Tuesday, June 29, 2010

The Strength of Our Economy Now...

...is not looking good. It's palpable to many, and all too real to still many more. But the numbers are showing it also.

We're not in a recession, if you go by the book, as we've had two straight quarters of positive GDP growth. But I think there's more to it.

For one thing, the U.S. stock markets are showing the signs we don't want to see. The up days are not happening on high trading volume, and the down days are happening on higher volume. This indicates weakness.

For another, the jobs reports are bearing bad news. Most of the new jobs are from temporary government stimulus, or from very temporary Census-related hiring.

And another example is the terrible housing data we just got. Real estate is about location, location, location, but, overall, the U.S. housing market is not going the right direction. Might even be going the wrong direction.

Here's the last of the big warning signs I'm tuned-in to at the moment: the TED Spread is starting to widen. That's the difference between the LIBOR and short-term Treasuries. An increasing TED Spread often comes before a downturn in the U.S. economy, as it indicates liquidity is being withdrawn (investors are getting a better deal in Europe than the USA).

Now, here are some positive indicators and factors:
1) U.S. corporate profits are improving, and not just on the bottom-line (which can be affected by cost-cutting) but also on the top-line (sales).
2) There are trillions of dollars on the sidelines now, sitting in cash, belonging to both consumers/investors and businesses. If things do turn around, the stock market could actually boom.
3) Europe is starting to shift from stimulus spending to "austerity" measures, and while the USA isn't exactly jumping the gun on that matter, the stimulus-oriented Democrats are not as politically strong as they were a year, or even six months, ago, and so the USA might try another tack sooner than expected.

Advice: bond funds over bonds, short- and intermediate-term bonds over long-term bonds; high-quality stocks over speculative stocks; global/flexible mutual funds over "style-pure" mutual funds; and, by all means, get rid of credit card debt and/or build-up an emergency reserves fund in a cash acct or a very low-volatility and readily-liquid ETF or mutual fund.

Monday, June 21, 2010

Insurance: How Much Do You Need?

Make sure you have enough life insurance, everyone. $1mm of investible assets for every $50k you need to spend each year. If you need $50k per year of spending money to replace your wife's income if she dies (to be expected if she makes a salary of, say, $75k), you need $1mm nest egg. If you have $200k in your portfolio and savings plus her retirement plan, then you need $800k of life insurance coverage on your wife. Make sure you or your Trust is the beneficiary.

Also, makes sure you have Long-term Disability Insurance, and pay the premium yourself, even if your employer offers to pay it for you as a fringe benefit. Paying it yourself allows you to get the income tax-free; if your employer pays the premium, you will have to pay income taxes on your benefit.

Waste no time with this. Too many people need insurance before they get the right amount.

More On Interest Rates and Bond Investing

I'm preparing for rising rates. While I don't expect the Fed to raise 'em this year, or even in 2011, it is bound to happen some day. Rates are as low as they can go (the Fed Funds Rate is now 0-.25%).

There is also the market-forces factor. If the USA keeps needing to borrow money, our national credit rating could be at risk and that, along with the flood of additional bond issues to the global markets, could naturally force rates up, regardless of the Fed's action.

Well-managed bond "ladders" and bond mutual funds can mitigate the "interest rate risk" of owning bonds. Remember, bonds are usually less risky than stocks and are used for the more conservative and/or the income-oriented portion of an investor's portfolio. But rising rates hurt the market value of bonds, so portfolio values can decline when rates rise.

There are many ways to address these scenarios, and I have my ducks in a row. If we hit rough weather in the bond markets, we know where the lifejackets and life boats are, and how to use them.

Saturday, June 19, 2010

Interest Rates and Bond Risk

The Federal Reserve is tasked with two primary objectives: maintain price stability, and maintain high employment.

Maintaining price stability means, simply, keeping inflation pretty low without pushing us into deflation.

Maintaining high employment... well, that means keeping unemployment low (not sure how else to explain that obvious objective).

In both cases, the most effective tool at the Fed's hand is raising or lowering the interest rates. Lower rates stimulate the economy because it makes it easier/more affordable for people and businesses to borrow money. Raising rates tames inflation by slowing down the economy.

But interest rates affect the value of bonds. Bonds, as I've posted here before, are thought to be the "safe" place to invest, but they do fluctuate in value. Rising interest rates force bond prices lower; falling rates lift bond prices.

Most folks buy bonds in order to get predictable income streams, not capital gains. Hold a bond to maturity, in fact, and you get your original money back. Your benefit was the income the bond paid while you owned it.

So, if interest rates are so low, aren't bonds scary now--won't they be likely to go down in value? Yes. If and when the Fed starts raising interest rates.

But that should only happen when the economy starts growing too fast again. We're just hoping it's really even starting to grow now. Some experts think it won't be for another year or two that the Fed will start raising rates.

So, this is potentially good for bond investors who need income or who seek relative safety compared to the volatile stock market. Alas, other forces could work against interest rate stability. If the USA's spending remains in deep deficit mode, we might need to offer higher rates on our more risky Treasury bonds when we sell more to fund our ongoing deficits.

The key is to know what you have and to have an exit plan. Most individuals should not tinker with individual bonds right now. It would be better to have a private portfolio manager run things, or to use a reputable and successful bond mutual fund.

Saturday, June 12, 2010

What To Do With Your Old 401(k)?

Do not roll it over into the 401(k) of your new employer. That's usually the best advice for the vast majority of people. Unless...

...you want your heirs to have worse tax treatment after you die

...or you prefer to have a very limited selection of investments available

...or you want no financial advisor to help you

...or, if you're a do-it-yourselfer, you'd rather have mediocre customer service instead of the excellent service provided by Schwab, Fidelity, TD Ameritrade, etc.

If it's somehow all about low-cost, the 401(k) might make sense. Except using exchange-traded funds at Fidelity or Schwab almost certainly eclipses that in terms of cost-savings, and it absolutely eclipses your 401(k) in terms of investment selection, even if you are limited to just some ETFs.

Now, if you think you'll ever need to borrow against your retirement plan assets, then DO combine your old 401(k) plans into your current one. But then take a serious look at your budget and figure out why you needed to borrow from your 401(k) in the first place. This is a huge red flag. Try not to go there.

Friday, June 11, 2010

Imports, Exports and Empties: Positive Economic Signals

Good economic news!

Six straight months of increasing port activity in Long Beach (the huge port near Los Angeles). Imports up 27%, exports up 15%, "empties" up up 35%. Empties are ships going back over to Asia to bring more stuff back here. This doesn't mean we're out of the woods, but it's a positive sign.

Thursday, June 10, 2010

Terminology To Offend Or Titilate

"Dead Cat Bounce"

"Sucker's Rally"

"Bull Trap"

These terms all apply to market upswings that have little or no fundamental economic or financial support. The stock market moves on valuation and sentiment, and sometimes one weighs more heavily than the other, sometimes at the wrong time.

Cat fans don't like the imagery of the first term, and most folks don't like to be thought of as fools, and investors who play to win hate to be caught on the losing end. But a ton of investors have bought in during a Dead Cat Bounce, a Sucker's Rally, or a Bull Trap. Especially in recent years.

Make long-term investments with money you can afford to go without for many years, and buy shares of companies you think are solid financially and will either share their profits, grow their business, or both.

Make short-term trades with money you can afford to lose forever. Buy shares of stocks you think will go up. Period. And try to avoid buying during an uptick that turns out to be a Dead Cat Bounce.

Tuesday, June 8, 2010

Predicting Economic Crisis: "What" Is Easy, "When" Is the Trick

Here is outstandingly keen insight from economist Professor Ken Rogoff, from an interview by Ezra Klein:

Start with a really important point: It’s very hard to call the timing of a crisis. You can see that an economy is vulnerable, and maybe even fairly reliably say you’ll have a crisis in 5 to10 years, but until it’s upon you, it’s hard to narrow the window down with any precision. Many of the people who say they predicted the crisis in a precise way had actually been predicting a crisis for years. There’s irreducible uncertainty coming from fragile confidence and political factors. The analogy is someone who’s vulnerable to a heart attack. You can go to the doctor and they can see your cholesterol is high and you have a number of risk factors, but you might go on for 20 years without anything happening. Or it might be 20 hours.

Because the timing is hard to call, policymakers have trouble getting seized by it. Why worry if it is not going to hit on my watch? And if you’re an investor and you’re making great money for five more years and then you have a bad year, you still have a good decade. But policymakers, especially, need to have a longer vision because of the human cost of financial crises, particularly in the hugely elevated level of long-term unemployment.

Sunday, June 6, 2010

Jobs vs. Unemployment

The latest jobs numbers are in and the USA gained over 400,000 in May. But only about 40,000 were from the private sector, as hundreds of thousands of temporary workers are being hired by the government to conduct the Census.

The USA's economy needs around 150,000 new jobs a month just to keep the unemployment rate from going up.

If we're looking to cut the unemployment rate from around 10% to a more desirable 5%, we need a lot more than 40,000 private sector jobs each month.

Friday, June 4, 2010

The "Death Tax"

Americans who die in 2010 will pay no federal tax on their estate, thanks to the "sunset provision" of the "Bush Tax Cuts". For 2009, any amount over $3.5 million was taxed at over 40%. Prior to that, the threshold was even lower and the rate was even higher.

But starting in 2011, the federal estate tax (aka the "Death Tax", to those who lament the matter) returns--any amount of one's estate over $1 million will be taxed at 55%, unless the law is changed by Congress and signed by the president.

So, the heirs of someone with a net worth of $3 million will have to come up with $1.1mm cash to pay the federal government. That, after the "benefactor" has paid a lifetime of income, capital gains, dividend and interest taxes while building-up the $3mm net worth; and we should remember that the companies that paid-out the dividends did so after being taxed on their earnings already.

Food for thought.

Thursday, June 3, 2010

The "real" Price of Gold?

Gold may have a lot of upside price potential, even with the major run-up it's had in recent years. It is about 30% below its all-time high price, if you adjust for inflation, and demand is likely to increase. A lot.

Gold prices historically have risen in times of fear and of inflation. And then there is good-old supply-and-demand.

There is already fear. The world's major economies are struggling, obviously.

There could well be inflation. The loose fiscal and monetary policies governments are using to fight-off recession and depression usually result in inflation.

And then there are China and Japan... China has just 1.6% of its currency reserves in gold, and Japan just 2.5%. The USA has 70% and Germany, another major developed economy, has 66%. In a world where the value of currencies is dubious at best right now, gold is probably going to be coveted.

What could this mean? Well, if China and Japan were to increase gold reserves to just 10% (nowhere near the 70% of the USA), the increase in demand for gold would be 3.5 times annual mine production. That would drive prices up, both for the gold itself and, presumably, for the stocks of gold mining companies.