://finance.yahoo.com/q/bc?s=%5EN225+Basic+Chart
[vi] Mike Perrault. “Palm Springs area home prices jump 15.8%” www.MyDesert.com May 22, 2013. http://www.mydesert.com/article/20130521/BUSINESS04/305210036/Home-prices-jump-15-8-?nclick_check=1
[vii] Martha Brannigan. “South Florida’s existing home prices jump by double digits from year ago.” www.TheMiamiHerald.com May 22, 2013. http://www.miamiherald.com/2013/05/22/3410566/existing-home-prices-up-double.html
[viii] Kristena Hansen. “Phoenix housing prices up 30% in past year.” Phoenix Business Journal. May 3, 2013. http://www.bizjournals.com/phoenix/news/2013/05/03/phoenix-housing-prices-up-30-in-past.html
[ix] Jennifer Robison. “Las Vegas seen as most undervalued home market in U.S.” Las Vegas Review-Journal. May 15, 2013. http://www.reviewjournal.com/business/housing/las-vegas-seen-most-undervalued-home-market-us
[x] Sudeep Reddy. “Number of the Week: Total World Debt Load at 313% of GDP.” Blog: The Wall Street Journal. May 11, 2013. http://blogs.wsj.com/economics/2013/05/11/number-of-the-week-total-world-debt-load-at-313-of-gdp/?mg=blogs-wsj&url=http%253A%252F%252Fblogs.wsj.com%252Feconomics%252F2013%252F05%252F11%252Fnumber-of-the-week-total-world-debt-load-at-313-of-gdp
[xi] Source: http://quickfacts.census.gov/qfd/states/00000.html
[xii] Graham Summers. “Japan Debt Crisis is 30 Times Bigger Than Greece.” www.MarketOracle.co.ok May 21, 2013. http://www.marketoracle.co.uk/Article40539.html

 

Moving Markets Update
Fill in the form below to sign up for my Moving Markets™ e-newsletter! Each month you'll get my take on what's going on in the financial markets and the economy.

Name
Email
Address
 
City
State   Zip
Phone
Company Info
Moving Markets is
Published by
USA Wealth Management, LLC

Founding Editor:
Dennis Tubbergen

Copyright 2010/13

961 Four Mile Road NW
Grand Rapids, MI 49544
P: 800-553-7526
F: 800-501-0543
Categories
Investing in securities involves a risk of principal loss. Having a particular investment strategy such as an exit strategy does not guarantee a profit and/or guarantee against loss.The information provided should not be construed as investment advice. It is important to discuss your financial situation with a professional prior to making any investment decision in order to understand the risks, benefits, costs and fees associated with a particular investment or investment strategy.