Paul Ferraresi » Economics

Health Care Blues

Paul — Wed, 05 Aug 2009 18:01:22 +0000

When I work on retirement planning for my clients, they rarely consider their health costs in retirement. Since most employees are covered by an employer plan and are only charged a small percentage of the true costs, well, they think this will continue forever.

As of this writing, Medicare and Medicaid are available to seniors but it is not cheap and the costs to individuals continue to rise.

A recent study by the Employee Benefit Research Institute found that a 65 year old man, who retires this year, will need $68,000 to $173,000 in current savings to have a 50-50 chance of covering health premiums and out of pocket costs in retirement. If he wants a 90% chance, then, the amount of savings needed jumps to $134,000 to $378,000. The variance depends on whether a former employer subsidizes health costs in retirement.

The cost outlook is worse for women because they tend to live longer and need more health care. A 65 year old- woman who retires this year will need between $98,000 to $242,000 in savings for a 50-50 chance and $164,000 to $450,000 in savings for a 90% chance.

The study found that health care costs in retirement rose 9% for men and 16% for women over the past year.

These estimates do not include savings needed for long term care or for basic living. As I have stressed with my clients, you need to begin planning now. Remember these two items (health and long term care) are in addition to normal living expense.

Start today or you know the outcome… discipline or regret.

The Dollar Devaluation

Paul — Thu, 04 Jun 2009 19:22:26 +0000

The massive government stimulus package and additional future programs are slated to increase our debt load to $10-12 trillion.
To the average American they can not understand the magnitude of this huge number. For simplicity, take one trillion one dollar bills, line them up end to end and it would reach to the moon (240,000 miles) and BACK (total of 480,000 miles). Not just once, but over 200 round trips. Get it???
With all the new money being printed to fund these programs will lead to good ol’ inflation. That is, too many dollars chasing too few goods. Well, when we have too much of something it looses its value, so, watch for the dollar to devalue, or lose value. That means the cost of inflation will increase.
Inflation hedging mechanisms for people include investing in real estate, commodities, natural resources, other currencies and, in gold. Experts predict gold to easily trade from $1,650 to $2,000 in the near future from the current $900 levels.
The U.S has borrowed massive amounts from foreign investors like the Chinese, Japanese and Europeans to fund our needs and entitlements. We are asking these same people to lend us more for these huge socialistic programs. Once we have their monies, well, there is an easy way for the U.S. Government to pay back the debt by NOT paying back any money. That is, by a devaluation of the dollar. So those that have lent money to the U.S., foreigners, and also you, by buying Government Bonds will be in trouble. That is, everyone will be paid back in cheaper dollars after devaluation that will buy less, cutting your standard of living. So, senior citizens with Government Bonds are probably going to be hurt the most, since they hold the largest amount of “safe” government paper.
This is not the first Government devaluation. The currency devaluation was effective in ending the Great Depression. In 1930, Australia was the first to leave the gold standard, immediately devaluing the Aussie by more than 40% and the economy quickly recovered. New Zealand and Japan followed suit in 1931, each with the same result. By 1933, at least nine major economies had enacted a devaluation of their currency by removing it from the gold standard, all of whom emerged from depression.
In the United States, our devaluation occurred in 1933, when gold was confiscated and the dollar was devalued by 41%.
The only thing that would remain the same or drop in value would be debt. All other assets would immediately be worth more (in nominal terms), whether it be a home, a stock, an ounce of gold or a used car.
My own view is that currently devaluation would also help relieve the imbalance we have with Social Security and Medicare. Since the dollar would be devalued, the liability on those claims would be reduced by the same percentage. Doing so would make those obligations bearable and feasible. Consequently, a formal devaluation of the dollar would achieve many goals, all of which would be beneficial to those who are debtors.
However, currency devaluation would be detrimental to those with cash instruments such as savings accounts, CDs treasury bills, bonds, money market funds, or other forms of cash assets. This is one of the reasons I advise people to diversify with gold which traditionally appreciates during times of inflation and currency devaluation. All other inflation hedges mentioned above would be beneficial also.
A word for the wise.

Looking Ahead For The Investment Markets

Paul — Tue, 10 Feb 2009 19:17:55 +0000

The economic turmoil that now embraces the planet of which we hear is more of a U.S. problem should not surprise anyone. You are witnessing the consequences of reckless indebtedness. The subprime mess was just the tip of the iceberg. The leaders in government were very indifferent as to “subprime” being a problem at all.
A little history….Bill Clinton in 1997 signed legislation to allow (demand) that banks lend money to “less fortunate people” (those who could not afford to pay for a home) in order for everyone to enjoy the American Dream. Alan Greenspan, head of the Federal Reserve at that time, accommodated this request by lowering interest rates. These low rates led to many years of “irrational exuberance” and the stock market finally died in the 2000 tech wreck, 911 made the economy stop and we had a recession. Greenspan lowered rates again, but this time the bubble was not in stocks, rather, in real estate. Fannie Mae and Freddie Mac were given the green light by Congress to accept all levels of credit loans. Wall Street wanted into the act and “securitized” these loans and sold them as “good” loan packages.
In 2001 President Bush presented to Congress his concerns over this sub-prime mortgage program with Freddie and Fannie but it was brushed aside and no investigation or legislation was enacted. In 2005, 2006, 2007 and early 2008 Chris Dodd, head of the Senate Finance Committee and Barney Frank, head of the House Committee on Banking, both fought against adding any more regulation to Fannie and Freddie. Both individuals stood firm and said boldly that these two agencies were strong, did not need any more regulation or oversight. The rest is history.
Now there has been a pattern of excessive aggregate indebtedness for quite some time at the corporate, government and household level, so, everyone is to blame. At the same time the tax code, in this country, encourages borrowing and discourages saving and investing. It seems everyone has a poor attitude of paying back debt. As a result when things begin to go sour on some debt, starting with subprime, the cascading effect was beyond what anyone ever predicted. Very few expected anything this severe, yet, the seeds were sown more than a decade ago (similar to when you watch friends over eat or over drink for a long time…sooner or later they pay the piper for the over indulgent behavior)
Looking ahead for you….unfortunately retail investors and institutional investors make their investments as if they are driving down the highway but looking through the rear view mirror. They all favor what has worked in the past. But, there is a powerful pattern of mean-reversion in the markets (that which is hot today is cold tomorrow and vice versa).
So the idea of looking at markets today and asking… what has been hit really hard, and as a consequence, may be priced at attractive levels. Well, this is contrary thinking to most people, including sophisticated investors. The temptation to buy what has done well recently and sell what has done poorly is the single greatest pitfall in investing and the main reason why a disciplined approach to asset allocation works very well.
With this in mind…..be careful of Government Bonds. These bonds have done very well recently, but, after a short deflationary cycle, which we are in, we will be hit with a huge inflationary cycle. This will lead to higher interest rates which translates into a loss in bond values.
Keep your eyes open to opportunities in emerging markets, gold, commodities, U.S. stocks and REITS. I have not seen deals and valuations like this since 1973-1974 when the DOW was at 570.
Remember you are looking at a 3-5 year investment window timeframe and not a bump up in prices tomorrow. Take advantage of this fire sale in the market now for a reward in 5 years. Or, will you drive down the highway in 5 years from now looking back through the rear view mirror after these items have gone up?! Then, like the masses do…will you buy when prices have gone up? You know the formula for the poor.. “buying when prices are high…and then selling when they are low.”
No, the correct formula is the opposite for the wealthy.

Deflation, Then Inflation

Paul — Thu, 05 Feb 2009 17:51:31 +0000

One of the most vexing questions plaguing investors these days is whether or not we’re headed for price deflation or price inflation. There are two offsetting influences…that will undoubtedly determine the direction of price growth.
History has shown that credit contraction is one of the harshest sources of deflation. The most recent Federal Reserve survey of senior credit officers showed that nearly 70% of surveyed banks have tightened their mortgage-lending standards. Stinginess among lending institutions is largely responsible for the 16% decline in our nation’s $22 trillion housing stock. Margin lending has been cut in half, forcing leveraged investors, like hedge funds, to disgorge marketable assets. The pullback in housing and equities, combined with plunging commodity prices, helped push consumer prices lower recently. Yet without the impact of food and energy, prices were essentially flat.
Persistent deflation is bad for the economy. Faced with declining sales and fixed interest obligations, companies will find it increasingly difficult to stay current on their debts. Consumers, facing similar challenges, will defer spending. Deflation fears have prompted lenders to require yields approaching 17% when purchasing below investment grade bonds. Offsetting the downward pricing spiral is unprecedented monetary and fiscal intervention in the form of stimulus and bailout programs.
The Fed’s balance sheet has expanded by $1.3 trillion in the past year. The Treasury has backed banks and money-market funds, has taken in the government sponsored mortgage companies and is toying with…bailing out the big auto makers. Eventually, this monetary expansion will push prices higher. Meanwhile, the Treasury market suggests prices will decline before they expand. The break-even inflation rate between inflation-protected Treasury notes and fixed-rate Treasury notes is nearly minus – 0.5% for the next five years. We recommend that investors brace for transitory deflation this year that will give way to inflation in 2010 and beyond. Take positions now to benefit from inflation and a dropping dollar.

FANNIE MAE EASES CREDIT TO AID MORTGAGE LENDING

Paul — Mon, 29 Sep 2008 19:19:05 +0000

The finance mess taking place in our nation has a lot of guilty partners. It is not just the bankers, Congressmen or Wall Street executives.

I received this 1999 New York Times article from one of my clients. This is only the tip of the iceberg. If you are upset about this fiasco…do not yell or complain…instead, call or write your representative. Tell them how you feel and make suggestions. If you do not…then, you will suffer the consequences and cannot complain later.

Here is the short article and a link to the full article.

By STEVEN A. HOLMES

Published: September 30, 1999

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets — including the New York metropolitan region — will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

”Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,” said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer (and current Obama advisor) . ”Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.”

http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260

Sellout or Buy In

Paul — Thu, 27 Mar 2008 16:17:39 +0000

Is It Time to…Sellout or Buy?

While I do usually try to look at the bright side of things, my enthusiasm for the long-term prospects of undervalued stocks has a lot to do with historical precedents. We frequently mention that according to data calculated by Morningstar, equities have returned 10.4% (large-cap) to 12.7% (small-cap) per annum dating back to 1926, with stocks trading for inexpensive fundamental valuation metrics performing even better.

Adding to our arsenal of historical data, we have also been busy this year crunching equity performance figures on a going-forward 1-, 2-, 3- and 5-year basis, based on the release of various economic statistics. The fact is that stocks actually do better over the long-term when economic data points are signaling economic contraction, rising unemployment and/or recession. This is primarily because the markets have already sold off by the time the statistics turn negative, with subsequent rallies beginning before evidence of recovery emerges.

Recently, there were three main economic numbers that caused quite a bit of consternation for investors, including the Philadelphia Fed General Activity Index, which came in much worse than expected at a reading of -24.0 in February. Interestingly, history shows that when the Philly Fed index was positive, large-company stocks posted an average gain of 11.1% one year out, while small-company stocks had an average gain of 12.6%. On the other hand, when the Philly Fed number was negative, which indicates contraction in the manufacturing sector, large-company stocks had a 14.1% average gain and small-company stocks had a 23.4% average gain over the next 12 months.

Next, the Conference Board’s Index of Leading Economic Indicators (LEI) declined for the fourth straight month in January. The Conference Board said, “The leading index has continued to decline since its most recent highest value reached in July 2007, and the weakness among the leading indicators has become more widespread…The current behavior of the composite indexes suggests increasing risks for further economic weakness, and that sluggish economic growth will likely continue in the near term.”

Sounds pretty ominous until one looks at these long-term (non-annualized) equity performance numbers when the monthly change in this gauge is negative, as it is today, versus when it is positive:

Negative or Zero LEI vs. Positive LEI

1-Year Large-Cap: 11.4% vs. 11.7%
1-Year Small-Cap: 18.9% vs. 15.9%

2- Year Large-Cap: 26.7% vs. 23.9%
2- Year Small-Cap: 44.0% vs. 32.5%

3- Year Large-Cap: 40.6% vs. 38.4%
3- Year Small-Cap: 66.0% vs. 55.0%

5- Year Large-Cap: 77.1% vs. 73.2%
5- Year Small-Cap: 129.4% vs. 110.4%

Inflation was also spooking investors recently as the Labor Department reported that the Consumer Price Index for All Urban Consumers (CPI-U) increased 0.5% percent in January before seasonal adjustment, with the year-over year figure climbing 4.3%. While the so-called ‘core’ rate, which includes the volatile food and energy components, rose ‘only’ 2.5% on an annual basis, inflation is certainly higher than the Federal Reserve would like, although Ben Bernanke & Co. are still widely expected to continue to lower interest rates when they get together next month.

Interestingly, once again, long-term-oriented investors are likely to see better returns when the CPI-U is high than when it is low. Using the current 4.3% reading as the inflection point, take a look at the following (non-annualized) performance figures:

CPI-U 4.3% or Higher vs. CPI-U Less than 4.3%

1-Year Large-Cap: 11.5% vs. 13.1%
1-Year Small-Cap: 19.2% vs. 17.5%

2-Year Large-Cap: 28.4% vs. 25.6%
2-Year Small-Cap: 49.0% vs. 33.2%

3-Year Large-Cap: 47.1% vs. 38.3%
3-Year Small-Cap: 70.8% vs. 48.3%

5-Year Large-Cap: 88.2% vs. 67.9%
5-Year Small-Cap: 156.7% vs. 100.2%

Obviously, there remain numerous issues about which we might fret, including the impact of the slowdown in the U.S. economy on corporate profits, and we certainly know we have endured turbulent market conditions on many previous occasions, including whopping 40%+ peak to trough declines in 1998 and 2002. Nevertheless, our experience has shown that equities remain the place to be for long-term-oriented investors. Staying the course in difficult times has historically been the right strategy with our value-oriented approach as recoveries have often been sharp and quick. It is very difficult for the folks who have bailed out of stocks to have the courage to step back in at just the right time.

Market Outlook:

We understand that earnings estimates will continue to come down, but valuations of equities in general remain very inexpensive, especially relative to interest rates. We’ve commented in the past on the so-called ‘Fed Model’, which compares the earnings yield (the inverse of the P/E ratio) on stocks to the yield on the 10-year U.S. Treasury. Equities are cheaper today than they were at previous market bottoms in October 2002 and March 2003.

I do think that stock prices will be higher by the end of the year and, more importantly, I believe that they will be significantly higher three-to-five years out, which is always the time frame that we work with. In addition to factors outlined above, some reasons for my continued optimism include:

1) The likelihood of additional Federal Reserve interest rate cuts
2) The tremendous amount of pessimism gripping investors
3) The $3 trillion that is sitting in money market mutual funds
4) The lack of significant insider selling (and the increase in actual buying) by corporate executives
5) The relative health (outside the financial and housing sectors) of corporate balance sheets

Reading Tea Leaves

Christopher — Mon, 18 Jun 2007 03:47:22 +0000

Most people become confused when they listen to economist speak. One of the toughest economists to comprehend was Alan Greenspan former head of the Federal Reserve. His replacement, Ben Bernanke, is also very hard to follow. The use of useless “economic indicators” drives me up the wall such as the “lipstick sales index”. Here are a few interesting indicators. Enjoy

Presidential approval ratings. When they go down, stocks go up. According to Ned Davis Research Inc., in weeks when the presidential approval rating was below 50%, since 1959, stocks rose at an annualized rate of 9.2%. In weeks when the approval ratings were above 65%, the Dow rose at a 2.6% annual rate.
Boxes. The fibre Box Association says that demand for corrugated boxes is a good leading indicator for the U.S. manufacturing and notes that almost all items that go into manufacturing-from raw material to finished goods-have to be put into a box.
Vegas visitors. Las Vegas is a major destination for both leisure travelers and conventioneers-when times are good. When times are bad? People still go to Vegas to drown their sorrows at the table, but the conventions don’t necessary follow.
Fast food. The burger-and –fries combo is a low cost, completely discretionary decision. When fast-food sales tick upward, the economy is usually also trending up.

And then there are the really more obscure economic indicators: immigration applications, the price of copper, the Colliers parking survey, Harvard B-School Graduates on Wall Street, Mexican home mortgages, Central Appalachian coal futures, and the Baltic Dry Index. You can find them all in the archives of the “Moneybox” column, written by Daniel Gross, at Slate magazine: www.slate.com

Interesting Facts:

50…Average percentage rise in value of 401(k) accounts for workers who saved consistently between 1999 and 2005

46,326…Median U.S. household income, in dollars, for 2005, a 1.1 percent inflation-adjusted gain from 2004