Market Update — July 1, 2013

2013 June 30
by SJ Leeds

Good morning.  Here are some of the numbers that I found most interesting from a few articles that I read this week.

 

Markets and Economy

Strong first half of the year.  The Dow Jones Industrial Average ended the first six months of the year up 14%.  The Dow was up over 15% through May and dropped 1.4% in June.

 

Higher yields.  The ten-year UST yield rose to 2.485% (from 1.63% in early May).  The last time that yields rose so much (as they did in the second quarter) was 2010 Q4.

 

Higher mortgage rates.  Rates on fixed mortgages surged this week to their highest levels since July 2011.  The rate jumped from 3.93% to 4.46% — the most since April 1987.  The rate on the 15-year mortgage increased from 3.04% to 3.50%.

 

Moving out of munis.  Investors took almost $10 billion out of municipal bond funds in the past month.

 

Low inflation.  Overall inflation was 1% in May from a year earlier. Core inflation rose 1.1% from a year earlier. That matched the previous month’s reading and equaled the smallest rise in underlying prices on record.

 

Underemployed young people.  In 2001 the underemployment rate (for 22 – 27 year olds) fell to as low at 35%, but last year it rose to 44%.

 

Banking

More IPOs.  Global equity issuance is up 36% (vs. the same period last year) to $381bn.

 

Fewer deals.  The value of deals announced globally fell 9.7% in the first half, to $870bn.

 

Thank goodness the bankers will be able to eat.  Investment banking fees have risen 9% to $36bn this year from the same period in 2012.  Of the global fee pool, 59% was generated in the Americas.

 

Oil

The oil is flowing.  The U.S. pumped 6.5 million barrels a day of oil last year, according to the Energy Information Administration, the most since the mid-1990s.  In April, we pumped 7.4 million barrels per day.  This was the best month in more than two decades.

 

But gas prices didn’t drop.  The price of a gallon of regular gasoline averaged $3.62 in 2012, the highest on record.

 

Fracking!  The fracking boom has boosted U.S. production by roughly 2 million barrels per day over the past five years.  While this is a large increase for the U.S., it represents just over 2% of worldwide oil consumption.

 

Gold

Gold hit three-years lows.  It has dropped 13% since the start of June and is down approximately 30% since the start of the year.   The 23% drop in Q2 was the largest quarterly decline since the start of modern gold trading.

 

Most commodities are down.  The Dow Jones Commodity index is down 9.9% this year.  But, lean-hog prices are up 19%.

 

I wish I hadn’t taken on that debt!  In the past 10 years, the 55 gold and silver companies analyzed by BMO Capital Markets have increased their net debt from less than $2 billion to a record of $21 billion.  In other words, firms have increased leverage and now prices have dropped.

 

Cost of mining an ounce of gold.  The cost of mining an ounce of gold rose to $775 in 2012 from $280 in 2005 (according to BMO).

 

 

Education

More degrees, but falling in the rankings.  From 2000 to 2011, the percentage of Americans (age 25 – 34) holding a degree (from either a community college or four-year institution) increased from 38% to 43%.  But, we fell from 4th place to 11th place (when ranked against other countries).

 

We need a one-semester degree.  More than 70 percent of Americans enter a four-year college (ranking us 7th).  But, less than two-thirds (of those that enter) end up graduating. If you include community colleges, the graduation rate drops to 53 percent. Of the 23 OECD countries being studied, only Hungary does worse.

 

Is it worth it?  According to the O.E.C.D., a college degree is worth $365,000 for the average American man after subtracting all its direct and indirect costs over a lifetime. For women, it’s worth $185,000.  (I haven’t read this report.  One thing I always wonder about is whether these studies compare jobs that require degrees with jobs that don’t.  If so, the numbers are misleading because many people with degrees end up working in jobs that don’t require degrees.)

 

The real salary jump comes from four-year degrees.  According to the O.E.C.D., a typical graduate from a four-year college earns 84 percent more than a high school graduate. A graduate from a community college makes 16 percent more.

 

Wealth gap in education.  The college graduation rate of high-income Americans born in the 1980s was 20 percentage points higher than in the 1960s. Among low-income Americans, it advanced only 4 percent.

 

On average, we’re average.  (Maybe we’re not ready for college?)  In 2009, American 15-year-olds ranked 17th in reading tests — among 65 nations. They ranked 27th in math and 23rd in science.

 

Higher cost of education (us teachers have to keep up with the bankers).  The tuition for 2011-12 at four-year public colleges rose an average of 15.6%, while the increase at four-year private nonprofit colleges was 10.2 percent.

 

Who charges the most?  Columbia University had the highest tuition among all private nonprofit colleges in 2011-12—just over $45,000—followed by Sarah Lawrence College, Vassar College, George Washington University, Trinity College, and Carnegie Mellon University, where tuition and fees all exceeded $44,000.

 

Tuition charges are somewhat misleading.  Net-price increases (increase in tuition less the increase in scholarship and grants) were 5.1 percent at public colleges and 8.5 percent at private nonprofit institutions.

 

CEO Compensation

CEO compensation.  The top 200 chief executives at public companies with at least $1 billion in revenue received a median 2012 pay package of $15.1 million.  This was a 16% increase from 2011.

 

Compensation is mostly stocks and options.  Median cash compensation was $5.3 million last year, while stock and option grants came in at $9 million.

 

CEOs own a lot of stock!  The median value of stock holdings of these C.E.O.’s was $51 million.

 

Golden parachutes.  More than 60% of Fortune 500 companies had golden parachutes in place by 1990. Today, about 82% of the CEOs of Standard & Poor’s 500 companies are entitled to some type of cash payment if they are replaced upon a change in control.

 

Have a great week.

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Market Update — June 24, 2013

2013 June 23
by SJ Leeds

A few interesting numbers I read this weekend:

  1. A bad week.  The S&P 500 fell 2.1%.  The MSCI emerging markets index fell 4.7%, its biggest weekly drop since May 2012 (credit the Fed, questions about China’s economy and financial system, problems in Brazil).  Gold fell to a nearly three-year low before recovering slightly on Friday.
  2. Stocks that are seen as “bond alternatives” have done the worst.  In the past month, the S&P 500 has dropped 4.6%.  The S&P index of consistent dividend-paying stocks has fallen 5.9% in the same period. The utility sector is down 8.4%. The FTSE index of U.S. mortgage REITs has fallen 13%.
  3. When will the Fed funds rate rise?  Recent FOMC projections show that only four Fed officials see short-term interest rates rising before 2015, while the remaining 15 saw rates remaining near zero until 2015 or 2016.
  4. Huge potential losses.  The BIS said in that a rise in bond yields of 3 percentage points across the maturity spectrum would inflict losses on U.S. bond investors – excluding the Federal Reserve – of more than $1 trillion.
  5. Yields can increase quickly.  In 1994, yields in many advanced economies rose by about 2 percentage points in the course of a year.
  6. Get my money out of there!  Based on the funds that report weekly, investors took $2.2 billion out of muni mutual and exchange-traded funds during this past week.  This is the largest outflow since December 2012.  Muni funds have seen outflows for four straight weeks.
  7. Are financial incentives strong enough?  Once new health insurance exchanges are up and running in October, companies with 50 or more full-time employees can either provide affordable care to all full-time employees, or pay a penalty. But that penalty is only $2,000 a person, excluding the first 30 employees. An employer’s contribution to family health coverage averages $11,429 a year.
  8. Don’t shake my hand!  A recent study says that only 5 percent of people wash their hands well enough to kill germs that cause infections and illnesses.  The study found that 33 percent of people did not use soap and 10 percent did not wash their hands at all.
  9. Women are drinking more.  In the nine years between 1998 and 2007, the number of women arrested for drunken driving rose 30%, while male arrests dropped more than 7%. Between 1999 and 2008, the number of young women who showed up in emergency rooms for being dangerously intoxicated rose by 52%. The rate for young men, though higher, rose just 9%.

 

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Summer Reading

2013 June 18
by SJ Leeds

I’m writing to give you some summer reading…because you don’t have enough to do.  First, three friends of mine run an investment firm (Goshawk Global Investments, L.L.C.).  They have written a couple of pieces about investing and I thought that you might find them interesting.  I’ve combined both articles into one pdf and here is the link.

 

Second, I gave a presentation ten days ago in Galveston about the Fed.  It was a long presentation (approximately two hours).  I know what you’re thinking…wow, Sandy talking about the Fed for two hours.  Who wouldn’t want to listen to that?  It reminds me of when I recently visited a friend at a law firm that I worked at (25 years ago).  He asked if I ever thought of returning to the law firm.  I told him that I would definitely be interested if I was diagnosed with a terminal illness…because every day at the firm felt like a month.

 

Anyway, here’s a link to my slide deck.  The purpose of the presentation was to summarize all of the issues that the Fed is thinking about.  I hope that you’ll find that it’s a really good summary of what’s going on in the economy.  You’ll see that it’s divided into sections:

 

1. Primer on the Fed

2. Growth

3. Fiscal Policy

4. Employment

5. Inflation

6. Monetary Policy

7. How to Follow the Fed

 

The slide deck includes my slides as well as many slides that were used by Fed Presidents and Governors in their speeches.  It summarizes many of their views on issues such as fiscal policy, the job market and inflation.

 

In order to put this presentation together, I spent a lot of time reading all of the Fed speeches (and other material).  I have to tell you that I’m surprised about the fact that we’re talking about tapering QE3.  In my opinion, many of the FOMC members are much more scared of deflation rather than inflation.  I would imagine that this has to be a very heated debate right now.  Some of the reasons that the potential tapering surprises me include:

 

1. The latest PCE price index (the Fed’s preferred measure of inflation) showed a .74% inflation rate.  The core rate (excluding food and energy) was around 1.05%.

 

2. The Dallas Fed uses a “trimmed mean” (where they exclude outliers on both sides) and it had its first negative reading ever.

 

3. The Fed has relied on the fact that our inflation expectations are “anchored” at 2% — but we have to wonder how much longer it will take before these expectations become “unanchored”.

 

4. NY Fed President Dudley recently spoke about lessons from Japan.  One of the (many) mistakes Japan made was to have a lot of “starts and stops” to their policies – where they thought that they had fixed things and then found out that they hadn’t.  Does the Fed want to stop QE and then re-start it?

 

Don’t get me wrong when you read this.  There are loads of potential problems from extremely accommodative monetary policy.   In fact, here’s a link to a blog that I wrote about this issue.  With that said, the Fed often fights the fire that is right in front of them – and that fire is deflation.

 

I’m sure that many of you think it sounds crazy to hear me say that the Fed wants inflation.  In my opinion, there is no question that the Fed wants some inflation (2%) and has great fear of deflation.  Ask Japan how difficult it is to end deflation.  I even wonder if the Fed wants some inflation (that is higher than 2%) in order to make it easier for the government to pay back our massive debt.

 

With all that said, President Fisher made a very strong argument as to why the Fed should stop buying mortgage-backed securities.  You should see this on Slide 129.  As usual, he makes perfect sense and I would agree with cutting back on the MBS.

 

Finally, there’s a slide in the deck that is “black” because it was a link to a youtube video that President Fisher used in one of his presentations.  Here’s the link (I found this amusing).

 

I hope you enjoy this slide deck.  Most importantly, I hope that it’s a good summary of the economy and helps to keep you up to date.  I’ll be interested to hear the FOMC statement today.

 

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive my occasional emails, here’s how:

 

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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

 

 

 

 

It Won’t Hurt That Much!

2013 May 28
by SJ Leeds

Bond prices dropped sharply on Tuesday (meaning interest rates increased), so I decided to write a quick note about an interesting Vanguard article that I read last week.  The Vanguard piece is actually a few years old and titled, “Risk of Loss: Should Investors Shift From Bonds Because of the Prospect of Rising Rates?”  Here’s the link.

 

The premise of their article was that whether or not the bond market is experiencing a “bubble”, you should stay the course.  While this may not be a surprising argument from a mutual fund family, I thought that they made some interesting points (that I’ll describe below).  (I tend to be a fan of Vanguard, so you can take my comments, as always, with a grain of salt.)

 

I’ll preface this summary with a key thought.  Several well-known investors have recently commented that it’s unlikely that anyone will look back ten years from now and say, “I wish I had put all my money in ten-year Treasuries yielding 2%.”  I agree – and this summary isn’t an argument to throw money into bonds.  Rather, I thought that Vanguard made an interesting argument that even if we’re in a bond bubble, the ramifications will be very different than when a stock bubble bursts.

 

Finally, realize that this Vanguard article was written when the Barclay’s Aggregate Bond Index was yielding 2.90%.  Last week, the index was yielding closer to 1.90%.

 

Here are some of their ideas:

1. Huge increases in bond yields are very uncommon.  (Another way of saying this is that huge drops in bond prices are very uncommon.  Prices and yields move inversely).  Imagine that the yield on the bond index moved from 2.9% to 6.9%.  This would be a tremendous move.  This type of move has only happened (within a year) twice before (1980 and 1981).  On a relative basis, a 140% increase in rates has never happened (in one year) in the U.S.  (Of course, you would have to believe that there’s a greater possibility of a 140% move when rates are low.)

 

2. If we did have a 400 basis point increase in rates (from 2.9% to 6.9%), losses would be significant.  The one-year price decline (~13.5%) would be the worst year ever.  The previous worst 12-month return was -9.2% (March 31, 1980).

 

3. After that one bad year, you’d (hopefully) be earning higher returns again (if rates didn’t keep rising).  After you suffered through that 13.5% loss, you would earn 6.9% per year going forward.  By the end of year three (one year of losses and two years of gains), you’d be close to even.  In other words, your losses would be offset by higher yields in the future.  See Vanguard’s slide below.

1 VG copy

 

4. You shouldn’t lose sight of the reason that you hold bonds – to diversify your portfolio.

 

5. A bond “bear market” is different than a bear market in stocks.  With stocks, we think of a bear market as one in which prices drop 20%.  We’ve never had that kind of drop in the bond market index.  With bond markets, we tend to think of a bear market as one in which returns are negative.

 

6.  The worst bond losses can’t be compared to the worst stock losses.  The worst 12-month drop in bonds was 9.2%.  This pales in comparison to losing 67.6% in stocks (for the year ending June 1932).

 

7. Calendar year losses in bonds have been relatively rare and small.  We’ve never had huge losses in bonds when viewing them on a “calendar year” basis.  The worst calendar year drop for bonds was 2.9% (1994).  That was followed by an 18.5% gain in 1995.  To put that 2.9% loss in perspective (for bonds in 1994), realize that stocks lost 2.9% (or more) on 27 different trading days in 2008!

 

8. Inflation would make losses worse.  All of the returns that are mentioned above are in nominal terms.  If you have losses plus inflation, your real returns are (obviously) worse.

 

9. Reasons for bond losses.  Higher interest rates are normally caused by either inflation, government budget problems or some systemic shock.

 

10. Bond losses could cause other problems.  Vanguard didn’t address the problems that could be caused by bond losses (such as the hit to bank capital due to losses in their bond portfolio or the increased cost of interest on government debt).

 

Talk to you sometime in the future…

 

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive my occasional emails, here’s how:

 

1. click on this link (or type www.leedsonfinance.com into your browser)
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3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

 

 

 

Reinhart and Rogoff Revisited

2013 May 12
by SJ Leeds

Has it been long enough that you miss me?  I didn’t think so.

 

First, I received so many emails when I said that I was going to stop my weekly writing – I wasn’t able to respond to any of them.  But, I read them all and I really appreciate all of your comments.

 

Second, here’s a link to a pdf file that contains the resumes of three of my MBA students.  They all were members of The MBA Investment Fund, a $17 million investment fund that I oversee with Keith Brown.  They are all willing to move anywhere for the right opportunity in asset management (sell side or buy side).  Don’t hesitate to email them or me if you’re interested.

 

Now, on to an issue that a lot of people have written to me about…Reinhart and Rogoff’s paper and their mistakes.  Here’s a quick summary of the situation and my thoughts about it.

 

Summary:

Reinhart and Rogoff (“RR”) are two Harvard professors who have written extensively about our current situation (high debt ratios, financial crises, etc.).  Probably their most influential paper was “Growth in a Time of Debt.”  The paper’s primary finding was that when debt-to-GDP exceeded 90%, the median country experienced a slowdown in growth of 1% and the average was a 4% slowdown.  (In other words, the middle country experienced slower growth, but there were some real disasters that really dragged the average down.)

 

Remember, a 1% slowdown in growth might not sound like much, but it’s huge!  Imagine that you take the U.S. growth rate from 3% down to 2%.  As a simple example, if we have 2% productivity growth, that means that we don’t need any more employees.  (In other words, our current workers produce 2% more and that’s how much we grew.)  In reality, our productivity is lower than 2%, but our growth isn’t that much higher than productivity.  So, it takes a long time to return to full employment.

 

A month ago, a doctoral student (and some faculty) at UMass – Amherst wrote a paper arguing that the RR paper contained errors and, as a result, had some incorrect conclusions.  The new paper is titled, “Does High Public Debt Consistently Stifle Economic Growth?  A Critique of Reinhart and Rogoff”.  The authors are Thomas Herndon, Michael Ash and Robert Pollin.

 

The new paper argues (among other things) that:

 

1. There was a spreadsheet error in the RR paper;

 

2.  RR selectively excluded some data (countries with high debt and growth that didn’t slow much); and

 

3. The weighting system that RR used was not justified.

 

As a result of these issues, the new paper argues that the average growth rate does not drop nearly as much as RR had said and that there is little discernable difference in growth at a 90% debt-to-GDP ratio.

 

Many people now argue that the RR paper was the basis of the austerity movement and that the paper has now been disproved.  Reinhart and Rogoff have admitted that there was a spreadsheet error but argue that their main finding was based on the median country (not the average country) and that their findings still hold.  Let me tell you my thoughts…

 

My Thoughts On This Issue

1.  The idea that there is one magical debt-to-GDP ratio (e.g., 90%) that will cause a country’s growth to slow is far too simplistic.  I think most of us knew this.  Certainly, in my policy class, I always spoke about this and I spoke about this in presentations I’ve given.

 

All countries are different and the amount of debt (relative to GDP) that they can handle differs.  Does a country issue the debt in its own currency or in a foreign currency?  How much of the debt is held by its own citizens as opposed to foreigners (who may flee)?  Is the country’s currency a reserve currency?  Does the country have growth opportunities?  These are just a few examples of other factors that also matter.

 

Relying on one single factor (like debt-to-GDP) is like saying that the home team will always win in a sporting event.  The home-field advantage is one factor (and it’s very important), but other issues are also important.

 

2. I’m always going to be wary of an empirical study that would have significantly different results if a few data points weren’t included.  (The new paper argues that RR left out some data points from New Zealand, Australia and Canada.)  Rather than relying on empirical findings (and arguing about whether New Zealand’s data should be included in these calculations), you should really be thinking about intuition.  Here’s my intuition:

 

If debt-to-GDP = 100%, that means debt is the same as GDP.  If interest rates return to their 30-year average (prior to the Fed’s zero interest rate policy), that would put rates around 5.7%.  That would mean our interest would equal 5.7% of GDP each year. Our tax revenue has averaged 18% of GDP for the past 60+ years.  So, if interest is eating up approximately 1/3 of our tax revenue, we’re not in a sustainable position.

 

3. The real problem (that much of the historical data misses because this problem didn’t exist in many of the past years) is that we have huge unfunded liabilities.  If they’re not changed, we will always be running a deficit.  If we’re running a deficit (and the “primary deficit” that we all discuss does not even include our interest expense!), when you add in our interest, we will have huge problems.  As our baby boomers start to retire in force, we’ll see this get worse.

 

4. To me, these numbers are pretty simple and pretty obvious.  But, just as simple and obvious is that we can’t just cut everyone’s Social Security and Medicare and think that it won’t affect anything.  First, we need to give people time to plan (and change the amount they save – and this will impact consumer spending).  Second, we need to recognize that this will impact retirement for millions of people.

 

The Social Security Administration says that among Social Security beneficiaries, 53% of married couples and 74% of unmarried persons receive 50% or more of the income from Social Security.  Among elderly Social Security beneficiaries, 23% of married couples and about 46% of unmarried persons rely on Social Security for 90% or more of their income.

 

5. Any of these changes will impact our growth.  Obviously, if we increase taxes (or the amount of income subject to Social Security payroll taxes), this will also impact our growth.  Add in the political issue (of cutting Social Security or raising taxes on an already-progressive program) and I’m going to have to take issue with anyone who says that Social Security is easy to solve.

 

6. Even this new paper, which criticizes RR, comes to a similar conclusion: that growth is impacted by debt.  This new paper shows that the average growth for countries with debt-to-GDP below 30% is 4.2% — just like RR.  With a ratio at 90% – 120%, the average growth is 2.4% (significantly higher than RR).  But, move above 120% and the average growth rate is 1.6%.  This might be more optimistic than RR, but this is still an ugly scenario.

 

7. I’ve read other research that came to similar finding about a slowdown in growth when the debt-to-GDP ratio exceeded 90%.  I’m curious as to whether these papers also had errors.

 

8. Reinhart and Rogoff had been seen as the heroes of the conservative fiscal movement.  As a fiscal conservative and social liberal, I would argue that their errors have done more harm than their research did good.  People are now (mistakenly in my view) using their errors to argue that the debt-to-GDP ratio doesn’t matter.  I believe it matters, we just don’t know when.  But, we never did know when and the biggest mistake was when people thought that there was a specific number that created a fiscal landmine.

 

Talk to you sometime in the future…

 

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive my occasional emails, here’s how:

 

1. click on this link  (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

 

 

The End of an Era?

2013 March 24
by SJ Leeds

First, I want to point out a 90-second piece that I did with Kris Maxwell.  It’s about “too big to fail”.  Here’s the link.  Obviously, the creative work is all Kris – and I think it’s really impressive.

 

Now, on to my news.  After approximately 5.5 years of writing (first an email service and then this blog), I’m going to hang it up for a while.  Yes, I’m breaking up with you.  But, it’s nothing you did.  It’s me.  I’ve changed.

 

The blog has been lots of fun for me.  It’s been a place to share things that I’m reading and thinking about.  I’ve learned a lot and I’ve met so many people.  With that said, the reality is that the blog takes a lot of time. And unfortunately, there’s really not a good business model in a blog.  So, it’s hard to justify the time that I find myself devoting to the blog.  I need to turn my attention to other work.  (I recently found out that my kids haven’t been saving for college and they’re somehow expecting me to pay.)

 

I hope to occasionally (a few times each year) send out something I find interesting or an article that you might be interested in.  I may also start an education-type business and will send out information if I do this.  In effect, I’m hoping that we can remain friends with benefits.

 

Thanks for supporting the blog.

Sandy

Market Update

2013 March 17
by SJ Leeds

First, thank you to everyone who clicked over to www.prayingforpeyton.com.  Here’s the link.  Jim and Kate were thankful for all of the interest and were especially grateful to everyone who made contributions to organizations that pursue research for childhood cancer.  Obviously, I’m also very appreciative of what you did.

 

Now, on to today’s blog.  Today, I want to hit two quick subjects: the employment participation rate and Howard Marks’ view about the future of equities.

 

The Employment Participation Rate

As most of you know, the unemployment rate would be significantly higher if the participation rate had not dropped.  The participation rate shows the number of working age adults who either have a job or are searching for a job.  If you’re not searching for a job, you don’t count as unemployed.

 

For the twenty years prior to the Great Recession, the participation rate had been above 66%.  Now, it’s below 64%.  If the participation rate were 66%, the unemployment rate would be 11.2%.

 

But, here’s what I found interesting.  One thing I had been hearing was that the participation rate was dropping because of demographics – baby boomers are starting to retire.  Well, that may be true, but if you look at the participation rate of people aged 55 or older, it tells another story (relatively steady to increasing over the past few years) (see chart below):

 

55 and over copy

 

You see drops in the participation rates of other groups, such as people with a high school degree (no college) and people with some college (but no degree).

 

 

Howard Marks

Howard Marks shared his views on the future of equities.  Here are some of his thoughts that I found most interesting:

 

1. The better that returns have been in the recent past, the less likely that they will be good in the future (all other things being equal).  (Simply put, you’ll have better returns buying stocks before the run-up, not after.)

 

2. When prices appreciate faster than cash flows grow, it’s safe to assume that some of the undervaluation has been reduced.

 

3. The 1990s had high returns due to economic growth, corporate performance, technological and productivity gains, declining interest rates, low inflation and relative peace in the world.  We also benefited from a naïve view of the debt-fueled expansion, the profit potential of e-commerce companies and the extent to which equity gains could be perpetuated.

 

4. After stocks run up, expectations of future returns increase.  This is opposite of what our expectations should be.

 

5. Earnings yields (the inverse of the P/E ratio) are high relative to interest rates.  While that’s a positive for stocks, it also reflects interest rates that are artificially low.  When rates go higher, stocks will be less attractive.

 

6. Future growth will be slower due to challenges in restarting growth and the dire prognosis for the federal deficit.

 

7. Profit margins are unusually high right now.  If they return to historic levels, stocks would seem more expensive.

 

8. Corporate cash is high – implying safety, potential for stock buybacks and possible dividend increases.

 

9. Investors still aren’t enamored with stocks – although they’ve had a very good run.  Many institutions are under-allocated to stocks – there is still relative disinterest.  This is a positive for stocks.

 

10. If we have another good year or two, sentiment on stocks would turn (and become positive)!  At that point, we’d switch from the fear of losing money to the fear of missing opportunity.

 

11. There are three stages of a bull market:

 

A. the first, when a few forward-looking people being to believe things will get better

 

B. the second, when most investors realize improvement is actually underway

 

C. the third, when everyone’s sure things will get better forever.

 

12. Howard Marks thinks we’re somewhere in the first half of stage two.

 

13. If he’s wrong, it’s not like you’ll be sorry that you didn’t pile into Treasuries (with their low yields).

 

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

 

 

 

A Special Blog

2013 March 12
by SJ Leeds

Today’s blog is a little different – it’s a short personal story and a request that you follow this link to read an entry posted on another site.

 

Approximately seven weeks ago, the son of one of my really close friends was diagnosed with cancer.  Peyton is 13-years old and has an aggressive form of cancer.  I’m very close with his parents, Jim and Kate.  I visited Peyton last week (in Tulsa).  Fortunately, he’s a strong kid with a strong family.

 

Jim started studying how little money is spent researching childhood cancer.  Together, we gathered some statistics about childhood cancer and we put them on a website.  Jim’s goal is two-fold: to educate people about this issue and to raise money.

 

I simply ask that you click on this link and read the stats.  Be sure to scroll down the page to see the stats.  (The website is called “PrayingforPeyton.com.)  It would have been a good blog entry on leedsonfinance.com.  I think you’ll find it interesting.

 

In addition, I encourage everyone to pray for Peyton, other kids in his situation, their families and all of the people who take care of these kids.

 

Have a great week and appreciate your health.

 

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

 

1. click on this link (or type www.leedsonfinance.com into your browser)
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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

 

 

Market Update – March 11, 2012

2013 March 10
by SJ Leeds

Austin or San Antonio finance job needed!  I have a former student who is moving back to Austin because her husband is joining that faculty at UT.  She’s done really well.  She has significant experience in corporate banking, customer relations and quantitative research.  She’s progressed rapidly in her career and her current responsibilities include providing data-driven strategic direction to the CFO and other executives of a large US-based bank.  I know her well and highly recommend her.  If you want her resume, send me an email.

 

Two parts to today’s blog…(1) summary of a recent paper that received some press; and (2) a few great stories and videos.  If nothing else, you MUST watch the one from CBS Sunday Morning.

 

I recently read an interesting paper that was presented at a Fed Conference.  It was titled, “Crunch Time: Fiscal Crises and the Role of Monetary Policy” and was written by David Greenlaw (Morgan Stanley), James D. Hamilton (UCSD), Peter Hooper (Deutsche Bank) and Frederic S. Mishkin (Columbia University).  (No need to email me – I’m aware of Dr. Mishkin’s role in “Inside Job”.)  It was a long paper (90 pages), but I want to share some of the ideas that I found interesting.  As usual, these are their ideas (and often their wording).

 

 

1. High borrowing costs can make fiscal policies unsustainable (if a country already has high debt).  Monetary accommodation can lead to a tipping point in inflation and currency flight.

 

2.  In order to maintain a consistent debt-to-GDP ratio, a country must run a surplus (as a percentage of GDP) that is equal to the difference between the nominal interest rate minus the nominal GDP growth rate.  (If growth > interest rate, a country can run a deficit in that amount.)  See figure 3.2.

 

3.2 copy
3. As the debt-to-GDP ratio increases, the cost of borrowing can increase.  At some point, creditors may fear inflation in the U.S. (rather than default).  This could happen if the market decides that fiscal reforms (necessary to return to a sustainable path) are unlikely to occur.

 

4. Emerging market countries can handle less debt because their debt is often denominated in foreign currencies.  Currency depreciation increases the debt burden and can lead to crisis.

 

5. When the Fed buys debt, the Treasury no longer has to pay interest to the private sector.  But, when the Fed buys the debt, they take on a liability: either reserves or currency.  Currency does not have an interest cost.  Reserves do.  When the Fed buys debt and creates a liability (reserves), the government has effectively swapped long-term debt for short-term debt.  This increases the risk of a financial crunch – where money flees and the government has trouble rolling over their debt.

 

6. The greater the current account deficit, the greater the potential problems from high debt levels.  Typically, this means that the government is financing their debt by borrowing from abroad.  The more debt held by foreigners, the greater the likelihood to default (and this threat should raise the cost of borrowing).

 

7. Gross debt is more indicative of the cost of borrowing than net debt.  In other words, when thinking about how much debt we have, you should include the debt held by the trust funds.  It may be that net debt is easier to manipulate.

 

8. Japan has very high gross debt (230%) and lower net debt (126%).  But, they seem to benefit from their citizens’ bias to invest domestically.

 

9. The U.S. benefits from being a reserve currency (resulting in great demand for our Treasuries).  In addition, approximately one-fourth of our outstanding debt is in the form of short-term T-bills with a cost close to zero.

 

10. The CBO assumes that our long-term rates will return to 5.2%.  But, rates could go much higher and cause huge problems.  See Figure 3.11

3.11 copy

 

11. Our current account deficit should not be a huge problem because we will become energy independent.

 

12. If Congress eventually engages in fiscal consolidation (balancing the budget), the question is what the Fed should be doing during this process.  Some people think expansionary policy increases future expectations (helping growth) and makes it more likely that fiscal consolidation will succeed.  Others think that expansionary policy reduces the incentives for fiscal consolidation.  They also argue that tight monetary policy will limit inflation expectations (which could be a risk since debt is high).

 

13. Simple “across-the-board” spending cuts are typically short-lived because it does not engender sufficient political support.  We need permanent, structural changes.

 

14. If Congress does come up with a “Grand Bargain” of entitlement and tax reforms, the Fed would probably slow their exit from their current extraordinary accommodation.

 

15. In the extreme, unsustainable fiscal policy means that the government will either have to issue monetary liabilities (known as fiscal dominance) or default.  The U.S. is unlikely to default.  Ultimately, the central bank has no power to avoid the consequences of unsustainable fiscal policy.

 

16. The duration of the Fed’s portfolio will peak at 11 years in 2013.  (As a really rough estimate, you can think of this meaning that if interest rates increase 1%, the value of the Fed’s portfolio will decrease by 11%).  While the Bank of Japan and the ECB have expanded their balance sheets, they’ve kept their durations close to 3 years.  (One reason that our duration has increased is Operation Twist.)

 

17. If interest rates increase or if the Fed incurs losses from the mortgage-backed securities that they hold, the Fed will not be able to remit payments to the Treasury (as the Fed has been doing recently).  (The Fed remits earnings to the Treasury.)

 

18. The inability to remit payments to the Fed could create political pressure or could impact Fed policy (timing of shrinking their balance sheet).

 

 

 

Part 2: Videos / Articles

 

I’ve got three videos / articles for you.  You might want to close the door to your office if you don’t want anyone to see you cry…

 

3. Husband sinks shot to help pay wife’s cancer bill.  This is a good video.  (You should read the short article – it will make more sense.)  This video could have been higher in my rankings if the guy had hugged his wife after hitting the shot!  (On average, it costs me about $20K to get Jenny to hug me, so maybe that’s what I’m thinking about.)  Here’s the link.

 

2. We all get frustrated with the airlines.  We don’t hate them like we hate Time Warner Cable, but we do get frustrated with them.  (I’m now with AT&T U-Verse and pretty happy.  Now, Jenny tells me to watch Cinemax and leave her alone.)  Lest I digress, this is a really cool story about United.  Here’s the link.

 

1. This is just an absolutely awesome video.  If you don’t like this one, there’s something wrong with you.  Here’s the link.

 

Have a great week.  It’s Spring Break in Texas.  Yes, I still get Spring Break.  Woo hoo!

 

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

 

1. click on this link  (or type www.leedsonfinance.com into your browser)
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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.

 

 

 

Buffett’s Letter

2013 March 3
by SJ Leeds

Help a young guy out!  One of my close friends has a son who is a junior at Princeton.  He’s on Princeton’s basketball team, is a great young man and he’s looking for a summer internship.  He’d love to work at a sports-related business but would be excited to have any other great opportunity.  If you’d like his resume, just send me an email.

 

Now, on to today’s blog…

 

Warren Buffett published his annual letter to his shareholders.  Here were some of the most notable comments:

 

Small acquisitions.  “Bolt-on” purchases (where small companies are bought to add on to existing businesses) are low risk, don’t burden the headquarters and expand the scope of proven managers.

 

What uncertainty?  There was a lot of hand-wringing last year among CEOs who cried “uncertainty” when faced with capital allocation decisions (despite many of their businesses having enjoyed record levels of both earnings and cash).  Yet, Berkshire spent a record $9.8 billion on plant and equipment in 2012 – 88% of it in the U.S.

 

Ignore the doomsayers.  Regardless of what the pundits are saying, “every storm runs out of rain”.

 

The future is always uncertain.  A thought for my fellow CEO’s: Of course, the immediate future is uncertain; America has faced the unknown since 1776.  It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them.

 

U-S-A, U-S-A.  American business will do fine over time.  And stocks will do well just as certainly, since their fate is tied to business performance.

 

We’ve been through hard times before.  Investors and managers are in a game that is heavily stacked in their favor.  The Dow Jones Industrial Average advanced from 66 to 11,497 in the 20th century, a staggering 17,320% increase that materialized despite four costly wars, a Great Depression and many recessions.  And that gain didn’t include dividends!

 

Don’t try to time the market.  Charlie (Munger) and I believe it’s a terrible mistake to try to dance in and out of it (the market) based upon the turn of tarot cards, the predictions of “experts” or the ebb and flow of business activity.  The risks of being out of the game are huge compared to the risks of being in it.

 

How Berkshire creates value.  Berkshire builds intrinsic value by (1) improving the earning power of our subsidiaries; (2) further increasing their earnings through bolt-on acquisitions; (3) participating in the growth of the companies that we invest in; (4) repurchasing shares when they are selling at a meaningful discount to intrinsic value; and (5) making an occasional large acquisition.

 

Insurance companies have problems.  Insurance company earnings are still benefiting from bonds that were purchased with higher yields than are available right now.  In effect, today’s bond portfolios are wasting assets.

 

EBITDA is not cash flow.  Our definition of interest coverage is pre-tax earnings / interest, not EBITDA/interest, a commonly-used measure we view as deeply flawed.

 

Accountants aren’t nearly as interesting as us finance guys.  After discussing accounting issues, he said, “and that ends today’s accounting lecture.  Why is no one shouting, “More, more?””

 

You have to pay for quality.  A common Buffett comment: It’s far better to buy a wonderful business at a fair price than to buy a fair business at a wonderful price.

 

Buying newspapers.  Interestingly, Berkshire is buying some newspapers right now (which doesn’t necessarily sound consistent with buying “good businesses”).  While he says that industry profits are certain to decline, he’s buying papers in small cities and towns where there is a real sense of community.  He argues that people want to know local news and there’s no substitute for a local paper.  He’s looking for papers in tightly bound communities and he’ll only buy papers that have a sensible internet strategy.

 

Investing in a public company.  Buffett mentioned recent the recent purchase of $1.15 billion of DIRECTV, saying he only discusses investments that have meaningful size.

 

We don’t need no stinkin’ dividend.  Buffett addressed the issue of dividends (Berkshire doesn’t pay dividends).  He made the case that the best thing to do with earnings is:

1. reinvest in the business (projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors);

2. search for acquisitions unrelated to our current businesses – need to be meaningful and sensible

3. repurchase shares – this is sensible for a company when its shares sell at a meaningful discount to conservatively calculated intrinsic value.  Buffett argued that this is the surest way to use funds intelligently: it’s hard to go wrong when you’re buying dollar bills for 80 cents.

Buffett made other arguments against cash dividends, including the fact that you’re forcing all shareholders to incur taxes.

 

Have a great week.

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

 

1. click on this link  (or type www.leedsonfinance.com into your browser)
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IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.