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