Archive for August, 2010

Leone’s Money Monitor Monthly for September 2010

August 30, 2010

By Edward Leone Jr. DMD MBA RFC

Contact Information

Dental    www.leonedmddentalcare.com

Financial Planning    leonee@vzw.blackberry.net

     As I stated in the August Blog, one of the goals and purpose of this blog is to have an interactive exchange of information and ideas. We did have a respondent to the August Blog. The respondent forwarded a paper done by David Kaiser PhD, a respected historian. Dr. Kaiser is currently a professor in the Strategy and Policy Department of the United States Naval War College. He dedicates this paper to a comparison of conditions in the US today with conditions in Germany during the middle 1930’s. It is scary, but a great read.  Google it. Read it and let us know what you think!

     Before I go into the variety of money and finance happenings over the month of August, I would like to spend some time sensitizing the reader to a very important financial planning issue that I find being over looked by many prospective clients. The question I pose is “What four documents must every individual have as a part of financial and life planning?” Those four documents are: 1. Advanced Health Care Directives (Power of Attorney for Health Care Matters) which grants on your behalf a person or entity to make health care decisions in your incapacity to do so. With out this document some judge in a court room may perform this duty and perhaps not to your expectations. 2. A Living Will which give directives on resuscitation and life support issues in the event you are faced with such conditions. 3. A Durable Power of Attorney for Custodial Matters in the event that you are incapacitated to the extent that you are unable to care for yourself and perform financial duties on your own. 4. A Will or will substitute to express your wishes regarding the disposition of property upon your passing. Without this, a judge will perform this duty based on law existing in the state of your residence and perhaps not in a tax efficient manner.  If you have not addressed these issues, seek out a financial planner and an attorney to get this portion of your financial and life planning acomplished.

     We are hearing and reading much about health care and the elements of the Obama Health Care Reform Act of late. This legislation appears to be as much a piece of tax legislation as it is related to health care. The mandates for production of a form 1099 by businesses on all expenditures above $600 is unworkable and under consideration by some in the US Senate for repeal. The tax on medical devices (we do not yet have a definition of what is a medical device) can also be unmanageable when we consider the potential for what may constitute a medical device. There is also talk in the Congress about repeal of this portion of the legislation. The 1099 issue will put businesses in a difficult situation regarding compliance. The record keeping and paper work associated with this will likely suppress business entity consumption of many products leading to a slowing of economic growth. It is also likely to be the full employment act for accountants. The tax on medical devices is a great way to reduce health care costs since demand will be suppressed. Such high-tech device purchases as the MRI Imaging device will be less frequent making the benefit of this diagnostic less available to the public. Such common devices of more modest cost will also see a slump in demand by those who cannot pay these additional costs. Devices such as dental implants, knee and hip implant devices will be less utilized unless third-party payers are willing to pay the tax instead of making it an exclusion in the plan designs they offer. We are also likely to see numerous adjustments in the financial reform legislation as more of the details unfold also.

     I just touched on economic growth in the last paragraph. You need to know that economic growth in the second quarter of 2010 slowed to 1.6%. This is certainly not a sign that good times will be returning soon. There are many factors that play into this happening. Only time, the election and the actions of the US Congress which can stimulate confidence in the future for the business universe or  perpetuate  uncertainty for business activity will tell the story.

     What does the average investor do in this climate and how is it best to strategize savings for retirement? These are very difficult decisions to make. Continued volatility in equity markets, particularly the slow downward trend we are witnessing has driven $380 billion into bond funds so far this year. The assumption of many investors is that bonds are safe. Certainly the yield is relatively safe, but market risk has to be a real concern now and into the future. Long term rates are at a low 2%. The only direction for interest rates is up. We just do not know when. It is common knowledge that the relation between bond prices and interest rates is inverse. When interest rates go up, bond prices decline. It is likely that bond portfolios will experience loses in the future as interest rates trend upward. There is no perfect investment for safety under all conditions. Many are driven to annuities with a guaranteed return which looks attractive in these troubled times. The price paid for that guarantee and the restricted access to your money are serious considerations before purchasing and annuity. Certainly short-term financial needs should be kept in cash or cash equivalents. Other investments may be placed in a diversified variety of longer term investments with the allocation tailored to the investor’s risk tolerance and time horizon.  Please use a professional to help with this work.  Nouriel Roubini in his book “Crisis Economics” suggests that a return to the restrictions put in place under Glass-Steagall where there was a full separation between commercial banks and investment banks is what we need to do. This business of to big to fail has to end. It does appear that there is some rethinking occurring in the US Congress regarding the status of Fannie and Freddie. The transparent trading of derivatives and swaps will also be helpful while a turn around in the real estate market is projected to take some time.

     It is clear that we live in a global economy where a shift is occurring according to the McKinsey Quarterly from developed to developing economies as it relates to rate of economic growth. Technological advances in rapid communication and low-cost labor markets will continue to perpetuate this trend. Emerging markets with younger populations will provide not only consumer demand, but also a source of capital, talent and innovation. The risks associated with international business transactions focus around protection of intellectual property, currency exchange rate volatility, geopolitical instability and quality standards.  As you can see all is not perfect, but it appears that the risk reward ratio is favorable for some businesses. When it comes to exchange rates, Jason Van Bergen of Investopedia tells us that six factors are at play: 1. differentials in inflation, 2. differentials in interest rates, 3. currency-account balances, 4. public debt, 5. terms of trade and 6. political stability and economic performance. The US is still perceived to represent quality in these areas; however, our status at present is clearly somewhat compromised. At Investors.com, an IBD Editorial presents our public debt standing at 62% of GDP and trending to 90% in the immediate future with a potential for it to be 146% of GDP by 2030 as our biggest problem.

     Among US international trading partners, China reached a new mile stone this past quarter achieving status as the #2 economy globally surpassing Japan at about 1/3rd the size of the US economy. Not all is rosy in the Chinese realm, though. We will spend more time on that in future blogs. Bribes as a part of doing business in China is a drag on the economy to the tune of 10-13% and there is more to come.

     On a final note, we observed a variety of primary election events over this past month. Some, I am sure are thrilled with the results, and others probably not. I took particular note of the Arizona Republican primary where Senator McCain prevailed after spending more that $20mil on a campaign. I sometimes wonder what the difference may be between a bribe in China and a political campaign contribution in the US. Look forward to discussions on social security, the national debt and derivatives along with more on the Chinese economy in future blogs. 

For The Record:

DOW                10,150.65

NASDAQ          2,153.63

S&P 500          1,064.59

Suggested Reading:    “Wall Street Words” by David L. Scott

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Leone’s Money Monitor Monthly for August 2010

August 1, 2010

By  Edward Leone Jr. DMD MBA RFC

Contact Information

Dental                                www.leonedmddentalcare.com                              

Financial Planning       leonee@vzw.blackberry.net

One of the goals of this blog is to invite interactivity. There were two responses to the July blog sharing information and opinions.

Respondent one talked about DOW support at 9800 and the need for the economy to reset while the stimulus  has a temporary affect and added a trillion dollars to the national debt. Respondent one also shares opinions on the need to see solidarity in word-wide financial markets, good earnings numbers to effect investors thinking when it comes to investing in equities and reduced government spending while holding the line on taxes.

Respondent two is very concerned about the national debt and points out that 10% of tax revenues went to pay the interest on the debt in 2007-2008. This trend is likely to increase. He quotes Milton Friedman’s statement in which he recommends a monetary policy where the money supply is increased at a fixed rate ( gradual level) to avoid the detrimental effect on the value of the dollar caused by the many adjustments we are experiencing. He poses a question on the run up in national debt and whether or not we are at the point of no return.

What do you the readers think?

Peter Schiff, on Forbes.com, writes about austerity vs. stimulus stating that there is a shifting in philosophy within the industrialized world which has caused governments with long-standing liberal attitudes on accumulating debt to become austereians, as he calls them, while the capitalists are becoming more socialistic. Schiff points out that Greenspan explains that lower deficits will restore confidence, diminish the threat of inflation and allow savings to flow to private investment rather than public-sector consumption. While Krugman, a devout Keynesian, states that cutting government spending will force the economy back into recession. He feels that flooding the economy with money is the stimulus that will cause consumers to spend and improve economic conditions at which time spending cuts, tax increases and higher interest rates which are necessary corrective measures can be tolerated. 

Will we have more stimulus or better discipline in government spending? What do you think?

The Motley Fool’s Morgan Housel, thinks that with the winding down of federal stimulus efforts, an economic slow down is evident.

Ken Sweet on Yahoo Finance thinks that the obvious anti-business White House and the environment in credit and regulation it has created is perpetuating the lack of business activity and the stalled creation of employment opportunities.

Mr. Prechter, the promoter of the Elliot Wave Theory, thinks that we are in for a market decline which could be the worst in 300 years according to reporting in the New York  Times. He predicts that the DOW will fall to bellow 1,000 in the next five or six years with depression and inflation factors as a grand market cycle comes to an end. Prechter say that cash is the place to be.

I am not so sure that we are in for as much trouble as many may think. If one does the math, it is clear that within all style boxes (large cap value, large cap growth, mid-cap value, mid-cap growth, small cap value and small cap growth) price to book ratios are at bargain levels. The likely trend for stock prices may be up, but when? Will this movement occur due to changes in government policy or in spite of government policy?

Do-fundamentals-or emotions-drive the stock market? Goedhart, Koller and Wessels write in the McKinsey Quarterly that emotions can drive market behavior in a few short-lived situations, but fundamentals still rule.  Behavioral finance theory points out that investors have a tendency to project current conditions and recent events into the future as the absolute for future outcomes. They also follow systematic behavior patterns in buy and sell habits due to momentum observed and may over react or under react to market anomalies. These irrational behavior patterns are generally accommodated for in market pricing over relatively short periods of time according to efficient market theory. How many times have we heard, “but this time it’s different”? Well, we shall see.

During these troubled times,  households with reduced income streams are having trouble maintaining a reasonable budget. Financial planners use financial ratios as a guide to demonstrate to families where their budgets may be distorted. Volume 6, Issue 4 of the Journal of Personal Finance has a great review on this subject written by Harness, Chatterjee and Finke. These ratios are helpful in identifying financial stress.  Once a personal financial statement has been constructed, the following are some ratios for analysis which can be applied: liquid assets/monthly expenses, total assets/total debt, liquid assets/total debt, total assets/total debt. I am sure you get an idea of how this analysis can help a financial planner and a client discover the status and financial health of the household budget.

Personal households are not the only entities having budgetary problems. What happens when a city goes broke. This subject is explored by Jonas Elmerraji in the Financial Edge. Through out history, he points out that this event is a rather rare occurence since governments most usually have ways of restructuring themselves. The bankruptcy code does provide for this event however, under chapter 9. Most usually the following factors would cause consideration of a Chapter 9: mounting pension expenses, loss of key tax revenue sources and lawsuits related to non-performance on credit issues. Does any of this sound familiar within your community environment? Be very selective in chosing municipal bond investments!

Now that the President has signed financial reform legislation into law, we should spend a little time examining it’s content.  Much as is the case with health care reform, this is legislation spread out over many pages which contain a variety of directives, but little detail on regulations which are still to be established and written. There is a provision for a consumer protection agency under the control of the Federal Reserve Bank and funded by fees charged to banks. It will set rules to avoid unfair practices regarding the issuing of consumer loans and credit cards, but exempts the auto dealers. Consumers will have better access to credit scores and debit card swipe fees will be caped. Mortgage underwriting will be tightened such that incomes sources must be demonstrated and not just stated. Fixed-equity annuities are exempt from additional regulation. (Are we seeing a pattern here which demonstrates how our most powerful industries can lobby the Congress to get their way in many matters?) There are a variety of mandates on banks which will raise reserve requirements, give FDIC additional powers to break up the big guys if necessary and institute more strict auditing activities for the Federal Reserve Bank. Derivative and swap trading will be more transparent and credit rating agencies will be under scrutiny over how they formulate their ratings. There are also oversight provisions concerning compensation practices in the financial industry. I am disappointed that there is no iteration of adjustment in the operations of Freddie Mac and Fannie Mae. Oh well, the Congress has control there as we have witnessed over the past dozen or so years. They are so well-managed and the oversight has been so complete that the government has been forced to take over ownership of a significant level of their assets. Good job U S Congress!!

For The Record:

DOW                     10,465.94

NASDQ                 2,254.70

S&P 500              1,101.60

Suggested Reading:        “Buffettology” by Mary Buffett and David Clark

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