Hot Off the Web– August 23, 2010

Personal Finance and Investments

In MarketWatch’s “In your flight to safety, don’t crash” Robert Powell reports on the recommendations of Ron Florance on how to approach these uncertain times, when many have the tendency to just rush to the perceived safety of gold, money-market funds, government bonds, buying puts, annuities and the like. He suggests instead suggests a three bucket strategy: (1) liquidity (6-18 months of living expenses in money market funds and ultra-short term bond funds), (2) investing for an economic recovery (investing in “global fixed income, global equity and global real assets”), and (3) investing for the economy’s unravelling (invest in “gold, managed futures and hedge funds”). The specific mix is to be determined based on the investor’s risk tolerance. (It sounds like a reasonable approach. The challenge is of course the deciding how much to allocate to each bucket. And that (the strategic asset allocation) is determined primarily by one’s risk tolerance and then perhaps adjusted for how pessimistic one might be by the direction of the world and markets (resulting in the tactical asset allocation). If you are interested in the subject you might want to also read my Asset Allocation II blog which comes at the problem somewhat differently but ends up in a similar place. (e.g. look at the PB column in the last table which is how I (Canadian based investor) approached the problem for my asset allocation as of a couple of months ago when I wrote the blog. Thanks to VP for suggesting the article.)

Jamie Golombek in the Financial Post’s “Don’t forget tax rules during the gold rush” clarifies tax rules associated with investing in gold. Gains or losses on gold (or commodities) can treated as ‘income’ (losses can offset income from other sources or ‘capital’ (cap gains are taxed at 50% of income), but whichever is chosen must be used consistently for all future gold transactions. If ‘capital’ approach is chosen then interest on borrowed money to buy gold and carrying costs cannot be included in ACB, however if ‘income’ approach is chosen than “both interest and maintenance fees would be deductible as expenses”.

In the Financial Post’s “Time to reset priorities”Jonathan Chevreau drives home the need to be debt-free before retirement. In fact he suggests that getting rid of debt should be given priority over retirement savings; in fact he says that “no equity fund or ETF can match the after-tax return of paying off high interest consumer debt. (Makes sense, especially in the current uncertain environment.)

Ted Rechtshaffen in the Globe and Mail’s “Grownup or child: Who values a dollar more?” looks at the use of the ‘lifetime value of a dollar’ as an approach to money and retirement planning.“What the lifetime value of a dollar comes down to is a philosophy of wealth management that takes into account not just rates of return, but how best to line up your lifetime cash flow needs. While it definitely incorporates the science of improving rates of return, it doesn’t place returns ahead of personal needs and lifetime balance. In a nutshell, it is about using the wealth you have and will attain to have the best life you can.”

WSJ/MarketWatch’s “6 expenses to ditch in retirement”  suggests that you consider ditching expenses like: disability insurance (probably no longer earning income) and life insurance (can spouse support him/herself from other income and assets), investment management fees (make sure  that total cost <1%), and  old house (perhaps smaller/cheaper house is adequate or rent or move to cheaper location).

Brett Arends recommends “Ten money moves that will always pay off”. Among his suggestions are : max the 401(k) (or RRSP), get rid of the vacation home, put $5,000 in an IRA or Roth IRA (or TFSA), pay off  credit card debt, and compare/negotiate prices with you home/auto insurance company.

Real Estate

The Canadian picture is discussed in the Globe and Mail’s “Canadian home sales sink 30%” Steve Ladurantaye reports that according to CREA July home prices were up 1%, but sales sank 30% from the same month a year earlier; however prices were off 3.5% from previous month and new listings were off 7.2%. In another article”“House prices now forecast to stagnate several years” Michael Babad quotes various economists: one suggests that “anybody who wanted to buy this year bought in the first half of the year”, another “expects prices to sink more through next year and then stagnate for several years, moving in line with inflation”, and a third that “Affordability was steadily eroded during the house price surge of late 2009 and early 2010”.

Suzanne Kapner looks at the U.S. picture in the Financial Times’ “U.S. housing: Sunset boulevard” pointing to a potential shift in housing policy emphasis from ownership (which now a couple of percentage points off the peak of around 69% 2-3 years ago) to being “well housed” (i.e. stop pushing ownership at expense of rentals). More researchers are questioning the perceived benefits of ownership like: safer and more stable communities, questionable investment value (long-term prices increased between 1-3% in line with inflation, well below stock appreciation), high real estate transaction costs, and the risk associated with valuations being highly correlated with job market, and potentially misallocation of public resources by generous support of homeownership yet underinvestment in infrastructure and technology. But experts warn that such a policy reversal would be painful. (And of course would like push house prices even lower.)

The global real estate picture is addressed in the Financial Times’ “Global house prices: The peaks and troughs” in a very interesting “interactive graphic (which) explores the peaks and troughs of global house prices since 2004”.

WSJ’s James Hagerty in “’Vultures’ save troubled homeowners” reports on how investments funds were established to purchase mortgage loans at deep discount and then renegotiate the terms with the homeowners who are behind in the mortgage payments. “these funds have an edge over banks and other lenders that can be mired in bureaucracy and hampered by government rules about which loans can be renegotiated and how “. The deep discounted loan purchase allows significant principal reductions and correspondingly lower monthly payments.

Pensions

In Benefit Canada’s “Pension innovation” a Sun Life VP celebrates Canada’s finance ministers’ agreement to: shelve a government sponsored supplementary pension plan and instead “to involve financial institutions in further exploration of universal workplace savings options”. (Many would argue that this is pretty self-serving from a financial industry with the highest mutual fund fees in the developed world.) He continues to argue that Canada’s failed pension system “ranks among the best in the world, and now it’s getting better”. (Somewhat pathetic, since after a decade of growing pension crises and half a decade of government studies, nothing of substance has been done achieved or even recommended other than we’ll make it easier for the financial industry to play in this space. How will this help the average Canadian?)

In the U.S. a growing chorus is focusing on state and municipal public pension crisis. Eden Martin in WSJ’s “Unfunded public pensions- The next quagmire” argues that “Public pension funds are in dire need of change, but state and local hopes for a federal bailout now stand in the way of change. Quashing that hope—which the Obama administration could do with an explicit statement that it will not bail out state and local pension funds—would spur the reforms we need.” William Walsh in the NYT’s “Pension fraud in New jersey puts new focus on Illinois” reports that the SEC charges the State of New Jersey of “misrepresenting the condition of its pension funds”. He also discusses the resulting “scrambling” done by other cities and states to insure that their pension disclosures are adequate. The article also echoes the concerns of many pertaining to the State of Illinois whose proposed reduced pension plan contributions are called “irresponsible”. (U.S. investors one might wish to be careful in reaching for some of the tax-free muni and state bonds given the steadily growing level of concern on their financial soundness in general and their underfunded public pensions in particular.)

Things to Ponder

The Financial Times’ James Mackintosh writes that it is a “Frustrating time for picking stocks”. “Shares are not responding to fundamentals, and both good and bad companies are seeing their shares blown by economic winds, not profits or earnings.” Over three months correlations between S&P 500 (large-co), S&P 400 (mid-co) and small-co indices were over 98%, compared to a historical 70% over 10 years. “The rise of index tracking (now >$1T tracks the S&P 500), and more recently of exchange traded funds, in part explains why shares increasingly trade alike….At times of crisis, investors dump their holdings indiscriminately, pushing up correlations. And at times of economic uncertainty, such as today, investors want to make macroeconomic bets (stocks or no stocks).” He concludes (perhaps counter intuitively) that for the long-term investor, when markets dump the good with the bad, it should be a great time to buy the good and dump the dogs.

Siegel and Schwartz in WSJ’s “The great American bond bubble” write that “From our perspective, the safest bet for investors looking for income and inflation protection may not be bonds. Rather, stocks, particularly stocks paying high dividends, may offer investors a more attractive income and inflation protection than bonds over the coming decade. …At current interest rates, government bonds will not be the answer. One hundred times earnings was the tipping point for the tech market a decade ago. We believe that the same is now true for government bonds.” For example “the 10 largest dividend payers in the U.S. are AT&T, Exxon Mobil, Chevron, Procter & Gamble, Johnson & Johnson, Verizon Communications, Phillip Morris International, Pfizer, General Electric and Merck. They sport an average dividend yield of 4%, approximately three percentage points above the current yield on 10-year TIPS and over one percentage point ahead of the yield on standard 10-year Treasury bonds. Their average price-earnings ratio, based on 2010 estimated earnings, is 11.7, versus 13 for the S&P 500 Index. Furthermore, their earnings this year (a year that hardly could be considered booming economically) are projected to cover their dividend by more than 2 to 1.”

On the inflation/deflation front, while there “is some probability of deflation”, the Globe and Mail’s “Five things ‘deflationistas’ neglect in parallels to 1930s” refers to Derek Holt’s arguments why this is different than the 30s like: the 30s was about “goods price deflation” now services make up  2/3 of the economy and their prices are ‘stickier’, consumers don’t believe it (based on prices they pay every day), today emerging market price pressures are higher than in developed countries and potentially higher prices will be passed onto developed countries. On the same topic in USA Today’s “Wall Street debates prospect of bond bubble”Adam Shell reports on the debate between those who argue that we are in a Treasury bond market bubble (10 year notes yielding just 2.62% compared to 4% in April, but 2.06% mid-crisis in December 2008) similar to the tech bubble a decade ago, and the “anti-bubble” crowd who claim this all makes sense since “inflation is virtually non-existent”. (An all out bet on 10 year or even longer Treasuries could only be the result of close to 100% conviction that we are going into a decade long deflationary period. Are we convinced?)

Jeff Opdyke in WSJ’s “Rethinking gold: What if it isn’t a commodity after all” suggests that gold is not a commodity. “Instead, “gold is a currency” whose daily price is a gauge of the market’s concern about the “potential diminishment” of the purchasing power of the dollar and other paper currencies”, quoting Brodsky.”If he is correct, it is the potential longer-term weakening of the dollar that is the real issue for the gold market, not inflation or deflation….Invest in gold, then, according your beliefs about the future of the greenback. Just don’t invest based on the idea that gold is a proxy for inflation.”

Gillian Tett in the Financial Times’ “Time for debate on equity market structure”, reports on counter arguments to long held beliefs that may have contributed to the “flash crash”. “In the past few decades it has been taken for granted in the west that high levels of liquidity are a good thing. The more trading that occurs, the easier it is to buy and sell stocks, and the lower that transaction costs should be – or so the argument goes.” “Most controversially of all he (Senator Kaufman) argues that there need to be strong regulatory incentives for HFT (and others) to execute large orders, at firm prices – and not exit when a crisis hits. In a sense, this is an appeal to a return of old-fashioned broking and market-making. While such services would be expensive (larger spreads), Kaufman argues that it is a worthwhile price.” (Adding some damping to the system might actually work.)

The Economist’s “China’s economy overtakes Japan’s in real terms” chart is not really interesting in that China’s GDP is overtaking Japan’s at market exchange rates (it’s been larger at PPP for some time), but it is interesting in that it shows that what we are seeing is not emerging but re-emerging China and India.

Paul Krugman in the NYT’s “Attacking Social Security” argues that the math of attackers of Social Security doesn’t add up: the increase in payout as percent of GDP is only from 4.8% to 6% over 20 years, any shortfall can be made up from general tax revenues. (Not sure if this makes sense given the rising U.S. deficit. But then his next point makes some sense.) He also says that the proposed fix based on maintaining benefits to current retirees and “to cut benefits many years in the future” sounds a lot like “In order to avoid the possibility of future benefit cuts, we must cut future benefits.” (Thanks to Dan Braniff of Common Cause for recommending article.)

And finally, Andre Picard reports that “Survey finds most fear boomers will cripple health-care system”. “Four in every five Canadians believe that the demands placed on the health system by aging Baby Boomers will result in reduced access and lower quality care, a poll commissioned by the Canadian Medical Association reveals…also widespread fears – by close to 75 per cent of respondents – that growing health costs will result in significant tax hikes”. Support is also indicated for user fees, especially for better off Canadians, private health insurance to supplement public care.”