May 2009
New York City hosts “Fleet Week” around Memorial Day. We went this year. It was our second trip.
If you ever have a chance, go. It’s worth it. The ships and equipment are certainly impressive, but not nearly as impressive as the men and women in charge of them. We’ll have more to say at the end of this letter.
On the financial front, so much has happened since our last letter, it’s hard to know where to start. But that’s the nature of crises. They can overwhelm. So we simply picked themes that should help you be better informed and better prepared for what’s coming:
- What You Must Know Now Before Investing in Municipal Bonds
- The Best Ways to Save Money: How to Avoid Losing Your “Safe” Money
- Safe Investing: Should you trust the Fed?
We’ve obviously got a lot to cover, but first a quick comment regarding being prepared for “what’s coming”: Does unimaginable danger lurk around the next corner? Or are those “green shoots” we keep reading about sending an “all clear” signal that the danger’s passed? Our view: the jury’s still out.
As for the “green shoots” crowd, there’s lots of noise about seeing positive GDP 4th quarter of 2009. Yippy!
But wait. Let’s take a quick look at the 1974 recession (a nasty sucker!):
|
1974-I |
1974-II |
1974-III |
1974-IV |
1975-I |
1975-II |
Gross domestic product |
-3.4 |
1.2 |
-3.8 |
-1.6 |
-4.7 |
3 |
(source: U.S. Bureau of Economic Analysis) |
Notice how GDP was up second quarter ’74 — right in the middle of the recession. It then headed back down. It didn’t turn up for good until mid-1975.
In addition to this evidence that a single positive quarter may not signal the end of the recession, it makes us nervous that more and more economists are calling the end of the recession. It’s not like most economists have a great record here. We don’t remember very many of them predicting either the current recession, or the historic credit crisis we’ve been living through.
We’re not stomping on green shoots. The recession won’t continue forever; it’s going to end at some point. In fact, it’s not a matter of being a pessimist or an optimist. (Don’t forget that people make a lot of money playing with our emotions. Scare-mongers play to fear. “Positive-thinkers” spread “happy-dust” to make us feel good.)
This isn’t about seeing the glass half-empty or half-full. Forget that stuff. The last thing you need in a crisis is to be taking sides or “reading into” things.
Just seek the truth. No “reading into.” Fair enough? OK. Let’s move on to…
What You Must Know Now Before Investing
In Municipal BondsWe’ve all heard about California’s recent budget problems. But California’s not alone in facing budget problems. In fact, the ratings agencies have announced that they are consideringdowngrading the credit ratings of all municipalities across the United States.
But before you dump your muni bonds, let’s analyze the problem first. Then we can suggest a reasonable approach to buying or holding municipal bonds now.
We’ll start with the following chart. Frankly, it really surprised us. Not the fact that the number of people employed by government has grown since 1946. But we didn’t realize that it’s been the local and state governments that have added the bulk of employees, not the Federal government.
Here’s the problem: local and state tax revenues have fallen as the recession has deepened. All states are suffering budget deficits. But don’t the states run into budget crunches all the time? Yes, but not like this.
The housing bubble caused prices of homes to soar. That increase in home values caused real estate taxes to soar too, providing gushing revenue streams to states and municipalities.
Not only did the typical municipality not save any of this increased revenue, but they went on a spending spree, including the hiring of new employees.
And even though they were collecting more revenue, instead of cutting their existing debt, they issued even more municipal bonds (debt). Why not? With increased revenue, they figured they’d take advantage of their higher credit ratings. Of course, they didn’t save any of the money they raised. They spent that too.
On top of all that, states like New York, California, Michigan, and Massachusetts have huge pension obligations to retired and soon-to-be-retired state and municipal employees.
Where’s the money going to come from to meet all these obligations and address those ballooning deficits now that revenue is decreasing?
And the final nail in the proverbial coffin, the pension funds the States have bothered to fund have collapsed in value, just like lots of other investment accounts. Can you see why the rating agencies have municipalities and the bonds they’ve issued on “watch”?
How does this affect you? If you have municipal bonds in your portfolio, you need to have them evaluated by a credit analyst. In the past, many people bought muni bonds from brokers who typically sold “insured” bonds. But now even the bond insurance companies are in trouble.
Witness the recent downgrading of the bond issue that funded the New York Mets new stadium, Citifield. The bonds were insured by a company whose rating was lowered because it’s got problems. So the bond’s rating was lowered too.
We always thought buying insured bonds wasn’t the most prudent way to put together a portfolio of muni bonds — in fact, it’s one that should be avoided. Why not buy a bond with a high credit rating based upon the financial health of the municipality (or organization) guaranteeing the interest payments?
(Remember, as opposed to Treasury bills, notes and bonds, municipal bonds are not backed by the full faith and credit of the U.S. government. While defaults have been rare in the past, we’re living in different times now, as you may have noticed.)
We always wondered, when push came to shove, whether bond insurance companies would be able to meet their obligations. Push came to shove in the last 24 months or so, and now we know. We were right to be concerned.
Since most people can’t effectively evaluate the credit quality of municipal bonds on their own, you’ll need professional help in this area. Just buying municipal bonds from a broker and collecting your interest may have worked in the past, but it may not now. Why take the chance?
Unless your broker is a credit analyst who will monitor the bonds (and he/she should charge a fee for this service), you’ll need to use a firm that can provide this service. There are a number of firms that will do this at a reasonable fee. They’ll find good bonds, even bonds that return above average returns that will offset their fee. You’ll collect your tax-free interest and sleep better at night.
The Best Ways to Save Money:
How to Avoid Losing Your “Safe” Money.If you put your savings into a savings account in a bank, or CD’s or a money market mutual fund, you’ve probably noticed that you’re getting almost no return on your money. That’s frustrating. Isn’t there some better place to put your savings where you can earn a decent return?
Be careful here. You could be trolling in dangerous waters. It’s called “reaching for return” or “reaching for yield.” That’s where short-term interest rates are so low that people are tempted to take risk with their safe, liquid money – money that’s intended to be available to pay for things like college tuitions due in a year or two or old, leaky roofs that have to be replaced.
Think of “reaching for return” as a kind of virus people catch when interest rates are as low as they are now. Like the flu or some other nasty virus, it clouds your judgment. People in this foggy state of mind will put at risk money that should be safe.
Here’s one that may tempt you now: putting “safe” money into treasury bonds now that they’re returning almost 4.5%. Treasury bonds are safe, aren’t they?
Problem: if rates continue to go up (and they just may do that), the treasury bond’s price will sink — by a lot.
Example: Invest $100,000 in 30-year treasury bonds, earning 4.5%. Collect $4,500 per year in interest. Tempting.
But if interest rates continue up, let’s say, another 10% to 4.95%, the value of the bonds goes down 10% – from $100,000 to $90,000. And if you “parked” money there that you might need any time before the 30 years is up (Remember we bought 30-year bonds), you’ll lose money when you cash in the bonds.
These sorts of bad decisions occur because of the “reaching for yield” virus. Safe money should only be committed to a “short” investment — something that is liquid so you can take the principle if you need it on short notice without losing value.
Let’s continue a bit with our “safe” theme…
Safe Investing: Should you trust the Fed?
Safe investing takes discipline. Part of that discipline is to limit the amount of “financial pornography” you allow into your brain. You know, all that junk information that’s shoveled at you from every conceivable source.
What about Fed pronouncements? Can we trust the Fed to give us good information? Certainly, the various Fed websites contain lots of data that’s interesting and helpful. But more specifically, can we assume they understand what’s happening right now in the economy or that they have a good idea as to what we can expect in the future, say over the next 12 – 24 months?
After all, Bernanke and crew strike us as pretty smart guys – as smart as academic economists can get. But it’s important to ask whether we can trust their judgment. After all, they have joined with the Treasury Department to spend or commit over $12.8 trillion (according to data compiled by Bloomberg as of March 31st) to deal with our current financial crisis and economic recession. Can we assume their policies, including the various bailouts we’ve all read about, were based on a reasonable understanding of what’s coming? Will their plans work out?
One way to find out is to turn the clock back to July 20th, 2007 (almost two years ago now). We’ll look at what they said then and see how good their judgment was. With the first wave of the sub-prime crisis hitting and Bear Stearns beginning its death spiral, Ben Bernanke told us to expect total losses of about $100 billion. Not to worry.
But it wasn’t long before Bear Stearns finally expired for good and those billions of losses began accelerating into the trillions we’ve all become so familiar with. A recent Federal Reserve report estimates the loss of wealth in American households alone as topping $11 trillion.
How could Bernanke have been so far off? Did he know what was coming? Was he just trying to avoid panic? Or was he as clueless as his words indicated at the time?
Think about it. Either way, he wasn’t a very reliable source of good information or opinion, was he? Even if he knew the truth and was just trying to keep us all calm, you would not have wanted to make investment decisions based upon what he said.
One of the definitions of “trust” is “firm reliance on the integrity, ability, or character of a person or thing.” How did Bernanke stack up? Hmm… That means that he was not someone to be trusted, doesn’t it?
Safe investing requires, among other things, care and vigilance, both in making decisions about where to put your money as well as monitoring those investments – and reliable sources of information, knowledge and wisdom. Use the Fed’s data, if you find it helpful. But don’t trust their pronouncements or their judgment.
Apology
We won’t be able to get to that new data we mentioned in our last letter — data that will shake up your notions about whether stocks are really the obvious choice we all thought they were for long-term investing. We still have to get to an important Memorial Day message and don’t want to rush you through what we believe are new and important insights into investing in stocks.
So we’ll simply apologize and just wait until next time. At least then we can give it as much space as we need to deliver the critical points in an organized, thorough fashion that will clear up some of the misleading data we’ve all been fed for the last thirty or so years.
Now on to…
A Personal Note: Memorial Day
(I posted the following thoughts on May 24th on my blog,http://rickesposito.blogspot.com/ since I knew the letter wouldn’t be finished before Memorial Day.)
Memorial Day means a 3-day weekend. Sadly, that’s what many of us think of first. Of course, it means a lot more than that.
We mourn the dead on Memorial Day — specifically those who gave their lives in America’s wars.
Have you ever attended a special service for Memorial Day? I haven’t. And I have to admit I’ve got to make an effort to even remember our war dead. It’s easy to slip into the “3-day weekend” syndrome.
The closest I’ll come to a special service is when the organist at the Catholic Church I attend plays “America the Beautiful” on Sunday – usually at the end of Mass. We’ll all sing one, maybe two verses. Then we head for the exits and get on with the weekend. We never get to the third verse.
But if you check the lyrics to that great American anthem, I think you’ll find that the third verse is appropriate for Memorial Day – especially this year.
Our financial crisis and economic recession has shaken us up as people and as Americans. Will the success that has characterized our country since 1776 fade into a distant memory?
We’ve all heard the tale of woe: the dollar is in danger of being replaced as the “reserve currency”; prosperity has ended; America can’t continue as the world’s #1 superpower.
Maybe that’s true. We don’t really know yet, do we? But whatever happens, we can’t forget our honored dead. With that in mind, let’s read the words of the third verse of “American the Beautiful” together:
O beautiful for heroes proved
In liberating strife.
Who more than self their country loved
And mercy more than life!
America! America! May God thy gold refine
Till all success be nobleness
And every gain divine!
If success is nobleness and gain is divine it puts a new perspective on things, doesn’t it?
It’s hard to imagine that our soldiers died to preserve the dollar as the world’s reserve currency, or so that we could all be rich, or that America would always be a great superpower.
Anyway, it seems that way to me.
P.S. — You’ll find more thoughts and ideas on wealth management and coping with our financial and economic crisis on my blog. Latest entries include:
- Will money management have to change now?
- Using a Mortgage Calculator: Watch out for this hidden danger
- Saving Money and Getting Nothing In Return: Does this make any sense?
Just go to http://rickesposito.blogspot.com/
Richard S. Esposito, ChFC
Lighthouse Wealth Management LLC
405 Lexington Avenue, 26th Floor
New York, NY 10174
Tel: 212-907-6583/Fax: 866-924-1952
Email: resposito@lighthousewm.com
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