Leone’s Money Monitor Monthly for the Month of March 2011
by Edward Leone Jr. DMD MBA RFC
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It is interesting that many comments I have made in past blogs regarding our economic problems are coming to be recognized and acted upon. It appears that the government’s role in the home mortgage industry will be changed drastically. Although the road to be traveled toward more fiscally responsible policy will be bumpy and contain many curves, the journey is starting. The debates taking place on the Federal and State level over how to balance budgets and reduce borrowing are healthy and needed. The practice by governments of making promises to employees regarding retirement and other benefits while not funding these programs with actuarial discipline, but rather using political considerations has caught up with us.
We are observing the kinds of influences global politics can have over financial markets in these past several weeks. Concerns over oil prices and supply issues are relevant. While political unrest and the instability of governments in Africa and the Middle East are feeding much speculation, it is difficult to predict the likely outcome. The effects of conclusion on these issues will take a while to unfold and will certainly be significant. Affordable food supplies are a topic of concern due to drought conditions in some areas of the world which have reduced production of corn and wheat. Some grain prices are up over 70% due to these factors and the accelerating demand globally. Hording of product is also a factor at this time. We must hope for record production during the 2011 growing season to mitigate these cost challenges. It is likely that hungry populations will lead to further political unrest. We are experiencing some price inflation in the US of food products, but since we are the world’s greatest exporter of food stuffs, the effects are modest compared to other countries where 25 to 50 % of earnings are spent to feed the family. A bigger concern for the US economy has to do with consumer spending. It is rising again, but at the expense of reduced savings habits and expansion of debt other than mortgage debt. This is not sustainable. We have to put people back to work in order to broaden and sustain the consumer drive to the economy. The slowing of layoffs is a positive trend. Government needs to measure the effects of stifling regulation on business and work to promote a favorable business environment without constantly screwing things up as the result of the unintended consequences of government activity. One example of this type of effect is the Heath Care Reform Act. The motive may be well intended in the eyes of some, but an analysis of the bottom line costs and utility result of this legislation is not a matter of consensus and could be very dangerous and harmful to individuals and society. There are many ways to solve health care service disparities. They need to be examined and vetted before implementation.
On the positive side of things, it is evident that the US economy is improving. GDP is projected to grow at a rate of 3.5% for 2011. The 2010 rate was 2.9% according to the Kiplinger Letter. The S&P 500 index is up 100% over the last two years. Given all of the potential forces stated in previous paragraphs, it will be interesting to observe the sustainability of earnings growth for this index. It appears that the NYSE Euronext and Deutsche Borse may merge. I have no opinion at this time as to whether or not this is a beneficial move from the prospective of traders and investors. It is significant that the US dollar is rising in value against other global currencies. We are still viewed as the safe haven when times are troubled. Many are looking toward the Euro to replace the dollar as a global base currency ; however, financial and economic challenges within the Euro zone along with the differences of commitment to solutions by European governments may slow or stop this trend of thought.
Interest rates are rising slowly in the US. The ten-year treasury bond is yielding about 3.6%, ten-year muni bonds are yielding 2.9 % if they are rated investment grade and ten-year corporate bonds investment grade are yielding 4 to 4.75 %. On the more speculative side, high yield corporates are yielding 7% and high yield muni bonds are yielding 5.8%. We are likely to see mortgage interest rates go up along with the cost of other types of loans. Richard Dobbs and Susan Lund of the McKinsey Global Institute wrote a great article in January of 2011 titled “Five Myths About US Interest Rates” . They make the points that:
1. The Fed controls the federal funds rate, but other long-term interest rates are determined by market influences such as inflation, government deficits and demand for capital.
2. Low interest rates are a temporary condition. Interest rates are likely to go up due to increasing demand for capital in emerging market economies along with the decreasing trend in global savings habits.
3. The thought that US policy should embrace low-interest rates so consumers will spend to boost the economy is in some ways self-defeating. Increased savings habits will help with the availability of capital for investment, reduce consumer debt as deleveraging takes place and secure the retirement prospects for the US population. There is a balance to be sought here.
4. The deduction of mortgage interest is untouchable. This would depend on adjustments in marginal tax rates if the deduction were to be eliminated.
5. Higher interest rates are not necessarily bad for the economy since they would benefit savers, limit the potential for speculation which leads to economic bubbles and focus efficiencies on capital budgeting by businesses.
It is my view that given the likely trends for interest rates, savers for retirement purposes may have been too conservative over the last several years. Much of the rebound in equity markets as indicated by the S&P 500 index may have been missed by bond holders. Interests rates are likely to go up. We are not sure when that big move will take place, but when it does, the market price of bonds held in those retirement portfolios will go down. It is important to maintain an appropriate asset allocation and diversification with a discipline of rebalancing of portfolio holdings in both good and bad economic times to avoid severe investment loses since markets do cycle and timing those cycles on a consistent basis is next to impossible.
For the Record:
DOW 12,130.45
NASDAQ 2,781.05
S&P500 1,319.88
Suggested Reading:
“Reengineering the Corporation” by Hammer and Champy
Leonesmoneymonitormonthly's Blog 
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