Monday, June 21, 2010

Currency exchange rates

Since the U.S. dollar is the reserve currency of the world, we as U.S. citizens tend to not think much about rates of exchange into other currencies.  Oil is priced in dollars, gold is quoted in dollars and there are many countries in the Caribbean and the Americas where prices at local shops and restaurants will be presented in dollars. 

We in the U.S. are beginning to understand that currency exchange rates matter greatly.  Currency is where the basic economics of any country come to rest.  Those countries with lower fiscal deficits (or even surpluses) and lower trade deficits will have currencies that grow stronger as compared to the weaker countries.  This means investments denominated in those strengthening currencies will also perform better, all other things being equal.

Sometimes governments and central bankers will effect policies intended to have a certain currency result.  For example, some countries may want a weaker currency to help stimulate exports or some may want a stronger currency to help attract and retain investment.  Eventually any such policies give way to the forces of the marketplace, if they are in any conflict with underlying economic facts.

Last Saturday China indicated it would permit its currency to float (within certain constraints) as opposed to their policies of the last 2 years of fixing the exchange rate to the dollar.  The market is responding today with increases in Chinese bonds and equities.   The Chinese currency situation helps point out the importance of giving serious consideration to the effect of currency exchange rates in the planning and implementation of any investment program.

Tuesday, June 15, 2010

May 2010 Market and Planning Update (Posted to our blog two weeks after sending to clients.)

Solvency is maintained by means of a national debt,
on the principle, “If you will not lend me the money,
how can I pay you?”
Ralph Waldo Emerson, philosopher and poet


As with prior letters, this letter will address both planning and investment market issues. At Payne Wealth Partners we believe proper handling of both planning and investments is important for clients to best achieve their goals.

PLANNING COMMENTARY

Like many things in life, you get out of wealth planning what you put into it. When we prepare client wealth plans we put particular emphasis on getting our facts and assumptions straight- there’s nothing we’re more serious about getting right. Some “plan inputs” are facts yet some must be assumptions- life expectancy, investment rates of return and tax rates, just to name a few.

What separates a meaningful plan from a plan not worth the paper it’s printed on is the independent critical thinking involved in determining what those assumptions should be (the facts are the easy part). As to investment rate of return- the “industry standard” seems to be, even after all the market turmoil of late, to “take the historical average” when determining what to expect from an investment portfolio in the future. While this is certainly the easiest approach (historical rates going back to the early 1900s are published annually by providers such as Ibbotson) it’s hardly adequate when determining the direction of our client’s financial future- and at this point seems overly optimistic.

Our approach has been to revisit these assumptions at least annually (this has been semi-annual revisits since 2007 due to market swings). Historical averages are a very small piece of the puzzle, while current market prices, economic outlook and macroeconomic trends are the vast majority of the puzzle (historical returns truly are not predictors of future performance!). As a part of this process there is always a vast amount of technical information gathered along with commentary from economists and thought leaders we follow. This aids us in formulating our best estimates to use in planning.

The point is that we must be intellectually honest with our clients about where investment markets will take them in the future, and how much we can rely purely on market returns to fuel financial goals. In the 1990s it was customary to see plans using average annual portfolio return assumptions well in excess of 10%. To our dismay we see others in our industry using similarly high returns even today, while our portfolio return expectations are much less than this. While it may be fun to look at how big the numbers can get when using a high return assumption, it certainly doesn’t aid in making prudent, informed decisions. We will continue doing our best work to determine the appropriate returns to use while planning our clients’ financial futures as we seek honest answers grounded in independent, unbiased thinking.

MARKET COMMENTARY

The month of May saw the S&P 500 decline 8.2% amid increasing concerns over European debt problems and their possible effect on worldwide growth. Greece received most of the media attention, but several European countries have high levels of debt relative to their overall economy including Portugal, Italy, Ireland and Spain. Observers have coined a term for these countries, PIIGS. With the concerns over PIIGS debt the Europeans together with the International Monetary Fund set up a one trillion dollar facility to purchase debt when needed; markets initially reacted in a positive manner as European stocks, currencies and debts appreciated, but by months-end all had resumed their decline.

Receiving less attention, but important nonetheless, are China’s efforts to control inflation and rapidly increasing real estate prices. During May China implemented rules requiring high levels of down payment on 2nd and 3rd homes and on May 31 announced what looks to be their first property tax at the homeowner level. May saw the Chinese Shanghai index drop about 10% to bring the year-to-date decline for the index to 22% as investors worry how much China’s economic growth rate will drop.

The “flash crash” also happened during May, with the Dow declining almost 1,000 points in just minutes and then recovering a majority of the losses before the day’s close. The regulators still don’t have a full explanation as to what happened, but computer generated orders undoubtedly played a major role. Unexplained volatility can only harm investor confidence in an already fragile market.

Despite the many problems, there is a positive backdrop of U.S. companies showing nice profit growth (1st quarter was 57% growth versus 1st quarter 2009), low inflation, and low interest rates. It would not be surprising to see stock price gains if the news flow would become a little less negative. But we are much more focused on key long-term themes to build our client portfolios, with such themes including:

• Most developed economies have issues with debt due to present historically-high levels combined with new debt to fund ongoing deficits, all exacerbated by the 2008 economic crisis. The better government debt to own over time is that of the emerging economies who as a whole have a debt to GDP ratio of 37% while developed markets are at 94%.

• Although the U.S. dollar has seen recent strength in a flight of money to perceived safety, expect the dollar to be pressured over the long-term (when compared to countries with sound fiscal policies) by dollar creation to fund deficits.

• Shorter maturities of debt are more attractive (as compared to longer term) since the trend of declining interest rates in place since 1981 will at some point reverse and become one of interest rate increases which could last for decades.

• Well managed companies (as chosen by experienced managers) will benefit from present economic challenges by gaining market share and making strategic acquisitions. Investments in these companies are favored to earn an above average return over time.

• Equity investments in emerging economies will benefit from their higher levels of growth, but will experience significant volatility.

These themes are expected to significantly affect our portfolio management decisions going forward and were reflected in our recent decision to increase portfolio allocation to emerging country debt. To get a better sense of our thinking you may wish to sign up to receive our weekly blog posts via email by visiting www.paynewealthpartners.com.

Friday, June 11, 2010

Our staunch ally

Remember Iraq in 1990 (Desert Shield/Desert Storm), then Iraq II in 2003 (Operation Iraqi Freedom), then Afghanistan (Operation Enduring Freedom), and so on.  There was one country that always backed the U.S. and that country was the United Kingdom.  Visit http://icasualties.org/oef/ and see that Afghanistan fatalities suffered by the U.K. ranks second only to the U.S.

Now we have the BP oil spill and the dramatic effects on the Gulf coast.  There is no doubt that BP has a significant and primary responsibility for containing the spill and paying damages.  However, President Obama has shown his seemingly politically contrived anger at BP in a variety of ways including condemnation of dividend payment and demand for payments to those idled by Obama's ban on offshore drilling.

BP has turned to the British government for help and received same as demonstrated in the attached article from yesterday's Financial Times http://tiny.cc/eheo4.  We can only hope that President Obama and his advisors remember who our most staunch ally is and contain their politically motivated rhetoric while continuing to seek solutions to the spill.

Friday, June 4, 2010

Interest rate history might help today's bond investors

This is a chart of the 10-year US Treasury interest rate going back to 1962.  The rate started 1962 around 4% and over the next approximately 20 years rose to a high of almost 16% in 1981.  The general trend in rates for the 30 years since the 1981 high has been down, with the 10-year US Treasury now yielding approximately 3.2%.

Returns from bonds are helped by declining interest rates and hurt by rising interest rates.  Concerned about stock market volatility, investors moved $379 billion into bond funds in 2009 (while withdrawing $9 billion from stock funds).  Could it be that investors are increasing their bond allocations just before bond returns are again harmed by rising interest rates (like the 20 years starting in 1962)?  No one can say what future interest rates will do, but the above chart does give some nice historical perspective.