By Edward Leone Jr. DMD MBA RFC
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Financial Planning: leonee@vzw.blackberry.net
The money and financial issues just keep coming our way. We will soon see the final bill on financial reform. It is interesting to observe the rhetoric coming out of Toronto, Canada at the G 20 meeting. The Europeans and Canadians want to reduce government spending to avoid further debt accumulation while Mr. Obama wants to creat more debt to offer additional economic stimulus. Based on the performance of financial markets globally, it may very well be that we are in the 2nd dip of what may turn out to be a double dip recession. If this is the case, given the head winds that the US Congress and the Executive have created for us with the climate of chaos and uncertainty for business, we may find ourselves in a prolonged economic recession going on into the future for perhaps another twelve to eighteen months. The growth rate for the first quarter of the years was adjusted down from 3% to 2.7%. New home construction starts are at very low levels in particular since the tax credit to new home buyers has been eliminated. The sales of autos and other durable goods, although improving, are also in a slump. It is clear that the consumer spark to economic recovery is not very strong if it even exists at all. Continued concern over the financing of European governments’ debt and the restriction of oil exploration due to environmental concerns also cloud the picture for a timely economic recovery. The S&P 500 Index is down approximately 12% from its April 2010 high. Our industrial out put is hovering around 69%. When compared to the average of 81% over recent years, we can see that productivity is fragile as is the potential for an immediate drop in unemployment. Many firms showing profitability are doing so by generating a smaller level of production at much lower cost and with many fewer employees. The June 6th issue of Bloomberg Business Week makes a very interesting observation on page 45 regarding the rush by many investors to precious metals in these trying times. It appears that, “Despite the recent runup, investors who bought at the historic peak are still waiting to break even. After adjusting for inflation, gold is at just half the level it reached in 1980, when the price rose to $850, equal to $2,266 today.” This observation brings out a point I like to make with potential clients in discussions over the effects of inflation. You need to have almost three times the income you had in 1980 to have the same purchasing power today as you had then. How is your purchasing power holding up?
The doom and gloomers are having a field day. Such experts as Meredith Whitney, Nouriel Roubini, Robert Prechter, Nassim Taleb, Gary Shilling, David Walker and others are dutifully pointing out issues surrounding bad government decisions and the untenable growth of government social programs which cannot possibly be supported in their present form into the future as burdens which must be addressed and over come in order to foster economic growth. Harry Dent does much interesting research on the relationship between demographic trends and economic activity. His work is a great source for another angle on what is actually happening to us and what we should do about it. Once again let me state that the November election will be important in shaping the rate at which our economy recovers. I must caution that even with a significant change in direction by the US Congress, fiscal policy changes occur slowly.
We have experienced a technology bubble and a real estate bubble over the past ten years. Forbes.com in the month of June did a great job of describing the five steps in the development of a financial bubble. They are as follows:
1. Displacement–The enamorization of a new paradigm in financial opportunity such as an innovative shift in technology or historically low interest rates.
2.Boom–Pricing rises rapidly as the trend becomes recognized and publicized. Investors want into this once in a lifetime opportunity at any cost.
3. Euphoria–Caution is thrown to the wind as asset prices skyrocket.
4. Profit Taking–Smart money is selling positions and taking money off the table.
5. Panic–Asset prices reverse direction as investors and speculators are faced with margin calls and must sell at any price.
Will we take heed and recognize this pattern in the future when it occurs again?
The impact that much of what is written in the above paragraphs has for the average working adult is in the sphere of retirement savings and the reduced or negative returns that many savers are seeing on their investments. The Financial Planning Association, in its May journal, quotes survey results which tell us that 57% of participants feel that they are behind in their retirement savings. The survey respondents say that they have little money to put toward retirement savings or that they have started to save too late in life. In addition, 38% of respondents state that they are very concerned about health-care costs. We learn that it is typical that the newly retired individual does not want to take the risk involved with keeping an adequate allocation of equities in the retirement portfolio, not understanding that the risk incurred is that retirement funds may not last for a potential 30 year retirement period without the strong earnings yielded by equities over time. This is a prime example of behavioral finance which leads so many retired persons to buy annuities. Here, the retired individual incurs purchasing power risk with a fixed annuity not considering how the fixed benefit will work under future inflationary trends. Those who invest in variable annuities with a guarantee minimum return many times experience high fees and returns over time which are more like those from a bond portfolio as opposed to an equity yield experience. Financial advisers are challenged many times to have the client realize the significance that the withdrawal rate has during the distribution phase of a portfolio. Clients who are concerned with the prospect of running out of money before end of life need to examine the prospect of working longer, saving more or spending less to gain additional financial security. Those of use who are true financial planners must also be educators for our clients.
Suggested Reading: “Power Hungry: The Myths of Green Energy and the Real Fuels of the Future” by Robert Bryce
For the Record:
DJIA 10,143.81
S&P 500 1,076.76
NASDAQ 2,223.48
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