Fed Takes Action

As the economy has grown stronger, the Federal Reserve has been discussing when to reduce its bond and mortgage purchases. For about 15 months, the Fed has been purchasing about $85 billion each month and has acquired approximately $3 trillion in these investments. The purpose was to add liquidity to the economy, which resulted in lower mortgage interest rates, lower long-term bond interest rates and a booming stock market. The Fed indicated this afternoon that they will taper off these purchases by about $10 billion, bringing them down to about $75 billion monthly. Tapering will reduce the flow of cash from the Fed but will also allow them to adjust upward easily if the economy shows signs of souring. If tapering does not disturb the economy, it will likely be followed by additional cuts until all purchases are stopped. The long-term impact of this change will likely be an increase in longer-term interest rates and slowing of the rise in stock prices.  I had not personally expected the change until March of 2014, once Janet Yellen was in place as the new Fed Chairman. The change is likely to be the last major action by the current Fed Chief, Ben Bernanke. At the same time that they announced the tapering of purchases, the Fed also indicated that short-term rates would remain close to zero until after the unemployment rate goes below 6.5%.  This information means that short-term rates will be likely to stay at zero until late 2015 or early 2016.

Ed Mallon

Market Turning Down

During the past number of market sessions, we have seen some profit taking on stocks and repositioning of bonds, which has moved the stock market down. The result is confusion on the economic front. The good news, announced on Thursday, was that in the third quarter the economy grew at a rate of 3.6%, rather than the 2.8% originally reported. Business inventories, at $116.6 billion--the largest accumulation of inventories since the first quarter of 1998--accounted for most of the growth. This growth is in sharp contrast with domestic demand that rose only 1.8% rather than the expected 2.1%. As a subplot, consumer spending dropped to 1.4%, the lowest since the fourth quarter of 2009. Retail spending, so far in the fourth quarter, does not seem to be picking up as we go into the biggest shopping period of the year. Retailers may have to take major markdowns before the holiday season is over, to align inventories with consumer spending. Corporate profits, after tax for the third quarter, dropped to 2.6% from 3.5% in the second quarter. If heavy discounting of inventories takes place, corporate profits may drop further. Expectations of advancing corporate profits have kept the recent stock rally going. The reality of what might happen to corporate profits is setting in and moving the market downward.

All is not lost. It appears this will be a correction and not a bear market. One of my favorite indicators is the number of initial jobless claims. I have not reported on that in a while. Last week, jobless claims were at 298,000, the lowest number we have seen in years, and the third weekly drop, which is also impressive. Not long ago, I was wishing for the claims to drop below 400,000! With all of this information, I am maintaining my position that the Federal Reserve will not reduce bond purchases before March of 2014. The liquidity level of the economy should remain constant, which is good.  The economy surprised experts in the second quarter, growing more than 2% after original estimates of 1%. Again in the third quarter, the economy grew at 3.6% after the original estimate of 2.8%. Who knows? Perhaps it will do so again in the fourth quarter.

Ed Mallon 

Change Afoot!

At this time of year, I look both back and forwards. In looking back, I see that we are better off, overall, this year than we were a year ago, from a financial perspective. Looking toward next year, I believe we will be better off than we are today. That being said, some interesting things on the horizon could have a significant impact on financial matters. If the agreement with Iran goes through, it could mean significantly lower oil prices for Eastern and Western Europe. This would be good for their economies and also for world economies as discretionary income would grow. The new Fed Chairman, likely to be Janet Yellen, will bring a softening to monetary changes that will be enacted by the Fed during 2014. This should result in less shock to the financial system as the stimulus is discontinued, and should reduce the risk of a major market correction.  The big unknown on the negative side is what Congress will do about the budget and deficit reduction.  I am guessing that the Republicans will not want a repeat of October as we head into an election year. We will see.

Thanksgiving is my favorite holiday. I wish each of you peace, joy and the blessing of living in a country like the United States of America!

Ed Mallon 

Market Conditions

There was a front page article in the Wall Street Journal this morning about “Mom and Pop” now entering the stock market, after an absence since 2008. It seems that by the time “Mom and Pop” enter the market, it’s at the top! I can’t say I completely agree with this but it does reflect how fast the stock market has gone up this year and the amount of new money being invested. According to Warren Buffett, a simple way to look at the market is to measure the ratio of the aggregate value of the stocks in the Wilshire 5000 to the U.S. GNP. If this ratio is under 100% stocks seem priced to buy. If it is over 100% stocks are pricey and will likely come down. According to this idea, back in 2009, when the ratio was 76%, it was a time to buy. As of September 30^th the ratio was 109%. Does this mean that stocks are headed for a tumble?

There are many ways to look at the stock market none of which has proven infallible. The market is based on what a willing buyer will pay a willing seller. We all know the stock market goes up and down and it is difficult to determine when it will do either. The best way to address this issue is to have a diversified portfolio of stocks and bonds that have a relatively low correlation to each other. As an investor you do not want to be “chasing” yield, but to set your investments in accordance with your risk tolerance. I am sure that Warren Buffett is not selling most of his investments in fear of a downturn in stock values, but he may be limiting new purchases until such time as he feels that there are better values.

Ed  

The After Glow

We all watched as the government shut down and witnessed how dysfunctional Washington has become. During this time the stock market held up rather well while interest rates on bonds tended to go up. As bond interest rises the value of the bonds decline. The impact on the bond market was reversed once a deal was struck. Bond interest rates have come down to a point we have not seen since mid-May, in some cases. For now, the Federal Reserve(Fed) continues to purchase about $85 Billion of mortgages and bonds each month to assure liquidity and continuing expansion of the economy. At some point in the future, the Fed will reduce and then eliminate their purchases. When this happens it is expected that bond interest rates will go up and the value of bonds will go down. It is likely that this reduction in purchases will not take place until mid-January when the new Chairperson of the Federal Reserve takes over. For now, there is a lull in the bond market. To counter the potential increase in interest rates, it seems wise to move bond investments into shorter duration bonds that pay little but have a lower risk of principal devaluation. For those portfolios that are largely in bonds, like a Conservative portfolio with 80% in bonds, there will likely be a reduction in earnings and negligible gains in principal by using this strategy. My guess is that this will all be played out during the next 12 to 18 months, after which time investment grade bonds should stabilize and become the sound investment that they are intended to represent. For now, I see an opportunity to rebalance portfolios to reduce the chance of principal loss in bonds.

Ed

Budget, Debt, Fed

The preoccupation in the stock and bond markets at this time is with what is happening in Washington. The mixed economic reports that came out last week indicate that the Federal Reserve will likely make no changes to their bond and mortgage buying program until very late this year or early next year. This has sent bond prices up as yields have fallen. At the same time, the equity markets are justifiably worried about what Congress is going to do to resolve the budget and Federal debt ceiling issues. If the debt ceiling issue is not resolved, the government will run out of funds by the latter part of October. Currently, the concern is with a budget resolution by October 1^st, the beginning of the next fiscal year. The lack of a resolution will result in closure of non-essential government services and the inability to pay Social Security and Military Pension benefits. The repercussions of this inaction would have a detrimental effect on the entire economy. This concern has lead to a downturn in the stock market. The short-term outlook is cloudy. In the long term, I believe the stock markets in the U.S. will do well if the economy continues to grow. Stocks trade at a multiple of earnings. On a trailing 12 month basis, the market’s current price-to-earnings ratio of about 19 is a third above its long-term average. This has occurred because earnings growth has been tepid while stock prices have gone up significantly. The expectation is that we will see greater earnings growth in the future. Shutting down the government could change this assessment. Bond markets will have to adapt to increasing interest rates over the next year or so, but should subsequently be fine.

Ed

From Damascus to Jerusalem

With all that is going on in Syria, I’ve been asking people how far they think Damascus, Syria, is from Jerusalem? One great answer I received was “it must be either very close or far away.” Apparently we are not much for geography in the United States. Most of us recognize that the Middle East is a very dense area of the world, but just how dense? In answering my basic question you can look in the New Testament, where Saul, soon to be Paul, has an encounter on the road from Jerusalem to Damascus. This indicates that, even 2000 years ago, it was possible to travel between these two cites on foot. The answer to my question is 135 miles. But this belies the question of density in the Middle East. Some interesting distances: between Damascus and Cairo, Egypt: 382 miles; Nicosia, Cyprus: 204 miles; Tel Aviv, Israel: 133 miles; Amman, Jordan: 109 miles; and Beirut, Lebanon: 55 miles. These are all capital cities in the Middle East and they are very close to each other. The fallout of the civil war in Syria on the countries surrounding it has lead to disruptions, as millions of people have fled from Syria to these nations. Any action that is taken in Syria will undoubtedly have repercussions on countries in close proximity, and we just don’t know where this may lead. Generally, this type of tenuous situation is not good for stock markets. The stock markets in the U. S. have shown no apparent significant downturn--yet! The Middle East still supplies about one-third of the oil that is used in the U.S. A disruption to the supply line, or worry about such a disruption, could send oil prices skyrocketing. Such an event would have a negative impact on the growth of the U.S. economy, with more consumer dollars going for gas and less for consumer products. While we are in the stages of becoming self-sufficient in energy, our infrastructure, to make this possible, is not yet fully in place. Today, on the front page of the Wall Street Journal, it was reported Secretary of State John Kerry, in London, 2855 miles from Damascus, in an off-the-cuff remark, suggested that President Bashar al-Assad could avert an attack by promptly handing his chemical weapons to the international community. Moscow, 2184 miles from Damascus, declared its support and quickly got Damascus on board. In Washington, DC, 5877 miles from Damascus, the vote on action in Syria became muddled. No matter the outcome, the Middle East does have an impact on the markets and citizens of the U.S.   

Ed Mallon

Is the Stock Market Too High?

A question that often comes up after the stock market has had a significant increase in value is: “Is the stock market price too high?” The corollary of this question may be: “Is the stock market too low, or under-priced?” Current economic data indicates that the economy grew more than expected in the second quarter. Instead of rising only about 1%, the government’s original estimate, it rose in excess of 2%. Housing start numbers came out this morning showing an increase in July over June of an estimated 50,000 (896,000 vs. 846,000). Consumers are spending more, initial job claims for last week dropped to 335,000 (the lowest since November
2007), employers added 162,000 new jobs last month, and the value of homes has increased. This is all good news, but there is some bad news, too. Retail earnings for companies like Macy’s, McDonald’s, Wal-Mart, and others that target lower- and middle-income people dropped. Manufacturing growth and factory orders are down. The Federal Reserve is indicating it is going to reduce, then eliminate, the stimulus it has been giving the economy within the next year. So how do you judge the stock market? Many say the “old ways” are out. But if the “old ways” are out, then how do you determine if this is a buying or selling opportunity? Let’s look at 
the old methods of making decisions. When we invest in stocks we are investing to capture the earnings and earning potential of a company. The price earnings ratio (P/E) is a significant way of looking at individual stocks and the broad market. It takes the price of a stock and divides it by the earnings of the stock. This gives us an understanding of how an increase or decrease in the price of a stock is determined, based on earnings of the stock. Using the S&P 500 as an example, the P/E is 18.62 vs. 15.89 a year ago, which appears to be a big increase in price vs. earnings in one year. We cannot stop at this point, because what we really want to know is how much will we earn between this year and next? The forward P/E, which looks at estimated earnings for the coming year, is 15.40, lower than the ratio was (15.89) last year. This appears to be a bullish sign for stocks because it indicates that current prices are not out of line with the norm. Another piece of information to examine is the percentage of dividends paid to the price of the stock. For the S&P 500, the current dividend rate is 2.04% vs. 2.07% a year ago, which seems to be a small dip. When we examine what is really happening, we must take into account the price gain from a year ago. If we had $100,000 in the S&P 500 one year ago, our annual dividend would be about $2,070 (2.07%). Between last year and this year our, account would have grown by 17%, the rise in the S&P 500 during the one year period. Now our account would have $117,000, earning 2.04% for an annual dividend of $2,387 or $317 more than last year. All of this indicates that, as earning on stocks have grown, the prices have risen and the companies have been paying increasing dividends. This seems to me to be a rational way to look at the stock market, even if I’m using the “old ways.”
Ed Mallon

Expectations

We all have certain expectations and so does the market place. As each year progresses, expectations arise about the future inflation rate, the growth of the economy, consumer spending, and other such areas of interest. Based on these expectations, investors make decisions about what investments they want, when, and how. As real results come in, the expectation is compared to the result. Generally, if the result meets or exceeds expectations the response is good. If the result falls short of the expectation, the response is not good. Last week, a report was released showing that consumer spending, a key ingredient in moving the economy, did not meet expectations and the market dropped. The market moved lower due to fear that consumers had curtailed their overall discretionary spending for everything except automobiles. This week, a report was released indicating that consumer prices were rising and exceeding expectations, moving the market up. The market rose because higher prices are apparently taking hold, thus increasing the possibility of added profits for companies. Currently, we are at the end of a quarter, with a half year behind us and a half year to go. Earnings from various companies are very important to the market at this time as analysts attempt to figure out what will happen for the balance of the year. We closed the second quarter with both stocks and bonds down for the month of June. As of this writing, stocks have staged a dramatic recovery and bonds are moving into positive territory. This is all good news, but the markets are very susceptible to wide fluctuations, and earnings reports will continue to come in between now and early August. At this time, the economy appears to be growing stronger, the Federal Reserve will reduce purchases on bonds, and the U.S. deficit for the current fiscal year, which ends on September 31, will be substantially lower than expected. This is good news for the U.S. economy and the stock market. We as investors need to remember that short term shifts in investments will occur, and we must be patient and look at the long term. To me, the long term looks extremely good.
Ed Mallon

Double Down!

The month of June was unkind to both bonds and stocks, as both lost value during the month. From the beginning of May until last week, Barclays index, which tracks investment grade bonds, was down 3.77%. Some people are referring to this as a “blood bath”, which it certainly is not.
Back in 1994, we had what has come to be known as the “bond massacre” when bond values dropped 5.3%. Bonds, like stocks, do go up and down, but bonds pay interest, which helps offset losses. The reason for owning bonds is that, over the long-term, they are more stable and can offset significant losses in stocks. The portion of the bond market that was most adversely impacted was United States government notes with maturities of 10 years or longer. These bonds were down an average of 10.8% during that same period. The long-term investor knows that a knee-jerk reaction is not the best investment move. As occurs quite often with a big selloff, the pendulum swung back, with bond interest rates falling later in the month and the value of bonds beginning to grow, although not back to where they had been at the beginning of May.
While it is unusual, stocks and bonds can rise or fall at the same time. Such was the case in June as stocks also fell. Using the S&P 500 as our measurement, the index fell from 1666 on May 21st to 1573 on June 24th, a drop of 5.6%. It recovered to 1606 by the close of the stock market on June 28th. In many respects, the second quarter of the year returned the gains of the first quarter. What precipitated this selloff of both bonds and stocks was an assessment by the Federal Reserve Board that the economy was getting stronger and would be growing significantly in 2014 and 2015. In May, I indicated that I thought the market was ready for a 10% correction but not a bear market. Some bonds have produced that correction, as have some stocks. The long-term outlook seems bright.
Ed

The Fed Makes its Mark

On Wednesday June 19th, following a regular Federal Reserve Board (Fed) meeting, Chairman Ben Bernanke made an announcement composed essentially of two parts. Mr. Bernanke said the Fed would wind down the bond-buying program, in which they have been buying $85 billion in bonds monthly, and work towards a goal of ceasing the operation by mid-2014. His justification for the change is an optimistic assessment of the current state of the economy and its direction over the next two years. The Fed expects the jobless rate, which was 7.6% in May, to fall to 6.5% to 6.9% by the end of 2014. Mr. Bernanke commented on better fundamentals, saying, “In particular, the housing sector, which has been a drag on growth since the crisis, is now obviously a support to growth.” He was referring to rising home prices increasing household wealth and thereby strengthening consumer confidence and spending. Overall, the Fed expects the economy to grow by 3.0% to 3.5% in 2014, which would be a marked improvement. The Fed also expects inflation to remain low, between 1.5% and 2%. Other members of the Fed indicated that it is unlikely the Fed will begin pushing up short-term interest rates until 2015. Better economic growth, low short-term interest rates and a housing boom all seem very positive. The problem is, many in the financial community believe the result of the Fed reducing, then eliminating the bond program will bring higher mortgage interest rates, a slowdown in housing, reduced consumer confidence and a stalling of the economy. Fear of what might happen when Mr. Bernanke steps down in January of 2014 is an additional negative. Markets don’t like uncertainty!
The bond and stock markets’ response to this change was sudden and sharp! The value of bonds and the value of stocks both dropped. As interest rates on a bond rise, the value of the bond drops. A month ago, for example, the 10-year Treasury bond had about a 1.7% interest rate. Now, the rate is 2.59%, or a drop in value of about 8%. The stock market has also taken a big hit with the S&P 500 down 5.7% since May 28th, falling from 1661 to 1566. Gold, too, has fallen. The day of Bernanke’s announcement, the value of an ounce of gold was $1,373.60 and is now $1,276.90, a drop of over 7% in a matter of days. So much for the safety of gold. For the investor, this may be a good time to take a summer respite and come back in the fall. The next few months could show substantial market volatility. If Mr. Bernanke and the Fed are correct, we should see the economy continue to pick up as we move forward in 2013. That being the case, the stock market should recover, eventually, and the bond market will settle down. For now, we will wait and see.
Ed Mallon
(written Monday, June 24, 2013)

Mixed Market

When putting together an investment portfolio, you do not want your various investments to move up or down in tandem all the time. That is why one of the basic tenets in building a portfolio is to use non-correlated assets. Two broad categories of non-correlated assets are stocks and bonds. Stocks move separately from bonds and for this reason we like to have both in a portfolio. The current environment might appear to contradict this non-correlation of stocks and bonds, since both have lost value since May 9th. In fact, this does not disprove non-correlation; it just proves that current information has pushed both stocks and bonds downward. The question, therefore, must be “Why?” Looking at the bond market, we know that as interest rates rise, the value of bonds decreases. Lately, interest rates have begun to rise, in large part due to the uncertainty of the Federal Reserve Board (FRB) policy on buying $85 billion of bonds monthly, which has kept rates low until recently. The stock market moved down, reflecting the fear that a reduction in buying by the FRB would stall the economy, just as it was beginning to pick up momentum. My belief is that the FRB decided to test the markets by seeing what would happen if a reduction in buying bonds was to begin shortly (this summer or fall). The result has likely been to make them very concerned about such a possible change. The FRB meets next Tuesday and Wednesday, and will be discussing this issue and what they need to do. As the fears of reduction of bond purchases by the FRB have grown, the currencies of Japan and Europe have risen, which, if continued, would curtail any chance of growth for them. Emerging countries are seeing the value of their currencies decreasing, as investors avoid risk in favor of liquidity, creating a negative impact on their economies. The impact of a possible change in bond purchases by the FRB has already resulted in the bond, stock and currency markets preparing for the worst. It is my belief that the FRB is well aware of their role in leading the world out of an economic recession. With what has taken place in a very short period of time, the fragile recovery is headed in the wrong direction. For three years now, the FRB has been working to create momentum in the economy. I don’t think they are going to do anything to disrupt the goal at this time. Everyone wants to know, “What’s the deal?” The FRB must come out next week and say, with a great deal of certainty, that there will be no change in our buying of $85 billion each month until early next year at the earliest, or some similar indicator of their plans! A week from today we should have a pretty good idea of what they will be doing and for how long. If not, markets will continue to be volatile.
Ed Mallon

In the Name of National Security

How far should the federal government be allowed to go in reducing freedom and privacy to provide security for our nation? Since 9/11, the federal government, in the name of national security, has not only reduced certain freedoms and collected more data, but has also authorized holding assets and individuals without their normal rights under the Constitution. This secretive use of power has been building up for some time. With the NSA document leaks, reported in the Guardian newspaper last week, the massive level of surveillance over the public was revealed. This time we were made aware of how invasive the government is willing to be to “protect our rights.” Clearly, the genie is out of the bottle, recognizing that large volumes of data can be mined easily to find specific information. The time has come to take the shroud off the NSA and make them as accountable to the public as any other government agency. When we allow our government to keep secrets from our own citizens, it does not turn out well. An open discussion and evaluation is needed to decide the boundaries for information gathering on our own citizens before we lose this hard won democracy that we all cherish.
Ed Mallon

In Memorium

(written) May 27, 2013
Each year at this time I go back in my memory to visit a friend and mentor. I joined the Cub Scouts at age 8. The Pack had 160 boys, met on Wednesday and had one adult leader (that is another story). The assistant Den leader was Michael Thomas Glynn. He took me under his wing and became the big brother I never had. He helped me become a Wolf. Then he was promoted to Den Leader and I was chosen to be the assistant. Mike moved up again and I became Den Leader. When I joined the Boy Scouts, Mike was my Patrol leader. I just kept following in Mike's footsteps. Mike had all the merit badges to become an Eagle Scout, but hard as he tried, he couldn't earn the last two required badges, swimming and life saving. He was proud of me when, with his encouragement, I became the first Eagle in Troop 416. Mike went on to graduate 66th in a class of 596 from West Point in 1965. To this day, I remember Mike's enthusiasm on Christmas Eve 1965 when he met my fiancé, Fran. He spoke about the career he hoped to have in the State Department when he completed his military service. Mike went to Vietnam on January 3, 1966. He was a Platoon Leader in Pleiku Province, Vietnam, when he was killed on May 28, 1966. He was the second member of the West Point Class of '65 to die in Vietnam. What might have been? At this time of year, we should look with appreciation and gratitude to the men and woman who serve in our military, and especially to those who have given their lives.
Ed Mallon

Indexes

As the economy has gone through its many changes, I have continued to watch certain trends. One of the trends is new jobless claims each week. The number for the week is good to know, and we’d like to see it below 350,000, but the four-week average is the important number. We want to see that drop below 350,000. Last Friday, the Labor Department announced the jobless weekly number at 335,000 and the four-week number at 336,000. This was good news.
This information is available to everyone, so it is important to have some personal indexes that are not controlled by the government or media. The BK index is used to get some sense of the impact of inflation on the economy. You will recall that back on September 23, 2010, I discussed the BK index and the alarming 27% jump in the index, while the CPI only went up 3%. Since that time, the index has gone from 1.59 to 1.65, an increase of approximately 3.8% over almost three years. This would indicate that inflation is not rearing its ugly head in the consumer marketplace. (For those of you who have forgotten, this index measures the price of a Junior Whopper with cheese at Burger King over time).
Another index that I use to determine the direction of the economy is the FMAS Index. This index has been pretty reliable at determining the direction of the economy. It is also known as a leading indicator because it tends to decrease before consumer spending as a whole goes down, and tends to rise as consumers begin to spend again. I have been using this index since I realized the income of my wife, Fran Mallon (FM), an artist, and the number of Art Sales (AS), tend to move ahead of the economy. Thus I am pleased to announce that for the first quarter of this year the FMAS Index is up 400%, indicating that the economy is about to become robust!
Another very important index is the EROORES Index (Ed’s random observation of real estate sales). While this index turns out to be hard to quantify, casual observation of my own neighborhood revealed that three houses went on the market during a three-week period, and all were under contract in less than a week. Many of my clients in Denver have noted that housing sales are going like “hot cakes”, and with the help of their observations, I have gathered that the housing market is totally robust. Yes, the economy appears to be headed in the right direction, however slowly that may be.
Ed Mallon

The Merry Month of April

April has turned out to be a most interesting month. The weather was “un-April-like” and the stock market “Un-Stock Market” like! The starting point is actually March 29th when the S&P 500 closed at 1569. The close on April 1st was 1564, down 5 points. Some market commentators immediately began discussing an “April Swoon”. By April 11th, the “Swoon” idea was no longer discussed, as the S&P 500 hit 1593. Now the experts were predicting all kinds of good things for the stock market. The middle of April is when large companies report their earnings for the first quarter. The results were subpar. Earnings either missed the consensus-estimated earnings (many companies); were better than estimates, but the company put forth possible issues facing them in the future (GE); or better than expected earnings, with experts fearing issues going forward (Apple). As the earnings season took hold, the stock market began to wilt (think “Swoon” again). By April 18th, one week after the high point, the S&P had dropped to 1542, down 51 points, or more than 3%. This was good for bonds, as interest rates fell and the value of bonds increased. Then something strange happened. The market went up, up, up. As of this writing it stands at 1598, the highest point of the month. So, for the month, both bond and stock values increased, and both gold and oil rose again. What can one make of all of this positive change? My only answer is that, as you look to the future, the economy, though growing slowly, about 2.4% for the first quarter, is growing. While earnings did not meet expectations, the stock market was able to rebound and take a longer perspective, which has not been the case for the past five years. If it continues, this is likely a good sign for the economy.
Ed

Unemployment Drop

It seems that even when it appears we are seeing “good news” it may belie bad news. It appears such is the case with the drop, reported last week, in the unemployment rate from 7.8% to 7.6%. The initial stated cause of the drop was people dropping out of the work force. Seems straight forward enough but it made me wonder; “What are they living on now?” Today the Wall Street Journal, in a front page article, seems to have come up with one place where these unemployed workers have been going. A rather high percentage are using Social Security Disability as their avenue for income. This is not to say that a person qualifying for disability shouldn’t get the benefit. During most recessions, people who lose their jobs or become underemployed and who have significant disabilities, will apply for benefits. During the early part of the recession, December 2007 thru June 2009, the percentage of people on government disability rose from 7.1% to 7.6%. At the end of March 2013, this had risen to 8.9%. This represents 8.8 million beneficiaries getting $137 billion of benefits, as well as 2.1 million family members getting $80 billion in aid. After two years on disability an individual can qualify for Medicare benefits too. Some states, during this prolonged recession, helped compound the problem, as they moved welfare and Medicaid recipients off their roles and onto the Social Security Disability program, ending the state’s payment responsibility. The average payment to a recipient is $1,130 a month, or about $13,560 annually. This is about $2,000 more than a person would get paid at the Federal minimum wage and also about $2,000 more than the poverty level. While the costs associated with the program are great, the plan is expected to have insufficient funds by 2016, it’s the loss of workers that may be the true burden to the U.S. In 1970 about 1.7% of the potential work force was on disability, now it is 5.7%. Of the 8.8 million on disability about 2.5 million are in their 20’s to 40’s. In the past the work force in the U.S. was growing at about 1.7% a year, now it is barely increasing, in part due to the increase in individuals getting disability payments and no longer working. The fear is that many of these potential workers, who could be retrained for other jobs, will simply remain on disability. As with many agencies of the government, the Social Security Disability agency is under-staffed and unable to keep up with medical reviews that might change the picture. In addition, back in the mid 80’s, Congress widened the sphere of who is eligible for benefits. In the long run, if Congress does not take action, the nation could have 2.5 million potential workers getting about $34 billion in benefits and not contributing to the economy. If these potential workers suddenly came back our unemployment might be 9.6% rather than 7.6%. A retraining program for some of these individuals seems in order.
Ed Mallon

Are we out of the woods yet?

My big question is: are we out of the woods yet? As investors, the biggest problem that we have experienced over the past six years is the high level of volatility in the stock market. Depending on good news or bad news, the stock market seemed to have had a knee jerk reaction to dispersed information. This has changed. Since the end of last year, the market has risen steadily. The only glitch was on February 25th, when the market took a rather big drop and then recovered. The “News Factor” is moving the market less, as we have seen with the bailout of Cypress. There is an old saying in the market: “the trend is your friend!” The trend appears to be upward. Looking at the long term, the U.S. Stock market appears poised for an extended rally as the economy continues to improve. I have no doubt that there will be bumps along the way, but moving forward, we want our clients fully invested in stocks relative to their risk tolerance. As I have noted in previous blogs, I still have concerns about the lasting value of intermediate to long-term bonds. At some point, the Federal Reserve will begin to allow interest rates to increase. When this happens, the principal value of bonds will begin to decrease. To mitigate this, we are using more short duration bonds in our mix. I am currently going through our clients’ asset allocations to make any necessary adjustments.

Taxes and Spending

Today we heard that the economy grew, just barely, at a 0.1% rate in the fourth quarter of 2012. Many reasons were given for this lackluster growth. To me, the most important part is that, at the beginning of 2013, taxes rose for all working Americans, with the increase in the payroll tax. Consumer spending accounts for about 70% of the economy. Higher taxes leave consumers with less to spend, so a rise in taxes generally dampens the economy. Now we are looking at a major reduction in U.S. Government spending, to begin March 1st. This too will impact the economic growth in the U.S.

For several years now, the Federal Reserve has been keeping interest rates low in an attempt to help the sluggish economy. This may now be more than offset by the tax increases and reduction in spending.

We are at a real juncture. The citizens of the U.S. want their entitlement programs left untouched: e.g. Social Security, Medicare, Obamacare, etc. Only 53% of the population pays income taxes and they don’t want to pay any more. So, we don’t want to cut spending and we don’t want to raise taxes. Sorry, can’t be done!

Congress and the President don’t seem to be in the mood to compromise. The pieces will fall as they may, leaving the consumer and business to pick them up and work with them as well as possible. Overall this scenario doesn’t seem to be good for our short-term economic outlook!

Ed Mallon

Economic Drag

The Labor Department today reported 366,000 new unemployment claims. The really good news is that the four-week average is 350,500. A number like this indicates that business is maintaining the best rate of employment since early 2008. The Labor Department also indicated that 157,000 new jobs were created by business in January. While this is not great, and we are looking for something in the 350,000 to 400,000 jobs range, it is better than a year ago.

The report also noted that in the 4th quarter of 2012, Americans worked more hours but business output was flat! Non-farm productivity fell by 2% during the final quarter and labor costs jumped by 4.5%. The GDP dropped to an annualized rate of 0.1%. These are not signs of a robust economy.

The Federal Reserve is buying bonds and mortgages at the rate of $80+ billion monthly, in an attempt to stimulate the economy. Millions of people are out of work and the unemployment rate has moved back up to 7.9%. With all of this mixed news the stock market continues its surge, with the S&P 500 up about 5% in January. Overall, it would therefore appear that we are holding our own but with a feeling of trepidation!
Ed Mallon

Old War Horses

The idea that "old war horses never die" is, fortunately, wrong. For years in Washington, we had Senators and members of Congress who knew the art of cutting a deal, where each side won and also lost. We had people like Tip O'Neill in the House and Ted Kennedy in the Senate, who worked out deals, doors closed, without the need to go to the brink. Much has been written about the impact of the new tax deal on average and wealthy taxpayers, but how in the world did we avoid the "fiscal cliff”? During this most recent budgetary crisis, various discussions among combinations of leaders like President Obama, the majority leader of the Senate, Harry Reid, and the House Speaker, John Boehner, could not come up with a workable deal. I kept wondering what had happened to the leadership in Washington. This deadlock was one for the books. But, like magic, leadership finally did emerge! With the House in gridlock and the Majority Leader of the Senate unwilling to budge, Senate Minority Leader Mitch McConnell called Vice President Joe Biden. These two "old war horses" worked together and came up with a solution. Was the solution perfect? No. Did it resolve the crisis? Yes. It may not mean much to most people, but for me, it gave me hope. Thank you, Joe Biden and Mitch McConnell, for showing us Washington can still work. I hope you will keep it going.
Ed Mallon