Economic Scene - Betting That Cutting Spending Won’t Derail Recovery - NYTimes.com

David Leonhardt in this morning's New York Times does a very good job of summarizing our current economic scene, so it is worth a read.

Here's an excerpt:

As is often the case after a financial crisis, this recovery is turning out to be a choppy one. Companies kept increasing pay and hours last month, for example, but did little new hiring. On Tuesday, the Conference Board reported that consumer confidence fell sharply this month.

And just as households and businesses are becoming skittish, governments are getting ready to let stimulus programs expire, the equivalent of cutting spending and raising taxes. The Senate has so far refused to pass a bill that would extend unemployment insurance or send aid to ailing state governments. Goldman Sachs economists this week described the Senate’s inaction as “an increasingly important risk to growth.”

The parallels to 1937 are not reassuring. From 1933 to 1937, the United States economy expanded more than 40 percent, even surpassing its 1929 high. But the recovery was still not durable enough to survive Roosevelt’s spending cuts and new Social Security tax. In 1938, the economy shrank 3.4 percent, and unemployment spiked.

Given this history, why would policy makers want to put on another fiscal hair shirt today?

Economic Scene - Betting That Cutting Spending Won’t Derail Recovery - NYTimes.com

Lest I be accused of being overly pessimistic (moi?), I should note that I attended a very interesting breakfast meeting this AM with the Ned Davis Research Group. I've always liked the Ned Davis research, since it compiles a vast amount of data and reaches its conclusions based on the numbers rather than "gut instinct".

The Ned Davis people remain bullish on stocks, believing that the emotions of the market are overlooking some pretty strong corporate earnings reports. They noted, for example,that the figures from the emerging markets remains very positive, and they don't see too many signs of their growth slowing.

However, they did note that most of their bullish stance is based on their optimism on emerging markets. If we see a slowdown in China, for example, they will need to revisit their position.

I should also mention they remain very negative on bonds (which is not a view I share, by the way).

We shall see.

Bond Market to G-20: You're Wrong

As I write this post, the 10-year Treasury note yield has dropped below 3%. The last time yields were this low was in the spring of 2009, in the aftermath of a financial panic and a stock market meltdown. Interest rates have dropped nearly 100 basis points over the last 3 months.

What the bond market is saying, I think, is that the current focus on cutting spending and raising taxes to reduce deficits is wrong. Economic growth remains anemic, unemployment is too high, and without a stimulus from somewhere else we face the real possibility of the economy sliding back into recession.

Again, I do not disagree that deficits longer term are a serious problem. It's just that I think the better solution to raising revenue is through encouraging growth rather than belt-tightening.

Already there are some real-time examples of what could happen if policies are not reversed. This morning's New York Times carried a long article about Ireland:

"When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow,” said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. “A lot of the argument was, ‘Let’s get this over with quickly.’ ”

Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.

Joblessness in this country of 4.5 million is above 13 percent, and the ranks of the long-term unemployed — those out of work for a year or more — have more than doubled, to 5.3 percent.

Now, the Irish are being warned of more pain to come.

I've highlighted one line in the excerpt for a reason. If the US - or any other industrialized country - applies the same medicine that the Irish have to their economy, what do you think the reaction would be if economic growth were to shrink by over 7%? In the US, this would mean nearly $1 trillion of lost economic activity.

And note too that the Irish are not being rewarded for the pain they are experiencing. Irish sovereign debt trades almost 300 basis points higher in yield than German bonds, or about the same level as Greece.

Further in the article:

Politicians here have raised taxes and cut salaries for nurses, professors and other public workers by up to 20 percent. About 30 billion euros ($37 billion) is being poured into zombie banks like Anglo Irish, which was nationalized after lavishing loans on developers.

The budget went from surpluses in 2006 and 2007 to a staggering deficit of 14.3 percent of gross domestic product last year — worse than Greece. It continues to deteriorate. Drained of cash after an American-style housing boom went bust, Ireland has had to borrow billions; its once ultralow debt could rise to 77 percent of G.D.P. this year.

Again, I have added the highlighting, only because it is so austere. In our public sector we are only beginning to ask our public sector employees to do very simple things like contribute to their own retirement plan, or work longer than age 55. Wonder what would happen if we cut salaries by 20%?

There is still time for these policies to change, and perhaps they will. In the meantime, I would suggest keeping an eye on the bond market: in 2007 bond investors say the problems earlier than the stock market, and fled higher risk bonds. If yields continue to decline, perhaps more questions need to be raised concerning asset allocation, at the very least.


http://www.nytimes.com/2010/06/29/business/global/29austerity.html?pagewanted=1&hp

A special report on debt: Repent at leisure | The Economist

I didn't think I would find this special report from this week's Economist all that compelling (after all, aren't we all reading daily stories about debt, fiscal crisis, etc.?) but it really was pretty interesting.

Here's an excerpt:

The problem with debt, though, is the need to repay it. Not for nothing does the word credit have its roots in the Latin word credere, to believe. If creditors lose faith in their borrowers, they will demand the repayment of existing debt or refuse to renew old loans. If the debt is secured against assets, then the borrower may be forced to sell. A lot of forced sales will cause asset prices to fall and make creditors even less willing to extend loans. If the asset price falls below the value of the loan, then both creditors and borrowers will lose money.

This is particularly troublesome if the economy slips into deflation, as happened globally in the 1930s and in Japan in the 1990s. Debt levels are fixed in nominal terms whereas asset prices can go up or down. So falling prices create a spiral in which assets are sold off to repay debts, triggering further price falls and further sales. Irving Fisher, an economist who worked in the first half of the 20th century, called this the debt deflation trap.

As I have been writing in several posts, I am still very concerned that current government policies are pushing us towards deflation, which will have very unhappy economic implications.


A special report on debt: Repent at leisure | The Economist

And it would seem that Paul Krugman also is thinking dour thoughts these days. From this morning's New York Times:

As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing...

...But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.

It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.

http://www.nytimes.com/2010/06/28/opinion/28krugman.html?ref=opinion

The Way We Live Now - The Public Pension Crisis - NYTimes.com

Roger Lowenstein has written a number of insightful books and articles on Wall Street and finance over the years (I would suggest, for example, that his biography of Warren Buffett is probably the most useful on the market).

Lowenstein wrote a book a couple of years ago entitled While American Aged which described the pension problems that plagued General Motors, New York City, and San Diego. It's an interesting read, as it describes in detail the past pension deals that corporations and politicians made that were never properly financed. Now those obligations are coming due, and there isn't enough money to pay for the benefits.

Pensions - and Social Security - have gradually emerged to become one of the major financial problems facing the public sector. It's not enough to say, "Well, we just have to cut the benefits", because it's not legally possible. On the other hand, when you read stories of teachers and policemen being laid off for lack of funding, it is clear that something has to be done.

One of the big problems, by the way, is the unrealistic investment returns that pension plans have used to calculate their required contributions. For years annual return figures of 8% to 10% were assumed, despite the fact that the funds were not returning anywhere close to those figures. Even today, with bond yields at 3% and the past return of the S&P 500 essentially flat since 1998, pension returns assume that somehow private equity and hedge funds will produce enough magic to bail out the funds.

Here's an excerpt from Lowenstein's piece in the New York Times last week, with the full link below:

....Pension obligations are a form of off-balance-sheet debt. As funds approach exhaustion, states will be forced to borrow to replenish them. Some have already done so. Thus, pension obligations will be converted into explicit liabilities (think of a family’s obligation to pay for grandma’s retirement being added to its mortgage)... if the unfinanced portion of all public pension obligations were converted to debt, total state indebtedness would soar from $1 trillion to $4.3 trillion.

Such an explosion of debt would threaten desperate governments with bankruptcy. Alternately, states could try to defray pension costs from their operating budgets. Illinois, once its funds were depleted, would be forced to devote a third of its budget to retirees; Ohio, fully half. This would impoverish every social (and other) program; it would invert the basic mission of government, which is, after all, to serve constituents’ needs.

The Way We Live Now - The Public Pension Crisis - NYTimes.com

Mortgage rates hit all-time low, but lending activity remains quiet

This is worrisome.

I posted a couple of days ago that it could very well be that current government policy may be too timid - the economy is showing signs of softening, and needs some sort of boost to keep it on a recovery path.

But I could be wrong. It could be that government has already done everything that it can reasonably be expected to do. With most of the world now focused on reducing deficits, it seems unlikely that we will see any significant stimulus packages proposed.

Fed policy is already accomodative, and it would seem to make no sense to restart "quantitative easing" - the credit markets have already pushed interest rates to low levels, as this article in today's Washington Post indicates.

So where will the catalyst come from?

An excerpt from the Post's article:

The average rate on a 30-year fixed-rate mortgage dropped to 4.69 percent this week from 4.75 percent last week, Freddie Mac reported Thursday. That marks the lowest level since the company started tracking the data in 1971 and breaks the most recent low set in December. Rates have hovered below 5 percent since early May.

Yet home sales are tumbling and mortgage applications are slipping. Potential buyers have retrenched, discouraged by employment fears, the recent expiration of a home buyer's tax credit and tough lending standards, industry experts said.

Mortgage rates hit all-time low, but lending activity remains quiet

And now we have the Germans turning the tables on President Obama, and lecturing our country about the dangers of borrowing too much (from the German publication Der Spiegel):

Germany Warns US Not to Become 'Addicted to Borrowing'

Indeed, German Finance Minister Wolfgang Schäuble poured more fuel on the fire in a contribution published Friday in the business daily Handelsblatt. Referring to US demands that Germany abandon austerity in favor of addition economic stimulus measures, Schäuble said that "governments should not become addicted to borrowing as a quick fix to stimulate demand. Deficit spending cannot become a permanent state of affairs."

http://www.spiegel.de/international/business/0,1518,702849,00.html

If low interest rates can't help, and if governments around the world continue to focus on raising taxes and reducing spending, we need to come up with more creative solutions to keep the fledgling recovery going. It will be interesting to see what comes out of the G-20 meeting this weekend.

Private Equity Firms Have Billions and Nowhere to Spend It - NYTimes.com

This article in this morning's New York Times is interesting from several perspectives.

First, it raises an interesting question regarding the motivation of the managers of the private equity funds.

And, second, it raises the more troubling question of why the managers haven't been able to spend more of the funds allocated to them. Do they think that valuations are not all that attractive?

Finally, here's a key section of the article, especially given the fact that many pension and endowment funds are allocating resources away from the public markets to private equity:

Many in the industry are getting caught in bidding wars. Firms are assigning surprisingly high valuations to companies they are acquiring, even though the lofty prices will in all likelihood reduce profits for their investors. A big drop in returns would be particularly vexing for pension funds, which are counting on private equity, hedge funds and other so-called alternative investments to help them meet their mounting liabilities.

Given the prices being paid for companies, investors’ returns over the life of the fund are likely to drop into the low to mid-teens, said Hugh H. MacArthur, head of global private equity at the consulting firm Bain & Company, which used to be affiliated with Bain Capital, the private equity firm. Returns will be even lower once fees are factored in. Private equity firms typically charge an annual fee of 2 percent and take a 20 percent cut of any profits.

While investing in private equity will probably be more lucrative than investing in public markets, “those are far from the gross returns of the mid- to high teens that we saw a few years ago,” Mr. MacArthur said.

Private Equity Firms Have Billions and Nowhere to Spend It - NYTimes.com

The Paralyzed Plutocracy: Five Reasons Why the Wealthy Aren't Feeling Better About 2009's Big Rebound in Their fortunes - The Wealth Report - WSJ

Interesting short post from the Wall Street Journal today.

From personal experience, I can tell you there is still a feeling of unease and concern among the clients and prospects with whom I have been meeting. True, most will acknowledge that conditions seem to be improving, albeit slowly, but are still reluctant to make any significant changes in their asset allocation away from a very conservative stance.

Besides the five reasons the article notes, I would add another: a feeling of frustration. For years investors have been told to invest in stocks for the long term, yet the S&P 500 is essentially unchanged since (gulp) 1998. Interest rates remain extremely low, however, especially on shorter maturity assets, and bank rates are mostly below 1% as well. Everyone is very aware that they need to make their retirement assets grow, yet the investment alternatives seem to be less than appealing.

In my opinion, the most interesting parts of the capital markets remain dividend-paying, higher cap stocks and longer maturity bonds. For investors with at least a modestly longer term time horizon (3 to 5 years), I think you can make a pretty good investment case for these sectors.

But I can empathize with the mood of the investor.

Here's my summary of the five points from the article (I have paraphrased the note):

1: Account values remain below where they were in 2007 - Rather than focus on the growth in account value over the past year, investors wistfully remember the "highwater" marks of a few years ago;

2: Reluctance to Realize Losses - a classic investment problem. Rather than realize the loss and move on, some are holding on hoping to at least breakeven - at which time they'll sell. In the meantime, there may be better opportunities elsewhere;

3: Very Few Are Truly Long Term Investors - most of us look at the last few months rather than the last few years;

4: Politics - correctly or not, there seems to be a feeling that the current administration is against high net worth individuals. Some are making investment decisions based not only economic or market trends but their own antipathy towards what is going on in Washington;

5: The Richistan Effect. While a millionaire may be wealthier than most, compared to their social circle they are feeling poor.

The Paralyzed Plutocracy: Five Reasons Why the Wealthy Aren't Feeling Better About 2009's Big Rebound in Their fortunes - The Wealth Report - WSJ

Economic Scene - The Caution of the Fed Comes With a Risk - NYTimes.com

Thoughtful piece from this morning's NY Times.

We have reached, it seems to me, an important juncture in the markets. Governments around the world are struggling to reconcile the need to address huge fiscal deficits with the truth that the economic recovery remains fragile.

Government intervention was crucial in starting the recovery 18 months ago, in my opinion. And once this support begins to be withdrawn, it is not clear that there is enough private demand to pick up the slack.

This morning's housing number is one example. Although it is just one data point, here's the headline from Bloomberg news:

May New Home Sales 300K vs 430K Briefing.com consensus; M/M -32.7%

June 23 (Bloomberg) -- Purchases of new homes in the U.S.fell in May to a record low as a tax credit expired, showing the market remains dependent on government support.

Sales collapsed a record 33 percent to an annual pace of 300,000 last month from April, less than the median estimate of economists surveyed by Bloomberg News and the fewest in data going back to 1963, figures from the Commerce Department showed today in Washington. Demand in prior months was revised down.

So what should the government do? That the Big Question. Here's an excerpt from the Times column, which suggests that Fed policy is doing too little rather than doing too much:

The main historical lesson of financial crises is that governments are usually too passive. They respond in dribs and drabs, as Japan did in the 1990s and Europe did in 2008. Or they remove support too quickly, as Franklin Roosevelt did in 1937, and then the economy struggles to escape its funk.

Look around at the American economy today. Unemployment is 9.7 percent. Inflation in recent months has been zero. States are cutting their budgets. Congress is balking at spending the money to prevent state layoffs. The Fed is standing pat, too. Bond investors, fickle as they may be, show no signs of panicking.

Which seems to be the greater risk: too much action or too little?

I'm worried that by restricting fiscal policy, and reducing the Fed's presence in the bond market, will lead to tougher economic times ahead.

Economic Scene - The Caution of the Fed Comes With a Risk - NYTimes.com

Trichet Renews Call to Keep Hard Line on Spending - NYTimes.com

Turns out the Europeans continue to believe the best way to revive their economies is to increase taxes and reduce government spending, ignoring President Obama's suggestions.

As I mentioned in previous posts, I am not suggesting that we shouldn't be concerned about deficits. On nearly every government level, promises that were made in the past are now coming due, and are wreaking havoc on government budgets. These clearly need to be addressed in a thoughtful manner.

But I have yet to find an example in the past when a government was able to save its way to prosperity.



Trichet Renews Call to Keep Hard Line on Spending - NYTimes.com

FT.com / Global Economy - Gold at new record high after Saudi reserves double

Following on my earlier post from this morning: Several clients have asked me what I think about investing in gold.

My answer is usually lukewarm to negative. First, while some cite the historic role that gold has held in protecting wealth, I would suggest that this depends on the time frame.

True, gold prices today have surged to record highs, yet gold was also trading around $850 an ounce when I started in the business - in 1980. In other words, for the last 30 years the compound return of gold has been something less than 1%, far below the rate of inflation in most industrialized countries.

Second, gold does not pay any interest. While this seems obvious, a non-interest bearing investment does little to help buy groceries or pay the rent. Moreover, the last time I checked, there are very few institutions that accept gold as a means of payment. Gold is only worth what someone else will pay for it.

And, third, is the simple fact that analysis of the gold market is incredibly hard, if not impossible. And this morning's FT carries a story that is a perfect example of this.

Here's the key paragraph:

Gold prices hit on Monday a fresh record high of almost $1,265 a troy ounce following the revelation that Saudi Arabia, the world’s largest oil exporter, is sitting on more than twice as much gold as previously thought, according to new estimates.

And it goes on:

The WGC revelation about Riyadh’s gold holdings comes just a year after China surprised the bullion market when it revealed its gold holdings were more than 1,000 tonnes, almost double what it had reported for years.

In short, all the various agencies and analysts which track worldwide gold supplies had no idea what two of the largest buyers of gold were doing. If they can't follow the demand/supply trends properly, how can they analyze the investment merits of gold?

FT.com / Global Economy - Gold at new record high after Saudi reserves double

Buttonwood: Something doesn't fit | The Economist

As a piece from the Economist last week discussed, the markets can't seem to make it their minds: is the world becoming more inflationary (which means you should buy gold)? Or are the recent deflationary trends here to stay (which means you should buy bonds)?

As it turns out, both gold and Treasury bonds are rallying, so it is hard to draw any definite conclusions from the market. Here's what the Economist concludes:

Perhaps the explanation is simpler. Martin Barnes of Bank Credit Analyst, a research firm, points out that the direction of official policy (low rates, quantitative easing, big deficits) looks inflationary but the economic fundamentals (a big output gap, sluggish credit growth) look deflationary. Faced with this dichotomy, investors who buy both Treasury bonds and gold are not displaying cognitive dissonance. They are just hedging their bets.


Buttonwood: Something doesn't fit | The Economist

Tax Report: Is a Roth IRA Safe From Taxes? - WSJ.com

Thoughtful piece from the Journal. While I agree with the article's conclusion - that a future tax on properly-qualified Roth IRA distributions seems unlikely - I was unaware that there was a short period of time when Congress did change the rules:

Given the desperate need for revenue, this isn't a totally idle fear. And unfortunately there is a precedent when it comes to taxing those who have saved what lawmakers think of as "excessive." From 1987 to 1997 they imposed a 15% excise tax on annual retirement-plan distributions over $150,000. The tax applied even if other rules forced the account holder to withdraw more than $150,000, and it could hit retirement assets in estates as well.

But then the article goes on to say:

This particular tax was so hated that it is hard to imagine its return. Michael Graetz of Columbia University, a former top tax official at the Treasury Department, also thinks it is unlikely that lawmakers would enact a wholesale levy on Roth assets. "That would be like taxing salary twice," he says. "Congress has never done this, and there's no reason to expect it will."

Something to think about.

Tax Report: Is a Roth IRA Safe From Taxes? - WSJ.com

How Working Longer Builds Security

Interesting article via the Center for Research at Boston College

As the article notes, although most surveys indicate that people plan to work until they are 65 year old, the average retirement age has been steadily declining to 62 years old.

Social Security, by the way, makes it pretty attractive to hold off for a few years before taking benefits. I went to a seminar a couple of weeks ago put on by someone from Social Security. The presenter noted that if someone waits four years before starting to take benefits - from age 66 to age 70 - the increase in benefit payments works out to be 8% per annum - not a bad return!

The math is pretty compelling to work just a few years more, if your health permits. Here's an excerpt from the article:

First, let's consider the impact of working and saving longer on your retirement income. Consider the example of a woman who is working full-time with an annual, fixed salary of $75,000 and tax-deferred savings of $150,000. Let's say that instead of retiring at 62, she decides to stay on the job for three additional years until age 65 and that annual inflation runs at a 3 percent rate. Let's also assume she saves 15 percent of her salary, or $11,250, for each of those additional working years.

Down the road, those decisions will boost her annual retirement income from investments by about 14 percent per year. At the end of those additional working years, her annual retirement income, in today's dollars, would be 43 percent higher than it would have been had she retired at age 62. If she could sock away even more of her income--25 percent-- the total increase in her income from her investments alone would be 60 percent.

How Working Longer Builds Security

Contrarian (Bearish) View:

I debated whether to post this note or not, but in the end I thought it raised enough interesting questions to be worth your consideration.

I remain mildly bullish on the stock market, mostly because the lack of appeal of any other investing alternatives. Today's CPI number indicated that deflation remains a major threat to our economy, and interest rates continue to move lower (at this writing the 10-year U.S. Treasury note is yielding 3.20%, which is the lowest level since the financial crisis in early 2009).

Still, as this note from the blog Clusterstock
notes, Felix Zulauf is a pretty savvy investor, and so is worth a listen.

Sufficient to say, I hope he's wrong.

Reforming France: State of denial | The Economist

More on the euro.

It is always easy for analysts and economists to make broad pronouncements about the prescriptions for what ails the euro block. However, as politicians know all too well, political reality and economics do not always mix.

For example, as this article in The Economist discusses, President Sarkozy of France is trying to raise the retirement age in France to 62 years old from 60 years old. To us in the U.S., this seems like a "no brainer"; you can't get any Social Security benefits until you're 62, and full benefits are not paid until you are 70.

Not so in France, where large protest rallies are being held against the proposed changes:

..... It was President François Mitterrand in the early 1980s who introduced retirement at 60 as a mark of progress, and it remains a totem for the left and the right. Martine Aubry, the Socialist Party leader, instantly called the government’s plan “irresponsible”, and says that the Socialists will reverse it if they are elected to power in 2012. Union leaders too have queued up to denounce the reforms. François Chérèque, one union boss, called it “a provocation”. A day of strikes and protests is planned for June 24th.

As a statement about France’s long-run resolve to control its public finances, it is also reasonably serious. France is running a high budget deficit (8% in 2010), which is closer to that of Greece (9%) than Germany (5%). Its gross public debt is forecast to be 85% this year. And it is under pressure from the credit-ratings agencies to send a strong message of its determination to get a grip on public finances.

Reforming France: State of denial | The Economist

From Fortune Magazine: Background Searches on the Web

I've always been surprised by the amount of information people will post about themselves on sites like Facebook. Moreover, even if you delete an email, it's never completely gone - any computer technition with a reasonable level of skill can retrieve anything you've ever written or received.

In short, once you put something out on the Web, or send an email, it becomes public information, yet too many people assume that if they delete a posting later that it is gone.

Well, it's not.

In this note from Fortune Magazine (via a tweet from Lindsay Pollack), the article discusses how much information an organization with reasonable internet skills can find out about someone.

Here's an excerpt:

The so-called deep Internet (also known as the Deepnet, the invisible Web, or the dark Web) is not new, but enterprising techies have recently come up with ever more sophisticated algorithms for trolling its vast contents. To get an idea of the size of the deep Web, consider: Researchers estimate it's more than 500 times the size of the everyday Internet you can see with an ordinary search engine...

.... this means that "Amazon wish lists can crop up. So can your results from the last marathon you ran, and whose political campaign you've given money to, and whether your house is in foreclosure." Ever filed an application for a patent? Declared bankruptcy? Fallen behind on your child-support payments? Been investigated by the Securities and Exchange Commission? A Google (GOOG, Fortune 500) search probably won't reveal any of that, but a deep-Web search could.

Here's a video from CNN discussing the subject:

Myths about fiscal austerity: A cut too far? | The Economist

I don't know whether to feel good about this or not.

I had a post last week where I shared my concerns (more eloquently written by Paul Krugman) that global governments were beginning a process of tightening fiscal and monetary policy at a time that the economic recovery is still fragile.

This was the pattern that the Japan followed in the 1990's, and the U.S. in the late 1930's - rather than try to encourage fledgling growth, the government authorities acted too soon, snuffed out the recovery, then had to come to the rescue again.

Not to worry, according to The Economist. Most of the conversations coming from government officials is mostly rhetoric:

Fortunately, however, the G20’s rhetoric is far tougher than the likely reality. Contrary to Mr Krugman’s fears, there is little evidence from actual budget plans that the world’s finance ministers are embarking on an immediate collective austerity drive. American politicians are still debating a second mini-stimulus. Even in Europe, where the focus on deficit reduction is greatest, the impact will in the short term be relatively modest.

But is this good? The Economist continues:

A calm look at the numbers, then, suggests that the odds of a collective G20 blunder towards recovery-wrecking austerity this year are low. The real danger of the current embrace of austerity is not that it is reckless, but that it is thoughtless—missing an opportunity to make the policy changes that will help economies most in the future.

More to think about.

Myths about fiscal austerity: A cut too far? | The Economist

UAW Fund Faces Bankruptcy: Headline from 2015 Wall Street Journal

This article appeared in this morning's Wall Street Journal concerning the UAW's Fund.

(Unfortunately you have to subscribe to the on-line version of the Journal to be able to read the whole piece, but there was one paragraph that caught my eye.)

First, some background: in January of this year, as part of their settlement with General Motors, Ford and Chrysler, the UAW assumed the responsibility for paying for the health care benefits for 800,000 retired members and their spouses. The fund - named voluntary employee beneficiary association, or VEBA - is huge, totalling some $45 billion.

Here's the part that interested me (quoting):

Earlier this year, consultant Ennis Knupp & Associates, Inc. conducted a study of the benefit obligations to the UAW retirees. The trust then adopted a plan to put half of its funds in global stocks, 25% in core fixed income and 12.5% each into Treasury Inflation-Protected Securities (TIPS) and long-duration fixed income.

In other words, according to the folks at Ennis (who I have worked with in the past, by the way), the best way for a large pool of assets whose liabilities will stretch for years is to put half of the fund in securities with a blended yield around 3%, and the remainder in stocks outside of the United States.

This to me is a recipe for disaster.

First, it seems that Ennis cannot make it mind: is it worried about inflation (the allocation of 12.5% to TIPS, whose yields are around 1.5%) or deflation (12.5% to long-duration bonds, which will only help if interest rates stay steady or move lower)?

Second, why global stocks? U.S. large cap stocks currently are among the most attractive in the world both on a valuation basis as well as offering reasonable dividend yields.

Third, whatever happened to buy America? Is Ennis so bearish on the future of this country that the only opportunities they see are overseas? Mind you, I am a big fan of international diversification, but it used to be that the UAW was one of the most strident proponents of staying invested in the U.S. Do their members really want to invest in companies that have taken jobs from their members?

And, finally, why would a fund that has a longer term time horizon (as VEBA should) have only half in stocks? True, the last 10 years have not been kind to the stock investor, but history suggests that the next decade should have better returns than most other asset classes.

Attention American taxpayer: Bailout Ahead.





UAW Fund Holds Promise for Money Managers - WSJ.com

Interest Rates Could Stay at Record Low Till 2012 - NYTimes.com

If my view of the way things are playing out on the global scene is correct, it will be several years before we see a significant increase in interest rates on either short or long maturity bonds.

Based on this article in today's New York Times, looks like at least the Fed's internal staff agrees.

Here's an excerpt:

And while a few Fed officials have argued that extraordinarily low interest rates could lead to new price bubbles, or excessive leverage and speculation by banks, Mr. Rudebusch argued that the relationship between short-term interest rates and financial imbalances was “quite erratic and poorly understood,” noting that Japan had very low interest rates for about 15 years without those problems.

In addition, Mr. Rudebusch said the federal funds rate was less central than in the past because the Fed has been buying mortgage bonds and Treasury securities to hold down long-term rates.

“Changes in long-term interest rates have much larger effects on the economy than equal-sized changes in short-term interest rates,” he wrote.

Interest Rates Could Stay at Record Low Till 2012 - NYTimes.com

Madame Non and Monsieur Duracell: German-French Relations On the Rocks - SPIEGEL ONLINE - News - International

And so the internecine war amongst the European leaders continues.

The personality clash between Chancellor Merkel of Germany and President Sarkozy of France comes at a time of huge stress on the euro, and is obviously not helpful. However, it does once again illustrate the basic problem in the euro block; namely, the coalition consists of 16 different countries whose interests are not necessarily compatible.

Here's an excerpt from this article from the German magazine Der Spiegel:

Can the German-French marriage be saved? According to a diplomat from Paris, that will require Germany to become a little more French and France, in light of the crisis, to become a little more German. In other words, it is time for the French to finally save money and the Germans to spend more of it.

For the moment, however, Germany is still looking very German.

Madame Non and Monsieur Duracell: German-French Relations On the Rocks - SPIEGEL ONLINE - News - International

Why You Shouldn't Convert to a Roth IRA - WSJ.com

Interesting piece from the Wall Street Journal.

What I have found in conversations with clients is the decision to convert is never totally obvious.

The best candidates for conversion, in my opinion, tend to be older, usually widowed clients, who are looking to reduce their estate tax burden as well as give their heirs more assets tax-free. By converting to a Roth, and paying the taxes now, you take funds out of your estate to pay the taxes, which means the estate tax burden could conceivably be less. Moreover, the beneficiaries of the Roth will receive tax-free distributions, assuming all of the various Roth conversion rules are followed.

In other cases, however, it can be more complex, as this article suggests.

The whole piece is worth a read (it really isn't that long) but here are the five reasons cited:

1. The tax bite is too big.

Clients often come to advisers asking about the Roth IRA conversion opportunity without realizing the immediate tax implications: They will have to pay income tax on any money they move out of a traditional IRA into a Roth account.

2. Retirement is too close.

The problem here is that it can take 15 to 20 years for the tax-free growth of a Roth IRA to make up for the taxes paid at the time of conversion, advisers say. And that period can be extended if the investor starts withdrawing money from the account. That makes conversion an iffy proposition for people who are nearing retirement.

3. The investor's savings are too concentrated.

Age is even more of an issue for investors who are looking to their IRAs as their primary source of income in retirement. That's because they will need to take distributions from the fund sooner than investors who have other resources, and in larger installments—leaving less time for investment gains to offset the conversion's initial tax bite.

4. Tax brackets often change in retirement.

Interest in conversions is being spurred by anticipation of higher tax rates ahead. Some investors figure they will come out ahead by converting to a Roth IRA now and paying taxes at current rates on the amount they transfer, rather than leaving their money in a traditional IRA and paying taxes at a higher rate when they make withdrawals in the future.

But there's a catch in that scenario: Most people fall into a lower tax bracket when they retire.

5. The income can change your tax bracket now.

If an investor is receiving Social Security benefits, the spike in income could force them to pay taxes on their Social Security money, he says. It also could interfere with efforts to receive financial aid for children's college tuition. And, he adds, if an investor is going through a divorce, the additional income could affect the settlement.

Why You Shouldn't Convert to a Roth IRA - WSJ.com

Wealth Matters - Confusion Over Estate Tax Keeps Advisers Busy - NYTimes.com

Good discussion in today's New York Times about the current state of estate planning.

If you have the chance to read the whole piece, you'll probably notice that the author raises more questions than provides answers. This unfortunately is where most financial planners are in June 2010 - since there is no clarification on "the rules", it is hard to advise clients how best to structure their affairs.

An excerpt:

The real problem comes for the merely rich — individuals worth more than $1 million and less than $3.5 million and couples with net worths of $2 million to $7 million who previously did not have to worry about the estate tax. If Congress fails to act again this year, the estate tax laws next year will revert to their levels before 2001, and that could snare a host of people who set up the estate plans on the assumption that there would be no tax when they died.

“If Congress does nothing, there would be a sevenfold increase in the number of estates subject to the tax than if the exemption stayed at $3.5 million,” said John Dadakis, partner at the Holland & Knight law firm.

As the law stands, the heirs of a single person who dies next year with more than $1 million would be subject to a 55 percent tax. (For couples, it is $2 million.) Heirs of that same person, with a $3.5 million estate, would have paid nothing in 2009 but could pay as much as $1.375 million in 2011, depending on the level of planning. And while this wealth may seem high in many parts of the country, it has professionals on the coasts grumbling.

The best advice seems to be: Stay Tuned.



Wealth Matters - Confusion Over Estate Tax Keeps Advisers Busy - NYTimes.com

FT.com / UK - The best a man can get: Japan's government bonds given hard sell

Ironic story in yesterday's Financial Times.

Apparently the Japanese government has hit upon a novel way to sell its bonds:

A high-profile advertising campaign to persuade millions of small-time investors to buy the country's sovereign debt has gone for raw sex appeal: "Women have a thing for men who own JGBs!! . . . right!?"

Owning bonds might not be everyone's idea of the way to a woman's heart but, according to the finance ministry advert, women prefer men who invest in solid government debt because they are sensible investors.

Of course, when you are offering yields of 0.4% on 5 year notes, and 1.2% for 10 years (which is what JGB's yield), you have to come up with something new!


FT.com / UK - The best a man can get: Japan's government bonds given hard sell

Obama hasn't learned lessons of Bhopal | Randeep Ramesh | Comment is free | guardian.co.uk

The horrific oil spill in the Gulf continues to get a lot of attention in the press, as well it should.

Cries of outrage, and demands for compensation, are raining down from the President and virtually every U.S. politician. BP's stock price also continues to get hammered, and has already lost far more in market cap (+$100 billion) than its actual costs or possible liabilities projected by the most pessimistic analyst.

There are now demands that BP suspend its dividend until the mess is cleared despite the fact that it easily has the financial means to pay it.

And yet, when viewed from the British side, our reaction smacks of being hypocritical, to say the least.

Chevron, for example, is embroiled in a huge environment disaster in South America, where locals say that hundreds have been sickened or died from toxic waste.

This U.K. columnist notes another example: the Union Carbide disaster in India. Here's an excerpt:

While Barack Obama is lambasting BP for spreading muck in the Gulf of Mexico, he should perhaps pencil in a date with the people of Bhopal when he visits India later this year. While 11 men lost their lives on BP's watch and the shrimps get coated with black stuff, the chemicals that killed thousands of people in Bhopal in 1984 are still leaching into the ground water a quarter of a century after a poisonous, milky-white cloud settled over the city.

The compensation – some $470m – paid out by Union Carbide, the US owner of the plant and now part of Dow Chemical, was just the cash it received from its insurers to compensate the victims, a process that took 17 years. But it's one rule for them and another for anybody else.

This is not to defend BP (how can you?) but to note that the U.S. is getting close to overplaying its moral righteous hand.

Obama hasn't learned lessons of Bhopal | Randeep Ramesh | Comment is free | guardian.co.uk

Calls for Stimulus Yield to Deficit Concerns - NYTimes.com

Yesterday I wrote that most of Europe is now talking about reducing deficits rather than adding stimulus. Now it appears that the U.S. is going in the same direction.

It's not that I'm not concerned about deficits - we obviously have to make some serious changes in government spending - but at this point I'm not convinced that the economic recovery is strong enough to deal with a large dose of higher taxes and lower spending.

If you think about the arithmetic from Econ 101, our GDP is calculated as follows:

GDP = C + I + G + X

where C is consumption spending; I is investment; G is government spending; and X is net exports.

The consumer is spending again, but only cautiously. Continued continued growth in by consumers will in large part be determined by jobs and the housing market. Unemployment remains stubbornly high, and even the most optimistic forecasts don't look for the jobless rate to decline significantly by year-end, at least.

Housing, as Paul Volcker said recently, remains totally a ward of the state. In other words, the mortgage market is being totally driven by government policies, and the Fed, at least, is pulling back on its activities in this area.

In short, I think the outlook for the consumer is probably muted for a while. And consumer spending represents 2/3 of our GDP.

Turning to investment, there still seems to be too much excess capacity to see much of a significant boost in cap ex. Moreover, it seems that more spending on new projects is occurring in lower wage cost markets, e.g. China or India. So not much help there.

Our export market will definitely be hit by the strength of the dollar, particularly against the euro. Moreover, most government policies around the world seem to be focused on "beggar thy neighbor" ideas, where internal growth is spurring by more exporting.

Which leads to government policies. If government spending is cut, or at least its growth reduced, I would argue this would remove a major source of growth. Again, I understand the argument that we need to do something about deficits, but I worry that this is not the time to do so.

There is a precedent, which is often referred to in the financial press. In 1937, government spending created a spur to the US economy, and things seemed to be getting better. By 1938, attention turned to reducing government spending and tightening credit. When this happened, the fledgling economic recovery was snuffed out, and the economy and employment plunged again. Only with the onset of World War II did the US begin to grow again.

Also, as I have said repeatedly, all of this talk of reducing government spending will eventually lead to more deflationary pressures.

Here's an excerpt:

The box that Europe, the Obama administration and Congress find themselves in today — desperate to stimulate the economy and fearful of the political reaction — gives new meaning to Milton Friedman’s famous line from the mid-1960s. “In one sense, we are all Keynesians now,” he wrote to Time magazine, referring to the theories of John Maynard Keynes, who called for government spending to counter downward cycles in the economy. In a less-remembered continuation of that sentence, he added, “in another, nobody is any longer a Keynesian.”

Today they are periodic Keynesians. The Senate has taken up a jobs bill that could cost $100 billion over the next decade, a fraction of last year’s historic stimulus package, but significant by the standards of other such jobs packages over the last two decades. “Here in the Senate, jobs will remain priority No. 1,” Senator Charles E. Schumer, a Democrat of New York, said Tuesday. “It’ll be almost an obsession to us.”

Not surprisingly, the parties cannot agree on the best path to satisfy their obsessions.

Calls for Stimulus Yield to Deficit Concerns - NYTimes.com

Estate Tax Dormant, Billionaire’s Bequest Is Tax-Free - NYTimes.com

I don't know if you saw this story in this morning's New York Times, but it illustrates the cost (to the Treasury) of the delay on the part of Congress to do anything about the estate tax.

As I mentioned in a post about a month ago, many estate lawyers had been thinking that there would be some clarity on the federal estate tax by Memorial Day. Well, the end of May has come and gone, and no action from Washington.

The problem is what steps, if any, investors should be taking in anticipation of estate tax law changes. At this point, it is simply not clear.

Here's a short excerpt from the piece:

Dan L. Duncan, a soft-spoken farm boy who started with $10,000 and two propane trucks, and built a network of natural gas processing plants and pipelines that made him the richest person in Houston, died in late March of a brain hemorrhage at 77.

Had his life ended three months earlier, Mr. Duncan’s riches — Forbes magazine estimated his worth at $9 billion, ranking him as the 74th wealthiest in the world — would have been subject to a federal tax of at least 45 percent. If he had lived past Jan. 1, 2011, the rate would be even higher — 55 percent.

Instead, because Congress allowed the tax to lapse for one year and gave all estates a free pass in 2010, Mr. Duncan’s four children and four grandchildren stand to collect billions that in any other year would have gone to the Treasury.

Estate Tax Dormant, Billionaire’s Bequest Is Tax-Free - NYTimes.com

Europe Tightens Its Belt

The recent moves to cut fiscal spending by some of the major European governments hasn't received as much attention in the U.S. financial press as I believe it should.

Governments around the world are facing the same problem: do they cut spending/raise taxes in an effort to reduce their budget deficits? Or do they propose more government stimulus - new spending/cut taxes - with the idea of growing their way out of their fiscal problems?

Most governments seem to be moving to the first alternative.

Yesterday, for example, the German government proposed large cuts in its federal budget:

The German government put together the largest austerity package since World War II on Monday, with spending cuts and new business levies aimed at saving 80 billion euros by 2014. Chancellor Angela Merkel says Germany, as Europe's largest economy, must set an example.

Radical Cutbacks: German Government Agrees on Historic Austerity Program - SPIEGEL ONLINE - News - International

And then there was new British Prime Minister David Cameron solemnly warning his country that severe cutbacks were coming:

Prime Minister David Cameron said Monday that Britain’s financial situation was “even worse than we thought” and that the country would have to make savage spending cuts to bring its swelling deficit under control.....

...Mr. Cameron said that at more than 11 percent, Britain’s budget deficit was the largest ever faced by the country in peacetime. But he warned that the structural deficit was more worrisome. Britain owes more than $1.12 trillion, he said, and in five years will owe nearly double that if nothing is done now.

The country already spends more on interest payments on its debt than it does running its schools, he said, adding that determining how to reduce the deficit and cut down on borrowing is “the most urgent issue facing Britain today.”

http://www.nytimes.com/2010/06/08/world/europe/08britain.html?scp=4&sq=david%20cameron&st=cse

There doesn't seem to be any consensus among economists about which course is best, but it seems to me that the near-term effects simply can't be all that good for the European economic prospects. Cutting spending and raising taxes at a time when economic recovery is only beginning seems premature, yet there is also no doubt that debt levels are spiraling to untenable levels.

Then there is the social consideration. Imagine the reaction in the US if the President proposed cutting spending not only on social programs but military outlays as well (if the US military were cut in the same proportions as the German government is proposing our military would move from 1.4 million troops to 265,000).

Finally, there is the news from Japan, where 20 years of loose monetary policy and aggressive fiscal spending has been essentially unsuccessful. Here's a recent headline:

TOKYO (MNI) – Outstanding loans by Japanese banks fell 2.1% year-on-year to Y396.12 trillion in May, marking the sixth straight y/y
drop after a revised -1.9% (initially -1.8%) in April, Bank of Japan data released on Tuesday showed.

Lending continued to drop due to weak corporate fund demand, though the annual rate was held down by sharp gains in lending a year earlier.

http://www.forexlive.com/111468/all/japan-may-bank-lending-2-1-6th-yy-drop-in-row-apr-1-9

Strategies - A Flight to Treasury Bonds That Wasn’t Supposed to Happen - NYTimes.com

I started my investment career at Scudder, Stevens & Clark in the early 1980's. I was hired to be an analyst in their bond research department. As part of a team of probably 20 bond professionals, I learned an enormous amount about investing from some of the brightest and most experienced investment professionals around.

Scudder's investment philosophy was thoroughly grounded in research in both the equity and bond markets. At a time when most managers picked stocks largely through "tips" or advice from friends, Scudder believed that extensive research in fundamentals would yield handsome returns for their clients.

Scudder at that time was one of the few places in the investment management world that had a bond research effort. I think it is fair to say that the whole concept of bond research started at Scudder, with investing giants like Herman Liss, Bob Pruyne and Sidney Homer (author of "Inside the Yield Book") studying the fixed income market in ways that very few had ever done. Their research set the stage for much of the kind of work that goes on in fixed income today.

One of the key concepts I learned as a fledgling investment professional at Scudder was to realize the futility of investing based on a single forecast.

Outlooks are always too uncertain, and no one has a perfect "crystal ball". Instead, attractive investment opportunities were to be founded by asking "what if", even if some of the scenarios seemed just too far-fetched to be true.

We had a name for this analysis: "Opportunity/Risk". Every week we spent hours developing scenarios and doing research on the risk/return profiles on a wide variety of different securities and sectors in the bond market. It wasn't good enough to say, for example, that you wanted to buy a particular bond based on a view that interest rates were going to move lower.

The question would come back: what happens if rates move in a different direction? Or what happens if credit spreads widen? Or what happens if the shape of the yield curve changes? And so on.

As simple of a concept as this seems, it is still too often forgotten by many in the investment management community.

For example, as this recent article from the New York Times points out, almost no one in the investment world at the beginning of this year forecast that interest rates could move lower, and so Treasury bonds were thought to be poor investments. Now it turns out that this widely-held view was wrong:

For people holding Treasury bonds, it’s been one of the best of times. In May, long-term Treasury mutual funds outperformed every traditional category of stock fund, according to Morningstar data, returning 5 percent. Ominously, only bear market funds — those dedicated to bets on a stock market decline — fared better. They returned 8 percent. These trends continued last week, with the Dow and the S.& P. 500 each falling more than 3 percent further....

...It is also sobering that a vast majority of economists and market strategists were forecasting a different chain of events. Treasury yields were universally expected to be rising, not falling, as the United States recovered from a deep recession. The domestic economy is, in fact, growing, and corporate profits have been rising, but the European crisis has overturned many expectations.

As old-fashioned as it might seem, I think that opportunity/risk analysis still makes sense.


Strategies - A Flight to Treasury Bonds That Wasn’t Supposed to Happen - NYTimes.com

Lost Decade, Here We Come - Paul Krugman Blog - NYTimes.com

Sobering words this AM from Paul Krugman's blog.

I'm not sure who's right - those who have become fairly hysterical about the looming deficits, while others (including Larry Summers of the President's economics team) are calling for a second dose of stimulus - but I would agree that imposing draconian spending cuts at a time when the economy is only beginning to improve doesn't seem to make too much sense.

Here's an excerpt from Professor Krugman:

The right thing, overwhelmingly, is to do things that will reduce spending and/or raise revenue after the economy has recovered — specifically, wait until after the economy is strong enough that monetary policy can offset the contractionary effects of fiscal austerity. But no: the deficit hawks want their cuts while unemployment rates are still at near-record highs and monetary policy is still hard up against the zero bound.

But what about Greece and all that? Look, right now sovereign debt problems are taking place in countries with a very specific problem: they’re part of the euro zone, AND they’re badly overvalued thanks to huge capital inflows in the good years; as a result they’re facing years of grinding deflation. Counties not in that situation are not facing any pressure from the markets for immediate cuts; as of this morning, 10-year bonds were yielding 3.51 in Britain, 3.21 in the US, 1.27 in Japan.

Lost Decade, Here We Come - Paul Krugman Blog - NYTimes.com

John Wooden, 99, Legendary U.C.L.A. Coach, Dies - Obituary (Obit) - NYTimes.com

"Failure to prepare is to prepare to fail."
-John Wooden

John Wooden died yesterday at 99 years old. Wooden was a basketball legend; he is still (I believe) the only man to be elected to the Basketball Hall of Fame as both a player and a coach.

Wooden's UCLA teams in the 1960's and 1970's dominated college basketball as no other team before or since has done. Winning 10 national championships - the final one came in 1975 - was an amazing feat.

John Wooden was widely admired, not just for the championships but also the way that he conducted his life. I have read a few books by Wooden, and always learned something from them.

Wooden was a huge fan of the value of preparation. He often said that his most enjoyable times as a coach were not the games but the practices. He and his coaching staff would meticulously plan each two hour practice session - no minute was allowed to be wasted.

He was a strong believer in the value of physical fitness, gained through intense practices.

He emphasized fundamentals. For example, he hated behind-the-back passes, which he thought were needlessly risky. He also liked players to use the backboard for their shots, believing that a bank shot had a better chance of success.

Wooden rarely scouted the opposing teams. He would point out that it made little difference whether he knew the tendencies of a particular player. Instead, he felt that if his teams focused on the fundamentals, and played the type of aggressive zone defense for which UCLA was famous, they would win most games. And of course he was right.

John Wooden was intensely competitive, as this morning's New York Times obituary pointed out. He might have looked like this mild-mannered school teacher from Indiana, but once the game started he was as ferocious as any coach around.

Wooden was devoted to his wife Nell. They were married 53 years. Nell would sit behind the bench at nearly every game. Right before the opening tip-off, John would look up in the stands to Nell and give her an "OK" hand signal. When she died, he visited her grave site nearly every day. He also wrote notes to her telling her how much he loved her, and missed her company.

It is a testimony to his widespread influence that his death merited a front page story in the Times this morning, even though he had coached his last game almost 35 years ago.

If you have the chance, read "They Call Me Coach" this summer. Even though it was written a number of years ago, it's a fun read, perfect for the summer. You'll learn valuable lessons about both basketball and life from one of the best ever.


John Wooden, 99, Legendary U.C.L.A. Coach, Dies - Obituary (Obit) - NYTimes.com