Rule of Thumb

There has recently been significant turmoil in the ongoing debate over public pension funds.  Primarily the conversation has centered around what level of pension benefits should be guaranteed for workers in the future.  There is also another issue that can be more subtle in nature- the rate of return assumed by actuaries that measure the adequacy of existing pension funds in relation to promised benefits. 

The lower the assumed future investment rate of return used, the more underfunded a pension system is measured to be (and vice versa).  The “rule of thumb” in the past has been to use historical average investment return figures.  The question is- “are historical returns representative of future results or are we kidding ourselves?”  We seem to agree with others in that it will be a more challenging world ahead- both for investment portfolios and personal financial planning.

Rules of thumb are generic, easy and fast- but also dangerous when plotting future financial results.  To learn more about the debate, visit http://tinyurl.com/6eusmbd to see a timely Wall Street Journal article on the topic.

February 2011 Market and Planning Update (Posted to our blog two weeks after sending to clients.)

“It’s not what you look at that matters, it’s what you see.”

Henry David Thoreau

PLANNING COMMENTARY

In a world that is filled with “the day’s hottest stock,” trading tools promising to make you millions and financial news and commentary aimed at appealing to one’s hope for “the easy road” it’s easy to become caught up in account balances and daily performance.  When looking at an investment account statement many see a dollar figure and a resulting gain or loss for the period.  The popular press and the typical financial advisor wants you to believe this is all that matters and it’s all you need to “see” when looking at your financial vitals- it’s easy to sell and easy to catch your attention with. 

But what good is an “investment-only” focus if you don’t know how you will accomplish your goals?  We’re firm believers that a truly comprehensive, constantly updated wealth plan must accompany investment statements as the tool needed to translate those numbers into what’s really important in your life.  College education for kids, an early retirement, travel with kids and grandkids, the vacation property you’ve always wanted- these are the things you should see.  These are the things that really matter.  You’re life is bigger and more important than an account balance. 

Our wealth planning division continues to work specifically to provide that perspective to our clients through wealth planning that translates the numbers and financial noise into actionable steps needed to accomplish financial dreams.

    

MARKET COMMENTARY

We’d like to share with you what we see in the municipal bond market.  Historically, municipal bonds have been considered a very high quality investment.  Over the past few months municipal bond prices have declined and interest rates have increased across all maturity ranges.  The initial sell-off occurred in November and was due to an increase in Treasury interest rates.  More recent weakness has been fueled by relentless negative media attention given to the potential for rising defaults.  Investor nervousness about the potential for more defaults has led to massive redemptions of municipal bond funds, driving bond prices lower. 

We believe many of the media reports and negative commentaries have greatly exaggerated the potential default risks.  Yes, careful credit evaluation is more important than ever and challenges do exist in many states (California and Illinois) and cities (Vallejo, CA and Harrisburg, PA).  However, in our opinion these examples represent localized problems, not systemic risks that will lead to wide-spread defaults across the entire municipal market.

Today, municipal bonds comprise a nearly $3 trillion market, which is made up of thousands of issuers in hundreds of healthy sub-markets.  Most municipal debt is structured to be as immune as possible from economic swings, and many issuers have set aside rainy day funds to help them weather difficult economic cycles.  On average, municipal debt service represents less than 10% of most state budgets.  In the case of general obligation bonds, payments of interest and principal are backed by the full faith and credit (i.e. taxing power) of the issuer.  It should also be noted that State governments cannot file for bankruptcy, cease to exist, reorganize, or be liquidated like a corporation.  State governments have a requirement to balance their budgets each year.  If budget shortfalls occur, then debt service payments carry a higher priority than other expenditures. 

In our opinion the market is pricing in a higher level of defaults than will actually materialize.  The recent rise in municipal bond interest rates and subsequent decline in their prices has created an opportunity for fixed income investors to buy quality securities at cheap prices, especially for those in higher income tax brackets.

CONCLUSION

Don’t let those that sell investments convince you that investment success is all that matters.  Setting and achieving family goals with the help of a comprehensive, constantly updated wealth plan is just as important as any investment concept.  Note that when considering investments, Payne Wealth Partners sees significant opportunity in the higher interest rates available in properly chosen municipal bond holdings due to a recent municipal bond sell-off. 

Price of Gas

When filling up your car, have you ever wondered what portion of the price of gas is comprised of crude oil?

According to the U.S. Department of Energy, about 67% of the price of a gallon of gas is comprised of crude only.  The rest of the cost comes from refining, taxes, distribution and marketing. 

From the Low

Yesterday, March 9, 2011, was the two year anniversary of the current bull market for the S&P 500 stock index.  From its bear market low on March 9, 2009, the S&P 500 has gained + 95.3% through the close of trading last Friday, March 4.  This return calculation is based upon the price change of the raw index and does not include any reinvestment of dividends.   

The + 95.3% return for the S&P 500 is its best two year gain following a bear market low for all bull markets since 1949.  No other two year result has produced a gain that exceeded + 68%.

Source: BTN Research.  The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the US stock market. 

Binge Spending

Typically a “binge” of any sort is considered unhealthy for the individual in question and those around them.  The Boston Globe published today a commentary written by Senator Scott Brown of Massachusetts that refers to Washington’s “binge spending habits” (to see the full article, visit http://tinyurl.com/4ggc9n4). 

Not only has federal, state and local spending been (for some time and continues to be) at a level that can easily qualify as “binge spending,” but it has also become a habit.  One could argue this is no more than a “bad habit” that we can take some time to “try to work on” or that it is a self-destructive addiction that requires immediate intervention.  It seems the majority of individuals seeking an honest evaluation of our fiscal health recognize that the latter of these two interpretations is, in fact the truth.    

What does $100 per barrel oil mean for the US?

The recent rise in the price of oil to above $100 per barrel will not send the economy back into recession according to Economists Paul Ashworth and Paul Dales from the research firm Capital Economist.  Over the past month we’ve seen a 14% increase in per barrel price of oil, and it has risen 28% over the past year.  This is a small increase in comparison to prior spikes that preceded previous recessions (see chart below).

Years	Rise in the Price of Oil	Time Period of Increase
1973 – 1974	240%	over a few weeks
1978 – 1979	150%	over six months
1990	150%	over three months
1999 – 2000	75%	over six months
2007 – 2008	100%	over 12 months
Presently in 2011	28%	over 12 months

One reason for caution this time around is that oil is not the only commodity to increase in price.  Agricultural prices are up 8% in the past month and by nearly 90% over the past eight months.  So, even though oil prices remain well below the 2008 summer peak of $145 per barrel, agricultural commodity prices are hitting record highs.  The two economists cited above believe that the gains in both agricultural commodities and oil prices will have only a modest impact on inflation and economic growth this year. They forecast a 0.4% increase in inflation and a 0.3% reduction in economic growth if prices hold at the current levels. 

Of course, the price of oil could rise further.  But equally, if tensions in the Middle East subside they could fall back.  Either way, the price of oil would have to rise much higher too seriously threaten the US economic recovery. 

We believe the key risk is how consumers actually react to the higher price of oil.  Given media coverage, at what point will consumers become nervous and feel the need to pull back spending?