Hot Off the Web– October 4, 2010
Personal Finance and Investments
In the Financial Post’s “The ant and the grasshopper: Are ants oversaving while grasshoppers frolic” Jonathan Chevreau discusses a report trumpeting that “low income Canadians (“grasshoppers”) can enjoy as high a standard of living as they have now without having to save for retirement”, via the combination of OAS/GIS/CPP paid for by taxing the hard-working “ants”. Chevreau then shifts to the shortfall that private sector middle and high income Canadians will have in retirement due to inadequate Canadian pension system. The rest of the article discusses the required income replacement rate (50%, 70% or 90%?) and the huge disparity between public and private sector pensions. But as the article notes there is no one size fits all replacement rate (in fact the post-retirement expenses have more to do with the pre-retirement expenses and planned/expected changes to it in retirement, than with pre-retirement income or its replacement rate) and Chevreau says that “it never hurts to err on the side of saving too much” (which is very true). (No doubt some will find it offensive to equate “low income” being necessarily associated with not working hard enough, but article reinforces the now consensus view that Canada’s private sector pensions are in “systemic failure” even though the federal government has not as yet recognized it.)
Tom Bradley in the Globe and Mail article “To beat the market, try a little sensitivity” suggests that investors today are “price insensitive” (the combination of being purely driven by strategic asset allocation and indexing has made us valuation insensitive). The messages are a little mixed, because then he says “Now I’m not saying that insensitivity is always a bad thing. In fact, on the individual investor level, it’s smart to be insensitive, particularly when it comes to asset allocation. Regular rebalancing is the best strategy for all but the most sophisticated investors.” But his conclusion is that sophisticated investors like his firm can do better with active management at least in security selection but less so with asset allocation. (Perhaps…but some actually believe that if you are going to be ‘active’ there is more value in applying it to asset allocation…who knows, the average investor is probably better off passive in both security selection and asset allocation.)
Ken Kivenko of the Canadian Fund Watch in “Investor Protection in Canada- Q3 2010”summarizes the impact of inadequate investor protection as follows:
“While the impact of deficient investor protection is financially enormous, the collateral damage is often more devastating. Besides losing their life’s savings, victims of financial
assault are affected in many ways: (1) Adversely impacts their health and accelerated their ageing, (2) Eliminates their capacity to trust other people, (3) Destroys their sense of self- respect and their dignity, (4) Creates a sense of hopelessness -an abyss of shame and self-doubt, (5) Paves the road for many of them to near destitution., (6) Causes terrible stress within families, (7) Causes them to have to get part-time jobs to help make up for the losses, despite their ill-health or age, (8) Makes it impossible to ever buy any gifts for their grandchildren –living with a broken heart, (9) Destroys any hope of leaving a legacy to family members, and (10) In other cases we’ve also heard of marital breakdown, severe emotional distress, nervous breakdowns, heart attacks, drug over-dose and even suicide.” Ken also pointed out the American CFP Board’s “Consumer guide to financial self defence”which has a great list of ‘red flags’ for investors to watch out for, such as: fiduciary or not (American CFPs are fiduciaries, while Canadian CFPs are not as yet far as I am aware of), variable annuities, guarantees, fraud, etc.
Penelope Wang writes in CNNMoney about “7 secrets to a richer retirement” Among the 7 secrets are: visualize and write down the future retirement that you want, benchmark your savings rate against others’, set up auto-reminders, consider a low-cost annuity for part of your savings, and educate yourself financially (Thanks to VP for referring the article)
In Sun-Sentinel’s “Floridians must face property tax reality” Robin Sanders sums up very neatly the whining Florida homesteaders about their property taxes. “The articles and letters stating we have a property tax problem because tax bills have slightly increased in a down economy for long-time homeowners are intriguing if not outright ridiculous. To recap the “predicament” — Floridians voted in Save Our Homes in hopes of ensuring their property taxes would essentially remain constant regardless of the value of their home, while completely ignoring newer residents, investors and snowbirds who sometimes paid 1,000 percent more in taxes than neighbors for the same valued home. Next, Floridians complained they were “stuck” in their homes because they could not take their huge property gains andsubsidized tax bills to another home, so Florida voters gave themselves portability, believing they were voting for permanent or grandfathered favorable tax status, regardless of its fairness to other Floridians. Now we have a “crisis” because some are seeing a tax increase when their property values decreased and cannot understand how that is possible.” (Also in addition Floridians have recently increased the homestead exemption from $25,000 to $50,000.) Sanders has three proposals: (1) amending Florida’s Constitution removing requirement for a super-majority vote on tax changes, (2) cities to declare a state of emergency or declare bankruptcy to remove the yoke “costly bureaucracies” run up during the “good years” and (3) “all voters need to pass an IQ test prior to casting their votes”. (I am not holding my breath; things will have to get even worse before sensible action will be taken on property taxes in Florida. Thanks to DK for pointing out the interesting article; but it is nice to see that there are promising signs suggested by a Florida resident reporter can write such an article and his/her editor actually allowed its publication. Perhaps there is hope.)
The July Teranet National Bank Canadian House Price Index indicates prices 12.4% higher than July 2009 indicating price deceleration, however only Vancouver showed month-on-month decline over June 2010 at -0.3%; Ottawa and Toronto prices increased in the month 1.5% and 1.2% respectively, with Calgary/Halifax/Montreal showing <1% increases.
In Bloomberg’s “Distressed homes sell at 26% discount in U.S. as supplies swells” Dan levy writes that “Homes in the foreclosure process sold at an average 26 percent discount in the second quarter as almost one-fourth of all U.S. transactions involved properties in some stage of mortgage distress, according to RealtyTrac Inc.” Similarly, in the Herald Tribune’s “Southwest Florida foreclosure trends bleak” Michael Braga looking at Florida’s west coast indicates “Given the sharp spike in foreclosure filings in July and downward trending sales prices since then, it is unlikely that the same (stabilized foreclosure rate) scenario will play out in the quarter set to end today. RealtyTrac will not be out with those numbers for another three months…. In Florida, foreclosure sales represented 34 percent of all sales, and experts expect those percentages to trend upward now that the homebuyer tax incentives have expired.
In the Globe and Mail’s “Real estate group reaches tentative agreement on MLS listings” Ibbitson and Ladurantaye report that the Canadian real Estate Association and Canada’s Competition Bureau have reached a tentative agreement which will unbundle real estate services and will “will allow sellers to hire an agent to post their property on the all-important Multiple Listing Service and then conduct the rest of the sale on their own, if they choose”. (Time will tell what this actually means in practice.)
Patrik Marier in the IRPP study “Improving Canada’s retirement saving- Lessons from abroad, Ideas from home”indicates that “Until now Canada’s retirement income system has done well in alleviating elders’ poverty and helping workers maintain their standard of living in retirement. But according to Patrik Marier, the latter achievement is threatened by problems in the coverage and governance of occupational pensions, and by the voluntary nature and high cost of savings alternatives. These issues, together with the limited generosity of public pension programs, mean that a significant proportion of today’s middle-income earners could face a decline in their living standards when they retire.” (The consensus is clear. Canada’s private sector pensions are in systemic failure, but the governments just continue to fiddle and pretend that there is no problem; in a recent reply, to an old letter I sent to an MP requesting action on pension reform, from one of the federal government ministers also suggests that Canadians need to take more personal responsibility and get more financially educated; sounds like complete insensitivity to many Canadians’ plight and to the real issues with Canada’s pension system. I will attempt to summarize Marier’s long paper in a blog this coming week.)
Things to Ponder
In the NYT’s “Cheap debt for corporations fails to spur economy” Graham Bowley writes that “Companies like Microsoft are raising billions of dollars by issuing bonds at ultra-low interest rates, but few of them are actually spending the money on new factories, equipment or jobs. Instead, they are stockpiling the cash until the economy improves. The development presents something of a chicken-and-egg situation: Corporations keep saving, waiting for the economy to perk up — but the economy is unlikely to perk up if corporations keep saving… (Also) The Fed’s low rates have in fact hurt many Americans, especially retirees whose incomes from savings have fallen substantially.” (Is the U.S. (and Canada) trying to fix the economy on the backs of retirees? At least this helps young families who have mortgages. Article brought to my attention in CFA Institute NewsBriefs)
Interesting article by John Steele Gordon in Commentary entitled “Investing, then and now and always- How much you can make depends on how much you are willing to risk”.In it he discusses how tightly risk and reward are coupled, and he looks at the full spectrum of risk. He also discusses his view on the differences between gambling (e.g. lottery ticket where winner takes all), speculating (e.g. buying gold where timing is everything, but you won’t lose everything) and investing (which, unlike the previous two, is about productive assets like corporations and land). He also looks at the evolution of investing, which until the 1920s was restricted to about 2% of the population and the changes since 1930s which drove up both average wealth and market participation. (Thanks to SR for recommending the article)
Maremont and Scism in WSJ’s “Shift to wealthier clientele puts life insurers in a bind”indicate that “The life-insurance industry has enjoyed beneficial tax treatment for its products for nearly a century. Whenever Congress tried to change that, insurers always had a mantra at the ready: We protect widows and orphans. Life insurance needs to be free from income taxes, the industry said, because of its special social function. It keeps survivors from a life of penury when a chief breadwinner dies.” The authors also report that 6.5%, 38.5% and 55% of the accumulated tax-free investment gains in American life insurance policies are owned by families whose net worth is in the 0-50, 50-90 and 90-100 percentiles, respectively. Life insurance has evolved from whole life, to term and all the way to the stranger originated life policies where older people buy policies and resell them to investors”. (Time will tell if life insurance will become a target in the U.S. government’s search for additional tax revenue.)
The Economist’s Buttonwood questions the “no-brainer” decision about emerging markets in “The last great hope: Emerging markets may be the next bubble”. But he concludes that despite the fact that there is no proven correlation between GDP/capita growth and investor returns, “Euphoria will follow as cheap money drives up asset prices—this may have already happened in parts of the Asian property market. Investors probably have no option but to ride the wave, if only because the outlook for developed markets looks so flat. There is, at least, more solidity to emerging markets than there was to dotcom stocks.” Also on emerging markets is David Parkinson’s Globe and Mail article ”World’s emerging middle class: An all-consuming passion” quoting a McKinsey report indicating that “The rapidly growing ranks of middle-class consumers span a dozen emerging nations … and include almost two billion people, spending a total of $6.9-trillion [U.S.] annually,” researchers David Court and Laxman Narasimhan wrote. “Our research suggests that this figure will rise to $20-trillion during the next decade – about twice the current consumption in the United States.” Still on emerging markets is Chrystia Freeland’s article in the Globe and Mail’s “Globalization 2.0: Emerging markets cross-pollination” where she writes that “In the next stage (of globalization), some of the biggest deals and some of the most important capital flows will be between emerging markets, with no need to stop over at Heathrow or JFK. Forget the past decade’s race-to-the-bottom rivalry between Wall Street and the City of London to be the world’s financial capital; the new motto of the moneymen, as one Manhattan banker put it to me this week, is “Mumbai, Dubai, Shanghai or goodbye.”… “Multinationals’ advantages in terms of know-how and capital have been neutralized by their inability or reluctance to grow explosively in complex, foreign environments”.
The SEC report on the cause of the “flash crash” is out but lots of scepticism remains about the report’s conclusions. .In the Financial Times’ “Report leaves key question unanswered” Mackenzie, Demos and Kuchler indicate that the report blames the “flash crash on ONE $4B trade initiated by a single firm’s hedging strategy on the futures exchange. “The report does not tackle the broader policy debate about whether the structure of the US equity market is robust enough to protect smaller investors in the era of rising rapid-fire computer trading strategies. “When you consider the number of firms out there making trades the possibility this could happen again, in my opinion, is very high.” Lauricella, Scannell and Strasburg in the WSJ’s “How a trading algorithm went awry” explain the SEC report’s conclusions as: “Generally, traders opt for algorithms that consider trading volume, price changes and the amount of time to complete a trade. But Waddell’s desk opted for an algorithm designed to sell 75,000 E-mini contracts at a pace that would range up to 9% of trading volume—and not take into account other factors….the likely buyers included high-frequency trading firms. A key feature of high-frequency trading firms is that they quickly exit trades…HFTs began to quickly buy and then resell contracts to each other—generating a ‘hot-potato’ volume effect as the same positions were passed rapidly back and forth.. The Waddell algorithm responded to the high volume by picking up the pace of its selling, even though stocks were spiraling lower….The selloff in the futures market then spilled over to the market for individual stocks. And as conditions worsened, the liquidity in the market evaporated because the automated systems used by most firms to keep pace with the market paused when prices began falling drastically. Overall, the report painted a nuanced picture of the role of high-frequency trading firms, some of which acknowledged pulling out of the market that day.“ Other contributing factors mentioned in the report related to exchange operations, but were not considered dominant. (Not sure to what extent this single trade will remain as THE root cause of the “flash crash”; it’s not clear if the so called “5 whys” of the root cause analysis methodology had in fact been done or just the first “why” was answered, or whether the fixes (to be) put in place will prevent recurrence of the real root cause.) Dennis Dick in the CFA Magazines “The tracks of my tiers- You can trade profitably in a two-tiered market structure”argues that “Predatory market-making practices and algorithmic trading may be regulated more closely in the future, but until that time, make the necessary adjustments to your trading styles to compensate for this environment. Place fewer passive orders, trade more liquid stocks, and don’t show your hand when trading thinner issues.”
A WSJ opinion piece entitled “Beggar the world” discusses the threat associated with rapidly rising volatility in currencies as nations try to maintain or gain trading advantages from currency manipulation. “Such sharp currency moves lead to huge swings in prices, especially for commodities like oil. They disrupt business planning, as companies find it difficult to know what their real costs and return on investment will be. And they lead to the misallocation of resources, with investment decisions pegged as much to exchange-rate movements as to long-run productivity gains or potential breakthroughs in technology.” “The larger threat here is to the dollar’s role as a reserve currency and to the overall world monetary system. The two worst monetary disruptions in the last 100 years occurred when the world’s leading economic powers abdicated a leadership role. In the 1930s, Kindleberger describes how the weakened British were no longer able to lead and the Americans were still unwilling…Listen carefully, and you can hear similar currency war drums pounding in the distance today. The task of economic leaders ought to be to head these forces off before they produce a crisis akin to those in the 1930s and 1970s.” On the same topic Martin Wolf in the Financial Times’ “Currencies clash in new age of beggar-my-neighbour” explains that” In an era of deficient demand, issuers of reserve currencies adopt monetary expansion and non-issuers respond with currency intervention. Those, like Brazil, who are not among the former and prefer not to copy the latter, find their currencies soaring. They fear the results.” Wolf concludes with “John Connally, Nixon’s secretary of the Treasury, famously told the Europeans that the dollar “is our currency, but your problem”. The Chinese respond in kind. In the absence of currency adjustments, we are seeing a form of monetary warfare: in effect, the US is seeking to inflate China, and China to deflate the US. Both sides are convinced they are right; neither is succeeding; and the rest of the world suffers. It is not hard to see China’s point of view: it is desperate to avoid what it views as the dire fate of Japan after the Plaza accord.” And then with a warning “What is needed is a route to these needed global adjustments. That will demand not just a will to co-operate that now seems sorely lacking, but greater imagination about both domestic and international reforms. I would like to be optimistic. But I am not: a world of beggar-my-neighbour policy is most unlikely to end well.”
In Brett Arends WSJ article “How to bet like John Paulson” he summarizes Paulson’s forecast as “We will get inflation because we have to. It doesn’t get any more straightforward than that…The government needs inflation. The country needs inflation. That will shrink these debts in relation to the economy, asset prices and incomes. Deflation would make debts even bigger in real terms. That would be a disaster.” (Except it is inflation that will be a disaster for retirees living on a fixed income!) The same story is covered in by Courtney Comstock in the Financial Post’s “John Paulson’s scary speech: Double digit inflation by 2012, gold at US$4,000”. Paulson says sell bonds, and buy gold and houses. (Forecasting is difficult, especially about the future; however it is difficult to argue with Paulson’s perspective unless the world or at least the U.S. has entered for an extended period a completely new economic regime. But even then some might argue that it is just a matter of time before inflation kicks in.)
In Globe and Mail article “The Fed’s second bubble” Jeff Rubin lays the blame of the last recession at the doorstep of the (Greenspan) Fed, and warns that the (Bernanke) Fed is paving the way for the next bubble. That is unless you believe USA Today’s article by El Nasser, Overberg and Cauchon entitled “Recession affecting every aspect of American life” discussing massive changes undergoing Americans’ lives and the potential fallout from those changes (thanks to David Rosenberg for bringing it to my attention). Similarly David Pett in the Financial Post’s “Pimco’s Gross gets even gloomier”is quoting Bill Gross who advises investors to lower return expectations dramatically “The hard cold reality of the “old normal” is that prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated. With deleveraging the fashion du jour, and yields about as low as they are going to go, prosperity requires another foundation.” He suggests investing in production. (Sounds old fashioned…”value creation” instead of “asset shuffling” or creation of complex financial “products” or “coin clipping” as in high asset management fees?!?…old fashioned and refreshing.)
And finally, in the Globe and Mail’s “How the Nobel prize may have sparked the credit crisis” Brian Milner discusses an interview with Nassim Taleb (Mr. Black Swan) suggesting that the awarding of Nobel prizes to economists (Markowitz, Sharpe, Merton, etc) gave the impression to people that economics might be a hard science. The next Nobel winner in economics will be announced on October 11. (This reminds me of John Kenneth Galbraith’s view that: “The purpose of economic forecasting is to make astrology look good”.)