Tuesday, November 30, 2010

What is it like to be German today?

First it was Greece and now Ireland. Who’s next? On Sunday the European Union (EU) agreed to give $89.4 billion in bailout loans to Ireland to help it weather the storm created by its massive banking crisis. Two of the 16 euro-zone nations have now sought financial support from the EU and the International Monetary Fund (IMF). Portugal and Spain are rumored to be next on the list of countries needing financial assistance. Germany has reluctantly supported the bailouts so far. The question is: Will they continue to offer their support if Portugal and Spain need a bailout too?


Germany is in a decent fiscal position today compared to the rest of the euro-zone with a Debt to GDP ratio of about 63%. Reference www.visualeconomics.com/gdp-vs-national-debt-by-country/ Germany has been proactive with their fiscal responsibility. They have a very hardworking culture and several years ago increased their “normal” retirement age from 65 to 67 to compensate for a rapidly ageing population that is living longer. However, in neighboring France a recent plan to raise the official retirement age from 60 to 62 provoked massive protests and outcry. Could the European Union shrink from 16 nations to something smaller so that Germany doesn’t have to continue supporting the bailouts of weaker countries like Greece and Ireland? At what point does the market start to demand higher interest rates on Germany’s debt because of the sins of their neighbors?

Certainly additional fiscal tightening is needed across the region. Tax increases are also likely to occur. Fiscal austerity is a must but does it threaten the structure of the EU or push the euro-zone back into Recession? Expect the financial problems of Europe to play out over a number of years and keep an eye on Germany as the key opinion in terms of both future bailouts and any eventual changes in the makeup of the European Union.

Tuesday, November 23, 2010

Wake up and smell the coffee

The Federal Deficit Commission issued it’s initial draft proposal earlier this month that began to lay the groundwork for it’s recommendations to cut the federal deficit by a cumulative $4 Trillion by the year 2020 (the full draft can be found here: http://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/CoChair_Draft.pdf). As many predicted, the draft proposal included a number of hotly contested recommendations, many of which had to do with cuts in “entitlement spending.” For example, the Social Security “Full Retirement Age,” which is the age at which one can collect unreduced Social Security retirement benefits, would increase to 69 by 2075. To put this in perspective, the current Full Retirement Age for those retiring today is 66. Note that actuarial estimates for increases in longevity are projected to fully offset these changes.

Of course there is usually broad public outrage when it comes to reducing “entitlement” benefits, whether or not it is needed or makes intellectual sense. An article titled “Taming Federal Deficit will require shared sacrifice” makes an excellent point that the only solution to the financial challenges our country faces is shared sacrifice (this article can be found here: http://www.thenewstribune.com/2010/11/15/1425125/taming-federal-deficit-will-require.html). We can all hope that U.S. leaders will have the courage needed to make tough decisions and help everyone realize that it is shared sacrifice that will make our country stronger and that without it, political bantering and further deterioration of our financial health is imminent. To the extent sacrifices must be made, how will they impact personal wealth plans in the future? How much should one depend upon Social Security income in their planning? One thing is for sure- it's time for all of us to wake up, smell the coffee, and get to work being proactive about our future. 

Monday, November 15, 2010

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

Before anything else, preparation is the key to success.
Alexander Graham Bell, inventor 1847-1922

MARKET COMMENTARY

In October, U.S. stocks as measured by the S&P 500 returned 3.8% representing about one-half of the year-to-date return of 7.8%. Developed international markets had a similar October return of about 3.6%, although their year-to-date return of about 5% is not as strong as in the U.S. Emerging markets enjoyed October gains of 2.8%, but still are the year-to-date equity return winners at about 12%. October’s equity gains can be at least somewhat attributed to the market’s expectation that further quantitative easing by the U.S. Federal Reserve will be good for stocks.

Investment grade bonds in the U.S. returned about .7% in October, bringing their year-to-date returns to parity with U.S. stocks at 7.7%. Expectations going forward for bonds are now tempered with the concern that present low yields and quantitative easing will combine to result in upward pressure on bond yields and downward pressure on bond prices and returns.

Returns on both stocks and bonds in the U.S. of about 8% for the first 10 months of 2010 likely exceed investor expectations going into this year, and this all leaves everyone with the question of how to position portfolios going forward. In this we must concentrate on proper preparation. At Payne Wealth Partners we have certain key investment themes for the long-term, however we also must recognize the possibility, or maybe even probability, of short-term volatility to the downside. In the short-term we feel investors must be prepared for possible negative market reaction due to:

• Disappointment if the Fed’s quantitative easing program is smaller or more tentative than expected

• Discouragement with election results or actions by Congress and the White House for the remainder of 2010 and beyond

Still, to us the long-term themes apply. Those key themes should guide how portfolios are constructed, and any significant volatility in the short-term should be viewed as an opportunity to reposition portfolios to further address the long-term themes. These themes include:

1. Emerging market economies will continue to grow more strongly than the rest of the world.

2. Emerging market currencies will have long-term strength against slow growth, debt-burdened developed markets.

3. Active mutual fund managers can add substantial value as they find those companies that will be the winners in a world that rewards winners and punishes losers more than ever before.

Our guidance to investors and to ourselves: be prepared for short-term volatility, but use it as opportunity to position for maximizing long-term returns.

PLANNING COMMENTARY

As election day nears, there are numerous financial concerns among U.S. citizens related to income taxes and/or estate taxes and, more specifically, how any changes will affect each family’s financial future. A recent Wall Street Journal article titled Key Tax Breaks at Risk as Panel Looks at Cuts details several income tax benefits rumored to be at risk due to the deficit commission’s goal to balance the federal budget by 2015. Potential recommended cuts include the mortgage interest deduction, the child tax credit and the ability of employees to pay health insurance premiums using pretax dollars. These possibilities – along with the looming departure of the Bush tax cuts which would affect not only ordinary income tax rates but also long-term capital gains and qualified dividend income – may cause significant increases in income tax rates in the near future.

When considering how all these possibilities relate to one’s personal financial situation, what wealth planning strategies should (and should not) be considered in light of these (and other) potential changes? What if tax rates do not increase- how can we concurrently be prepared for this possibility? We continue to work to help our clients understand the impacts that legislative changes have on their overall financial goals as they occur. More importantly, all of the continued uncertainty speaks to how important being prepared for all the possibilities is to successful completion of long-term goals. For example, the mixture of assets one creates and manages on their balance sheet as it relates to taxes (taxable, tax-deferred, tax-exempt, etc.) is a critical tool in remaining prepared for change and must be managed continuously as it relates to one’s goals and circumstances.

The best way we’ve found to accomplish this is to continue updating our clients’ personal wealth plans at least annually and make continuous recommendations to adapt. It’s one thing to react to happenings, it’s another entirely (and of much greater value) to proactively address potential changes and be prepared in advance. We’ll continue to provide our best guidance so that our clients can remain prepared for these many uncertainties.

Monday, November 8, 2010

Global Economic Rebalancing

Later this week, President Obama and Treasury Secretary Timothy Geithner join other world leaders in a G-20 meeting in Seoul, South Korea.to address an agenda (http://tinyurl.com/24odlxl ) that includes "build on this less-than-robust recovery and further enhance international cooperation to generate strong, sustainable and balanced growth."  The world for some time now has grown in an unblanced way, with emerging countries like China enjoying above average savings and investment but below average consumption, while developed countries like the U.S. had high levels of consumption and low levels of savings and investment.

Certainly, a rebalancing must occur.  However if that rebalancing occurs too rapidly, the effects of reducing consumption in the U.S. could cause significant global economic problems including another dip into recession in the U.S.  Each country sees the manner and timing of this global rebalancing differently. 

China and the U.S. are the 2 most important players in this rebalancing.  In China consumption represents approximately 36% of GDP, while savings and investment is about 50% of GDP.  Consider the U.S. where consumer spending is about 70% of GDP while the savings rate is around 5%.  There is a neat diagram of components of GDP at http://www.moneychimp.com/articles/econ/gdp_diagram.htm.

It will take a long time to rebalance China and the U.S. to something significantly different than their present components of GDP.  Also, the rebalance will periodically happen in sudden and unsettling fashion.  As governments take different approaches to the rebalance we should all be hopeful that G-20 and other vehicles can help the world avoid problems as much as possible.

Wednesday, November 3, 2010

Quantitative Tightening

The emerging market economies of the world are taking tightening steps, in part to offset the effects of the U.S. Fed's "quantitative easing".  Yesterday Australia raised interest rates by 1/4% to 4.75%.  Australia is widely viewed as a proxy for China given their commodities exports to the Chinese.  India has also raised rates with their central bank rate for short-term funds now at 6.25%.

These countries are worried about capital flows from the U.S. (and other developed markets) being enhanced by the increased liquidity from the anticipated next step of  Fed quantitative easing.  As capital flows to the emerging markets it will cause inflationary increases in all goods.  Increased interest rates and increases in their currency relative to the U.S. are two ways these emerging economies can fight inflation.

All of this reminds us that the effects of any market or policy changes are global.  The key for investors is to keep this global point of view in mind as they make portfolio decisions.