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.

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:

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  September 1, 2008 - Dow Jones Industrials Average (DJIA) begins the month at 11,543
  
  
  
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  September 7, 2008 - Fannie Mae and Freddie Mac are placed in conservatorship.
  
  
  
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  September 15, 2008 - Lehman Brothers declares bankruptcy. DJIA drops 504 points.
  
  
  
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  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.
  
  
  
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  September 17, 2008 - DJIA drops 450 points.
  
  
  
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  September 18, 2008 - The SEC suspends short selling of financial stocks.
  
  
  
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  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.
  
  
  
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  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.
  
  
  
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  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.
  
  
  
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  September 29, 2008 - Vote on TARP in House of Representatives failed to pass. DJIA drops 778 points.
  
  
  
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  September 30, 2008 - DJIA closes at 10,850 about 6% loss for the month.
  
  
  
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  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!

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.

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.

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.