Thursday, December 31, 2009

2010 Full of Wishes, Hopes and Fears

I hope that all of my clients and readers of this Blog have had a wonderful Holiday Season and that 2010 will be prosperous for all. As usual, those in the money management business take some time to look ahead and try to figure out what the coming year will hold. Those of you who are long time readers of this blog and my previous newsletter know that I’m not shy about making predictions.

Let’s start with the economy. In October the initial Gross Domestic Product (GDP) was reported at 3.5%. In November it was revised down to 2.5% and the final revision in December GDP was further revised downward to 2.2%. My guess is that if they made a January revision it would be further reduced. I have serious concerns that the economy in 2010 will disappoint and the GDP will be lucky to be in the 1.5 to 2% range. Look for increasing cries for another stimulus program to try to create jobs and push GDP. I think the American people are concerned about the exploding deficit and will be strongly opposed to any new spending programs.

Jobs will be the most important issue of the year and the lack of jobs have had ramifications. With functional unemployment at around 18% jobs will be the page one issue until the election. If the economy hasn’t turned up and we do not see significant improvement in unemployment numbers look for a significant voter backlash and a major power shift in not only in the Congress but look for the president to make a move to the middle. (like Bill Clinton moved to the middle when the American voters changed the balance of power)

I think the Democratic Congress and the President will try and front load as much of the legislative changes in policy as they can before the election takes center stage. The heath care bill may well be the first vote on the continuing power of the president and the current Democratic controlled Congress. I do not know for sure if the health care bill will pass. The difference between the House and Senate seems almost insurmountable but we will find out by mid January.

What is the out look for the markets and interest rates? While the S&P 500 is up about 24% on a year to date basis over the last two years the S&P 500 is off about 23%. I do not expect the stock market to produce another 20% plus year in 2010. A return that was flat to up just slightly would be a great year. There has been a great deal of hope in the returns for 2009 and I do not see them carrying over into 2010. I’m looking for a significant correction in the range of 10% to 15% sometime in the first quarter.

My greatest fear is for the near retired and those people already in retirement. The Census Bureau, which by the way will hire 1,000,000 people next year, currently estimates that there are 72 million baby boomers and 32 million people over the age of 65. The boomers have experienced the “Lost Decade” for stocks. The first decade of the 21st century saw the return on the S&P 500 have a negative total return of 23%. The retirement savings of this over 100 million people has been adversely impacted and jeopardized the retirement security of this large segment of America.

The historical decline of interest rates especially short-term savings rates is causing this group of Americans to start spending principal well a head of what would be normal in retirement. I expect this problem to become more acute in 2010 as many of the higher yielding CD’s will be replaced at interest rates one third of the older CD interest rate. As long as unemployment continues above 8% I can find no reason why the Federal Reserve will start raising short-term interest rates. If I’m right that short-term interest rates will stay close to zero well into 2011 then look for increasing examples of retirees being subject to fraud because they are desperately looking for higher income to survive.

The key for survival in 2010 will be income. I expect income producing investments to be in increasing demand throughout all of 2010. If you need income to pay your bills and the cash flow from your investment is meeting your needs then don’t worry about the changes in the price. For my clients who needed income over the last 16 months got their checks. Yes, their principal went down but it recovered. I do think they will see some volatility but I think their income is secure.

One final thought: Look at how much risk you have in your portfolio. See how much of your money is in income producing assets and what percentage of your assets you have in common stock. Take any opportunity in the beginning of 2010 to rebalance your assets towards income assets; you’ll have less downside.

Dan Perkins

Wednesday, December 9, 2009

Did you ever play Hide and Seek as a child?

“Hide and Seek” is a game we played when we were children. Someone was “it” and had to stay at the base and count to 100 while the rest were to try and find a place to hide and not get tagged out. After the seeker finished his count to 100 he started to look for the rest of the players and his job was to tag them before they could safely return to base without being tagged and then they were safe. Depending upon how you played the game the first or last person tagged was “it” for the next game.

So you are asking yourself, how is Dan going to spin this childhood game into something related to investing? For about the last 40 years you could play "Hide and Seek" with your money. If you didn’t like the way the stock and bond markets were acting you could safely Hide your money in a money market account. You could stay hidden as long as you wanted to earn a modest return while you were seeking new investment opportunities.

Many people in or near retirement have been using money market mutual funds and CD’s to not only Hide money from risk but also these accounts have provided supplemental income which has made a real difference in the quality of life for people. Today these money market accounts are providing close to zero return, some you can’t put money in and others you can’t get money out.

US Government Money Market Funds are yielding, in many cases, zero percent return. This past week the government had an auction for $28 billion in 30-Day T-Bills which are typically found in money market mutual funds. The demand or cover ratio was 5.33 times and the yield was zero. The government borrowed $28 billion and is paying no interest to borrow the money.

If you bought some of these T-bills how are you going to pay your bills with no income from your investment? The willingness of people to Hide money from risk in money market accounts or T-Bills at no return tells me they are unwilling to Seek out alternative investments. In a recent seminar I asked the question why keep money at zero return? The answer someone offered was, “zero is better than loosing money in your investments.” Clearly there are millions of Americans who have chosen to play "Hide and Seek" with their money, but they have chosen to only play half the game. These modern day players have hidden their money but are not seeking alternatives.

I asked a person recently what would have to happen to make them move their money from money market mutual funds yielding zero? The answer was, “When interest rates rise.” I asked him if the Fed doesn’t mover interest rates till 2012, how will you pay your bills? He said “I don’t know, I hope the Fed starts raising rates in January 2010.” If the Fed keeps interest rates low till 2012 then many retirees will have to start liquidating assets to pay bills.

There are alternatives that can provide safe and predictable income but in order to find them you have to be will to play the rest of the game and Seek them out. If your Seeking alternatives why not contact me for some of your alternatives.

Dan Perkins

Saturday, November 28, 2009

You buy insurance on your possessions and your life why not your investments?

I’m writing this blog on Black Friday as the world markets came under pressure with the problems in Dubai loan payments. The leaders are saying this is an isolated problem and the amount at risk is no problem for the word markets. We heard that same statement made about the US real estate market two years ago. I don’t know if there is a bigger problem, but I have learned that where there is smoke there is fire. Only time will tell how serious the problem turns out to be.

Just think, if you bought gold on Wednesday you are down $33 in two days. Most of the global stock markets are off 3% to 5%. Here is the question for consideration: Is this the correction the markets have been looking for or is this a dip and in turn a buying opportunity? It is somewhat ironic that we set a 14-month high on the Dow Jones at the close of business on Wednesday and then had this correction. It is possible the Dubai problem becomes the event that takes some of the froth off the market and causes people to rethink the valuations of the market.

The significant amount of volatility in the markets raises questions. How can I protect myself when prices fall on stocks and bonds without selling and going to cash? which is paying nothing). One of the trade offs in making the sell decision is: If I sell a stock that has a current yield of 8% and then invest in a money market fund earning close to zero I’m giving up a significant amount of income.

It is possible, to some degree, to protect yourself on the downside. There are many ways to buy this insurance; some insurance is short-term while others can be left in place for years. For most of my clients I tend to use insurance that has no time limit. One form of short-term insurance is options. Options give you the right to buy or sell your stock for a price for a specific time frame. The problem with this form of insurance is that stock options are for a specific stock and while it may give some insurance on one specific stock it can’t give you protection on an entire portfolio of stocks and no protection on bonds. You can trade futures on both stock and bond markets but again, for the most part, they have a specific time frame.

I want longer-term protection that gives me the longest times frame and covers the broad stock and bond markets. I have found that using Exchanged Traded Funds (ETF) for both the S&P 500 and the bond markets gives me the greatest flexibility. I understand that some people think that these short ETF’s should not be allowed. They believe that people do not understand the risk of these investments. I could say that many people do not understand much of the risk they are taking with their investments.

I use the SDS, ETF for insurance on the downside for the S&P 500 and the SSO ,ETF for the long side of the market. In the case of Treasury bonds I use the TBT, ETF to buy insurance on the short side of the fixed income markets. Let me point out that I’m not trying to time the markets; I know that markets go up and down and they don’t do this in a fixed manner. I may have to hold on to a long or short position for an extended period of time before I sell. Here is the point. If I’m short the market with the purchase of the SDS and the market goes up, then hopefully my stocks will go up and my ETF will fall in value. When the markets turn and stocks fall then my SDS will start to increase in value. Just like insurance on your home you hope you never have a claim but if you do have to file a claim then you feel good about having the protection. The use of long and short ETF’s can give you long-term protection and most importantly reduce the volatility of your investments. Don’t you wish you could buy insurance on the declining value of your home? You can, the symbol is HPB.

Dan Perkins

Friday, November 13, 2009

10.2 Unemployment May Be The Death Knell To The Money Market Fund Industry.

On Friday November 6, 2009 the unemployment rate was reported at 10.2%. The markets were expecting double-digit unemployment, but not till sometime in the first quarter 2010. The result of the unemployment number may well be the demise of the money market mutual fund industry. TD Holdings, the third largest retail brokerage by client assets, reported last week that the fee waiver for their money market mutual funds impacted the earnings results in perhaps the biggest bull market in 80 years. Can other brokerages like Charles Schwab be far behind in reporting similar results impact on earnings through fee waivers?

Charles Schwab reported in its third quarter earnings report that money market fund fee waivers increased to $78 million through the end of the quarter resulting in a 24% decline in overall revenue. Randy Merk, CIO of Schwab expects that there will be $200 million in fee waivers for 2009. He further said that if interest rates stay low in 2010 he expects that Schwab will report $100 million in fee waivers per quarter next year.

On Wednesday November 5, the Fed Open Market Committee reaffirmed its position when it said that it would hold interest rates low for the dreaded “Extended Period of Time”. The market was hoping for a better unemployment number on Friday and because we are now at 10.2% and probably moving higher the likelihood that the Fed will be tightening next year went out the window and the possibility of return for both managers and investors alike. The estimates for the peak in unemployment will have to go up as economists were looking for a peak in second quarter 2010 at around 10.5%. Some are predicting that we may go above the post World War II record that was 10.8 in 1982.

For most of this year money market mutual funds managers have been under pressure by outside directors to do whatever was possible to hold the net asset value (NAV) of money funds at $1.00. The vast majorities of both US Government and General money market funds have waived most of their management fees and managers are now paying some if not all of the other operating expenses to hold NAV at $1.00 even if the return is near zero.

If near zero return is not bad enough for regular money market mutual funds, according to the Investment Company Institute (ICI) in a recent report there is also over $1 trillion dollars in separate account variable annuity and variable life products that are losing money. The ICI reports that approximately one third of the separate account assets are in money market accounts. If you look at the Wall Street Journal report on separate account performance ( you will find, net of mortality and expense fees, all these accounts are losing money. Some separate accounts cash accounts are showing losses as much as 1.60% on a seven-day yield basis. If you look at cash account values in separate accounts you will see that they are declining. People are loosing money on cash investments.

Because of the employment data the short end of the bond market saw the yield on 90-Day T-Bills fell to 3 basis points. All of the money funds are trying to shorten their duration and therefore they are becoming the victims of their inability to accept that the money market mutual fund business model is broken. Time is wearing them down along with the loss of income.

Many of the US Government money funds are closed to new and sometimes existing investors can’t add money. I have noticed that some general money funds are beginning to close so no new money can be added to existing accounts. The enormous stock market rally has taken the spotlight away from the problem of no return on cash. When the stock market has a serious correction and investors want out of equities, where will they go? Those investors in separate account investments will see their losses continue when they get out of stocks and go to cash. Cash at zero return will not be acceptable; cash at negative returns is even less acceptable.

I think return of invested capital is in the offing for many money market mutual fund holders especially the smaller funds. The asset management companies will have to come to grips that after the first of the year they could be looking at perhaps two more years or more of no fee income from whatever is left in the money market accounts. The idea of no income will not be acceptable and they will want to find ways to get out of the business. Closing funds and distributing assets is the quickest way out of the business. It is possible that some management companies will break the buck and use the cover of the prospectus language of potentially loosing money and look to keep whatever money they can on their terms.

If you think about the customer earning zero percent on money market funds when they could earn at least 3 to 4 basis points on a direct purchase of T-Bills the fund industry has to ask if they are doing the best thing for the clients. As advocates for the client investment advisors have to help clients get the most on their money with the least amount of risk.

The problems of making little or no income on market mutual funds and separate account cash investments require both industries to rethink their business model. I believe that the new model will see the NAV of $1.00 disappear and people will be exposed to the potential of losing money. I think both the managers and the investors will continue to loose money until reality sets in and true business decisions are made.

Dan Perkins

Friday, October 30, 2009

The "Titian's of Talk" get it wrong?

We want the economy to recover so much we act like a moth drawn to the flame when talking heads, the “Titian's of Talk”, spew a message of false hope. The stock market was down on Wednesday and then rallied based on the GDP number on Thursday-- just to give it all back on Friday. I was amazed by the pundits who were saying that surely the Fed would have to start raising interest rates sooner rather than later based on the GDP number.
What bothers me about these “Titian's of Talk” is that they get people excited about the smallest move in the market or economy and try to pump the market to get people to buy. The most recent volatility in the equity markets tells me that I have been right for 35 years in watching to see what happens over a longer period of 24 hours before I make a decision to invest.

On Wednesday the NASDAQ broke down through it’s 50 day moving average, so the “Titian's of Talk” warned that we could see another 5% correction. Yet when the market was up almost 200 on Thursday the breach of the 50 day average and the recovery over the moving average caused hope to spring eternal. On Friday the market went down 250 points, the NASDAQ went through it’s 50 day moving average so what will the “Titian's of Talk” say tonight?

Gold, interest rates, and oil are down and the dollar is up, yet less than a week ago the “Titian's of Talk” were saying the place to be was out of the dollar and into those currencies that were commodity based like Canada and Australia because these are natural resources economies. They were saying that gold is the new currency and that people needed to get out of the dollar into the “New Currency”.

The “Titian's of Talk” are saying that the Fed needs to start raising interest rates sooner rather than later because of the movement of GDP. Next Friday we get another read on the unemployment in the United States with the release of the jobs or employment data. I expect that we will not see a downturn in unemployment until next year and perhaps not until the 4th quarter of 2010.

I believe if unemployment stays between the 8% and 10% level, the Fed will not start increasing interest rates on the short end of the yield curve no matter what the “Titian's of Talk” say. The Fed has told us they do not see a problem with inflation and they are more concerned about getting the economy growing and new jobs being created.

The “Titian's of Talk” are short-term thinkers and they are reactionary investors. They can say “I like this” or “I don’t like that” and people listen to them and in some cases invest the way they preach. For some people this approach might be OK, but I prefer to let things develop over time rather than make a decision on an economic number from the government that will be revised at least twice from here.

Dan Perkins

Friday, October 23, 2009

Can biting a Greenback today tell you if it has value?

In the 1800’s gold coins were used as currency instead of paper. People used their teeth to bite into the coin to see if it was real. Paper money from the Federal Government didn’t get started until the Civil War. The dollars nickname of “green backs” was created then because of the green ink used to print the money. Some people today believe that inflation in terms of currency started with the printing of the first “green backs”

Recently I was asked about the purchase of gold bullion, at these levels ,as a hedge against future inflation. I thought about the question a little while and then responded. I asked if the local Safeway would take gold in payment of the supermarket bill at the checkout? Another question was how would you make your car payment, house payment and utilities that are due each month? The response was, I'll just sell some of my gold and convert it to dollars then I’ll have the cash to pay my bills.

I suggested that if you take what they call in the gold trading business, Physical Deliver, of the gold, in order to sell it back the buyer they may want the metal assayed which costs money. I also suggested that they call one of the advertisements we all see on TV and ask the price to buy and the price to sell it back to them. The difference between the price you buy and the price you sell is the spread. If the spread is greater than 3.5% then you are probably being ripped off.

If you were to buy gold at $1,058 and wanted to sell it your dealer fee would be 3.5% of the current market of $1,058 or $37.00. In order to break even when you sell then you would need the price of gold to be, assuming a 3.5% dealer fee $1,095. You may also have to pay an assay fee in addition to the dealer fee, which would increase the price you would need to break even.

I asked were there any other reasons beyond inflation why they wanted to own Gold? The answer was, “I think things could get very bad again and I think gold can afforded me some protection if things do get bad economically in the United States.” So, what this person was concerned about was that America would get into trouble again and the rest of the world would be OK.

While gold is getting a great deal of press, the decline of the dollar is helping feed the marketing of buying gold. I have seen several articles about OPEC wanting to switch to a different currency than the dollar for the payment of crude oil. I do not know of any currency in the world that has the size and liquidity to handle the world’s commerce including the Euro. Over the last three and one half decades I have heard many times the idea of replacing the dollar with a basket of currencies and every time there is an economic or political problem in the world money runs to the dollar.

Ask your self this question? If the world’s economies are in such great shape then why is the yield on the 90-Day T-Bill 4 basis points? The answer is that enough people are concerned about the global economic prospects that they are willing to keep $3.5 trillion dollars earning almost zero return in money market funds.

If you buy gold then as the saying goes, “Let the buyer beware”, and make sure you have enough greenbacks laying around just in case.

Dan Perkins

Monday, September 28, 2009

What Is The Bond Market Telling Us About Inflation?

Recently two powerhouses took different stands on the merits of owning or not owning the longer-term Treasury Bonds. Bill Gross the President and co-founder of PIMCO the largest fixed income manager in the world. Mr. Gross said he had increased his long Treasury positions to the highest level in many years. While on the other hand Jim Cramer of CNBC Mad Money said that he believed you should sell out of any long dated Treasury positions you owned. So far Bill Gross is winning the battle of the forecasters.

Only time will tell if either is correct, but I think the more important issue at hand is what the bond market is telling us about the prospects for inflation and growth. As I write this blog the yield on the 30-year bond is just above 4% while the yield on the 10-year bond is 3.25%. I suggested in a previous blog that I thought that the yield on the ten-year bond could reach 3% perhaps even go below.

When the majority says that something will have to happen it usually doesn’t. The majority is telling anyone who will listen that inflation is just around the corner and the Fed should be raising interest rates now to stem the tide of potential inflation. I believe that bond market is telling a much different story. The bond market is beginning to price in deflation.

The stock markets are going to 10,000 on the Dow Jones and 1,100 to 1,200 on the S&P 500 if you believe the majority of annalists on the street. The S&P 500 has moved almost 60% off of its March 9 bottom. Lets say that the forecasters are correct that the S&P 500 could go to 1,100 from this level by the end of 2009. If the S&P 500 were to go to 1,100 from this level then the upside is 3.7% of additional return not much risk reward opportunity.

Some time ago I suggested that there were a few simple things you could watch to tell you about the recovery in the economy. One was Jobs and another was the real estate market or single-family home sales and prices. I would like to add one other item to your short list of things to watch and that is the price of gold. Gold is supposed to be the great inflation hedge and everybody should have some right. If you adjust the current price of gold for inflation the comparable price to the previous high is $870. If you were to buy gold today at $1,000 it pays no income and if we are in fact headed for deflation you could loose a great deal of money.

I have been saying for some time that I felt that the recovery, when it came, would be weak and unemployment would stay above 8% for an extended period of time, perhaps several years. It appears that a very small minority believe that we could be in for difficulty for several years to come. I just can’t see the Fed raising interest rates with unemployment above 8%. I still expect to see a slow and low recovery and no change in interest rate policy for several years.

I believe that the bond market is giving us a warning. The bond market is saying that inflation is not a problem and it will not be a problem. People keep asking the question; why are people buying all of the excess of US Treasury debt. They can’t understand why this debt is being sold at such low interest rates and with high demand. I believe the answer is that the buyers don’t see inflation and are more concerned about deflation and a US Government bond is still the safest place to have your money. I also believe that people are trying to put a round peg in a square hole by saying this is what should happen based on the past. There are some people who remember the great depression of the 1930”s. I think all the rules are off the table when it comes to investing money today and the demand for the treasury debt is sending a loud and clear signal.

The people who maintained their wealth in the last depression did so by buying Treasuries not common stock. If you are not convinced that the future is not as rosy as many are predicting then you are buying or should be buying Treasuries across the entire maturity curve. My money is on Bill Gross.

Dan Perkins

Friday, September 25, 2009

Who is Buying all of our Government Debt and why? Understanding the Carry Trade.

A carry trade may be a new concept to many of you so let me explain what a carry trade is for investors. In its simplest form a carry trade is a leveraged transaction. If an investor can borrow money at a low enough cost they might be able to invest the money in something that will pay a higher return than the interest expense to borrow the money thus earning the difference called the spread.

If an investor could borrow money in Japan at lets say one quarter of one percent (25 basis points) and can buy US Governments with a yield of 3.4% then he makes the difference between the cost of money and the actual cash flow. In our example the spread is the difference between borrowing at 25 basis points and earning at 3.4% or 3.15%. This spread is 12.6 times greater than the cost of funds, the net of 3.15% divided by.0025 (the 25 basis points).

US Government bonds can be leveraged at pennies on the dollar. Let us assume that we stay within the acceptable leverage that the government thinks is reasonable for US Banks and that leverage ratio is 10 to 1. If we take our example and leverage it 9 more times then our potential return is the 3.4% interest on our initial buy and 3.15% times 10 times. The potential outcome is 3.15% time 10 plus the initial 3.41% on the first bond. The bottom line in this carry trade is the potential of just under 35% return.

Look at the chart below at the bottom you will see the light green line. This line represents the cost of money in Japan.

For over 10 years you could borrow money in Japan for less then three quarters of one percent. The rest of the charts show all the places you could take this money and leverage it as we illustrated above in a carry trade transaction.

There is now a country that is offering interest rates lower than Japan. Can you guess who that country is? The good old US of A. The cost of short-term money in the United States is almost half of what the cost of money is in Japan. Japan has kept interest rates low for over 10 years trying to stimulate its economy but to no avail. The US Central Bank has provided over $1.5 trillion dollars of liquidity in the credit markets to avoid a serious depression in the United States. The US is now in the carry trade business in a huge way. If Japan has had to keep short interest rates low for 10-years to try and protect its level of economic growth then why are so many people talking about the Fed and its exit strategy and begin to raise interest rates. As I have said before I believe that this recover will be low and slow the Fed will be reluctant to increase interest rates with unemployment at almost 10%.

People keep asking why are investors are buying up all of out new issue Government debt? The real answer is that US Government debt has one of the lowest costs and the greatest opportunity for leverage—the carry trade than almost any other fixed income security. If the Fed keeps interest rates low and I think they will, the American carry trade will be around perhaps as long as the one in Japan.

Dan Perkins

Tuesday, September 1, 2009

So what if the dips don’t hold this time?

As the stock market rally continued throughout the summer one of the cries from the talking heads was to buy the dips. With all the put and call activity there is a floor under the market that will keep it from falling below 3% so they say.

We should find out soon if the buying power of buying the dips will hold. The S&P 500 closed down 2.21% on Tuesday. If the dip is going to hold, the dip bottom should be around 991 on the S&P 500. If we break 991 then I believe we could have a series of downdrafts that could take us down to my original target of 900 to 910 on the S&P 500.

Over the summer, as the market rallied, the talking heads were spouting about how much the market is up from its bottom. The S&P 500 is up about 48% from the March 9th bottom, but the rest of the story is that, on a year to date basis, the S&P 500 is up about 11%. If we fall to the 900 to 910 on the S&P 500 we would be, in effect, winding up flat or with zero return for the year. The idea of losing all of the recovery will cause people to react quickly.

We may well have seen the high for the year in the market and if we get to a point where the market drops 5 percent then look for panic selling to increase by those investors who want to protect any profits they have left.

Buying the dips reminds me of the story about the little Dutch boy who stopped the leak in the dike by putting his finger in the leak until someone could come and plug the hole. The pressure of all the water behind the Dike could not be stopped by one finger.

The pressure from many investors who have seen some recovery in their portfolios will act like the water behind the dike. Once the crack begins to open it becomes impossible to stop the onslaught of water coming through the dike. Investor psychology is like the water behind the dike. Once the water starts flowing through the crack more water wants to get through the dike. When the market psychology changes to the point that investors want to get out, the pressure on the markets increases. If we look at what happened in the period from September to March investors were panicked and wanted out at any price. While I do not envision that type of panic selling this time around people will react quickly to get out of stock positions because they do not want to see again the losses they experienced over the last 12 months.

When you start getting nervous about the market and you want to get out you need to think about what you are going to do with the money. According to Barron’s online the average US Government Money Market Mutual fund is yielding on average 3 basis points with On the other hand hundreds of them offering zero yield.general money market mutual funds are yielding 6 basis points but like many of the Government Money Market Funds many of the general money market funds are also yielding zero.

Know where you are going before you go. The old Chinese proverb says, “If you do not know where you are going any road will take you there.” Don’t make decisions under stress. Look at what you own and ask yourself where else you would go with the money. If you can’t find a really good alternative then stay where you are. You need to look around and see how many other people have their finger in the dike.

Dan Perkins

Monday, August 24, 2009

50 years later we ask did we make a mistake

We are in the throws of a very heated health-care debate in the United States. Some think the system is broken and the government needs to control health care insurance. The opposition raises the question, can we afford the cost to have the government run the health care bureaucracy? Some would ask what track record does the government have in running health care? We decided to move the administration of Medicare to the states because the Federal Government couldn’t manage it. The government passed a Stimulus Package this year of $750 billion; so far we have spent less than $100 million. People blame the inability of the Washington bureaucracy to get the money out.

During the debate we have heard about health care in Canada and England and how good it is to the residents. Some say these two are great examples of health care for all. There is the joke that in Canada that your dog can get a hip replacement faster than the owner. In England the expansion of the private pay health care system seems to be driven by people who want a better quality of care than National Health Insurance can provide.

In an interview with CNBC, Peter Toogood, (yes that is his real name) head of investments for Old Broad Street Research of London, talked about the problems with National Health Service. He said that the health care program in the UK is “unfundable” longer-term. He said that when they started NHS 50 years ago they were figuring that people would live 65 to 70 years of age. He said, “What has happened is that the number of people who are living into their 90’s is placing an incredible strain on the financial resources of NHS.”

NHS says that the increasing demands on the health care system is more a result of evolution rather than a revolution in the UK. They never thought then that people would be living to such an extended age. Perhaps we need to ask in the United States health care debate about longevity as it relates to our health care system. It is clear to me that if we look back at the original intentions on Social Security nobody envisioned the number of people to be covered and the length of peoples lives.

Speaking of Social Security and health care, the trustees of the Social Security Trust Fund are currently contemplating no increase in benefits for the next two years. We do know that the people on Medicare Prescription Drug program will see their monthly cost go from $28 to 30 per month.

Barbara Kennedy, the former Congress Women from Connecticut, says that people need the cost of living adjustment. If the Trustees freeze benefits for two year those on benefits will have less to spend and will have to dip into their saving to make ends meet.

We are facing difficult decisions that have some long-term ramification if we get it wrong. At least one person in England thinks the problem was short-term thinking. As we discuss the issue of health care in the US we need to make sure that we look at the UK as the model analyzing what they did wrong so we don’t make the same mistakes and find out 50 years later.

Dan Perkins

Friday, August 14, 2009

What do the markets and teeter-totter have in comon?

When I was growing up The single scariest thing to do in the local playground was the infamous teeter-totter. You got on and gently went up and down, but sometimes somebody got on with you that took you to the top and then jumped off. You could see them jump off, but for a second you were suspended in mid air just before you came crashing down. This past week was like the childhood teeter-totter in the park. One day we’re up and the prospects for the economy look great. The next day things didn’t look so great so the market went down. Well on Friday your friend jumped off leaving you up in the air and you knew that you were going to come crashing down. You also knew that it was not going to be a pleasant experience. So what happened on Friday that ruined your ride?

Consumer prices were flat in July as energy costs retreated following a big surge in June. Over the past 12 months, prices dropped the most in nearly six decades as the recession and lower energy costs kept a lid on inflation. The Commerce Department says consumer prices showed no changed in July, in line with analysts' expectations and far below the 0.7 percent jump in June. Prices fell 2.1 percent over the past 12 months, the biggest annual decline since a similar drop in the period ending in January 1950. Most of the past year's decline reflects energy prices falling 28.1 percent since peaking in July 2008.

Many market experts have been looking for some form of correction after the almost 50% run up in the market since the March low. The problem was that they have been looking for the correction for the last 15% of the market move. I also have been looking for a correction. After the S&P 500 hit 1,000 (May7) the market closed at 1,004 on Friday and has been higher but the correction is coming.

I suggested in a previous blog that the market would not have a serious correction until enough money from the sidelines had been sucked into the market. A significant amount of money has been drawn into the market, but not the level that I was looking for to come in from the sidelines. While we may see a continuation of the decline through the end of the month I do not expect to see the correction to be very deep.

Once this correction is over I would expect to see a run in the S&P 500 to close around 1,100 before we start down again. One of the phrases you hear again on the street is “Buy the Dips”. The logic in buying the dips is that the markets are going higher and every dip is the chance to get in before the market goes even higher. I think I have heard that saying more than once before, I think the person who said that was the person who jumped off the teeter-totter.

Well that person you got on the teeter-totter with is selling you the idea of buying the dips, but when they bail out you will come crashing with more than your bottom hurting.

Dan Perkins

Friday, July 31, 2009

Were You Ever a Super Hero?

When you were a kid did you have a super hero? Well I did and my superhero was Superman. I could pin on a bath towel and it magically turned into a red superman cape. It did not matter to me that the towel was white I was still superman. By the way, what super hero did you want to be when you were little? Can you remember?

I liked Superman because he stood for truth, justice and the American way. I’m not sure that I knew then what those three things stood for, but I know I have a better understanding about them today. I recently came across one of those items that caused me to be concerned about the concept of truth.

Some of you may recall the problems experienced by the Reserve Fund last fall. This first money market fund had to close for redemptions because it's directors said that a $785 million position in Lehman commercial paper was worthless due to the bankruptcy filing of Lehman the day before.

People who had money in the fund were told that there would be no redemptions and you could not get your money out. The problems experienced by Reserve Fund and other money market funds caused the government to insure through FDIC, money market mutual funds. That protection was extended to September 2009 when it will, unless extended, expire and the FDIC insurance on about $4 trillion in money fund assets will revert back to the way things used to be.

As a routine I check the Reserve Fund web site, to see what is happening in the Primary Fund. Below is a copy of the Floating Rate Note section of that fund. I have highlighted in bold the Lehman Brothers positions for you to see. This is important; the directors of the fund could not value these positions and could not find a discernible market for this commercial paper.

As you can see below they are showing the value of these positions at full value, what they paid for the position. So, when you look at this report you are led to believe that these positions in Lehman have not lost any value and when they sell them, because the fund is in liquidation, you’ll get all your money back.

Floating Rate Note ASB FINANCE LTD. 08/25/2009 1.0712 500,000,000 9.36%
BARCLAYS BANK PLC 09/16/2009 1.0744 200,000,000 3.75%
DEUTSCHE BANK AG NY 10/21/2009 0.8388 208,000,000 3.89%
GENERAL ELEC CAP CORP 09/24/2009 0.3550 200,000,000 3.75%
HSBC USA INC 10/15/2009 0.9250 275,000,000 5.15%

LEHMAN BROS HLDGS INC 03/20/2009 0.0000 250,000,000 4.68%

LEHMAN BRTHRS HLDG INC 10/29/2008 3.7100 185,000,000 3.46%

LEHMAN BRTHRS HLDG INC 10/27/2008 3.2900 200,000,000 3.75%

LEHMAN BRTHRS HLDG INC 10/10/2008 3.0000 150,000,000 2.81%

LLOYDS TSB GROUP PLC 08/07/2009 1.2862 183,000,000 3.43%
NATIONAL AUSTRALIA BK LTD 10/06/2009 0.8594 60,000,000 1.12%
NORDEA BK EXTENDIBLE SHORT 09/24/2009 1.4494 114,000,000 2.13%
ROYAL BK SCOTLAND PLC 10/09/2009 1.0294 390,000,000 7.30%
Total Floating Rate Note 2,915,000,000 54.59%

If in fact the Lehman positions prove to be worthless, then the funds shareholders would take a loss of $785 million. Let's assume that everything else is redeemed at par and the fund takes the loss of the $785 million in the Lehman position then the net asset value goes from $.97 to $.73. The net result is the possibility in a money market fund to loose 27% on your money.

What has me in my superhero costume is that the fund can get away with showing to the public that the Lehman positions are carried at par when in fact they maybe totally worthless. As one new contact I made on my most recent trip to Sanibel said to me, “Don’t tell me they are carrying them at par.”

I have a new super power. It is called Transparency. As a super hero I want to bring to investors the need for more transparency in all types of investments. This new power will not allow me to leap tall buildings in a single bound, but it can, if people use it, thwart wrong doers like Bernie Madoff and protect investors. As investors if you do not understand an investment then don’t buy it. If it seems risky it probably is. Don’t buy it. If it sounds too good to be true then it probably is. Do not buy it. My X-ray tells me to look at the returns in the 10-year Treasury market as the benchmark for risk. If the yield on the 10-year is 3.75% and somebody is talking about 10% then think real hard, use your X-ray vision to make a good decision.

Dan Perkins