Fed To End Quantitivate Easing

Probably the biggest thing the U.S. government has been doing to stimulate our economy in the wake of the 2008 financial crisis and recession has been something called "quantitative easing".  It is pretty much the practice of the Fed buying bonds from the Treasury to stimulate the economy.

Those bonds are sold to give our government more operating cash, to either pay bills coming due or spend the money on necessary services and/or projects that our leaders believe will be stimulative to the economy.  Sometimes, like I understand is the case now, the Federal Reserve actually prints new paper money with which to make the purchases.  The risk is inflation in the future, but such risk is taken with the intention that the short-term stimulus effects are worth the risk.

Now the economy is growing.  Slowly and not necessarily surely, but measurably and postively.  The Fed is thus in the middle of tapering the Quantitative Easing, creating a glidepath to ending QE (it had been buying $85 billion worth of bonds every month).

But last week one normally hawkish Fed big shot was surprisingly outspoken--and dovish.  He said the Fed would not necessarily end QE as planned, impying that the Fed would help the securities markets if need be (we were in a market decline last week, and he is thought to have been speaking to that matter with intent of reassuring investors)...  Word is, though, that most of his peers (including those with a vote on the matter, which I believe this one fellow does not have) intend to end QE for sure.

In short, the nFed is said to be on track to end QE, even if one of its members may have spoken his opion of what should be done instead of saying what the Fed will do.

Bill O'Grady (not Bill Gross--I cite each pretty often and want to be clear:  O'Grady is the global investment strategist/thinker, Gross is the manager of bond portfolios and mutual funds) writes today about this.  See the second and third paragraphs in the item linked here:  http://confluenceinvestment.com/assets/docs/2014/daily_Oct_20_2014.pdf

Okay, I wanted you to know the basics in case it is not clear.  I hope it helps.  Please contact me with any questions.  Thank you.

--Gary

Gary Partoyan

Potomac Wealth Strategies, LLC

(703) 746-8195 direct

Visit us online for helpful ideas and information!

Small Business is the Heart of the American Economy

The Small Business Administration (SBA) cites 10 reasons why small businesses are "the heart of the
American economy."

1. Small businesses make up more than 99.7% of all employers.
2. Small businesses create more than 50% of the nonfarm private gross domestic
product (GDP).
3. Small patenting firms produce 13 to 14 times more patents per employee than
large patenting firms.
4. The 22.9 million small businesses in the United States are located in virtually
every neighborhood.
5. Small businesses employ about 50% of all private sector workers.
6. Home-based businesses account for 53% of all small businesses.
7. Small businesses make up 97% of exporters and produce 29% of all export value.
8. Small businesses with employees start-up at a rate of over 500,000 per year.
9. Four years after start-up, half of all small businesses with employees remain open.
10. Small businesses create 75% of the net new jobs in our economy.

Bill Gross' Lets It All Hang Out--Radical Change of Approach Needed for USA

If you can get over the initial intellectual/emotional hurdle presented by this article--that college is, for many if not most, as it is currently working, not exactly part of the solution to our economic woes--you'll find a lot to chew on here.

Bill Gross is arguably the greatest money manager in modern history (he's "the bond king" and "the Warren Buffett of bonds"--and his PIMCO Total Return fund is the largest mutual fund on the planet and owns a tremendous market-beating track-record), and he has a global perspective that is almost uniquely astute and often pretty unconventional.  And he calls it like he sees it, whatever "it" is...

In short, he sees no way for private-sector market-based idealism--OR government-as-usual--to dig us out of this hole any time soon.  Time to think radically, perhaps.

We have created less than two-million jobs while the workforce has expanded by 15 million people in the past decade.  And while he doesn't say it here, there's a strong argument to be made that the 20mm+ jobs created in the previous decade were largely thanks to a largely false (over-leveraged, service-based instead of asset/manufacturing-based) economy...  think of the causes of the economic disaster that started in late-2007 and persists today.

Balancing the budget and re-jiggering the cost-curve of entitlements and healthcare programs are of course necessary, Gross says or implies, but will not be enough to close this employment gap, and neither will the education provided by Today's version of undergraduate college education.

Call to action, or crazy billionaire screaming?  Either way, I'm listening.

How To Prepare For the Storm We Hope Won't Hit Us

With a new round of "quantitative easing" (printing new money so the Federal Reserve Bank can buy US Treasury Bonds that investors and China don't want to buy at such low interest rates) threatening to cause potentially crushing inflation, albeit while it is intended to fight-off looming near-term DEflation, Americans and others around the world are afraid.

Rightly so, as this could get ugly. It's a big storm brewing, but we don't know if it will hit us or pass us by. For those who want to prepare for it hitting us, here are some action items I recommend:

1) Make sure you have life and disability insurance enough to pay the bills for the family if you die or can't earn your living any more.

2) Pay-down or pay-off any credit cards and personal loans, including 2nd mortgages and HELOCs.

3) If you accomplish #2 above, then build-up cash reserves, preferably a year's worth of necessary family living expenses (food, shelter, transportation, health insurance and medicine, but no need to budget, in this case, for vacations and clothes and spa treatments).

4) If you have investments, diversify globally; 50% of your stocks/stock-mutual-funds should be investing in foreign developed and emerging markets, and same with your bonds/bond-mutual-funds.

5) To make #4 really work, do not use index funds or even traditional style-pure mutual funds; find global and flexible mutual funds with consistent management and outstanding long-term track records--the best among them were down only 25% or less during the 2008 40% market crash, and many were actually UP during the early-2009 market crash, and they have kept-up pretty well during the post-March 2009 market rally; these funds also often invest in currencies and commodities better than most of us ever could.

6) Be prepared to do radical things, like the adult children moving home, or the elderly grandparents moving-in.

7) Stay optimistic. There are some good signs. Ford Motor Company has made an astonishing turn-around, so other manufacturers can also.

8) Take prudent advantage of current low interest rates--re-finance your house and investment properties, buy that new car if you need to, consolidate debt you can't pay-off.

9) Make sure you have that cushion described in #2 and #3 above.

Helpful?

Re-Fi Updates

Progress. The lending industry is still a shambles, but it is at least opening up a bit.

One client owns an investment condo and wants to re-finance into a shorter-term and a fixed interest rate, even though it would cost him more money each month (giving up some cash flow to obtain more stability). The condo is worth twice what he owes on it, and it's more than paying for itself for many years now as an investment property. Still, earlier this year, he was just-plain rejected... "We don't do investment condo re-fi right now. Sorry."

Last week, though, the same person got some traction. "We can do that. The rate for investment properties is a lot higher than if you lived in the condo, and we can't let you take any cash out. But we can definitely re-finance it for you if you like the numbers we offer."

Not great, but progress, and I am trying to monitor the key economic signs for us.

New Normal, No Normal, or Old Cyclical?

What sort of economy is the USA and the rest of the developed-economy world facing now and for the next number of years?

Bill Gross and Jeffrey Gundlach, two of the best bond fund managers on the planet, are the proponents of "new normal" and "no normal" theories, respectively, of the near- and intermediate-term economic outlook for the USA.

New Normal, by Gross and his team, is about persistent low-growth economics coupled with high unemployment over the next half-decade or so. Not another collapse, but hardly much of a recovery situation. Here in the developed world, that is. Opportunities abound eleswhere.

No Normal, espoused by Gundlach, is more about there being so much uncertainty that we can't be sure what will happen. Inflation or deflation? Recovery or double-dip, and with old jobs returning or there being a need for brand-new jobs?

Former economic advisor to president Obama, Christina Romer, thinks we are in the "old cyclical", not a new/no normal environment. She seems to think this is similar to what's happened in the past. Maybe so, but I think Gundlach and Gross have a better feel for what is actually going on in the real economy.

Politicians and ivory tower-dwellers are not to be ignored, but when there is a difference of opinion this significant, the investment experts with awesome track records, like Gross and Gundlach, probably are more worthy of our attention.

Ten Reasons to Be Optimistic

Jim Cramer is the enigmatic on-air and online investment "guru" whose specific advice I generally avoid but whose ability to see from a distance trends in the economy is often quite impressive.

He recently he spoke of 10 reasons why we can afford to be optimistic. Here they are:

1. The euro is higher against the dollar. European debt is now off the table and fears of a high dollar are not abating.

2. Back-to-school sales beat estimates.

3. Unemployment is "on a gentle slope downward."

4. The commercial property market is showing an "unexpected firmness."

5. Copper, oil and the Baltic Dry Index are at high levels.

6. Auto sales have been strong.

7. Mortgage applications have been up 9% this week.

8. Obama has a better relationship with the business world.

9. Big-Cap tech, like Cisco (CSCO), Intel (INTC), Oracle (ORCL), IBM (IBM) are showing unexpected strength.

10. The S&P 500 chart is in a reverse head and shoulders pattern, signaling a bottom.

#5 is the most interesting and appealing to me. Copper and the Baltic Dry Index, especially.

I am pessimistic about the U.S. economy, but I am bottom-up bullish on the stock markets. There is always a chance to get in early and make long-term money, even in bad markets. If Jim Cramer thinks the U.S. market is looking like a good bet, so much the better.

Tax Cuts: Do They Pay For Themselves?

Maybe, maybe not. This is a tough question to answer definitively, and the subject almost always gets political, and I prefer to keep this blog about sound ideas and facts instead of political stances.

Okay, with the American business sector acting as if it's on "hold" until government policy changes (taxes, regulation, etc.) are clear or in effect, we wait and debate. One huge debate is whether Congress should allow the "Bush Tax Cuts" of 2001 and 2003 to expire as scheduled, or if we should raise some rates and not the others or maintain status quo.

It is widely held, by those who believe cuts in marginal income tax rates will stimulate the economy and thus actually increase tax revenues, that there's a lag-effect for the stimulative results to appear. Some of the most ferocious debating and punditry right now is whether such tax cuts really do lead to higher, not lower, federal revenues.

With that in mind, here is some data right from the CBO and OMB:

US Budget Receipts (just from individual income taxes)
2000 was $1,004 billion
2001 was $994 billion, down 1.0%
2002 was $858 billion, down 13.7%
2003 was $794 billion, down 7.5%
2004 was $809 billion, up 1.9%
2005 was $927 billion, up 14.6%
2006 was $1,043 billion, up 12.5%
2007 was $1,163 billion, up 11.5%
2008 was $1,219 billion, up 4.8%

Tax cuts were approved in '01 and '03, so their effects likely started being felt in '02 and '04.

Federal receipts from income taxes grew a lot each year starting in 2004, while the economy did not grow at the same rate. Way too many variables would factor in here for the results to be conclusive, but the income tax cuts do correspond to increased revenue to the government.

(Here's the US GDP data for the same time-frame)
2000 was $9.76 trillion
2001 was $10.1 trillion, up 3.5%
2002 was $10.4 trillion, up 3.0%
2003 was $10.9 trillion, up 4.8%
2004 was $11.6 trillion, up 6.4%
2005 was $12.4 trillion, up 6.8%
2006 was $13.1 trillion, up 5.6%
2007 was $13.7 trillion, up 4.5%
2008 was $14.6 trillion, up 6.6%

Troubling Signs: The No-Go Re-Fi

More signs pointing to economic trouble ahead... A client was rejected, flat-out, this week in two attempts to re-finance the mortgage on an investment property. Surprised? No. But this is not good news.

In short, the condo he bought as a bachelor is now an investment property he rents-out. It pays for itself, and then some, from rental income. It is also worth about twice what he owes on it. His credit rating is top-shelf, and his wife's is even better. They make enough money to do all the things they do, and they carry no debts other than their mortgages.

Nonetheless, he was rejected. The superstar mortgage broker he went to, who is one of the best salesmen you'll meet and a great guy, looked at his situation and said, "no dice." Then he went to Morgan Stanley Credit Corp, where the mortgage is right now. No dice--"we don't do any investment condos right now".

Folks, under Bush, and now Obama, Bernanke's Fed and Paulson's/Geithner's Treasury have flooded our economy with liquidity to get it going again. It comes in the form of actual money being sent out of government coffers, in the form of absolute rock-bottom interest rates, and in the form of regulatory adjustments. The intention is to spur the economy in the right direction.

It may well have prevented a Great Depression II so far, but it's not working beyond that. If this guy's own lender won't let him re-fi a loan that has a spotless record when he's in better financial condition than at the outset of the loan years ago, and when--get this--he was basically offering to pay them MORE money, something is not working. That's right, he wants to re-fi out of a 30-year loan and into a 15- or 20-year loan that would give them a higher interest payment from him each month. Since most mortgages don't last more than 5-10 years, it's arguably irrelevant that they'd normally rather have him for 30 years than for 15 years.

My point? Drop your politics and look at the reality on the ground. Whatever "They" have been doing so far is just not working. The economic activity in this country depends greatly on confidence and credit. When banks won't even make solid bets on existing customers who are willing and able to pay more, we're not yet back on track.

Debt-to-GDP Ratio: Great Recession vs. Great Depression

The US government entered the current "Great Recession" with $65 of debt for every $100 of Gross Domestic Product. That ratio has exploded to 90%. Meanwhile, household debt (the sum of the personal debts of all of us individually) hit close to 100% of GDP early on in the Great Recession and has dropped to about 92% as the Great Recession has continued.

At the beginning of the "Great Depression", on the other hand, the debt-to-GDP ratio was 16%, and it was 44% when the Great Depression ended. But while household debt was around 100% at the onset, like it was recently, it went down to about 20% as Americans deleveraged themselves.

In one scenario our government borrowed less than the other scenario. And, respectively, We the People unwound a lot more of our personal household debt then than we have thusfar.

Problem: the measures taken by the government to stimulate the economy have, arguably, the desired result for a period of time, but they then lead to significant economic contraction. When the economy slows, individuals may have the option to leverage-up their personal balance sheets to pick up the slack... if they have room to spare.

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.

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.

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.

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.

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.

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.