Can We Avoid Japan-type Woes? U.S. Hears Echo of Japan - NYTimes.com

Long article in this morning's New York Times comparing the U.S. and the 20 year economic woes of Japan.

Not a lot of new information, but the continuing malaise of the U.S. economy (and particularly high unemployment) will doubtlessly play a big role in Tuesday's elections.

Here's an excerpt:

However, some warn that the United States could still get it wrong, especially if the midterm elections produced a sharply divided political landscape.

“The danger is if the U.S. plunges into policy paralysis just like Japan in the 1990s,” said Shumpei Takemori, an economist at Keio University in Tokyo. “Ideological divides and political divides can make bold policy action impossible.”

In fact, some economists warn that the United States may be deeper into Japan-style stagnation than is widely realized. Simon Johnson, a former chief economist at theInternational Monetary Fund, estimates that the total output of the American economy this year will be no higher by his estimate than it was in 2006.

“We’ve already lost half a decade,” said Mr. Johnson, now a professor at theMassachusetts Institute of Technology.

U.S. Hears Echo of Japan’s Woes - NYTimes.com

I had a long conversation yesterday afternoon about what the stock market might do if, for example, the Republicans are able to regain control of the Senate.

My two cents worth: I almost don't think it will matter. No matter who wins, the choices are incredibly difficult, and there are no easy answers. It is simple, for example, to campaign on a platform of cutting government spending, but 82% of the federal budget is already mandated by either law or contract (e.g. the interest on the federal debt).

Raising taxes on higher income folks wins applause in some corners but even this has risks, as the article notes:

In the annals of economic policy blunders, the one in which Hiroshi Kato played a hand in early 1997 ranks among the biggest in recent Japanese history.

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Issei Kato/Reuters

Bank of Japan’s headquarters. Japan is in an economic morass from which it has yet to emerge.

The Great Deflation

Studying Past Blunders

This is the second in a series of articles that will examine the effects on Japanese society of two decades of economic stagnation and declining prices.

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Mr. Kato led a government advisory committee that concluded that the economy, which was then finally starting to rebound from the collapse of its 1980s land and stock bubbles, was healthy enough to raise the national consumption tax to 5 percent from 3 percent.

Aimed at reducing deficits, the tax increase instead quickly snuffed out the fragile recovery, pushing Japan to the brink of a financial meltdown and thrusting the nation deeper into the economic morass from which it has yet to emerge even today.

“Our sins are large,” Mr. Kato, now president of Kaetsu University in Tokyo, said ruefully. “I hope the rest of the world can learn from this mistake.”ticle notes at the very beginning:

One Reason for Recent Stock Market Rally: Corporate profits' big climb

I have had a very busy week meeting with clients and prospects, which I have enjoyed. There have been a couple of themes that have come out of these meetings, which I thought were interesting.

One of the major concerns for most investors is coping with low interest rates. Money market rates are essentially zero, which makes it painful for savers. One client I met with yesterday has over $500,000 in a money market fund which, as he pointed out, means that he's earning $500 a year on his account - ouch!

The other major theme might surprise you somewhat: Most of my clients are interested in adding to their stock portfolios.

We all know the economy is muddling along, at best. However, given the alternatives, stocks - especially large cap, dividend-paying stocks - can offer better yields and the chance for capital appreciation than corporate or municipal bonds.

The market has also had a good tone recently, which adds to the more positive feeling that my clients might have.

I came across this piece (tip of the hat to the Washington Post, via Politico ) that also was a little surprising: recent corporate profit growth has been the strongest in decades.

You don't hear a lot about this in the press: the Republicans don't want to give the Obama administration any credit, and the Democrats don't want to appear as helping corporate "fat cats".

And yet corporate America is flourishing.

Here's an excerpt from the piece:

Does President Barack Obama deserve credit for the fact that corporate profits have risen faster under him than during any other 18-month period since the 1920s?

“The better question is whether he wants the credit,” said Douglas Holtz-Eakin, who was an economic adviser to Republican Sen. John McCain’s 2008 presidential campaign. “Obama sounds a lot like he wants corporations to be less profitable.”

Profits have surged 62 percent from the start of 2009 to mid-2010, according to the Commerce Department. That is faster than any other year and a half in the Fabulous ’50s, the Go-Go ’60s or the booms under Presidents Ronald Reagan and Bill Clinton.

Under another president, especially a Republican president, the data on corporate profits would be envied. George W. Bush, who dedicated a good deal of his presidency to tax cuts aimed at boosting business profits, probably would have loved such results. It took Bush nearly four years to post the gains that Obama has managed in less than half the time.

Read more: http://www.politico.com/news/stories/1010/44268.html?wpisrc=nl_wonk#ixzz13koXR4D1

Corporate profits' big climb - John Maggs - POLITICO.com

Aging Gracefully: Being Healthy at 100 Takes Some Homework — Jane E. Brody - NYTimes.com

The New York Times has been running a series of articles discussing how older Americans have been able to keep relatively healthy, even at age 100.

From a financial point of view, a healthy lifestyle can yield huge benefits, since medical expenses tend to be one of the major drains on savings as we get older. Put another way, being in good physical condition is one of the smarter investment decisions anyone can make.

My wife Christina (a.ka. Mrs. Random Glenings) has always been a walker, which has meant that she is in good shape. As it turns out, Chris is following the advice of many doctors, who suggest that even the most simple exercises like walking 30 minutes a day can make a difference.

Here's a excerpt from the article:

The good news is that the age of immobility can be modified. As life expectancy rises and more people live to celebrate their 100th birthday, postponing the time when physical independence can no longer be maintained is a goal worth striving for.

Gerontologists have shown that the rate of decline “can be tweaked to your advantage by a variety of interventions, and it often doesn’t matter whether you’re 50 or 90 when you start tweaking,” Dr. Lachs said. “You just need to get started. The embers of disability begin smoldering long before you’re handed a walker.”

Lifestyle choices made in midlife can have a major impact on your functional ability late in life, he emphasized. If you begin a daily walking program at age 45, he said, you could delay immobility to 90 and beyond. If you become a couch potato at 45 and remain so, immobility can encroach as early as 60.

“It’s not like we’re prescribing chemotherapy — it’s walking,” Dr. Lachs said. “Even the smallest interventions can produce substantial benefits” and “significantly delay your date with disability.”

“It’s never too late for a course correction,” he said.

Being Healthy at 100 Takes Some Homework — Jane E. Brody - NYTimes.com

Bill Gross on Bonds: Fed Easing Will Likely End Bond Bull Market, Gross Says

I mentioned the commentary of Ambrose Evans-Pritchard earlier today, and posted the note from Jeremy Grantham yesterday, so it seems only fair that I let you see what Bill Gross from Pimco is saying.

I still think that interest rates will move lower before they can move higher.

Now, I know what some of you are thinking: the yields in the bond market have been spiking higher recently. 10 year Treasury bond yields are now back above 2.70%, after touching 2.39% earlier this month. But don't forget that the yield on the 10 year was 2.80% in early September, and hit 4% in early March 2010, so we are really tracing some of the earlier decline. It is hard to see how interest rates soar when the Fed is committed to keeping interest rates low, probably through at least the end of 2011.

Still, Bill Gross has been The Man in bonds for many years, so he bears a listen (excerpt from Bloomberg):

“Check writing in the trillions is not a bondholder’s friend,” Gross wrote in his monthly investment outlook posted on Newport Beach, Calif.-based PIMCO’s Web site today. “It is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.”
...

“We are, as even some Fed Governors now publically admit, in a ‘liquidity trap,’ where interest rates or trillions in QEII asset purchases may not stimulate borrowing or lending because consumer demand is just not there,” Gross wrote. “Escaping from a liquidity trap may be impossible, much like light trapped in a black hole.”

Under what PIMCO calls the “new normal,” investors should expect lower-than-average historical returns with heightened regulation, lower consumption, slower growth and a shrinking global role for the U.S. economy.

“If QEII cannot reflate capital markets, if it can’t produce 2% inflation and an assumed reduction of unemployment rates back towards historical levels, then it will be a long, painful slog back to prosperity,” Gross wrote.


Fed Easing Will Likely End Bond Bull Market, Gross Says

Is QE2 A Good Idea?: The Fed's impending blunder – Telegraph Blogs

First Bill Gross of Pimco, then Jeremy Grantham of GMO, and now today Ambrose Evans-Pritchard of the London Telegraph.

All are saying that the Fed - whose heroic actions two years ago saved the world financial system - is wrong to embark on a second round of quantitative easing (a.k.a. QE2).

I have a lot of respect for all three gentlemen, so it is worthwhile paying attention.

The bottom line, it seems to me, is that economic growth in the U.S. remains tepid, and unemployment is too high. The standard Keynesian solution of more fiscal stimulus seems politically impossible, so the government is looking to the Fed as the least painful way to boost the economy.

(After all, if the Fed acts, you never have to show leadership and do what is right for the long term health of the U.S. - but I digress).

Would QE2 be a mistake?

As Mr. Evans-Pritchard's column indicates, in order to be effective, QE2 will have to be massive, in the order of trillions of dollars. If the Fed does a half-step stimulus, it probably will not be effective, and so it will be open to huge criticism by Washington and the rest of the country.

So I'm not sure what the final answer is, but here an excerpt from from today's column:

But we are no longer in a systemic financial crisis, and the Fed’s motives have become subtly corrupted. Having argued during the boom that it was not the business of central banks to stop asset bubbles – and specifically that any fall-out could “safely” be cleaned up later – Bernanke now seems to determined to validate this absurd doctrine, bending all the sinews of the US economic and financial system to this end. One error leads to the next...

Simon Ward from Henderson Global Investors said his measure of velocity is rising at a robust rate of 8.7pc. “QE1 was justified during the crisis because monetary velocity was collapsing at that time. But now that velocity is recovering further QE is not needed. In fact it is potentially very dangerous,” he said.

Exactly

The Fed's impending blunder – Telegraph Blogs

Jeremy Grantham of GMO - Quarterly Letter

This is a rather long (16 pages) post from Jeremy Grantham of GMO, who I believe is one of the best market strategists around.

Bottom line: The Fed's encouragement of higher debt and more speculation will eventually comeback to haunt us (hence the Halloween theme) but for now the markets should benefit.


Grantham October

A View from Germany: French Fury Goes Beyond Pensions - SPIEGEL ONLINE - News - International

I saw this article in Spiegel Online, the German news publication. I thought I would post it only because it presents a much different view of the French protests regarding pension reform.

In the U.S. press reports, you get the idea that the French people are basically just a bunch of illogical citizens who refuse to face fiscal reality, and that allowing workers to retire at age 60 defies common sense.

This is not too dissimilar, by the way, to the way the French were treated in the days prior to the Iraq war, when they insisted that the U.S. did not have sufficient evidence that Saddam Hussein was close to preparing weapons of mass destruction.

In any event, here's the view from Germany:

Yet, as Der Spiegel points out, a French worker is eligible for a full pension only after working 40 years. If they decide to retire at 60, their benefits are significantly less:

In fact, 60 is merely the earliest possible retirement age for workers who have been paying into the system for at least 40 years. Anyone who retires at 60 in France without having completed the full contribution period must accept substantial reductions in benefits. The only problem is that Sarkozy clearly has no interest in initiating a socially accepted reform that has the support of the unions. In fact, such a reform has hardly been discussed at all. Basically, the outcome was announced before the beginning of any debate on the issue...

..In other words, the government... never sought the possibility of a sustainable, widely accepted solution. Instead, it used pension reform as a declaration of war against the unions, the Socialists and other adversaries...

The outcome is now one-sided and warped. Workers, particularly civil servants, are taking on virtually the entire burden of the reform, while employers emerge largely unscathed. Worst yet, workers with extremely long contribution periods are penalized, women are put at a disadvantage and hardship cases are not sufficiently taken into account. It is, in a nutshell, a socially unjust reform. The manner in which it was (not) negotiated is, in a political sense, perhaps the greatest scandal of all, while the current turmoil is the logical consequence.

So, according to the article, the real problem is that President Sarkozy is using the pension issue for political gains. Moreover, his own government seems oblivious to the public outrage against the swirl of corruption that seems to surround the Sarkozy administration.


Sarkozy's Perfect Storm: French Fury Goes Beyond Pensions - SPIEGEL ONLINE - News - International

New Deficit-Busting Tool: Govenment Sells TIPS With Negative Yields

For clients who fear inflation coming down the pike, I often get questions about TIPS (Treasury Inflation Protected Securities).

First a disclaimer: I do not believe that inflation will be a problem for years to come. There is too much capacity anywhere you look to create inflationary pressures.

I understand that Fed's current policy of printing large sums of money and throwing it into the market is scary, and could be inflationary, but I think that when you have too much supply and very tepid demand it is hard to stoke the inflationary fires.

Still, I could be wrong.

And so when clients ask about TIPS, here's what I say:

Inflation-indexed securities have been an imperfect inflation hedging mechanism for investors in this country as well as abroad for many years. Britain, for example, introduced inflation-indexed bonds in the early 1970's but the value of the bonds did not protect investors. The problem is the calculation of the inflation rate itself.

In this country, for example, economists usually talk about the consumer price index (CPI). The problems with CPI are numerous, however, ranging from geographical differences in prices to the "substitution" effect. In addition, roughly 40% of the CPI calculation is something called "homeowners equivalent rent", which is the government's attempt to measure the cost of housing.

For example, let's say you have two people: Mary, who lives in San Francisco, and John, who lives in St. Louis.

Housing in San Francisco, according to the Case-Shiller indexes, has been remarkably resilient. Prices on houses in San Francisco are up approximately +10% year-over-year, making it one of the few places in the country that has seen housing appreciation.

Other living expenses in San Francisco are high as well. For example, I heard on the radio this morning that San Francisco has the highest cost of gasoline in the country, with a gallon of unleaded going for $3.15.

John, on the other hand, has seen the value of his property decline year-over-year. And unleaded gasoline only cost $2.55 a gallon in St. Louis, which according to the radio this AM makes it the cheapest place in the country to buy gas.

So whose experience is the correct one to measure inflation?

Then there's adjustment mechanism. The government takes the trailing 12 month CPI at the end of each year and adjusts the principal balance of the TIPS. For example, if the last 12 month inflation rate is 3%, the principal balance of a note goes from, say, $1,000 to $1,003. This process is then repeated until the TIPS mature.

(This principal adjustment, by the way, is taxable if the bond is held in a taxable account, creating a "phantom income" problem for some).

I could go on, but let me add a couple of more points.

Historically, money market rates have tracked inflation pretty closely. Put another way, going back several decades, the "real return" (i.e. inflation-adjusted) of money market funds has been zero. This is seems logical: capital markets don't reward riskless investments, but they don't historically penalize them either.

If you really think that inflation is just around the corner, just leave your money in cash, and rates will begin to rise if inflation picks up.

Finally, I should note that bond traders have another interpretation of "TIPS": "Totally Illiquid Pieces of Sh*t". While off-color, the traders are reflecting the fact that TIPS tend to be one of the lesser liquid bonds that the Treasury issues, and often the bids are poor when investors attempt to sell prior to maturity.

So, if you're looking for an investment that trades poorly, offers mediocre protection against inflation, and wants you to pay a yearly fee to the government besides (which is what a negative yield means), the Treasury just sold $10 billion today, so there should be some trading in the secondary market.

But I wouldn't recommend them.

Here's the details from today's New York Times:

Inflation-protected securities sold at negative yields for the first time ever on Monday as traders anticipate that the Federal Reserve will start a new round of asset purchases.

Analysts said that asset purchases by the Fed would lead to a higher inflation rate and a positive return on the bonds.

The $10 billion auction of the five-year bonds sold at a negative yield of 0.550 percent, according to the Treasury Department. The results of the auction of the securities, known as TIPS, came as indexes on Wall Street edged higher, buoyed by recent strong corporate earnings and a rise in housing sales. The previous lowest yield for the TIPS was in the auction on April 26, when the yield was 0.550 percent.

Treasury Sells Bonds With a Negative Yield - NYTimes.com

Worried about the Economy? Buy Stocks.

Yesterday's New York Times business section had a good piece summarizing the case for buying common stocks.

The economy, as we all know, is not particularly robust. The worse the situation appears, the more likely that another dose of aggressive intervention by the government. A number of Fed officials have signaled over the past several weeks that QE2 is likely to occur next month in an effort to stimulate the economy.

If the Fed floods the capital markets with more liquidity, it seems pretty likely that a good chunk of this stimulus will wind up in the stock market, boosting stock prices as we head into year-end.

So we are in this somewhat perverse environment: The worse the economic situation appears, the more likely the Fed will intervene aggressively, and stocks could rally.

And then, if the stimulus works, the Fed will begin to withdraw its support, and probably try to raise short term interest rates. This would be likely to hurt stocks.

So if you're worried about the economy, and you're an investor, there seems to be only one course of action (for at least the next few months): Buy Stocks.

Here's an excerpt from the article:

So the Fed appears to be gearing up for further unconventional action — the launching of a second round of “quantitative easing,” or QE2, as it’s being called.

While the details aren’t clear — they are expected to entail the purchase of more Treasury securities, and the expansion of available credit in the financial system — the general outline of Fed policy has seemed evident to market strategists for weeks.

“The Fed is easing,” says Ralph Acampora, a veteran market analyst and a partner at Altaira Wealth Management. “When that happens, stocks tend to rise. That’s got to count as good news.”

Mr. Ritholtz puts it this way: “When the Fed opens its fire hose, you’re going to get wet. If you’re smart, you get ready for it.”

Expected Fed Policy Gives Some Solace to Investors - NYTimes.com

QPRTs in Estate Planning

Yesterday's New York Times had a special section called "Wealth" focusing on financial planning and management.

One of the articles - written by Deborah Jacobs, author of very useful Estate Planning Smarts - had several good tips, I thought, about how to effectively pass your primary home to your heirs.

First, a general comment about the section. Most of the articles dealt not with "get rich quickly" thoughts that seemed to dominate the financial press a few years ago. This reflects the mood of most clients I speak to these days: wealth preservation, and not outliving your savings, is the #1 topic.

QPRT's are a popular way to leave one's primary residence to your heirs. Here's what the article had to say:

CREATE A QPRT With the Qualified Personal Residence Trust, known as a QPRT (pronounced CUE-pert), you put your primary residence or vacation home into an irrevocable trust, retaining the right to live there rent-free for a specified number of years. During that period, the trust, of which you could be trustee, owns the property. If you survive the preset period — a condition for this technique to work— ownership can then pass to the beneficiaries, usually children, or go into another trust, often called a dropdown trust, for the rest of your life (you would then need to pay rent if you want to live there).

The taxable gift with a QPRT reflects the value of the right to acquire the personal residence a certain number of years from when it is set up, discounted by the probability that the person setting up the trust will live that long. Figuring the discount involves a complex actuarial calculation based on the Section 7520 rate set each month by the Internal Revenue Service. The higher the rate and the longer the term, the bigger the discount and the more savings associated with the QPRT, said Mr. Katzenstein, whose Tiger Tables Actuarial Software (www.tigertables.com) does such computations.

Leave the Children the House, Without a Big Tax Bill - NYTimes.com

The first paragraph from the article brings up a point that a lot of people don't think about when they set up a QPRT. Namely, once the preset period ends, you have to pay market rents in order to continue to live in your own house.

I have couple of savvy (and very healthy) clients who set up QPRTs years ago whose preset terms have ended. They are now trying to figure out the best way to pay market rents to their children, or else face the loss of a very effective estate planning tool.

Their children are uncomfortable with taking money from their parents to live in their own homes, but unless the estate lawyers can come up with some creative techniques my clients will have no choice.

Cut Prices? Advertise More? Companies face a dilemma

I will be out tomorrow at an off site event with my fellow portfolio managers, so I thought I would do a quick post this evening.

I went to hear Alexia Quadrani from JP Morgan today. Alexia follows the advertising and media companies for JPM, and has a pretty good take on the space.

Alexia reported today that the ad market is incredibly strong - probably stronger than it has been in years. It is even picking up in areas which you might not expect, like outdoor advertising.

Why is this happening when the economy is so weak?

This blog post from the New York Times today is a good discussion of what a number of businesses are going through these days. Most are struggling to get "top line" (i.e., sales) growth. So the question becomes: do you advertise more, or just cut prices, to try to boost sales?

Here was the author's take (who happens to own 5 businesses in the Chicago area):

Once we’d done the math, it became obvious that it made the most sense to go after those...customers who had never heard of us. We decided that spending 1 percent more for advertising – including traditional media, social media (it’s not free; you have to pay someone to do it), and Google AdWords — was a better use of our money than cutting prices. That’s because the 50 percent group that has never heard of us is a much bigger target than the other groups and because advertising would also give us a shot at the people who know about us but are going elsewhere and the people who have not been happy with us...

..Every company is different, and every company’s position in the marketplace is different. The bottom line is that playing around with pricing is not always the most effective way to increase the bottom line, even though it may seem the easiest. You’ve got to do the math. Making yourself busier doesn’t necessarily make you more money.


Should I Charge Less or Advertise More? - NYTimes.com

Be Careful What You Wish For: China Raises Interest Rates

For the last few weeks, Congress has been quite vocal about its demands that China allow the value of the yuan to appreciate versus the dollar. So yesterday The Bank of China announced a very small increase in internal interest rates, which presumably would have added at least some value to holding yuan versus the dollar.

So what happens?. Well, in the vein of pure Newtonian physics, for every action there is a reaction, and the markets reacted badly across the world. To name a few effects:

1. Stock markets get slammed across the world, with the U.S. market falling 1.5%;
2. Oil drops by 4%, or the largest decline in 8 months;
3. Gold falls by 2.6%;
4. Brazil announces its second tax on foreign investment in an effort to try to reduce the appreciation of its currency;
5. Japan and Canada, among other nations, express concerns about the currency markets. The Japanese central bank again publicly worries about the strength of the yen.

I could go on, but you get the idea. Markets are never as simple to manipulate as public leaders would like us to believe. Moreover, as nations across the world compete to see who can depreciate their currencies faster to help spur domestic economic growth, the eventual effects may not be what people want.

One of the most interesting points about yesterday's move in China was the fact that only recently Chinese officials had said that they did not see the need to change interest rate policy. In my opinion, the Chinese continue to want to send the message that they do not have to follow the lead of any other countries in determining domestic economic policies (especially the U.S.).

Here's an excerpt from today's Wall Street Journal:

Investors were split on the impact China's move will have on currency diplomacy. Tensions have been building as a result of the money flooding into emerging markets, driving up the currencies of countries such as Brazil and South Korea against the dollar.

Because China effectively pegs the yuan to the dollar, exporters in those countries have been losing competitiveness against China, their chief rival in the global markets. In response, many governments have been pushing back against the tide of money boosting their currencies.

Those issues were front and center Tuesday.

Brazil raised the tax on foreign investment in Brazilian bonds. And in Seoul, the South Korean finance minister said the government was considering reinstating a withholding tax on foreign investors' holdings in some Korean securities.

China Raises Interest Rates - WSJ.com

Beating the Odds in Wealth Preservation

My boss Jay Henderson passed along an interesting article to me last week.

Titled "Creating a Goal Based Wealth Allocation Process", the piece is written by Ashvin Chhabra, Ravindra Koneru and Lex Zaharoff.

The article discusses strategies that advisors can follow in helping their clients achieve their goals. I have posted a link to the complete article below, but I thought I would highlight just a few thoughts.

Long term wealth preservation is harder than it seems. The most interesting paragraph, in my opinion, was about halfway through (I have highlighted a couple of lines, as well as adding a paragraph break):

In researching how wealthy families created their wealth and then how some were able to sustain it while others lost the wealth, we came across the following insight. To create wealth required concentrated risk taking, often magnified through leverage. To sustain it, the better strategy was to diversify and take a diverse portfolio of risks.

This was highlighted through a study of the Forbes 400 ( a list of the wealthiest individuals in the U.S.) over a 23 year period. Of the 400 on the list at the beginning of the 23 year period, only 50 remained on the list. The principal factor in dropping off the list was that they did not change their approach to risk taking and their concentrated wealth did not keep up with increases in the market. The interesting insight from this study was that any of the original 400 who would have sold their concentrated asset at the beginning, paid taxes and simply invested in the S&P 500 index, would still be on the list today.

The authors go on to discuss the steps that wealthy families should consider in their investment strategy.

In their opinion, there are seven factors that should be considered in a successful strategy:

1. Taxes
2. Cash Flows
3. Asset Location
4. Minimum Wealth Level
5. Understanding Multiple Risks
6. Keeping it Simple
7. Factoring in Emotions

In the end, all successful investment strategies should have three broad objectives: Protecting one's minimum wealth level; maximize the probability of maintaining one's standard of living; and provide an opportunity to reach for "aspirational" goals.

I won't go through all the details of the article here, but if you're interested I would suggest either buying the article at the link below or using Google to get the full text.


http://www.iijournals.com/doi/abs/10.3905/jwm.2008.11.3.048

Japan and Aging Populations

Commenting on a several recent articles discussing demographics, and the aging of the population in many countries around the world:

First, on the front page of the New York Times yesterday, there was long article about the long-running economic malaise in Japan. Japan, of course, has been mired in a deflationary, slow growth world for more than 20 years despite massive fiscal and monetary stimulus.

Although I have read and written about Japan frequently over the last few years, what was striking to me was the depressing effect that deflation can have on a society:

But perhaps the most noticeable impact here has been Japan’s crisis of confidence. Just two decades ago, this was a vibrant nation filled with energy and ambition, proud to the point of arrogance and eager to create a new economic order in Asia based on the yen. Today, those high-flying ambitions have been shelved, replaced by weariness and fear of the future, and an almost stifling air of resignation. Japan seems to have pulled into a shell, content to accept its slow fade from the global stage.

http://www.nytimes.com/2010/10/17/world/asia/17japan.html?pagewanted=2&sq=japan&st=cse&scp=2

What the article does not discuss is the decline in birth rate in Japan, which is slowly becoming an important issue not only in that country but globally as well.

There was the piece in the Times's Business Section talking about aging, and how important a role that demographics can have in determining government finances. This paragraph in particular caught my eye (I have added the highlighting):

For the first time in human history, people aged 65 and over are about to outnumber children under 5. In many countries, older people entitled to government-funded pensions, health services and long-term care will soon outnumber the work force whose taxes help finance those benefits. This demographic shift also means that the number of people living with dementia, whose treatment is estimated to cost $604 billion worldwide this year, is expected to more than triple, to 115 million, by 2050, according to a report this year by Alzheimer’s Disease International, a group representing 73 Alzheimer’s associations around the world.

Slipstream - How Aging Populations May Crimp the World’s Finances - NYTimes.com

Besides the effect on government finances, the private sector is obviously affected as well. In particular, many older Americans have viewed their houses as sources of funds if they need money in their later years. However, in the midst of the current housing crunch, a large amount of supply coming from seniors looking to "cash out" could also prolong the decline in housing prices, not to mention the strain it could put on seniors.

So the question for the investor: What should one do to protect your future?

Well, to me at least, common stocks need to play an important role for savers, especially if one has a longer term time horizon. While not screaming "buys" based on current valuations, stocks can offer reasonable returns along with, in many cases, dividend yields that are higher than many higher grade bonds.

But apparently my views are not shared by everyone, according to this morning's Wall Street Journal. Pension funds - pools of cash that should have a very long time horizon, especially given the trend towards longer lives noted in yesterday's Times - are pulling back from stocks:

After making the same kinds of investment blunders as many individuals, corporate pension funds now are seeking the same remedies: fleeing stocks for the perceived safety of bonds.

A growing number of pension managers are concluding their pursuit of maximum returns was a mistake, interviews with managers and consultants show. Instead, many funds are trying to achieve stable returns that more or less keep pace with the plan's obligations.

http://online.wsj.com/article/SB10001424052748704540904575451793471885092.html?mod=WSJ_hpp_LEFTWhatsNewsCollection

This to me makes no sense. There were several reports last week that pension plans in the public sector continue to use return assumptions of around 8% in deciding whether they are actuarially sound. With bonds yielding around 3% (unless you're buying much longer maturities), why does an increased allocation to fixed income make sense for a fund with a longer term time horizon?

Randon Glenings on Other Sites

Susan Weiner (who I have corresponded with on Twitter but never yet met) pointed this piece out today. It comes from a site call Advisortweets.com

ww.advisortweets.com/blog/financial-advisors-tweet-currency-wars-dollar-qe2

Advisors Weigh In On Currency Wars, The Dollar, QE2

The strength of the U.S. dollar, currency wars and quantitative easing (QE and QE2) are topics that have broad appeal to advisors whose tweets appear on AdvisorTweets.com. A search for any of the terms will produce a rich list of content recommendations from several advisors.

Here’s a sampling of recent tweets that advisors have sent with links to content representing their own views:

1. 
   dhglen Random Glenings: Currency wars are necessary if all else fails – Te… http://t.co/VuRE41C 11 Oct 2010 from Tweet Button

— this quote was brought to you by quoteurl

1. 
   dhglen Random Glenings: More On Currency Wars http://t.co/ig7oWnf 13 Oct 2010 from Tweet Button

— this quote was brought to you by quoteurl

1. 
   WadeSlome Dealing Currency Drug to Export Addicts: Quest for devaluation nirvana is a waste. #IMF #QE2 #currency $WMT http://wp.me/pxctV-PL 08 Oct 2010 from WordPress.com

— this quote was brought to you by quoteurl

http://www.advisortweets.com/blog/financial-advisors-tweet-currency-wars-dollar-qe2

Talking Facebook and Business - ‘The Social Network’ Captures the Facebook Obsession - NYTimes.com

My wife, daughter and I went to see the movie "The Social Network" last weekend. It's a pretty good film - I can see why it continues to top the weekly box office figures.

The movie also got me more inspired to experiment more with Facebook (yes, I know there are already more than 500 million people on Facebook, but, hey, better late than never).

In any event, there was a good write-up in this morning's New York Times about the movie. I would agree with the columnist Joe Nocera that one of the real smart moves that Zuckerberg & Co. made was to minimize the advertising on the site in order to make it "cooler". As Mr. Nocera writes:

For me, one of the film’s great scenes comes when Mr. Saverin is trying to persuade Mr. Zuckerberg to accept more advertising for Thefacebook. Mr. Zuckerberg won’t hear of it. “I mean it is time for the Web site to generate revenue,” a frustrated Mr. Saverin says in the film.

“Thefacebook is cool,” responds Mr. Zuckerberg. “If we start installing pop-ups for Mountain Dew, it’s not going to —— ”

The dialogue ends there, but you get the point. Mr. Zuckerberg was exactly right — it was Facebook’s coolness that allowed it to overtake MySpace, which had a huge head start but became less cool with every ad it took. I have no idea if that exchange between the two men took place in real life, but it is one of the truest moments in the movie. By the time Mr. Zuckerberg allowed his once-close friend to be brutally pushed out of Facebook, he had long since outgrown Mr. Saverin as a business strategist. Had Mr. Zuckerberg remained loyal to Mr. Saverin, Facebook would never have become the dominant site it is today.

Talking Business - ‘The Social Network’ Captures the Facebook Obsession - NYTimes.com

The interesting part of all of this from an investor's point of view is that many of the companies dominating social media today are privately held: Facebook; Twitter; LinkedIn; Zinga; and Craigslist, to name a few. One of the analysts that I heard recently said that while many of these companies will eventually go public or be bought, there are too many advantages to being private and not answer to shareholders to the sites followers. In fact, this analyst said that if Google hadn't needed to monetize some of its stock to pay back some of their investors that they too would have preferred to remain private.

In short, while no one denies the incredible growth of the internet space, it's hard to find ways to invest in it.

A comic interlude: My kids have always been worried that I would jump on Facebook, so perhaps this video would have some relevance to their concerns:

Google Tolls the Bell

Normally I don't comment on quarterly earnings, particularly for a company like Google, which professes to not try to manage quarterly earnings reports.

But in this case I want to make an exception.

Google's earnings numbers last night were astonishing, especially in a weak economy. True, some analysts will question the rapid rise in Google's costs (they have been hiring like crazy, adding more than 1,500 people last quarter to bring their total employment to over 23,000), or whether Google TV is a good idea or not.

But what really caught my eye was the amount of money the company now generates from their advertising, as well as their new Android phone (I have added the highlights in this excerpt from the New York Times):

Search advertising revenue still drove Google’s better-than-expected performance in the third quarter, when revenue climbed 23 percent and net income rose 32 percent. But for the first time Google said on a call with analysts, display ads — nontext ads with images and video on YouTube and other Web sites — are on track to generate more than $2.5 billion in revenue in the coming year, while mobile ads are on track to contribute another $1 billion.

“Where’s the next multibillion-dollar business after search?” said Jonathan Rosenberg, senior vice president of product management at Google, on the call. “There’s your answer. It’s display and it’s already here.” About mobile, he said, “Clearly this is the future of search and the Internet.”

I have attended a number of analyst meetings recently on technology companies, as well attending a presentation by a senior advertising executive from the ad agency Hill Holiday yesterday. While I knew that the pace of change in the digital age has been fast, I continue to be amazed at the pace of change.

First to the presentation yesterday. Stacey Shepatin has been involved in media buying for clients like John Hancock and Dunkin' Donuts (the official coffee of Random Glenings, by the way). Ms. Shepatin has been employed in the advertising business for 13 years, and her knowledge and presentation skills were impressive.

The most effective way to advertise a product, according to Ms. Shepatin, remains television. Americans are watching more TV than ever, especially live sports, and companies that want to build brand awareness need to invest in this space.

The second most important advertising venue was the digital space, i.e. the internet. Advertisers can get more "bang for their buck" on the web than they can on the traditional media outlets, like newspapers, magazines, radio and billboards.

This is of course an enormous change from a few years ago, but it also explains why traditional media companies are gradually dying. It also explains why Google is doing so well.

Google has more competition than you might think, by the way. One of the most surprising competitors (at least to me) was Facebook.

Justin Post at Merrill Lynch follows the internet space. When I saw him the other day, he pointed out that 14% of the internet traffic in the United States is spent on Facebook. Not only are people connecting on Facebook, they are also playing games on the site, which is how they wind up spending so much time on Facebook.

Facebook continues to expand, and are now a serious threat to overtake Yahoo in terms of email traffic. The next step for Facebook? According to Mr. Post, it might very well be search, which of course is Google's "bread and butter".

That's way some estimate that Facebook is worth $35 billion, even though the company is still a privately-held corporation.

For investors, all of this presents both challenges and opportunities. It seems almost indisputable that the internet space is one the fastest growing segments of our economy, but it is also not clear who the eventual winners will be.

Will it be device makers like Apple, which continues to amaze with its suite of products?

Or what about Amazon, which could eventually take its digital reader Kindle and turn it into a more direct competitor to the iPad?

Or what about the "old" technology companies like Oracle, IBM or Microsoft - their hardware and software products still are run by the majority of people in both home and business, yet the valuation of their stocks are very cheap; are they a buy?

And then there's this: At some point in the next couple of years, some of the most important digital companies that are now privately held will be coming public: Facebook; LinkedIn; Twitter; Zinga; etc. When these companies go public, will investors move dollars currently invested in names like Google and Apple into the newer offerings? What will this mean for their stock prices?

Lot's to think about on rainy Friday morning here in Boston.



Google’s Income Rises 32%, Topping Forecast - NYTimes.com

Institutional Client Third Quarter 2010 Letter

Usually at the end of each quarter I write a couple of client letters: one for my individual clients, and the other for my institutional investors. This is what I sent my institutional clients this quarter:

Although September is typically one of the weakest for stock market performance, this year was different: The S&P 500 produced a total return of almost +9% last month. September’s strong showing pulled year-to-date stock returns back into the green, with the 9 month return of the S&P now at +2.3%.

Several things have been striking about the positive performance of stocks recently.

First, while the stock market has moved sharply higher, much of the recent economic data tells a story of an economy struggling to regain some the momentum started in the spring.

Unemployment rates in particular continue to run at very high levels, contributing to the general malaise that seems to have settled throughout much of the country. While stock market performance and economic reality have often diverged in the past, the most recent dichotomy seems particularly noteworthy.

A second striking characteristic of the recent market rally is the high correlation of stock price movements across both industries and sectors. Normally there are areas of strong leadership, while others will lag.

However, in the most recent market action, the market leaders have been the highest beta names (when the market is rising) or the lowest beta stocks (when the market is falling), regardless of sector. This type of market action makes it difficult for stock pickers to practice their craft with any real degree of success.

There has also been a noticeable lack of trading volume in recent market activity. Part of this may stem from the lack of any discernable differences in market action, but it could also reflect a general cautious attitude among the investment community.

Moreover, much of the stock market activity seems to be centered in a relatively small handful of stocks. For example, in the month of August nearly 10% of the trading volume in the stock market was centered on one exchange-traded fund (ETF) that represents the S&P 500. Moreover, 90% of the volume that month was centered on just 112 of the more than 10,500 listed shares.

What seems to be happening, in our opinion, is that much of the rise in stock prices (as well as commodities and bonds, for that matter) reflects a combination of the massive liquidity that the Federal Reserve continues to add to the capital markets as well as the historically low level of interest rates that currently prevails.

While there is no denying that much of the earnings news from Corporate America has been reasonably positive, it seems more plausible that stocks are rising mostly because the other investment alternatives (especially bonds) seems to offer only modest longer-term return potential.

With all of this as a backdrop – mixed economic fundamentals but strong Fed-provided liquidity tailwinds – we start the fourth quarter modestly optimistic for stocks. Stocks continue to offer the best alternative for investors with a longer term time horizon, particularly in those areas which offer an attractive combination of reasonable valuations and often attractive dividend yields. In short, as the old adage goes: “Don’t Fight the Fed”.

More On Currency Wars

More on the ongoing currency wars, this time from the FT's Martin Wolf.

Last week I posted a note that cited the German magazine Der Spiegel. Seen from the German point of view, the American demands for the Chinese to allow the markets to set the appropriate rate for the Chinese yuan seems hypocritical, given our benign neglect of the dollar as a way to boost our economy.

Here was the quote from the article posted on October 6:

There is, however, also a fair amount of hypocrisy behind the latest American initiative. Nobody has controlled the currency markets as much as the US has in the past. The US Federal Reserve still continues to print dollars to finance skyrocketing government debt. The fact that this erodes the value of the US currency is something that the Americans seem not to care about. Of course, this makes imports into the US more expensive, but it also makes American exports cheaper and enhances the competitiveness of US companies.

In yesterday's FT, Mr. Wolf notes that in a currency war the U.S. is sure to win, at least in the short term, since we control the world's reserve currency:

Above all, today’s low and falling inflation is potentially calamitous. At worst, the economy might succumb to debt-deflation. US yields and inflation are already following the path of Japan’s in the 1990s (see chart). The Fed wants to stop this trend. That is why another round of quantitative easing seems imminent.

To put it crudely, the US wants to inflate the rest of the world, while the latter is trying to deflate the US. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world.

FT.com / Columnists / Martin Wolf - Why America is going to win the global currency battle

In my opinion, however, I am still not convinced that merely depreciating the dollar will solve all of our ills. On the other hand, there seems little doubt that trade wars waged by currencies can turn into mutually assured destruction.

Finally, I would note the following news item today, which underscores the urgent need that most of the world feels to do something about the huge trade imbalances (from today's New York Times):

SHANGHAI — China said Wednesday that its exports continued to surge in September and that the nation’s foreign exchange reserves ballooned last month, data that is likely to keep pressure on Beijing to appreciate its currency.

The government said its monthly trade surplus reached $16.9 billion in September, with exports up 25 percent and imports climbing 24 percent.

The surplus narrowed from August, when it had reached $20 billion, but it was still an enormous figure, analysts said.

Also Wednesday, Beijing said its foreign exchange reserves soared $194 billion in September to a record $2.65 trillion, far more than economists had forecast. China already had, by far, the world’s largest currency reserve holdings.

http://www.nytimes.com/2010/10/14/business/global/14yuan.html?_r=1&hpw

All Together Now

I've written several times recently about the high correlation of stock price movements across all industries and sectors. According to Ned Davis Research, correlations now stand at 50-year highs.

As it turns out, correlations are also at historic highs across different asset classes. Commodity price movements (including gold) are tracking quite closely to price changes in stocks and bonds.

This presents a challenge to investors. The reason for diversification - the hallmark of portfolio management - is that non-correlated asset movements reduce overall portfolio volatility. If all prices are moving in tandem, however, diversification as a risk reduction tool is less effective.

There is the additional question was to why correlations are so high right now. Much of the answer seems to be centered on the efforts of many of the world's central banks to either stimulate their economy, or weaken their currency (to try to make exports more attractive), by intervening in the capital markets.

In the U.S., for example, bond prices have soared in recent weeks in anticipation of another round of quantitative easing by the Fed. The 10 year Treasury note, for example, is trading at 2.37% this morning, down nearly 70 basis points since the end of July.

This week's Buttonwood column in the Economist has a somber discussion of the highly correlated markets:

...Dhaval Joshi of RAB Capital, a fund-management group, says that there have only been four other quarters since 1980 when gold, equities and Treasury bonds have strengthened simultaneously.

... it is doubtful whether the simultaneous strength of gold, equities and bonds can last much longer. Mr Joshi says the four previous periods of triple strength since 1980 were all followed by falls in Treasury-bond prices.

Nor are rising gold and equity prices necessarily compatible. David Ranson of Wainwright Economics has looked at the relationship between gold and stockmarkets since 1824. Some might think that shares, thanks to their links with the real economy, would do well in inflationary times. But that is not what the data show.

When gold was up by more than 20% over a five-year period, the median return from large-cap American stocks in the same era was just 2.1%. And when gold fell by more than 20%, the median large-cap return was 99%.

Buttonwood: The magic bullet | The Economist

For now, the market remain well-bid. Investors are shrugging off poor economic or company-specific news, and adding to portfolios. However, if all of the buying is solely in anticipation of the Fed, this could turn out to be a false dawn.