Hot Off the Web- June 19, 2009

This week President Obama tabled proposals for “sweeping reorganization of financial market supervision” and more consumer protection. The proposals are now being debated in Congress with apparently “some” resistance to dramatically increasing the Fed’s regulatory oversight and enforcement role since according to many it was a significant contributor to the current crisis. Damian Palett reports in WSJ’s “Draft details new rules for markets” tough new centralized federal oversight are underway of the financial regulatory system encompassing: consumer protection, exotic financial products (credit derivatives), windup of large financial companies, and SEC registration of hedge funds. (And why not, the financial companies have “earned” the additional oversight; now if only Canada could do the same, or we are waiting for an even bigger crisis?) Numerous other WSJ articles such as “Historic overhaul of finance rules” and “A new consumer agency with enforcement teeth” cover the topic. The latter article reports on an ambitious plan to protect consumers, including: financial firms can choose to offer “plain vanilla” products or be subject to heavier regulation, resolve of long-running brokers’ suitability vs. financial advisers’ fiduciary responsibilities approach, and automatic enrollment into retirement savings plans.(Clearly anything that moves closer to a more level playing field between financial institutions and the consumers specifically with more transparency in cost and likely outcomes is a positive step. I suspect that if the proposed changes stick in the US then steps in the same direction, long overdue in Canada, will also be inevitable.)


In Globe and Mail’s “Holding companies have their benefits”Tim Cestnick explains that if you own a business, adding a holding company can bring a number of benefits such as: tax-free dividends, more efficient reinvestment, income splitting, income timing avoiding US estate taxes.

Jonathan Chevreau writes in the Financial Post’s “Move over Fraser Smith: tax-deductible mortgage plan” that there are now two sources of help you make your mortgage interest payment tax deductible: the Smith Maneuver and TDMP; banks were also indicated as offering such service, but without the tax advice.

Inflation/Deflation and the Economy

Arthur Laffer writes in the WSJ that we must “Get ready for inflation and higher interest rates”. He then proceeds to point to a 10x percentage increase in the monetary base and the sure to follow higher inflation and higher interest rates in the long-term (in the short term also higher stock prices). “To date what’s happened is potentially far more inflationary than were the monetary policies of the 1970s, when the prime interest rate peaked at 21.5% and inflation peaked in the low double digits. Gold prices went from $35 per ounce to $850 per ounce, and the dollar collapsed on the foreign exchanges.”

Another puzzle is commodity prices 50% off their peak but 50% up from their through. Though he does not know which the correct answer is, John Authers tries to explain in Financial Times’  “Surreal goings on in the commodities show” using analogies with a couple of Monty Python skits; neither outcome is good.

In NYT’s “Building a portfolio that will stay afloat when inflation returns”Tara Siegel Bernard suggests that while it is not clear when (and according to some if) inflation will return in 6, 12 or 18 months we should take some steps now if our portfolio is not ready. Some of the suggestions include: shorter bond maturities, TIPS, foreign bonds and stocks, stocks in general, commodities REITs and real estate.

Other articles continuing with “on one hand, but then on the other hand” inflation/deflation are “Investors should bury any inflation fears” and “Consumer prices keep inflation in check” . In a related story “Pricing debt” the Financial Times’ Dhaval Joshi argues that while government borrowing is increasing there is a considerable decrease in corporate and household debt; the price of debt will be a function on the total demand and “the recent rise in bond yields (rise in bond prices) may be short-lived.”

Martin Wolf’s “Recession tracks the Great Depression” in the Financial Times is well worth reading. He shows industrial out, trade volume, money supply and fiscal balances graphs with the current slump overlaid on the depression data; he discusses many similarities and some differences. “Last year the world economy tipped over into a slump. The policy response has been massive. But those sure we are at the beginning of a robust private sector-led recovery are almost certainly deluded. The race to full recovery is likely to be long, hard and uncertain.” And similarly, Reuter’s Ros Karny in “Fed’s Warsh warns of false optimism on US economy”, Warsh warns “not to take recent gains across a range of asset prices as proof the U.S. economy is on the verge of a strong recovery…The rather indiscriminate bounce off the bottom — across virtually all assets and geographies — may be more indicative of a one-time reset, which may or may not be complete…private demand, the true arbiter of economic performance, “remains weak” even while government spending has surged, and the jobless rate is likely to peak at a higher rate, and linger longer at those high rates, than in recent recessions”

Senior Life (and Death)

Victoria Knight reports in the WSJ that “Elder-abuse cases on the rise”Reported cases of financial elder abuse have doubled over the past two years. This is often by adult children who may be taking advantage of co-residency or power of attorney to appropriate assets from frail/dependent parent possibly at siblings’ expense. Also in the past week in a Canadian context “CARP poll uncovers high rate of elder abuse: Those with caregivers most at risk” , reporting that 9% (783,000) of over 55 Canadians were affected and those with caregivers had have double the occurrences. This survey also looked at different types of abuse and psychological abuse was over three times more frequent than financial abuse. (I suspect that very often when financial abuse occurs, it is not recognized as readily as psychological abuse. Once psychological abuse occurs, it is a narrow line to cross to get to other kind of abuse.)

Globe and Mail’s Richard Blackwell reports in “Death takes a holiday”that the funeral industry saw a significant drop in business during the first quarter (SCI one of the largest operators indicates 11% drop; other large operators reported 3-8 %.). What seems to be puzzling is that while the long term trend has been trending downward, the size of this drop is a discontinuity. Reasons suggested (official CDC figures not yet available) include lighter flu season this year, 1% fewer days in the quarter than last year (leap year), fewer births late 20s and early 30s, and improved healthcare. (The only thing not mentioned is that after years of these firms consolidating mom and pop funeral homes, there may be a resurgence of new mom and pop operations? Or perhaps we are actually seeing a significant change in the slope of the longevity curve?)

Bob Adams writes in Barron’s “Next the Retirement Bubble” that if we think we earned our 30 years of unproductive and no income producing retirement, then we don’t understand realities of the situation. Instead he suggests a Life Sabbatical: “When you retire, consider it a three-year sabbatical. Do what you want to do, when you want to do it. But keep your eyes open for something that interests you, where you can earn some income. Look for something you enjoy, something that really pleases you. When your sabbatical is over, you should have found a new line of work that will help you enjoy the rest of your life and pay for whatever makes it comfortable. You may earn less income than before, but the purpose is to supplement your retirement funds, prevent total dependency on others for your income, and keep you growing. Then you can share your happiness with the rest of us, not your pain. Take full retirement only when you must, when you can no longer be productive.” (Wow that quite a brutal message to some. Don’t remove the harness!)

William Hanley writes in Financial Post’s “Gearing down expectations”that the combination lower future returns and increasing level of savings will drive boomers to “re-examine their needs and wants” and there will be lots of discomfort for those who can’t reset to the likely end of the “Age of Excess”.

Personal Finance and Investment Products

In WSJ’s “Is Vanguard sailing into uncharted seas?” Jason Zweig explains the fundamental difference between Vanguard and other fund companies, in the context on what appeared to be a surprising bid by Vanguard for Barclays’ iShares fund family, which ultimately went to Blackrock for $13.5B. Here is Zweig’s short paragraph explaining the absolutely fundamental difference: “you need to understand how Vanguard is structured. Other companies that run mutual funds seek first to maximize the profits of their own public or private shareholders, not the returns of the investors in the funds. Vanguard, instead, is owned entirely by the investors in its funds, who earn higher returns as Vanguard lowers fees.”  (Is the difference between Vanguard and ‘other fund Cos’ the same or similar as the difference between a ‘mutual life insurance company’ and a ‘share holder owned’ one? If yes, then perhaps we should go back or start re-creating mutual life insurance companies again.)

Here is another example of- if it sounds too good to be true, it usually is! Don’t buy this unless you’d be happy to own the stock at the current price. In WSJ’s “Reverse convertibles: A nest-egg slasher?” Larry Light describes what they are about. “Reverse convertibles are short-term bonds that are coupled to well-known stocks and often pay double-digit yields.  (Now there is a red flag given current interest environment!) Once the notes mature — their terms generally last from three months to a year — investors get their principal back. Yet if the underlying stocks plunge to a certain point, called the “knock-in” level, usually 20% to 30% down, investors get the shriveled stocks in lieu of the full principal.” (Handle with great care or, even better, stay away!)

I’ve ordered Jonathan Clements’s new “The Little Book of Mainstreet Money” but haven’t received/read it as yet. However, based on his earlier writings at the WSJ Personal Finance section, he is unquestionably one of the best personal finance writers and it would be safe for me to recommend it for your consideration. I’ll review it in a couple of weeks.

I also haven’t seen as yet “Zvi Bodie debunks stocks for the long-run on PBS Newshour” which was reviewed by Jonathan Chevreau in Financial Post. Bodie always challenges your thinking; I plan to view it  in the next couple of days.

In WSJ’s “Balanced is out, Absolute is in” Sam Mamudi discusses how due to losses in diversified portfolios last year, many investors are turning more to a slew of new products promising greater bear market protection. However, he quotes a wealth manager “I’m quite skeptical of any fund that says you can have your cake and eat it, too”. (You should be too. There is no free lunch.)

Dan Richards in Globe and Mail’s “Take a stress test of your own portfolio” encourages all investors to run annual stress tests on the state of their financial affairs. “You need to stress test three things – how much you’ll spend in retirement, how much you save for retirement and the risk you take in investing those savings. For each, you create a base case and then examine the impact of different scenarios.” This includes looking at scenarios and outcomes on inflation adjusted retirement income, assets/savings and longevity.

Those looking for an advisor may want to read through “Getting advice” from Australia; a lot of it is applicable to North America as well. (Thanks to Fund Observer’s Ken Kivenko for bringing this to my attention.)

John Dizard in the Financial Times’ “Nothing to profit from credit default swap” suggests that it’s time to wind up, for good, the CDS market in an orderly fashion. “Credit default swaps are not a useful hedging product, since they do not have a predictable relationship with an underlying asset, i.e. specific loans or securities. They are not a useful tool for price discovery, in the way that exchange traded commodities futures and options can be…..CDS are really side bets, like those play-contracts on internet sites.” While proposed clearing platforms could be used to gain visibility of the existing contracts, unlike clearing houses for futures exchanges have the mechanisms which allow them to act as credible counterparties to transactions (own capital, strict margin requirements…).

In the Financial Times’ “Don’t give up on active managers” John Authers reports that more pension plans are giving up on active managers. He suggests that “valuation spread”- “the degree to which the cheapest quintile of stocks are cheaper than the average for all stocks” are much greater than usual and they tend to revert to the mean. While they don’t in the long run, when the “valuation spreads” are narrowing  “slightly more than half of US general equity mutual funds beat the S&P 500, based on annual returns. Only about a third do so when spreads are widening.” This is also a time then value style of investing outperforms. And sure enough, Gregory Zuckerman writes in WSJ’s “Mutual funds are beating the Street” ; “This year is turning into an entirely different ballgame. The average U.S. stock mutual fund rose 9.9% through June 10, according to Morningstar, compared with a gain of 5.3% for the S&P 500. Eight of the 10 largest mutual funds are up more than the S&P 500, some dramatically so.”

Dave Kansas in WSJ’s “Do you have time to get back in the black”looks at ‘time’ as the most important factor in recovery of your retirement portfolio. (You recall the saying “what’s important is not timing the market, but time in the market!) The ‘super-safe’ approach won’t get you there. Given the criticality of ‘time’ he breaks down the approach into: under 40 (time heals, save early for compounding, and include equities international and domestic equities), 40-55 (max out 401(k) and also set up not tax sheltered automatic savings plans,  don’t lose your nerve and change strategy ) and 55 and over (consider an annuity if you can cover your minimum required income for life-there is no universal agreement on this, for equity exposure use index funds) One adviser counsels “Having enough is more important than having more…If you’ve reached enough, you don’t want to be gambling for more.”

Real Estate

In Canada, the Statistics Canada’s New Housing Price Index shows April price decline over March of -0.6% with a decline of -3.2% from the peak. Price declines of -0.6 to -1.2% were evident in Toronto, Calgary and Vancouver. The Teranet/National Bank House Price Index covering month of April is expected to be released next week so we’ll have a better handle on house price direction of existing housing stock; while less real time in nature, this should be a better indicator than some Toronto real estate agent’s anecdotal evidence that bidding wars are on again(?!?). And, speaking anecdotal evidence from real estate agents “Housing pieces recovering: CREA”, the Canadian Real Estate Association reports that “Housing prices are recovering, with the average resale price in May – skewed by an increase in sales activity in the country’s most expensive markets – reaching the highest level on record.” (Now what is the value of such a “statistic”? What’s the information content here? This may not be very popular with the Real Estate broker community, but there really should be some regulation associated with the timeliness and transparency of data pertaining to real estate transactions; as is, there is sufficient fuzziness associated with transactions due to the lack of homogeneity of housing in general.)

The just out BusinessWeek in “Where housing will be in 2012” predicts that “Home prices (median US) are likely to fall for the next year, then stabilize, with a rebound in 2012 (to year end 2008, not 2006, prices) as the overall economy takes off again.” They also then remind the reader that “all real estate prices are local” and that “there’s still plenty that could go wrong in the housing market”.


And finally on pensions, the Financial Times’ “Pensions pay the price of equity bias” Norma Cohen discusses companies only two years ago were jumping up and down about how pension surpluses should handled, are now gradually capping/exiting defined benefit plans in the UK. She then refers to experts indicating that accounting “surpluses” “are based on accounting rules that do not reflect economic realities: companies are allowed to discount the cost of providing tomorrow’s pensions in today’s money at rates that are much higher than those an insurance company would use in deciding whether to take on those same liabilities. And there are no hard and fast rules about how long employers can expect their former workers to live after ­retiring, a factor that has significantly raised pension costs.” Many are questioning now why were pension funds so heavily invested in equities, rather than in assets which their liabilities (rather than gamble with pensioners’ assets and then leave them holding the bag when company seeks bankruptcy protection)? She also indicates that mortality assumptions are also left to companies’ discretion! (I suspect that somebody will start asking if private DB pensions are a giant government sanctioned Ponzi scheme, but in UK pensioners are at least protected by a generous government backed pension insurance; not the case in Canada- here it’s just a Ponzi scheme without any safety-net to speak of.)


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