June 2011

June 30, 2011 11:00 a.m.
The Week in Review

The trading week and the quarter are winding down, and it’s been a very interesting week in the markets, economy, and world of personal finance. Let’s take a look at the highlights.

The Data

There were only a few pieces of economic data this week. The most interesting to me was the first report. It showed that household income growth is falling and falling rapidly. There still isn’t much private sector support for income growth, and the federal government’s enhancements to income are peaking or fading. In addition rising gas and food prices pinched incomes, causing households to reduce some savings and cut spending in other areas. It’s easy to see why businesses don’t want to expand and hire with so little potential for higher household spending. Also on the negative side was the Case-Shiller home price report. It showed a modest decline, indicating prices might be settling in at a new low instead of continuing the double dip. Unemployment claims also remained solidly above 400,000, verifying that businesses still aren’t hiring.

On the positive side, energy prices continue their recent decline. Also, the Chicago Purchasing Manager report this morning was very strong. It’s tough to interpret this, since it covers only the Chicago region and is an outlier from other recent reports.

The overall impression from the data is a slowly growing economy in which the growth rate is likely to stay at 0% to 2% annually. The recent impediments to growth are partly temporary (higher commodity costs, the effect of the Japan earthquake) but others are longer-lasting (fading stimulus measures, deleveraging, attempts to reduce growth in emerging markets).

The Markets

The investment markets didn’t seem concerned about the data and appear to be looking forward to a new burst of growth. The plan to again defer a resolution of the Greek debt problem was viewed positively. Stocks rose all week and could rise enough to register positive returns for the quarter. Treasury bond yields rose, giving Vanguard Long-term U.S. Treasury a loss of over 2% for the week. iShares COMEX Gold Trust declined about 2.5%. Essentially flat for the week were WisdomTree Dreyfus Chinese Yuan, DoubleLine Total Return Bond, and TCW Strategic Income.

Hussman Strategic Growth had a modest loss for the week, since it’s largely hedged, but has good positive returns for the month and the quarter.

I don’t see the last week or so as a reversal of the previous trend. This is a period of light trading volume, so it’s not likely to establish a new trend. Instead, I think the rise in stocks and decline in bonds are the result of misplaced relief at a temporary solution to the Greek debt problem and a brief relief rally or correction after a couple of months of steady stock losses and bond price gains.

Some Reading for You

The solution to the Greek debt problem is both short-term and a technical or effective default. But there’s still a long way to go for a real solution. U.S. investors shouldn’t be complacent. It could affect your conservative money market funds. Even the regulators are starting to notice. Here’s a summary of how the Greek problem could affect your money market fund.

For some years I’ve told those approaching their silver years to establish relationships with good doctors. As you get older it will be harder to find a doctor who’s willing to accept new patients, especially those who pay with Medicare. Here’s new evidence that doctors are turning away potential patients whose insurance offers low payments.

The Federal Reserve continues to punish savers by keeping interest rates low. You have alternatives. We’ll explore these in a coming issue of Retirement Watch. For now you can read about some alternatives here and here.

June 27, 2011 01:30 p.m.
The Weekend in Review

Is it, as Yogi Berra once said, déjà vu all over again? There was a seies of headlines over the weekend that sounded quite a bit like those from the financial crisis. Perhaps a new financial crisis is not upon us, but there are strong signs that the first financial crisis is not over. Consider these articles:

The Next Mortgage Bombshell by Jonathan Laing in Barron’s: Housing prices are falling again to post-bubble lows, and a wave of foreclosure properties (the shadow inventory) hovers in the background to suppress prices and perhaps lead the next downturn. Laing says the result of this will be major losses for the mortgage insurance companies. Mortgage insurance used to be a sure moneymaker, something any idiot could make a fortune doing. May be not anymore:

The next domino likely to topple is the so-called private-mortgage-insurance industry, which permits buyers to purchase homes without making a full 20% down payment. Private mortgage insurance covers the first 25% of a mortgage’s value against default, plus accrued interest. Some $700 billion of U.S. mortgages carry such insurance, with most of it owned by Fannie Mae and Freddie Mac and backed by the federal government.

The most at risk are the three companies that specialize almost exclusively in the coverage: MGIC Investment (ticker: MTG), Radian Group (RDN) and PMI Group (PMI). The other chief participants in the industry-Genworth, United Guaranty and Republic Mortgage Insurance-have the distinct advantage of having corporate parents with diversified business lines and more financial resources with which to buttress their businesses.

Debt Hamstrings Recovery by Tom Lauricella (The Wall Street Journal): This is a theme we’ve pursued in Retirement Watch for several years. The extreme levels of debt in the U.S. and Europe keep a lid on economic growth and will continue to do so until debt is down to the long-term average levels or less. People won’t use credit to finance purchases. They’ll buy only what they can afford out of current income, after allocating some to a savings rate that is higher than in the last decade. Those of you who’ve been reading my monthly missives regularly are familiar with the argument. But it’s unusual to see if in the mainstream financial media. The recent decline in economic growth is causing people to take a fresh look at the issue.

Around the globe, the inability of governments and households to reduce their debt continues to cast a shadow over Western economies and the financial health of individuals. Today, U.S. consumers have more mortgage and credit-card debt than they did five years ago, and the U.S. budget deficit is worsening. At the same time, European governments are having to throw billions more euros at Greece to keep it afloat.

The repercussions are likely to play out for years to come in the form of patchy economic growth, further government market intervention-such as last week’s decision by oil-consuming nations to release more oil onto the markets-and frequent financial-market swings.

The fundamental problem is that reversing the trend of piling on the debt requires some combination of cutting spending, growing income or the economy, and inflation. But wage growth is stagnant and home prices, which underpin much of the debt problem, are still falling.

Meanwhile, in a vicious circle, businesses aren’t hiring or investing because they know consumers are tapped out. Banks, for their part, are hoarding cash, being stingy with new loans.

Costly Rush Away from Risk by Serena Ng, Carrick Mollenkamp, and Aaron Lucch (The Wall Street Journal): It seems the big banks, especially the investment banks, were doing it again. Once the Federal Reserve began quantitative easing, the banks bought a lot of mortgage-related securities, especially on commercial real estate. They figured the Fed and the government were putting a floor on these assets, so they were safe.

The recent selloff, begun in April, was a jolt to Wall Street firms that thought they had found a safe haven in buying mortgage securities and selling them to clients.

After losing most of their value in the aftermath of the financial crisis, bonds backed by commercial and residential mortgages enjoyed a year-long rally, aided by investors who sought to counter the low-interest-rate environment by piling into assets with higher yields.

Then the market turned. The reasons were twofold: Early selling begat more selling, creating a downward spiral, and a string of bad economic news in the U.S., the earthquake in Japan and fiscal problems in Greece prompted investors to move from risky assets, traders said.

Bonds backed by subprime home loans in states such as California and Florida fell by 23% from April to June, according to pricing data from Amherst Securities. The ABX, an index that tracks the value of bonds backed by subprime home loans, tumbled 21%, to about 46 cents on the dollar, from 59 cents, according to data from Markit.

The question now for investors in Wall Street banks is whether the firms had bought sufficient protection against the mortgage-bond selloff.

Some folks never learn. These banks were preserved from liquidation by the government, and the same players largely were left in place. It seems these players have been making the same mistakes they made the first time.

This is why we’ve been conservative and selective in our portfolios the last couple of years. It was clear the problems weren’t solved. At best they were deferred. The Fed and the government were able to cover things for a while with stimulus. But there’s a limit to how long stimulus can last. It could be the recent downturn is temporary due to the problems in Japan and the slide in commodity prices. But I doubt that explains all or much of the growth reduction, and I wouldn’t bet my portfolio on it.

June 14, 2011 01:30 p.m.
Adjusting Our Portfolios

The July 2011 issue of Retirement Watch is scheduled to be posted on the web site on Wednesday, but I want to give you a preview of some changes in our  investment recommendations.

As you know, I’ve been expecting the economy to slow as the stimulus programs fade. I believe they did not accomplish their goal of carrying the economy until it could create sustainable economic growth without the support. But the weak data are coming in faster than I expected. I thought the economy had enough momentum at least to carry through 2011, but that might be too optimistic. The recent slower growth could be due to temporary factors, such as the Japan earthquake, but I doubt it. The economy is slowing.

I also remain concerned about the European debt crisis on one hand and emerging bubbles and overheated growth in China and other emerging markets.

In the July issue I’m recommending a sale of Needham Growth, though it’s avoided triggering the “sell below” price in the June issue. With the possible change in the economic picture, Needham Growth has more risk than I want to take. I’m recommending holding Dodge & Cox Stock but following the sell below price on it. I also recommend a sale of Harbor High Yield Bond.

We’re going to add new positions that I believe will profit from the coming currency upheavals I see developing. China will have to revalue its currency against the dollar at some point, so I’m recommending a purchase of WisdomTree Dreyfus Chinese Yuan (ticker: CYB). I’m also adding iShares COMEX Gold Trust to the portfolios.

Another new recommendation is Vanguard Long-Term U.S. Treasury Bond fund. I think the markets are under-estimating the reduction in economic growth. When the extent of the decline becomes clear, long-term interest rates will decline further, creating a profit in long-term treasury bonds.

Yesterday there was unusual movement in TCW Strategic Income. The fund was at $5.50 a week ago. On yesterday’s opening it fell to $4.95. But it quickly recovered much of that decline. It’s now at $5.25. There’s no news from the company or market to explain the move. Looking at the price chart, the fund fell sharply on very heavy trading volume at the market open, and then it recovered. It appears that a large investor or adviser decided to sell all its holdings at once. We retain our sell signal. Remember our sell signals apply to closing prices.

You’ll be able to read all this and more tomorrow on the members’ web site, but I wanted to give you a preview today.

June 3, 2011 10:00 a.m.
The Slowing Economy and Markets

This morning’s employment report made it obvious to everyone. Economic growth is slowing, and it might be slowing rapidly. For some weeks now, the economic reports have been an almost unbroken string of negative surprises. The reports not only were below expectations, many of them were significantly below forecasts. Economic growth never reached a very strong rate after the financial crisis. It was above average for a brief period, and then slid to around the long-term average. In the last few months growth slipped below average and now probably is below a 2% annualized rate.

Some analysts believe the recent slow patch in growth is temporary and largely due to Japan’s earthquake and the after effects. I don’t think that’s the case. The recent growth drop was too fast and too pervasive to be attributable to the production problems in Japan.

The U.S. economy was propelled out of the financial crisis by exports and manufacturing. These sectors benefited largely because the developing economies came out of the downturn faster and resumed their pre-crisis high growth rates. I’ve reported in the recent past about the divergences between large, export-driven U.S. companies and smaller U.S. businesses. The growth in revenues in U.S. companies primarily is from overseas sales, and the largest companies are earning more of their revenues outside the U.S.

The developing country governments now are seeking to slow their growth rates because of fears of emerging bubbles and rising inflation. That’s starting to put a small dent in exports and manufacturing, and that effect should increase as policies become tighter.

Also contributing to slower growth is the winding down of the fiscal and monetary stimulus in the U.S. The European debt problem and the uncertainty it creates are not positive for growth.

There doesn’t seem much appetite in the U.S. for another round of quantitative easing or further fiscal stimulus, but that could change. The private economy doesn’t seem able to generate sufficient economic growth on its own, so those attitudes could change. But we have to assume no further stimulus is coming and that the past stimulus might simply have borrowed investment returns from the future.

The questions for investors now are: How much will economic growth slow? How should we position our portfolios for this situation?

The answer to the first question has to be: We don’t know. Each of us can create possible scenarios and conclude one is more likely than the others. But there are too many variables and moving parts. And much of the future course of events depends on policy decisions by a number of government officials in the U.S and many other countries around the globe. Good decisions could substantially improve the picture, while bad decisions could land us back where we were in late 2008 and early 2009.

The safest course is to assume the coming years will have persistently low economic growth, below the long-term average in the U.S. Balance sheets in the U.S. still carry too much debt, so the deleveraging continues. The housing market is in the doldrums, and it’s going to stay there for a while. Businesses still aren’t hiring, and there are signs they’re slowing the rate of capital investment. New laws and regulations also are increasing the cost of doing business and stifling growth.

For a more comprehensive statement of the case for tepid economic growth going forward see the latest secular outlook from PIMCO. You also can view the videos of Alan Greenspan’s appearance this morning on CNBC here, here, and here.

The answer to the second question is clearer.

First, you need to maintain a balanced, diversified portfolio. Focus on managing risks instead of seeking the highest returns. You want elements of your portfolio to benefit from different economic outcomes. Some assets should benefit from rising growth, some from falling growth. Some should benefit from higher inflation, and some from falling inflation. You also want nimble managers who have the authority and ability to change their portfolios in response to changing markets. My “hedge fund” mutual fund portfolio meets this description, and we try to maintain this kind of balance in our Managed Portfolios.

Second, you should consider having a dynamic element to your portfolios, such as our Managed Portfolios. In these portfolios we’re likely to take advantage of some new opportunities in the near future.

Developing economy currencies are linked to the dollar. As a result, these countries are importing the Fed’s easy monetary policy. They have to separate themselves from this policy to prevent higher inflation. This should cause their currencies to rise. It’s possible to invest in these currencies directly or through mutual funds that buy short-term government bonds in the developing countries. I’ve been researching the choices and will make portfolio decisions soon.

Treasury bonds, believe it or not, will have some trading opportunities. Slow economic growth keeps a lid on treasury yields, while inflation seems to put a floor on them. When 10-year yields are above 3%, an opportunity develops.

I also continue to search for safe, solid yields. We’ve earned these in mortgage securities, preferred securities, and high-yield bonds.

We’ve been fortunate that our strategy has been working in this environment. While stocks and commodities low money in May, our portfolios managed small gains. They also had very small losses on the days stocks suffered major losses recently. Our policy of diversification and seeking safe, solid yields is keeping our capital intact and positioning us for some capital gains.