February 2009 Archives

Henry "Bud" Hebeler runs the www.analyzenow.com website. He sent me an article he just wrote on Generic Investment Advice. Here's how I've described Bud for a BW article:

In 1956, Henry "Bud" Hebeler left Boston with a graduate degree in engineering from MIT for a job at Boeing (BA) in Seattle. Some three decades after making that long trip in a Volkswagen Beetle, he retired as president of the company's giant aerospace unit. It wasn't long before Hebeler, disgusted by much of the retirement-planning industry, started a new career dispensing conservative financial advice that can be curmudgeonly but is always insightful

Here's the article:

For perhaps 40 years I have followed a general allocation rule to keep my fixed income allocation between an upper limit of my age as a % and a lower limit of 10% less. So at 75, my target range for fixed income investments is between 65% and 75%. Only when fixed income investments get outside of these limits do I rebalance, and I do this only about once a year if necessary. (The Business Week article about my views last week mixed up the formula bit unless you read the sentences very carefully.)

In my last book, I show that using limits instead of an absolute allocation formula is more effective at buying when stocks are low and selling when they are high.

Right now, I am not buying equities to bring my allocation into balance. For the first time I'm violating my own rules. I know that's market timing, and I'm opposed to market timing, but if you read my articles in the Economics section of Helpful Articles on www.analyzenow.com, or any of my press in the WSJ, Bankrate.com, Business Week, Kiplinger's, etc., you'll see why. In short, debts are just far too high.

My current advice to those who were within my allocation limits at the start of 2008 is to delay rebalancing. That would be the correct action either if the market rebounds to prior levels or if it gets worse. As far as new investments from savings from wages, I'd follow my allocation rules but lean to the higher limit of fixed income investments.

As you know, when you buy fixed income investments you are buying debt, and that's not a good thing to do if anticipating hyper inflation as I do. But you can get some debt that's inflation protected. I saw the current situation developing over ten years ago, so I've acquired much more of inflation protected debt and on better terms than you can now. One of my components includes immediate annuities with inflation adjusted payments, but the underwriter turns out to be AIG. (Maybe that's all right now that it's owned by the government.) Now, I'm just getting shorter term instruments basically to preserve capital. My tax situation is such that TIPS aren't that attractive to me, but I'm thinking of converting part of my 401(k) into an IRA where I can buy TIPS (not a TIPS fund).

With rare exceptions, I don't. I buy low-cost, tax-managed, stock index funds. Mirriam likes to speculate with stocks because some of her friends do. Fortunately I was able to get her to sell them at opportune times. That's not skill. It's just plain luck. One very wealty man was asked how he got so rich. He said he alwa ys sold too earl y.

I try never to buy a bond fund. I invest in ladders of individual issues and hold them to maturity. I'm a little scared of municipals right now, so I've got quite a bit of cash from maturing muni bonds now in muni money markets waiting for something I like.

I had an expensive financial advisor that Boeing provided who got me into a lot of real estate partnerships. All I did was verify the old adage that a partnership is formed when two people get together, one who has all of the money and the other who has all of the knowledge. When the partnership liquidates, their positions are reversed.

I've never been financially sophisticated enough to get into options and hedge funds.

And so ends my epistle on generic advice. You can use it in the future to show how wrong I was.

The employment number with a 7.6% unemplouyment rate and a plunge of 598,000 in payrolls is even worse than it appears. For one thing, the broadest measure of unemployment, including marginally employed workers, jumped to 13.9%. And government statisticians revised their previous unemployment numbers for 2008, saying that 385,000 more jobs were lost than initially estimated, bringing the total job loss to 3.6 million.

Washington had better get its act together on the fiscal stimulus package. There is no reason to believe that this month is any better than last. The jobs data shows that the downward trend is gaining momentum. We're now not all that far from the depths of the 1981-82 downturn.

It's getting harder and harder to get a job. This chart from the BLS is the number of unemployed 27 weeks or more.

The Conference Board came out with this press release this morning:

The Conference Board Employment Trends Index (ETI)™ fell further in January. The index now stands at 96.6, down 1.0 percent from the December revised figure of 97.5, and down 18.6 percent from a year ago.

"The Employment Trends Index™ has recently been declining faster than at any time since the 1974 recession," said Gad Levanon, Senior Economist at The Conference Board. "Such declines suggest considerable job losses will persist for several more months. It is becoming clearer that the continued worsening economic conditions are forcing many companies to make further downward adjustments to their workforce."

The unemployment rate will clearly breach 8%. Question is, will it go higher than 10%. Sad to say, that appears to be the right forecast.

This is why we need fiscal stimulus.

Thanks to Brad Delong for the chart. It simply explains why most economists, even those distressed by the thought of fiscal stimulus or not liking aspects of the current plan, are supportive.

Since I have no idea how long the recession will last I'm less concerned about the mix of short-term and long-term spending, and most of the longer term spending projects make sense anyway.

There's a good chance that job losses are accelerating this month.

The numbers are dismal. In 2007, 37 million people were living in poverty. That's 4 million more than when the business cycle expansion started 2001. Real median household income grew by only 0.26 percent a year throughout the years of economic expansion, according to the Center for American Progress. That abysmal improvement meant that incomes were below 2000 levels.

The unemployment rate is currently 7.6%, and it's a safe forecast that it will breach 8% soon. What does rising unemployment signal about poverty?

According to a recent analysis by the Center, more than 12 million Americans are at risk. It calculates that the number of people living in poverty will rise by 12.4 million by 2010 if the unemployment rate reaches 11 percent. And more than 7 million people will fall into deep poverty, living below half of the poverty line.

The study also notes that sharp hikes in poverty happened in previous downturns. For instance, the ranks of the poor grew by 9 million between 1979 and 1983, and it grew by 8 million between 1989 and 1993.

Any debate about the future of unions in the U.S. is really a discussion about public sector unions. The private sector's unionized workforce is simply too small to matter outside of a few industries. .

The chart is from Harvard University Labor and Worklife program at the Law School. I also think the relative small size of private sector unions is one reason the hope that unions will be a force for combatting poverty is misplaced. Unions are finding it hard enough to hold on to their place in the middle class.

The website Visualizing Economics has a good map of poverty in the U.S. from 1980 to 2007. Check it out.

I've already discussed on Marketplace Money that the tax problems of Tim (Turbotax) Geithner and former Sen. Tom Daschle are arguments for serious tax reform and tax simplification.

In the meantime, maybe it should be law that anyone in Congress and the White House has to do their own taxes. No professional help. No accountants. That might be an incentive for tax reform.

I'm reading Peter Bernstein's latest newsletter, and he starts it off with this quote:

Above all, let us recognize that the future will not look like the present. In the 1920s, we were told we would never have a depression. In the 1930s, we were told that the economy would never pull itself out of stagnation (without government help, that is). And in the 1950s, we were told that the wage-price spiral will never stop spinning and that inflation will go on forever....The truth of the matter is that our economy is always changing and that no trend can go on indefinitely. The danger lies not in change but in the excesses of optimism or pessimism which result from assuming that this time there will be no change.
PLB, Harvard Business Review, July-August 1957

A nice reminder....

Many economists have wondered if Benjamin Strong, the powerful and savvy head of the Federal Reserve Bank of New York, hadn't died in 1928 would he have managed to prevent the recession from turning into a depression. Anyway, there is a nice passage about Americans and speculative bubbles from Strong in "The Lords of Finance" by Liaquat Ahamed.

"In Strong's view, something about the American character--the exuberance, the driving optimism, the naive embrace of fads--lent itself to periods of speculative excess. 'It seems a shame that the best sort of plans can be handicapped by a speculative orgy,' he mused almost philosophically to Norman [the head of the British central bank] at the end of 1925, 'and yet the temper of the people of this country is such that these situations cannot be avoided.'"

He's right. The downside should be limited or contained when the bubble bursts, but bubbles also reflect innovation and optimism, the belief that tomorrow will be better than today.

The President will propose how to help out homeowners facing foreclosure. David Leonhardt of the New York Times has a good article today on the choices facing the Administration. In essence, the Administration has to choose between focusing on those homeowners in dire financial straits or to include homeowners with mortgage payments they can meet but on homes worth far less than the value of the mortgage. It looks like the Administration will direct resources toward the most desperate homeowners.

But Dean Baker,co-director of the Center for Economic and Policy Research in Washington D.C., offers a far better solution on his blog.

We know that the people who run Citigroup, J.P. Morgan, Wells, and other major financial institutions may not be the sharpest knives in the drawer, but how much do taxpayers have to cough up to make up for their ineptitude? David Leonhardt's discussion of housing bailout plans never seems to consider the possibility that we would just let large numbers of foreclosures occur and let the banks eat their losses.

Yes, many, if not most, of the banks will go under. So what? Why should taxpayers support convoluted schemes to protect these bank executives and their shareholders from their own ineptitude. We can protect homeowners by simply giving them the right to stay in their home as renters following foreclosure. It's a simple, costless and bureaucracy-free solution, but it screws the banks. So, the folks in Washington and the media apparently are not interested.

Well, I'm interested, and I don't see why not? So far, my sense is that Treasury remains for too solicitious of bank shareholders and bondholders.

It's time for the Administration to shift strategies on GM and Chrysler. The bailout isn't working, and I don't see how it will. Paul Ingrassia is a former Dow Jones executive and Detroit bureau chief for this the Wall Street Journal. He has a good piece on the auto bailout in Op-ed section of the Wall Street Journal (subscription required). The money quote:

GM justifies its bailout request by contending that a bankruptcy filing will cost the government $100 billion to guarantee pension payments and other obligations. But here's the thing: The total of nearly $45 billion requested so far from the Treasury Department, the Energy Department and friendly foreigners gets us almost halfway to $100 billion, even if the company doesn't request more money down the road -- which one suspects it will. Without a bankruptcy filing, the issues with the UAW, dealers and bondholders are likely to remain unresolved. The same pain-avoidance motive that has kept these issues festering for years will continue.

This is just what Chapter 11 bankruptcy is designed to deal with. Don't throw good money after bad. The government will have to provide back-up financing for the companies in bankruptcy. That's fine.

American RadioWorks producer Laurie Stern has been reporting on poverty and the economic downturn. Here's a recent observation from her:

Lately I've been getting to know people in Muncie, Indiana and Eagle Butte, South Dakota. At first glance, the places have little in common. Muncie has a proud, if receding, blue collar history and an up-and- coming university. Eagle Butte anchors the Cheyenne River Lakota Sioux reservation: more than a million acres of rolling ranch land with 10,000 people and 90,000 cattle.

There is significant poverty in both places, and people are coping in similar ways. As jobs dwindle, families combine to share money that comes in through wages, government assistance or charitable donations. Adult siblings move in with each other; grown children move home, elderly aunts and uncles are invited to share a room, and pay rent if they can. You can always double up with a relative, share some food, a vehicle, or get a loan when you're desperate for cash.

In Eagle Butte and Muncie, the family remains the safety net to count on.

Producer Krissy Clark has been hanging out in Las Vegas and following a number of families for an American RadioWorks documentary that will air in the spring. It's focusing on foreclosures and neighborhoods. You can listen to background information as Krissy pulls together her story on this podcast..

I got this question the other day: "We just hit the bear market low that we hit on Nov. 20. Is this the bottom? Is now the time to jump into the market?" JOHN, MINNEAPOLIS

Here's my answer in the Star Tribune.

Ah, I wish I knew. It's impossible to know whether the market is hitting bottom now -- or might do so several years from now. And these are unnerving days, with fears of an extended recession replaced by growing worries of a depression.

That said, there is a discernible rhythm over the long history of the markets. Specifically, the despair that marks financial catastrophes often sets the stage for better returns later on.

"Markets tend to overshoot in both directions," the late financier Leon Levy wrote in his memoir, "The Mind of Wall Street.'' Levy's book, published in 2002, remains a smart conversation about markets, psychology and economics. Of course, there's no guarantee that the stock market will revive this time around. But it seems a reasonable bet considering the country's history of innovation, an educated workforce, entrepreneurial traditions and the determination of the White House and the Federal Reserve to stop the economy's downward momentum.

Take the stock market debacle of the Great Depression: The Dow's 17 percent drop in 1929 was followed by a 34 percent decline in 1930, a 53 percent drop in 1931, and a 23 percent fall in 1932. Still, young investors bold enough to gamble on stocks during the Depression would have seen their stake grow tenfold by the time they reached retirement in 1957, notes Oxford historian Niall Ferguson.

The famed economist John Maynard Keynes speculated on a rebound. He had a portfolio worth about $40,000 after losing 80 percent of his money when commodity prices collapsed in 1928. Keynes believed that President Franklin Roosevelt would revive the U.S. economy "He shifted his strategy from short-term speculation to long-term investment and, at the lows of the Depression, put together a concentrated portfolio of a select number of British and American equities," writes Liaquat Ahamed in his new book, "Lords of Finance.''

By 1936, Keynes' net worth was close to $2.5 million -- the equivalent of $30 million now, Ahamed writes. "Lords of Finance" is well worth reading.

Even if optimism is the right strategy, the big problem is that the timing of the stock market recovery is uncertain. That's why the proverbs that preach diversification and dollar-cost averaging remain good advice for anyone investing for the long haul.

There are a lot of factors accounting for the borrowing boom--and bust.

But one factor that may be underappreciated is that many people had a reasonable expectation that the borrowing would pay off.

Incomes typically pick up during an economic expansion, justifying the increased household debt. In a sense, the rule of thumb many of us carried in our mind was that a rising tide lifts all boats, right? Financial optimism had been the right approach for much of the postwar period. For example, according to the Economic Policy Institute, in the 1969 to 1979 economic cycle inflation-adjusted household income grew 4.5%, from 1979 to 1989 by 6.5% and from 1989 to 2000 by 8.3%.

It's the recnt period that different. From 2000 to 2007 real household income fell by 0.6%. What's happening today is a massive downward adjustment in growth expectations.

Treasury Secretary Paul O'Neill was right--very right. What a missed opportunity. We wouldn't be in the fiscal mess we're in if O'Neill had won the argument.

This pasage is from Ron Suskind's book, The Price of Loyalty:

The package of tax proposals, led by the 50 percent cut in the individual tax on dividends, had been all but buried before the midterm elections; it came up infrequently and always in the past tense - what George Bush wanted to do but couldn't afford.

He was speechless. Cheney moved to fill the void. "We won the midterms," he said. "This is our due."

O'Neill was run out of town. And we're paying the bill.

Barry Ritzholz at The Big Picture has this chart comparing the current bear market in stocks to previous plunges, 1929 to 2009.

Mike Mandel at Business Week cuts the numbers a different way, painting an even gloomier picture. He notes that the S&P 500 is down 50% adjusted for inflation (February 17, 1999 to February 17, 2009). He calculates that the stock market was down roughly 50%, adjusted for inflation, in the worst ten years of the Great Depression (September 1929 to September 1939).

One last set of numbers: The last quarter century--until recently--was considered the era of private enterprise innovation and poor government fiscal management. From 1983 to 2008, the annual total return on stocks was 9.8% a year. Yet, according to Peter Bernstein, the dean of finance economists, long Treasuries produced an 11% average annual return over the same time period. Go figure.

Rent and ownership are competing markets. Looking at the rent to price ratio is a quick way of judging whether homes are overvalued or not. Calculated Risk ran the numbers off the latest Case-Shiller national home price data.

It looks like prices still have a ways to fall, although perhaps not much more. The wild card is that rental prices are alos coming down in a lot of markets, which will put additional downward pressure on home prices.

Warren Buffett's annual letter to shareholders is out. His company, Berkshire Hathaway, had its worst year since the premier stock picker took it over in 1965. Of course, a lot of CEO's would kill to have his results--even in a bad year.

As always, his letter is a remarkable document. I'd recommend reading it several times. I plan on it.

But for right now I want to highlight a segment of the letter that warns of a Treasury market "bubble." The timing is uncertain, but I think he's right. No market rallies forever. Investors don't like zero percent yields. The economy will rebound, eventually.

Here's what Warren Buffett has to say:

The investment world has gone from underpricing risk to overpricing it. This change has not been minor; the pendulum has covered an extraordinary arc. A few years ago, it would have seemed unthinkable that yields like today's could have been obtained on good-grade municipal or corporate bonds even while risk-free governments offered near-zero returns on short-term bonds and no better than a pittance on long-terms.

Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns.