Thursday, December 31, 2009

Looking back over 2009- Stocks

Wow!  Stock returns for 2009 were superb, particularly that part of the year from the lows reach March 9 of this year.  With a return of 28% year-to-date and 69% from March 9th to present, the S&P 500 demonstrates how well stocks did.

Stocks of developed international markets did even better, in part due to currency gains from a weak dollar.  The index known as MSCI EAFE is the generally accepted benchmark for these markets, and has a year-to-date return of 31%.

Leading the pack in stock returns were the emerging markets of countries like China, India and Brazil.  The return for the MSCI index for emerging markets year-to-date is 78%.  These stocks went down quite a bit more than developed markets in 2008, so they were coming from lower levels.  Also, they benefited from investor sentiment that sees these countries as the primary driver of worldwide economic growth for years to come.

So 2009 taught us that there are recoveries after the stock lows brought about by forced selling of those who must deleverage and emotional selling of those who got scared and followed.  Investors who really prospered maintained their discipline, followed their allocation plan, and even better identified opportunities that the tidal waves of selling created.  There was much to learn from 2009 and those who tried to time the market or who reacted emotionally and sold at the lows paid a big price for the lesson.  Let's hope investors can remember these lessons for a while.

Saturday, December 26, 2009

Looking back over 2009- Bonds

2009 was for bonds a year where risk paid big rewards, while the safety of places such as U.S. Treasurys (which protected so well in 2008) meant losses.  First let's look at what happened with Treasury yields-- remember that when yields go up, prices go down.  The interest rate paid on the 10-year Treasury note went from 2.25% at 12-31-08 to 3.75% currently while the interest rate on the 30-year Treasury bond went from 2.6% at 12-31-08 to 4.6% presently.  To assess the effect on investors in these instruments, consider the 21% loss for year-to-date return on the iShares 20-year Bond Fund (symbol TLT).

While rising rates hurt investors in Treasurys, the improving economy meant big gains for investors in bonds with some credit risk (meaning some risk of default).  In fact, more risk generally meant more return (just the opposite of 2008).  The iShares Investment Grade Corporate Bond (LQD) has returned about 9% year-to-date.  The Barclays High Yield Bond Fund (JNK) has earned 37% year-to-date.

Is there a lesson in all of this?  To us the dramatic change from 2008 to 2009 for bond investors simply reinforces the importance of not simply following the crowd or reacting to what all of the TV "experts" or cable talk show hosts say.  As always, successful bond investors in 2010 and beyond will be those who perform the hard work of constantly evaluating the risk/return opportunities of different bond sectors, maturities and issuers, and then have the courage to act in a manner that is at times contrary to popular opinion.

Friday, December 18, 2009

Could the 2010 Estate Tax Rate be Zero?

Little noticed in the Washington furor over healthcare legislation is the scheduled reduction to zero of the estate tax effective January 1, 2010.   Presently the first $3.5 million of an estate is not subject to tax, with the maximum rate of 45% for amounts in excess of this exemption.  Under the terms of present federal statute (brought about by the 2001 Tax Act commonly known by its acronym EGTRRA) the estate tax will automatically be repealed effective January 1, 2010 unless Congress acts very soon (note the House of Representatives is scheduled to start it's holiday break after session today, Friday December 18th and not return until after the first of the year).

Most estate planners, including this writer, were of the opinion that Congress would not allow the repeal to occur.  Since EGTRRA has only 2010 as a year of no estate tax with a "sunset" provision that provides for reinstatement of estate tax effective January 1, 2011 with exemption of $1 million and maximum rate of 55% (60% counting surtax on estates over $10 million up to about $17 million), having one year with zero estate tax is unbelievably bad social policy.  Wealthy families would benefit tremendously from a death and resultant inheritance in 2010 only.  Gallows humor has described this environment as "Throw Mama from the Train".

We are at the precipice of such a 2010 with no estate tax and all that comes with that.  Sad that our political "leaders" have allowed it to come to this.  What happens (or doesn't happen) with estate tax legislation now bears extremely close scrutiny.

Tuesday, December 15, 2009

November 2009 Market Update (Posted to our blog two weeks after sending to clients.)

“When I started counting my blessings, my whole life turned around.”
Willie Nelson

In this season of Thanksgiving, we are mindful of our many blessings. What we will do here is to simply list, in no particular order, a few of those things for which we are thankful.

• The sense of team and purpose we feel as all of us at Payne Wealth Partners work together to serve our clients’ needs in wealth planning, investment management and life.

• The trust our clients place in each of us as professionals, and in our firm and the 99%+ of our clients that have stayed with us in these most challenging times.

• A Federal Reserve led by a scholar (Ben Bernanke formerly a Princeton professor) who specialized in the Great Depression and knew the steps to avoid a reoccurrence.

o Bernanke is highly intelligent having scored a 1590 out of 1600 on his SAT going on to graduate summa cum laude in economics from Harvard and earn a PhD in economics from MIT.

o After having been appointed to chair the Federal Reserve in 2006, one of Bernanke’s first speeches was titled “Deflation: Making Sure it Doesn’t Happen Again.”

• The system of capitalism that was sorely tested over the past 18 months, but has surely survived. In capitalism the search for profits ensures the market will produce those goods and services that the consumer desires to purchase. Although excesses can result in this system, this is still the most efficient system for allocation of capital and human resources. This system will reward most those individuals that work hard and remain responsible to their family, community and self.

As we examine the month of November (where the S&P 500 return month-to-date through Friday, November 27 is 5 1/2%, and year-to-date return is 24%), we are of the opinion that the period of rapid investment recovery from the lows of this March has come to an end, and we now must look forward to what type of economic growth we can expect to drive returns in the future. At Payne Wealth Partners, we see more economic challenge than opportunity over the next several quarters. Although some cyclic recovery is to be expected after any recession, the challenges going forward are significant, including:

• A US stock market that is presently trading at a PE ratio of approximately 20x future 12 month earnings and therefore has already priced in substantial profit recovery.

• Stock and bond markets worldwide that still are counting on government support for much of their current pricing. Policy makers are now beginning to publicly discuss how and when to remove this stimulus and to no one’s surprise there is some disagreement.

o Just this week the European Central Bank was discussing some possible tightening in the near term while the World Bank was promoting the continued presence of stimulus to assure not dipping back into recession

• A US home mortgage market where almost 11 million (about 1 in 4) mortgage holders are “underwater” (mortgage in excess of home value) with areas like Nevada, Arizona and Florida where the percentage of those with negative equity ranges from 45% to 60%. Notably in Indiana less than 9% of mortgages are underwater.

• A worldwide banking system that is still undercapitalized, including China where the Banking Regulatory Commission this week is reported to have said the banks must increase capital from 10% to 13% of risk-weighted assets.

• Unemployment in the US of 10.2% (or 17.5% if we include those underemployed and who have just given up looking) and still on the rise. Such high levels of unemployment have historically weighed on consumption and resulting economic growth.

For our client portfolios, we continue to maintain equity positions at the low end of our target ranges to account for the above concerns. Additionally, we continue to emphasize emerging market positions in both equities and bonds (to enjoy economic growth of emerging markets while benefiting from anticipated future dollar weakness against these currencies), and build some positions in alternative assets that can provide returns which are somewhat uncorrelated with the overall stock market. We are making no changes to client portfolios, other than to continue to move into alternative assets as described in last month’s investment commentary.

Tuesday, December 8, 2009

U.S. unemployment for November

Last week saw improvement in U.S. unemployment numbers, as the unemployment rate declined from 10.2% to 10%.  However there is still much with which to be concerned.  Key is that the rate which reflects both underemployed and those who have just given up looking for a job is still over 17% (17.2% for November vs. 17.5% for October). 

Other unemployment notable facts include a 28.5 week average length of time without work for all umemployed persons.  Also, 38.3% of those unemployed have been jobless for at least 27 weeks.  These measurements are at record levels since such recordkeeping began in the 1940's.

We think unemployment and its implications for consumers is still very concerning.  We may not see the full impact of unemployment until government stimulus for things like auto purchases, home purchases, possible job tax credits and the like have run their course.

Tuesday, December 1, 2009

U.S. Budget Deficits affect everything (including war)

Tonight President Obama will present the latest planned changes in the Afghanistan war strategy in a speech to be given at the U.S. Military Academy at West Point.  There will likely be few surprises in the speech as the contents have been widely published already, including an increased 30,000 additional troops.  Today's Wall Street Journal contains an interesting article http://tiny.cc/vVaR1 on the economics of such troop additions.

A few numbers according to the article:
  • $1,000,000-  annual cost per soldier in Afghan theater (White House estimate)
  • $500,000-  annual cost per soldier in Afghan theater (Pentagon estimate)
  • $400 per gallon-  cost of fuel when delivered to certain Afghanistan locations
  • $1 per gallon-  cost of same fuel in the United States
  • $30 billion-  annual cost of 30,000 additional soldiers (per White House)
  • $3.6 billion-  present monthly cost of U.S. military deployment in Afghanistan
  • $65 billion and $61 billion-  Afghanistan and Iraq, respectively, Pentagon budget requests for fiscal year ending September 2010 (prior to tonight's announced troop additions) 
Expect these costs and the affect they will have on the already outsized U.S. budget deficit to be front and center in the debate over the U.S. strategy in Afghanistan.

Sunday, November 29, 2009

Dubai debt concerns

On Wednesday, November 25th there was an announcement by Nakheel, the Dubai World property development arm, of a planned default on a $3.5 billion payment due on December 14, 2009.  Nakheel proposed a 6-month extension of the payment.  Stock and bond markets around the world declined in response to this, led down by shares in banks.

To put this in some perspective, the entire public debt of Dubai is estimated to be $80 billion (about the same size as their GDP), with about $60 billion of that issued by Nakheel and other Dubai World affiliates (much of it for property development).  For comparison, the US government has over $100 billion invested in Citibank alone. 

Everyone knows property development in Dubai has been hugely overdone (they are presently working to finish world's tallest skyscraper) and they made questionable investments near the peak of the bubble in other worldwide real estate investments (i.e. ill fated CityCenter in Las Vegas http://tiny.cc/HnAdc ).

The size of this upcoming $3.5 billion default and even the size of all of Dubai's debt itself is not material.  Instead this is important only as a reminder that there are still problems out there.  Banks worldwide are thought to still be short of needed capital, and any possible losses such as Dubai just brings this back to mind.
 
Sometimes it is good to be reminded that investments offer both risk and return.  Maybe that way we can avoid immediately going back to the bubbles that helped to cause the economic crisis in the first place.

Monday, November 23, 2009

Alternative assets

Alternative assets have an important role to play in achieving portfolio diversification.  To start, Wikipedia.org defines alternative assets by examples including real estate, commodities, collectibles and private equity.  We would expand that definition to be non-traditional holdings (i.e. not stocks, bonds or cash) that over time perform in a fashion differently than traditional portfolio assets.

It is this lack of performance correlation with stocks, bonds and cash that makes alternative assets attractive to portfolio construction.  The extreme market volatility of 2008 and early 2009 provides a good opportunity to view which alternative assets in fact did perform substantially different than stocks and bonds.  In such market duress some of the so called alternative assets, including many hedge funds, turned out just to be traditional assets with high levels of leverage, thereby increasing the risk of portfolios where they were used. 

Frequently, but not always, alternative assets also are less liquid than traditional assets (for example, it is easier to sell a stock than an apartment building).  However, there are some alternative assets that are also liquid and are can be purchased in an open-end mutual fund format.

Informed investors may well begin to use alternative assets, particularly those that offer liquidity, to reduce overall portfolio fluctuations in some of the future volatility that many market experts expect to see.

Monday, November 16, 2009

October 2009 Market Update (Posted to our blog two weeks after sending to our clients.)

The four most dangerous words in investing are “This time it’s different.”
Sir John Templeton, founder Templeton Mutual Funds


As we approach the end of October (this is authored on Thursday, October 29th) we continue to examine the events of the past 18 months (to gain perspective on those dramatic events) and to consider what can be reasonably expected for the future. First, the returns on the S&P 500 are 1% month-to-date for October and 20% year-to-date for 2009. These returns indicate a US stock market that has bounced back dramatically from the March 9, 2009 lows (when the S&P 500 was down 24.6% YTD), but where the bounce back gains would seem to have largely occurred. Now the market would seem to be trying to determine where the economy and stock prices are headed over the next year or more.


Last week saw a new book released by author (and NY Times business reporter) Andrew Ross Sorkin with the title “Too Big to Fail”. About 600 pages in length, this is a fascinating, behind the scenes look at how government and Wall Street dealt with last year’s events. We are left with a number of impressions from this read:


1. Until the September 14, 2008 Lehman Bros. bankruptcy filing few of the players realized the severity of what was happening.

2. The quality of information on asset values at some of the biggest financial companies in the world was extremely poor, particularly at Lehman and AIG.

3. The primary component that holds the world’s financial system together is trust, and when that is removed there is systemic failure.

4. The road from riches to rags can be a very short one once trust is lost, or in street parlance once others will “no longer take your name”. The 580 million of Lehman Brothers shares outstanding (of which ¼ was owned by their 28,000 employees) traded at $65/sh starting 2008 ($38 billion total market value), $20/sh in August 2008 ($12 billion total market value) and was virtually worthless by September 15, 2008.


Turning to the economy and stock market in the future, we generally see two schools of thought: (1) “New normal” economy of reduced consumer spending, high levels of unemployment, increased government involvement, lower household and corporate borrowing, and reduced company revenue and earnings leading to low stock returns. The “new normal” theory has be put forward by the highly respected people at PIMCO (who manage the largest bond mutual fund in the world). (2) “Traditional economic recovery” (our term) with inventories being rebuilt as consumers start to spend again leading to increasing corporate profits. The “traditional economic recovery” approach has a number of proponents, including Dr. David Kelly, who is chief market strategist at JP Morgan funds.

Referring to the quote at the beginning of this, the “new normal” would fall into the category of “This time it is different” thinking and should be closely examined in comparison to the “traditional economic recovery” arguments of Dr. Kelly and others. We present each below and then give our conclusions. As a preview, at Payne Wealth Partners we really do think this time it is different, at least over the long-term.

Dr. Kelly provides the following to support his belief in “traditional economic recovery” with GDP growing at an annual rate of at least 4%:

• Credit spreads (level of corporate interest rates as compared to US Treasury instruments) have returned to normal levels

• GDP logged solid 3.5% growth in the 3rd quarter after four quarters of decline

• Over past 50 years there have been 7 recessions and GDP growth for first full year after these recessions has averaged 5%

• Bigger recessions result in bigger recovery; 1st year after two biggest recessions of past 50 years saw GDP grow average of 7%

• Four areas of the economy that are severely depressed could be expected to provide over ½ of economic growth in a traditional expansion (even though they only account for 17% of long-term GDP growth): Autos, housing starts, inventory rebuilds, business equipment spending

• Unemployment can be expected to grow into mid-2010, but then come down at a rate of about 1%/yr over the next five years thereby adding a full 1% to each of those years GDP growth

Bill Gross and Mohamed El-Erian of PIMCO support their case of the “new normal” with:

• The US entered last year with Federal debt to GDP at 45%, but is presently adding to this at a rate of 10%/year. This trend must eventually result in higher interest rates which will slow the economy. At some point the US government credit rating can be expected to be lowered from AAA if the deficits continue at these high levels.
• Consumer indebtedness in US and UK is still too high relative to income expectations and will reduce future consumer spending.
• Banks are holding more reserves at requirements of both regulators and their management, and will not provide the necessary credit needed for recovery in areas such as residential and commercial real estate
• Unemployment has risen beyond expectations, and is expected to remain high for years and eventually settle back at a higher “natural” rate than experienced in the past
• The high levels of public debt will inhibit future fiscal stimulus and will greatly complicate how governments eventually exit their private sector support

At Payne Wealth Partners, we must choose a set of future expectations against which to make our portfolio decisions. As to those future expectations, we see a likely short-term to intermediate-term environment much like that expressed by Dr. Kelly, but with the positives of such an environment already largely reflected in today’s pricing of equities and in levels of corporate interest rate spreads over Treasuries. When we look out longer term we lean to the “new normal” arguments and the lower returns for stocks (and certain bonds) such an environment would bring. For this reason we have our portfolios generally targeted to stock allocations at the low end of our allowable ranges. Specific steps we are taking now in client portfolios:

1. Slightly reducing our allocations to high-yield bonds which have experienced year-to-date returns in excess of 35% as markets normalized. Although we still feel this category has additional future return potential, now is time to eliminate some risk and lock in profits.
2. Slightly increasing our allocations to emerging market equities (with a reduction in developed market international equities) to reflect our plan to continue to increase the exposure of portfolios to the high levels of economic growth we believe emerging economies will experience.

3. Establishing a position in alternative investments that will bring to portfolios return that is somewhat uncorrelated to the stock and bond markets. We are funding this with the reduction in high-yield bonds and a reduction in investment grade bonds (that are again at normalized spreads to Treasuries). Specifically we will have positions in a managed futures mutual fund (Rydex/SGI Managed Futures Strategy) and an option-collared stock fund (Gateway).

Longer term, we can see continuing increases in allocations to the emerging markets, although we would note that it is now commonplace to see emerging markets investments recommended by many, so we would not be surprised to see some short-term struggles for an area that today seems somewhat overdone. Further, we likely will continue to build investments in alternative types of investments that will provide some absolute levels of returns and with correlations designed to offset some of the ups and downs of traditional stocks and bonds.

Friday, November 13, 2009

China

Investors and policymakers worldwide recognize that China continues to increase in importance to all. With a centralized government and a strong balance sheet, China was able to quickly provide stimulus last year. An important part of the stimulus was huge increases in lending (from government controlled banks) starting 4th quarter 2008. At its peak in the 2nd quarter of 2009, Chinese credit growth for a 3 month moving average (annualized) was about 60%. This has since been brought back to about 20% as the Chinese authorities worked to avoid bubbles in their real estate and stock markets.

Even though the Chinese “manage” their economic releases through central government filters, there is certainly significant growth in their economy. This week they released data showing property development and investment for January to October increased by 18.9%. This doesn’t appear to be too speculative as the number for same period of 2008 was 24.6%. The World Bank believes Chinese household incomes are rising faster than prices and therefore affordability is increasing.

Chinese authorities have not raised interest rates, and observers think they will not until first half of 2010 at the earliest. In the meantime it will pay all investors worldwide to give close attention to economic and market news from China to make sure this key growth engine continues to power everyone’s returns.

Saturday, November 7, 2009

U.S. unemployment now over 10% for first time in 26 years

In October U.S. unemployment rose over 10% (to 10.2%) for the first time in 26 years, and only the 2nd time since the 1948 employment record keeping began.  Behind this headline number we examine additional concerning details:
  • the rate of unemployment rises to 17.5% when including those who have stopped looking or are working part-time since they can't find full time work
  • although unemployment in management and professional occupations is only 5%, the rate in production is about 15% and the rate in construction is about 20%
Although the 3rd quarter U.S. GDP was recently announced at a preliminary estimate of growing at an annual rate of 3.5%, the jobs report shows this growth has yet to reach Main Street America.  Further, some now estimate additional increases in unemployment such as Moody's Economy.com who sees the rate peaking at 11% in mid-2010.

In the meantime, Congress and the White House have been focused solely on healthcare legislation.  Expect this to change in the near future as voters this week sent a signal of dissatisfaction with election of Republican governors in New Jersey and Virginia.  Although the White House claims to have saved or created 640,000 jobs with fiscal stimulus, the math by observers reveals the cost-to-date of each such job to be $92,000.  A jobs credit bill is now being discussed, but the already record-high U.S. budget deficits make any such action challenging for lawmakers.

The big question for the economy and investment markets seems "Will U.S. consumers continue to spend as concerns about unemployment grow amid a diminishing ability of government to do anything about it?"  We shall see.

Wednesday, October 28, 2009

Healthcare reform- some key facts to consider

Washington is presently dominated by the debate over healthcare reform.  It is a very important issue, because a US federal budget that is already showing sizeable deficits will be blown up by Medicare costs of the baby boomers if past health cost rate of increases continue.

Here are a few key facts to consider as we all hear so much on this subject according to Moody's Economy.com:
  • Insurance is the most capital-intensive of all US industries.  This explains why insurance companies continue to consolidate into larger surviving companies.
  • Consolidation has resulted in near-monopolies in some areas, with a single health insurer holding market share in excess of 70% in 1/6th of all metropolitan areas.
  • Because of reduced ability to spread the risk, the cost of individual health insurance premiums (up 80% in last 5 years) has increased much more rapidly than large group insurance premiums (up 35% in last 5 years).
  • Of the 46 million uninsured, approximately 30 million earn more than $25,000 annually and about 20 million of those earn more than $50,000 annually.
  • Of the 46 million uninsured, the vast majority (almost 40 million) are of working age between 18 and 64.
We present these facts with no editorial comment just help the reader as you see the continuing outflow of healthcare "fixes" from Washington.

Thursday, October 15, 2009

September 2009 Market Update (Posted to our blog two weeks after sending to clients.)

“The more things change, the more they remain the same”
Jean-Baptiste Alphonse Karr, French journalist

The investment markets are finishing the third quarter of 2009 in fine form. For the quarter the S&P 500 returned about 15% leaving it up about 20% for 2009 and down about 6% since September 30, 2008 (all returns as of September 28, 2009 close).

It is instructive to look back a year. Let’s recap some of the timeline highlights (lowlights?) of September 2008:


  • September 1, 2008 - Dow Jones Industrials Average (DJIA) begins the month at 11,543


  • September 7, 2008 - Fannie Mae and Freddie Mac are placed in conservatorship.


  • September 15, 2008 - Lehman Brothers declares bankruptcy. DJIA drops 504 points.


  • September 16, 2008 - Reserve Primary Fund (large money market fund) who owned Lehman Brothers commercial paper reduces it share price below $1 and investors worldwide begin to redeem money markets. American International Group (AIG) receives downgrade in credit rating, suffers liquidity crisis and receives an $85 billion credit facility from the Federal Reserve to avoid bankruptcy.


  • September 17, 2008 - DJIA drops 450 points.


  • September 18, 2008 - The SEC suspends short selling of financial stocks.


  • September 19, 2008 - U.S. Treasury guarantees money markets under temporary program and the administration proposes Troubled Assets Relief Program (TARP) to purchase illiquid assets of troubled financial institutions.


  • September 21, 2008 - Goldman Sachs and Morgan Stanley convert from investment bank to bank holding companies with approval of Federal Reserve to permit better access to capital.


  • September 25, 2008 - Washington Mutual, nations largest savings and loan, seized by FDIC. Most of its assets transferred to JPMorgan Chase. Wachovia in sales negotiations.


  • September 29, 2008 - Vote on TARP in House of Representatives failed to pass. DJIA drops 778 points.


  • September 30, 2008 - DJIA closes at 10,850 about 6% loss for the month.


  • October 31, 2008 - DJIA closes at 9,325 for a loss of about 20% since beginning of September.

The events of a year ago rocked the world. Many experts have described what they believe was the cause of the financial upheaval. Our view is that the world, led by the U.S., became much too comfortable with high levels of debt and the high asset prices and high consumption that such debt supported.

Although asset prices have recovered significantly, there are still concerns. The U.S. and most developed countries of the world have sizeable budget deficits and see public debt as a percentage of GDP growing to levels many of these countries have never experienced. This debt is financed by investors at presently low rates (the 10-year U.S. Treasury bond rate is about 3.3%), but the declining quality of the balance sheet of the borrower countries (including the U.S.) would seem to indicate higher interest rates in the future. The currency of countries with such increasing debt like the U.S. should experience decreases in future value.

The high levels of debt that companies employed in the past led to higher profits to owners. Lower levels of corporate debt in the future should lead to lower profits. Consumers will purchase less as they reduce spending and increase savings to pay down debt and replace lost wealth. This also will lead to lower profits.

Governments worldwide have provided huge levels of support to cushion the economy of their nations. This support is still almost entirely in place. At some point this government help will be withdrawn and the private sector will need to exist on its own. Given the large amount of government support, one can expect such withdrawal will certainly be felt by the markets.

We are saying that the concerns that led to last September’s historic events still exist in significant part, or have been replaced with new and equally important concerns. Investors need to stay in the game (or they wouldn’t have experienced the stock market gains of 2009), but we all need to be attentive to many factors, including government policy, economic indicators and the level of security prices. To control risk in the present environment we have the stock portion of client accounts near the low end of our target ranges.

It should be noted that interest rates have changed significantly from the extremes reached over the past year. High yield bonds show this most clearly. On March 27 of this year the high yield bonds average rate was 18.09% for a spread of 15.33% over the 10-year Treasury rate of 2.76%. As of September 25th high yield rates were 10.29% for a spread of 6.96 over the 10-year Treasury rate of 3.33%. During the intervening period, high yield investors received significant gains in the prices of bonds. At Payne Wealth Partners we have targeted a present 7% of client portfolios into high yield bonds, however we expect to see this position reduced or eliminated in the near term as a result of the rate declines.

Our firm continues to advocate for investing in emerging markets. The economic growth rate of those economies should be higher than developed markets and their currencies should perform better. We may very well target future increases in the portion of our portfolios that is invested in emerging markets.

Please read this quick planning note regarding Roth IRAs. Fidelity Investments just released a survey where 83% of investors questioned were not aware that starting in 2010 the income limits for Roth conversions will be removed. We want to make sure each of our clients is in the small 17% minority that understand the potential opportunity this rule change will provide. In the past Roth IRA conversion has been limited to those with income below $100,000. Roth IRAs grow tax-free and all distributions come out tax-free. The Roth IRA account owner is never required to take minimum distributions (unlike a traditional IRA where taxable required minimum distributions must start at age 70 ½). Roth IRAs inherited by children and other heirs are income tax-free to them and they are allowed to take the money out very slowly (over their single life expectancy). We have discussed Roth IRA conversion with many of our clients for whom we manage IRA money and provide planning services. If you have any questions about this please ask!

Tuesday, October 13, 2009

Former Treasury official's prescription for deficit reduction

Former deputy US Treasury secretary Roger Altman wrote an opinion article published in the Financial Times this weekend (http://tiny.cc/omEn6) in which he expressed significant concern over the level of budget deficits and their effect on interest rates and the US dollar.  Mr. Altman points out that the continued budget deficits over the next 10 years would result in the Treasury having to borrow $4 trillion annually and asks the question "does anyone think that once recovery takes hold and private demand for capital strengthens, the Treasury will raise $4 trillion per year at below 4 per cent, as it is doing today?"

Altman sees the potential for rising inflation, rising interest rates and significant decline in the value of the dollar unless something is done to get the US budget deficit under control.  His proposal-- legislation creating a bipartisan deficit reduction group of administration and congressional leaders who will study the possible solutions for cutting spending and raising revenues and make recommendations by December 31, 2010 that are then submitted to Congress for an up or down vote.

We can hope our leaders will do something like Mr. Altman has proposed and we can also hedge against the rising inflation, higher interest rates and weaker dollar in the event they don't.

Friday, October 9, 2009

Greed (Oct. 9, 2007) and fear (March 9, 2009)

Today marks precisely 2 years since the Dow Jones Industrials Average (DJIA) reached its all time high of 14,164.  Investors at that time were focused on profits to be made in stocks after seeing over 115% of stock market return since the lows of 2002.  It would be fair to say greed ruled the day at that point.

Fast forward to March 9, 2009 when the DJIA closed at 6,547 as regulators and investors alike worred about a severe recession and the deflationary effects of a near collapse of the financial system worldwide. It would be fair to say fear ruled the day at that point.

For comparison purposes the DJIA closed today (October 9, 2009) at 9,864.

Behavioral finance studies tell us the average investor is much more willing to buy when the market has been going up, even if this results in overpaying for an asset and reducing future returns.  Likewise, the average investor is much more willing to sell when the market has been going down, even if this results in missing out on future recovery and reducing returns.  A study by Dalbar, Inc. shows that for the 20 years ended December 31, 2008 the average investor (with their buying and selling at the wrong time) earned only 1.9% per year while the S&P 500 averaged 8.4% for the same time period.

There is much to learn from examining this market history.  Hopefully the lesson of not allowing greed and fear to overwhelm rational decision making will be remembered by investors the next time markets reach a high or low extreme.

Sunday, October 4, 2009

Diversifying from the U.S. dollar

Seasoned U.S. investors generally grew up in a period of worldwide economic dominance by the United States. For the past 2 decades, or more, investors of all countries purchased U.S. investment assets and hard assets (like real estate) because the U.S. was seen as the economic world leader. The U.S. dollar was the reserve currency of the world (ie. the default currency for crossborder transactions and the safe haven currency in times of turmoil).

The economic landscape seems to be changing. Economic growth in the U.S. going forward may well lag that of the rest of the world, particularly emerging markets. Fiscal budget deficits in the U.S. and resultant borrowing demands may put upward pressure on interest rates and downward pressure on the dollar. Worldwide investors may sell U.S. dollar denominated holdings to create the funding for diversifying into other areas of the world.

If things turn out as discussed above, the ones to reduce their dollar exposure earlier will fare better than those who continue to be significantly overweight the dollar. There will certainly be periods of U.S. dollar strength, however those who continue to hold the vast majority of their investments in U.S. dollar denominated holdings may find themselves suffering poor relative performance as compared to the rest of the world over the long-term.

Tuesday, September 29, 2009

Emerging markets

An article in the September 28, 2009 issue of the London Financial Times caught our eye http://tiny.cc/lNKSn . The writer, Marko Dimitrijevic of Everest Capital was discussing the significant role that so-called "emerging markets" play in the world economy. He notes that emerging markets represent 30 percent of the world's stock market value and 50% of the world's economy. More telling was his calculation that for the period 2003 to 2009 while sales of the developed world grew at a growth rate of 5% annually, emerging markets grew at 11% annually.

Investors tend to look at the emerging markets as the volatile little brother to the more stable and much larger developed world big brother. Those roles may well be changing.

Friday, September 18, 2009

Guarantee Program for Money Market Funds ends today

Little noticed today was the U.S. government step to end the program under which they guaranteed money market funds. One year ago, the Reserve Primary Fund (a large money market fund) who held significant positions in commercial paper issued by the recently bankrupt Lehman Brothers was forced to "break the buck"-- meaning their money market positions were no longer worth the customary $1 for each $1 invested.

As a result of the unusual step by Reserve Primary Fund, money market holders began a massive withdrawal of funds as they fled into US T-Bills. Business felt this very quickly, as money market funds are a chief purchaser of commercial paper issued by US industry to fund short-term cash needs. To stop money from continuing to flee money market funds, and attempt to stabilize the commercial paper market, the US Treasury pledged $50 billion from the Exchange Stabilization Fund to back their guarantee of money market funds.

We can remember many conversations with clients as to why their money market fund investments were safe given this government guarantee.

What a difference a year makes! The expiration of the government guarantee for money market funds is about a page 3 story at best. Government has concluded (and we would concur) that holders of money market funds no longer feel the need for a government guarantee to protect their investment.

We can only hope that as other government support for markets is withdrawn it will be the non-event that this was. We still have significant concern that may not be the case.

Tuesday, September 15, 2009

August 2009 Market Update (Posted to our blog two weeks after sending to clients.)





Common sense tells us that consumer spending growth comes from highly employed, well-compensated labor, and we are far-far from even approaching that elemental condition. The fact is that near double-digit unemployment has resulted from numerous business models that are now broken: autos, home construction, commercial real estate development, finance, and retail sales.” Bill Gross, PIMCO

August closes another month of gains in stocks, but stocks would require still more gains to offset the losses of last fall. Stock price gains have been very strong in the emerging markets, as investors bet those markets will continue to “decouple” from slow growth developed economies. Below is a schedule of returns (as of August 28, 2009) for selected mutual funds to assist in understanding market returns:

After such a run in prices from the market lows of March, many market experts are expecting a pause or even a pullback. Beyond this, at Payne Wealth Partners we are concerned about the economy, particularly in the U.S. and other developed countries. This is a theme we have developed in prior writings and the facts continue to support this thinking.

High levels of unemployment (with no expectations of relief anytime soon), wealth effects of house price and market declines over the past two years, and constricting credit are resulting in reduced consumer purchases. Consumer confidence as measured by the University of Michigan Consumer Sentiment Survey Index is at about 65 and has been range bound this year between 55 and 70. Compare this to an index in August of 2007 of 83 and in August of 2004 at 96.

Corporate revenues also reflect consumer concerns as, per Goldman Sachs, the sales of the S&P 500 companies in the 2nd quarter were down 16% from a year earlier, after a similar decline of 14% in the 1st quarter. Overall profits for the S&P 500 companies beat expectations because of reductions in expenses as evidenced by selling, general and administrative (SG&A) expenses that were down 6.4% in the 2nd quarter (also per Goldman Sachs) versus a year earlier. Expenses can only be reduced so much, and it will take true revenue growth to push stock prices higher over the long-term.

The monetary actions of the Fed and other central banks around the world coupled with government spending programs have worked to slow economic declines (U.S. 2nd quarter GDP down only 1% annualized) or in cases like France and Germany (each up about 1% annualized in 2nd quarter) return to economic growth. But government supported growth is not the same as sustainable growth and we have yet to see how economies worldwide will perform without the significant public sector subsidies. Although risks of deflation remain due to excess capacity as companies operate at reduced levels due to reduced customer demand, the high levels of government involvement seem to point to higher inflation in the long-term (another theme we have discussed for some time). Given our concern about sustained economic growth we presently have targeted the stock position in our portfolios near the low end of our allowed ranges.

There is a part of the world with true economic growth and that is the emerging countries. Most of these countries have below-average levels of government debt and are not running the high budget deficits of the U.S. and other developed countries. They don’t have expensive programs like Medicare and Social Security that further threaten already strained budgets. And their citizens are emerging consumers, as opposed to the developed country consumers whose excessive past consumption has left them with high levels of personal debt. To us this means capital invested in emerging countries will generally have a better opportunity for good return than that in developed countries. Additionally, currencies of these emerging countries should reflect their better balance sheets and perform better than that of the U.S. and other developed countries.

With the emerging country advantages in mind we have for some time targeted ½ of our international stock positions to be in emerging markets. The table above shows the return advantage emerging markets have experienced as compared to U.S. stocks. We are now establishing a targeted 5% position in emerging country bonds in all portfolios to reflect the long-term currency advantage we expect. This will be funded by a shared reduction in U.S. investment grade bonds and in high yield bonds.

To conclude, we are pleased with the significant recovery experienced in stock prices but at the same time we are concerned that conditions may not exist for sustained real economic growth. Given our concerns, we have our portfolios positioned to underweight stocks (as compared to neutral positions). We do continue to believe in the story of emerging countries and see their economic advantages as favoring both their stocks and their currencies over the long-term.

Friday, September 11, 2009

Have Profit Margins Peaked?

Taylor Payne authored this blog. Taylor is President, Wealth Manager of Payne Wealth Partners. Please read more about Taylor here.

The London Financial Times reports that as a percentage of corporate output, second-quarter profits before depreciation, interest and taxes was 35%. Compare this to the long-term average for such margin of 29%.

Common sense tells us that as companies see their revenues fall, they had to aggressively cut costs and this has provided a boost to margins. However, such a lift to profit margins seems only temporary.

Banks have had huge margins given their low costs of funds and a steep yield curve that permits them to lend out at large spreads. These bank margins are not sustainable as the yield curve flattens.

Also, non-financial companies have received a profit boost from shrinking costs associated with reducing inventories (e.g. sell items from inventory that went in at a lower cost than present), but that is largely over.

With profit margins looking toppy and US stocks at about 18 times earnings it is difficult to see stocks making major advances from these levels.

Friday, September 4, 2009

Mr. Know-it-all

We all know people that think they know it all, right? Usually the wisest of a group knows that to be truly successful in any endeavor you must surround yourself with those people that are known to be the most knowledgeable. Any effort to be a true “Mr. Know-it-all” ends in failure while becoming part of a network of intelligent people leads to success. Ed Slott, a leading IRA expert seems to agree. That’s why Ed started a group called the “Ed Slott Elite IRA Advisors”. The purpose of the group is to bring advisors together from across the country on a regular basis to discuss the ever-changing world of IRAs and Qualified Retirement Plans. Today there are trillions of dollars in tax-deferred accounts and the balances are a growing portion of individuals' net worth, making specialized training in this area crucial. Ed also has a team of technical experts available to the members of the group at all times to assist in complex client situations and in developing specific steps in implementing high-end strategies. This network of other experts is precisely why Perry Moore of Payne Wealth Partners became a member of the group two years ago. Since joining, Perry has moved into the “Master Elite” group that comes with more rigorous training and ongoing education. The knowledge gained from the group squares well with Payne Wealth Partners culture- one of information sharing, teamwork and innovation. Are you relying on a self-proclaimed "Mr. Know-it-all" or a team with the necessary professionals and resources to deliver success? To find out more about the Master Elite Advisor Group, Ed Slott and why this network and training is so important for your planner to have, visit www.irahelp.com.

Monday, August 31, 2009

What does recovery mean?

The U.S. economy contracted at an annual rate of 1% in the 2nd quarter which is a significant improvement over the decline of 6.4% (annualized) in the first quarter. This is a significant improvement and has been accompanied by over a 50% increase in stock prices as measured by the S&P 500 from the March lows. Some portion of the improvement in stock prices and in the economy must be attributed to actions by the Federal Reserve and the Treasury. The government supports are not sustainable in the long-term, and to some extent must be removed at some point in the future.

So what kind of recovery will we see, particularly as some government stimulus is removed? Stock price increases would seem to indicated the market believes we will see a strong period of growth as inventories rebuild and consumer demand increases. We are somewhat skeptical of this, and would instead worry that 2010 could see an economy with high unemployment and slow growth (possibly even periods of declines). We quote the analysts at PIMCO who said on August 20, "Government intervention on an unprecedented scale... has brought about stabilization. But this does not provide the foundation for a V-shaped return to business-as-usual. The violent rise in unemployment, above 9% in U.S. and Eurozone, is a significant challenge to income growth, and in turn, consumption growth and top line growth for business."

We may have a long way to go before we reach what truly feels like recovery. This seems to be time for caution by investors.

Friday, August 21, 2009

Alphabet Soup Revisited


Perry Moore authored this blog. Perry is Director of Wealth Planning at Payne Wealth Partners. Please read more about Perry here.

In a 2005 newsletter we wrote about the maze of professional designations those in our industry carry in an article titled “Alphabet Soup”. There were so many designations, in fact, that most investors didn’t have the slightest idea what each meant, and more importantly, what each required of the advisor to earn and maintain. Four years later the maze has turned into a labyrinth.

In a recent article by Elaine Floyd at horsesmouth.com, the International Association of Registered Financial Consultants estimated there are over 80 designations currently available to financial professionals. This does not include what would fall in the insurance, tax, and legal areas- with these the number quickly climbs into the hundreds. What complicates matters is that each of those designations has its own set of requirements (or in some cases lack of requirements) for education, ethics, experience, testing, and continuing education. For example, there are designations that require submission of a resume and $300 fee for completion. No specific education, testing, ethics or experience requirements! Still others require attendance at a 2-day seminar and a larger fee of $600 to obtain a designation. Compare these to the Certified Financial Planner™ designation, which requires a bachelor’s degree, 3 years experience in financial planning, passing a 2-day 10 hour exam (with pass rates averaging 50%), 30 hours of continuing education every 2 years, and ongoing ethics training. Quite a difference- but how can an everyday investor determine the differences when all the letters behind advisors’ names look so similar?

There are a number of things an investor should do to arm themselves with the right information. Finra.org provides details about every financial designation available here:
http://apps.finra.org/DataDirectory/1/prodesignations.aspx - you can find information on all the critical parts of every designation you may see an advisor using. With some quick research you’ll be surprised at how many “designations” are more smoke and mirrors than major accomplishments. Of course you can always ask the advisor what they have done and continue to do for their designations- look for the details about the programs they’ve been through and what they’re doing on an ongoing basis to keep up with planning, investment, and legislative changes. Another easy source to access is the website for the provider of the designation you’re checking out. For example, by doing a google search for “CFP” you can quickly find www.cfp.net- the Certified Financial Planner™ Board of Standards website. The old saying goes- “caveat emptor”- only this time you’re armed with the right sources to do your homework and pick out the winners.

Monday, August 17, 2009

Commercial Real Estate

There continues to be much concern over the commercial real estate market. This is mentioned frequently in the consumer press, and we have had clients ask about what risks we see for the entire economy.

Commercial real estate is suffering from high levels of debt incurred in the days of low interest rates of 2007 and prior, and the high prices paid for some real estate that the debt was used to acquire. The financing came from banks and also from Commercial Mortgage Backed Securities (CMBS). This debt does not have the long maturities of residential housing, with significant amounts of 3 to 7-year paper scheduled to mature over the next few years. It is this maturing debt, and the now lower prices of real estate, that has some observers so concerned.

Goldman Sachs was recently quoted in the press as expecting another 20% price decline in commercial real estate. Companies are downsizing (thus reducing their demand for real estate) and debt holders may be liquidating real estate collateral, so additional price declines make sense to us. Certain commercial REITS and others who have high levels of debt are at significant risk in this environment.

We did note just today the announcement that the government TALF program (where the Fed makes low cost loans to acquirers of asset-backed securities including CMBS) that was scheduled to end December 31, 2009 has been extended for an additional 6 months as to CMBS. The Fed is trying to improve liquidity for commercial real estate with this extension and it is reasonable to think the government will provide additional assistance in commercial real estate if they feel it necessary.

Our conclusion: commercial real estate price deflation and defaults in the debt secured by such real estate is a legitimate concern as to the economy. We would think the government would do what they could to soften the economic blows from this problem, but it is one more headwind the economy and markets will have to deal with.

Friday, August 14, 2009

July 2009 Market Update (Posted to our blog two weeks after sending to clients)


“A wise man makes his own decisions; an ignorant man follows public opinion.” Chinese proverb

As we write this on July 28, 2009 the Dow Jones Industrials average closed the prior day over 9,100 and the S&P 500 closed over 980. Compare these levels to the March 9th close for the Dow of 6,547 and for the S&P 500 of 676 and you can see that U. S. equity prices are up approximately 40% from those March lows. Stocks in the U.S. (as measured by the S&P 500) have increased approximately 7% so far in July alone and approximately 10% for YTD 2009. Investors who sold at those low levels in March have missed out on a very significant upward move in prices.

One of the key reasons for the July gains were positive surprises on corporate profits for the quarter ended June 30, 2009. A good example of such a positive surprise is the report from Apple that showed a 15% jump in quarterly profit and even more meaningfully reported a 12% increase in quarterly revenue from a year earlier. This means consumers were willing to increase purchases of Apple products despite the challenging economy and the market seems to interpret this as an indication that consumers may not be as stingy as expected. According to Thomson Reuters, 77% of companies reporting have exceeded profit estimates and this has also supported recent market gains.

All of this has many market experts revising upward their earnings estimates and market targets. Goldman Sachs has raised its estimate of S&P 500 earnings for 2010 to $75 and has raised their year-end target for the index to 1,060 (from prior target of 940). If the $75 earnings prediction proves accurate, it equates to a price earnings ratio of 14 on the new 1,060 target.

International stocks have done well also, with the MSCI-EAFE index up 15% in dollar terms YTD through July 24, 2009 (5% of this increase came from dollar declines). Emerging markets (especially those in Asia) have done exceedingly well, with Asia ex-Japan up 43% in dollar terms through July 24.

Corporate bonds have also done well, as the very high spreads of investment grade issues as compared to U.S. Treasury securities have now returned almost to the levels that existed before the September 15, 2008 Lehman Brothers bankruptcy. Quality corporate bond spreads that were 600 bps over Treasury securities in March of this year are now less than 300 bps. Likewise, high-yield spreads of almost 1900 bps in March are now under 1000 bps (100 bps = 1%).

We believe our client portfolios were well positioned to participate in the 2009 gains of U.S. stocks, international stocks (including emerging markets) and corporate bonds (particularly high-yield bonds). This was possible because we did not follow public opinion and sell in early March when there were broad worries about deflation and possible depression. Instead, we worked to keep client portfolios invested consistent with their written Investment Policy.

Going forward we think there are still many economic challenges. One key challenge is what could happen with home foreclosures. Home prices (per the 20-city Case-Shiller index) are down 32% from their mid-2006 peak. As a result 15 million homeowners- one in five of those with a 1st mortgage- are under water (their home market value is less than their mortgage). If these homeowners run into any significant financial difficulty (lose a job, medical claim, etc.) they are at severe risk of walking away from their mortgage. This could spiral home prices down further as these foreclosed homes are sold at low prices. The Obama administration has advanced plans for helping homeowners, but these programs are unwieldy and to date have helped relatively few.

A retrenching consumer in developed countries, particularly the U.S., is another significant risk. No one yet knows what level of past consumption will be redirected toward savings to replace wealth lost with declining home prices and shrunken investment portfolios. All such reduced consumption translates into reduced corporate sales and reduced corporate profits which would challenge stock prices.

We continue to follow the themes expressed in past reports. Those themes for how we invest client money include:

  • Developed countries will be faced with weak consumption as consumers deleverage and increase their savings rate to help restore lost wealth.
  • Emerging countries have a growth advantage with an emerging middle class, high savings rates (that can be redirected towards consumption) and low government debt.
    High budget deficits will lead to increasing levels of government debt compared to GDP, resulting in a weaker U.S. dollar (and weaker currencies of most other developed countries).
  • There is an increasing possibility of significantly higher levels of interest rates on government bonds in the U.S. and other countries where government debt to GDP increases materially over the next decade or more.
  • There is a risk of much higher inflation (although time is needed to clear excess capacity) if governments worldwide don’t skillfully remove monetary stimulus.
  • It is important to understand that human behavior results in markets that overdo things on both the upside and downside.
We are not recommending any changes to client portfolios at this time, but we do continue to consider a number of possible investment themes and strategies. Also, we are periodically rebalancing portfolios to their Investment Policy, as we always have.

Monday, August 10, 2009

NAPFA Consumer Webinars

One of the great challenges to consumers of financial services is the lack of clear information on financial matters. The National Association of Personal Financial Advisors (www.napfa.org) is attempting to address this with "consumer webinars". These are free one-hour presentations over the web by fee-only, fiduciary financial practitioners from a variety of cities.

These just started on August 7, 2009 and will be held monthly in the future. More information, including a schedule, an archive of the first webinar "Money 101: Knowing the Basics" can be found at
http://www.napfa.org/consumer/ArchivedSessions.asp.

Thursday, August 6, 2009

FORTUNE MAGAZINE: "The next great bailout: Social Security"

The most recent issue of Fortune magazine contains a compelling article on Social Security at http://tiny.cc/RYxRm. The author of the article (Allan Sloan) who is nearing retirement age, points out that Social Security is nearing the point where annual cash flow (payroll taxes collected from workers minus claims paid) will turn negative. The annual Social Security cash flow deficits must be funded with additional Treasury borrowing which will put further upward pressure on interest rates.

Mr. Sloan proposes some fixes for the problems, including raising the covered wage limit (but not too high). He is very clear that it is important not to "tax the rich" too much in any such fix.

After the health care legislation is done (which is supposed to address the even more challenging Medicare solvency questions), Social Security would seem to need some attention. Let's just hope Washington is up to the task.

Friday, July 31, 2009

Report on reforms to restore investor confidence

On July 15 a blue-ribbon panel co-chaired by former SEC chairmen Bill Donaldson and Arthur Levitt issued their "Report on Financial Regulatory Reform: The Investor's Perspective" http://tiny.cc/cyFtq. There are many encouraging comments in this report, including on page 14 where we find "In order to improve the quality of advice provided to retail investors and to protect them from abusive practices, the SEC should be empowered to reform compensation practices that create unacceptable conflicts of interest, improve pre-sale disclosures, and subject all those who provide personalized investment advice, including broker-dealers, to a fiduciary duty."

Page 15 of the report addresses the problems associated with "... a series of decisions by regulators over the years allowed brokerages to call their sales representatives "financial advisers," offer extensive personalized investment advice and market their services based on the advice offered, wall without regulating them as advisers.

We hope Congress will carefully consider the matters addressed in this report. Investors will be best served by advisers who are subjected to a fiduciary duty.

Monday, July 27, 2009

Baby Boomers cut spending

An excellent article in BusinessWeek (http://tiny.cc/diOKI) sets out how baby boomers are cutting their spending in this economy. The question becomes "what effect will this lower consumption have on corporate profits". The stock market has rallied recently in part due to optimism about revenue growth at consumer oriented companies like Apple. But the lower consumption may be a long-term trend and some experts believe this would serve to constrain corporate profits and economic growth for years. The BusinessWeek article discusses one such forecast of 2.4% GDP growth over the next thirty years, versus an historical 3.2% annual growth rate since 1965. This is a key consideration all investors will have to measure as they make decisions going forward.

Friday, July 17, 2009

The challenge of setting future return expectations

Periodically our firm will revisit what we believe different asset classes will return over the long-term future. This is important as future return levels are a key assumption in preparing wealth plans that will assist clients in determining when to retire, how much to spend in retirement, and other key issues. We (as have others of our profession) have typically looked at historical return information and historical relationships between different types of investment assets and from this information have set our future return expectations.

After the events of the past year or so, things have changed. A very good discussion of how things have changed can be found in an article titled "Beware of the 'Business as Usual' Mindset" authored by Mohamed El-Erian, co-CEO of PIMCO. You can find the article at
http://tiny.cc/eH9Qs. In the article El-Erian sets out 4 key questions:
1. How far will the balance shift away from markets and toward governments?
2. How will governments finance their growing involvement in the economy?
3. To what extent will this alter the role of the U.S. in the global economy?
4. How far will governments go in de-risking the financial system?

You can read how Mr. El-Erian answers each of the questions in the linked article. Our firm concludes that these issues raise the risks for all of us in terms of trying to have the funding to accomplish our key goals. We believe the answer is to have more of a safety cushion in a wealth plan. That may require working longer, spending less, being more flexible on goals or any number of other strategies. Key is to have a wealth plan and in that plan to properly measure what the goals are and what the cushion is to assist in protecting those goals. As the world changes in so many ways, including market changes, such a wealth plan must be updated each year to have continued relevance.

Monday, July 13, 2009

June 2009 Market Update (Posted to our blog two weeks after sending to clients)









“Face reality as it is, not as it was or as you wish it to be.”
Jack Welch, former CEO General Electric, author, commentator

The quarter ended June 30, 2009 looks like it is going to end with stocks up about 15% (as measured by the S&P 500 index) over the past three months. The S&P 500 index which is 925, as this is written on June 29, 2009, has come a long way from March 9th when it was at 676 amid great concern about the economy, deflation, deleveraging, and a government that couldn’t get its message right. So, what has changed?

For one thing, the economy has stopped dropping like a rock. This can be seen in the endless flow of economic statistics like the May unemployment release that indicated nonfarm payrolls declined 345,000 jobs compared to over 600,000 for each of the three prior months. Experts now think that the U.S. economy, which was dropping at an annual pace of around 6% in 4th quarter 2008 and 1st quarter 2009, has improved to a decline of around 3% in the quarter just ending and will become positive after that.

Another helpful thing has been a continued policy of low interest rates by the Federal Reserve (and central banks worldwide). Rates on savings accounts and other assets seen as riskless are so low that investors have found themselves accepting some risk in order to earn higher returns. Our entire system is based upon the risk/return equation, so it is nice to see the markets become more rational.

Fiscal policy has also helped as stimulus programs of the U.S. and other countries have helped to put money and spending into the economy. China has been the most successful with this as their 4 trillion Yuan stimulus (amounting to 12% of GDP over 2 years) has led to strong recovery as reflected in a 9% increase in May industrial production (as compared to May 2008). The World Bank recently revised its 2009 China growth forecast from 6.5% to 7.2%. Investors in China have been rewarded with a market that is up about 35% so far in 2009 (as measured by the Greater China Fund GCH)—compare this to the S&P 500 up about 4% for the same period.

What matters is where we go from here. For that we return to the key themes we have been developing since last fall. Our themes for how we invest client money include:

  • Developed countries will be faced with weak consumption as consumers deleverage and increase their savings rate to help restore lost wealth.
  • Emerging countries have a growth advantage with an emerging middle class, high savings rates (that can be redirected towards consumption) and low government debt.
  • High budget deficits will lead to increasing levels of government debt to GDP resulting in a weak U.S. dollar (and weak currencies of most other developed countries).
  • There is an increasing possibility of significantly higher levels of interest rates in the U.S. and other countries where government debt to GDP increases materially over the next decade or more.
  • There is a risk of much higher inflation (after 2 to 3 years needed to clear excess capacity) if governments worldwide don’t skillfully remove monetary stimulus.

It is important to understand that human behavior results in markets that overdo things on both the upside and downside.

This brings us to “what are we doing now?” Our approach has been to closely monitor worldwide economic and market events to either validate our themes, or cause us to change them. The above themes, which we believe events have validated, have led us to establish significant positions in emerging market equities (we like these for their better growth prospects and the ability to diversify away from the U.S. dollar). We also took sizeable positions in high yield bonds when the price of these went so low (and interest rates so high) as markets reflected the overreaction of investors fleeing risk. Our client portfolios have a reduced level of U.S. equities (as compared to a “normal” level) due to our concerns over a weak economy and a weak U.S. dollar. We continue to consider further diversification away from the U.S. dollar in form of investments like gold or managed futures. Given our concern over possible significant levels of inflation down the road, we are also evaluating a possible return to PIMCO Commodities Real Return fund, which combines a commodity position with Treasury Inflation Protected Securities (TIPS).

As of the end of June we have made no significant changes to client portfolios over the past 30 days. You can see the themes we see developing and some of the investments we are considering to act on those themes, however at present we are content to stay with what we have already done.

We are also very busy on the wealth planning side of our services. The unusual market conditions have created significant opportunity in high net worth scenarios to implement strategies that permit transfer of significant wealth to future generations without the cost of estate taxes that can take 50% from beneficiaries. These same unusual market conditions have created the need for us to help clients clearly evaluate their plans for retirement and other life goals and make changes wherever necessary. Our firm has professionals dedicated to providing these planning solutions and they are working very hard to add planning value where we can.

Friday, July 10, 2009

Proposal to impose fiduciary standard on broker-advisers heads to Hill - Investment News

Proposal to impose fiduciary standard on broker-advisers heads to Hill - Investment News

In a statement regarding the draft legislation as put forth by the Treasury Department, they said “The legislation outlines steps to establish consistent standards for all those who provide investment advice about securities, would improve the timing and quality of disclosures about investments, and would require greater accountability from securities professionals (our emphasis added).

We think it is quite remarkable that the administration is clearly saying the fiduciary standard is the preferred way to serve the best public interests. One can only hope that the big brokerage firms and other special interests won't be able to get this removed or watered down in what eventually passes through Congress.

"Safe" investing in U.S. Treasurys?

When risk assets all over the world collapsed in price in 2008, many took refuge in U.S. Treasury instruments. As a result the 2008 return for the index representing various maturies of U.S. Treasurys was 13.7%. The 2008 return on the Treasury bonds with 30-year maturities was an eye-popping 41.3%.

2009 is a different story. Investors have found that investing in Treasury instruments can have a downside also as interest rates have increased and driven prices down. For the 6 months ended June 30,2009 the weighted index of all U.S. Treasury securities has gone down 4.3%. Even more dramatically, the YTD 2009 return on 30-year maturity Treasurys is a negative 20.3%.

So much for the safety of U.S. Treasurys!

Monday, June 29, 2009

Projected U.S. Budget Deficits Understated

Can there be a subject more dry than that of the U.S. Budget? But this is something that affects all of us. If the United States continues to run high levels of budget deficits into the forseeable future, it can lead only to higher interest rates and the depressing effects of those high rates on our economy. The 2010 budget is on the web at http://tiny.cc/U4qmp. If you visit this site be sure to click on the "Updated Summary Tables". Go to table S-1 where after a projected deficit for the fiscal year ending 9-30-2010 of $1.8 billion the ratio of debt to GDP is forecast to be 59.9%. Now look out to 2019 where the debt to GDP is forecast at 70.1% which could be acceptable, but still a substantial increase from 9-30-2008 when it was 40.8%. No, the real concern is the level of GDP growth that the Obama administration has assumed in getting to these results. For that you must go to table S-13. There you can see projected GDP growth for 2010 of 3.2%, 2011 through 2013 all in excess of 4%. No responsible expert has indicated growth anything like this. So we can count on lower GDP growth, much higher deficits and much higher debt to GDP ratios. And this will lead to higher interest rates. You can see in table S-13 that the rate assumption for the 10-year Treasury note is 5.2% for years 2013 and after. We question if anybody will lend the U.S. money at that rate if our budget deficit (and therefore our borrowing) is growing as rapidly as it would in a low GDP growth environment. With higher levels of debt and higher interest rates, the mere interest cost on the national debt will begin to crowd out other important items. It seems Congress and the administration are content to leave that problem for others to figure out in the future. How very unfortunate.

Friday, June 19, 2009

Obama's plan includes fiduciary standard for brokers

http://tinyurl.com/kvza6l

One of the outcomes of this financial upheaval is a revisit of regulatory governance at all levels of financial services. Although this is just in the proposal stage, and must work its way through Congress, it is encouraging to see the White House this week advocate for a fiduciary standard for brokers-- meaning they must act in the best interest of their clients. Presently, brokers are governed by a much lower "suitability" standard. Registered invesment advisers (such as Payne Wealth Partners) are required to operate to a fiduciary standard. For more on the subject of fiduciary, visit
http://www.focusonfiduciary.com/.

Thursday, June 18, 2009

Retirement at the Tipping Point

http://www.agewave.com/RetirementTippingPoint.pdf

The link above is to a May 2009 published study titled "Retirement at the Tipping Point" and co-authored by Ken Dychtwald PhD, CEO and founder of Age Wage, a firm founded to study aging and its implications. Interesting in the responses from the 2,082 people surveyed was (1) those not yet retired now plan to postpone their retirement an additional 4.2 years, (2) an estimate of 7 years will be required to return their investment portfolios to previous peak levels, and (3) the most important advice to next generation is to "live within your means". It is notable that only 18% had actively planned for and were confident about their financial future.

Monday, June 15, 2009

May 2009 Market Update (posted to our blog two weeks after sending to clients)









"Inflation and deflation in this levered world coexist nearly side-by-side.”
Bill Gross, PIMCO founder and co-CIO


Any review of today’s investment markets must include significant conversation on the subjects of both inflation and deflation. Deflation is defined as a continuing decrease in the prices of goods and services, such that consumers greatly slow their purchases as they wait for cheaper prices. Investors want to sell assets in a deflationary environment because they believe the future price will only become less. Inflation is the opposite condition, whereby buyers seek goods and services that are increasing in price. Investors want to buy assets in an inflating environment, as they believe the future asset price will increase.

Debt is an important consideration as it relates to inflation and deflation. In a period of deflation, debt magnifies the losses of the investor, while in periods of inflation debt magnifies gains. Too much debt can cause deflation, as borrowers are forced to sell assets to pay down debt and those sales cause the asset prices to decrease in a deflationary spiral. This is exactly what happened in the Fall of 2008.

Governments worldwide, led by the U.S., are trying to “reflate” the markets to fight deflation. Key steps include record low interest rates, spending stimulus programs, central bank asset purchases, financial institution support and direct investment in industries such as autos. Without these steps the problem of deflation could have become deep and prolonged. Most experts today feel that the risk of such a deflationary “depression” is now very minimal.

So here we are on May 28, 2009 (S&P 500 closed at 907) with asset prices significantly above the lows reached on March 9, 2009 (S&P 500 closed at 676). The fact that the S&P 500 is 34% higher in less than a three month time period tells us that the reflation efforts by governments have enjoyed some good success. However, there are many issues for investors to be concerned with going forward.

One key issue is how and when governments will withdraw their support of the markets. If support is withdrawn too soon or too suddenly, an economy that is recovering could dip back into recession (thus the concern this might be a “W recession” of down-up-down). If support is withdrawn too late or too slowly, inflation can heat up. Certainly policy will not be handled exactly right.

Markets have begun to reflect some of these concerns. The interest rate on the 10-year U.S. Treasury Note is 3.7% today, compared to 2.3% at December 31, 2008, as markets begin to wonder if the program of Federal Reserve “quantitative easing” will have sufficient Fed buying of Treasuries to keep rates low. The average 30-year mortgage rate nationwide has increased to about 5.4% after recently being below 4.75%. The U.S. dollar, which rose significantly as the safe haven currency while the world sold risk-based assets, has declined about 10% since March 9th (versus a basket of foreign currencies).

At the same time, deflation risks are still present. An important risk is that imposed by the low percent-of-capacity at which economies are operating. In the U.S. an April decline in manufacturing industrial production marked a total decrease of 16% since its late 2007 peak even though the total decrease in U.S. real GDP from the top in 2007 to now is still less than 3%. In countries such as Taiwan and Singapore the circumstances are much direr as they have seen their real GDP decline by over 10%, thus crossing the line into official depression.

A recent U.S. consumer confidence indicator showed a sizeable increase, and the markets responded positively. Looking behind those numbers reveals that much of the increase in consumer confidence comes from a big increase in the “expectations” portion of the measure. This sets up a possible disappointment for consumers if those expectations of an improving economy aren’t sufficiently realized and risks a further future pullback in consumer spending.

So we have a world economy that is in somewhat of a tug-of-war between deflation and inflation. Government policymakers will have to do the almost impossible task of handling policy in a fashion to avoid fueling too much of either. Markets are encouraged by the reflation steps taken so far, but they show their concern about where things are headed by a significant increase in interest rates. Consumers are beginning to show signs of improving sentiment, but their fragile psyche could be damaged easily by signs of additional economic weakness.

The markets have come a long way since the lows of early March. Our portfolios have been rewarded with high levels of returns in emerging market equities and high yield bonds. These are two asset classes we have shifted more money into over the past six months. Much can still go wrong, and we are still of the opinion that our April reduction in large company U.S. stocks in favor of quality bonds was the right type of portfolio insurance. At present we are making no additional changes in client portfolios, but are evaluating a variety of possible holdings including those that protect against U.S. dollar weakness and inflation.

We also continue to update client wealth plans so that we can evaluate client goals and how they are affected by these challenging markets. Further, in those specific client situations where it makes sense, we are using the low stock market levels to model and recommend high-end planning techniques such as Roth IRA conversions and wealth transfer tools like Grantor Retained Annuity Trusts (GRATS).


Wednesday, May 27, 2009

Contacting Us

For a no-obligation consultation with one of our professionals, call Payne Wealth Partners at 812-477-6221.