Thursday, January 27, 2011

Things are changing


Gold Has a Sinking Spell Gold prices today are down to $1,310 nearly $100 in less than a month’s time, after gaining about 30% versus the dollar in 2010.

T-Bill rates fall the most in a month

Rates on U.S. one- and three-month bills fell the most in a month after the Treasury Department said it will reduce borrowing on behalf of the as the U.S. approaches a debt-borrowing limit.

Crude oil down to lowest level in a month.

The spread between Brent North Sea is now almost $12 and crude is down another 2% today

New Claims Up unexpectedly by 51,000 above consensus.

Are these the corrections people were hoping for but didn't really want? Can a stock market corrections be far behind?

Dan Perkins

Thursday, January 20, 2011

What clients told me is important

Each year in January I try to meet with as many of my clients in person as I can. We talk about the previous years performance, what my expectations are for the coming year and what changes I might want to make in their portfolios.  I also spend time asking them what are they concerned about for the next 12 months and longer.
I have to say that I was very surprised by the comments I heard this year especially after the mid term election results. I found two themes were repeated more than any others in these discussions; the level of government spending and the amount of debt at both the Federal and state level. 
Clients who owned municipal bonds were worried about the interest payments and if they would receive their money back when the bonds were due. A look at the chart below -- it shows why they are and you should be concerned. Look at what has happened to the total return on the national index line of tax-free bonds and California and New York long-term bonds. What the picture shows is that there is very little confidence in the muni marketplace.
In a recent article in the New York Times covering the problems in the State of Illinois, it reported that the state was over $13 billion in the red. The article went on further to say that the State needed to borrow $3.7 billion to make the retirement fund payments so there was sufficient money to make payments to the beneficiaries.  In the deep recesses of my mind I remembered that Illinois had come to the bond market twice before with pension bonds to shore up the shortfall. 
I did some research on my own and found  that with the most recent $3.7 billion in pension bonds the state had issued over $30 billion in pension bonds to help fix the fund in the last 10 years. The Times article went on to say that Illinois had the lowest pension-funding ratio in the nation. It suggested that the state had only funded about 65% of its liabilities. 
Many states have serious funding issues and growing deficits because expenses are exceeding income and have for some time. S&P just reported that they believe that the amount of unfunded post employment liabilities at the state and local level is in excess of 2 trillion dollars. We found out through our new governor in New Jersey that a number of local governments had not been making payments on behalf of their employees to the state retirement fund. They were living off the assumption that the state pension funds would earn 8% and cover their shortfall and unfunded liabilities.
The big problem with using an 8% assumed return for pension assets is that the S&P 500 has had an average rate of return over the last 10 years of negative returns. So how valid is the 8% assumption?
If the plan sponsor, the state, were to adjust downward the assumed return on the pension assets reflecting as PIMCO says is the new normal, then the contributions from the governments to fund the pension liabilities would have to rise significantly. The reason is that the lower rate of return the greater the amount of money that has to be invested to produce enough to make the pension payment to the beneficiaries. The states don’t have the money to make the current payments let alone increasing the amount of the contribution driven by a reduction in the assumed rate of return.
In my first blog of the year I suggested some of the things that could adversely affect the markets this year, one was the problem in the municipal bond market. I think the chart above shows why I have concerns. I truly believe that with unemployment at just under 10% and the housing market going nowhere we are sitting on a time bomb. Illinois answer was to hold spending at the 2010 level which was already at a deficit, increase personal income taxes by 65% and raise taxes on corporations. I truly believe that the public sector retirement system and other state budgets have to change. I realize that many people will be hurt, but unless we bite the bullet now millions of Americans besides state employees will be adversely affected.
If you think that muni bonds looks attractive then take another look at the chart and see what the capital markets are saying about the desirability of owning tax-free bonds.
Dan Perkins   

Sunday, January 2, 2011

Some things to think about for 2011.


The price of gasoline at the pump may have the biggest impact on the growth prospects for the economy in 2011. On Monday 12/27/10 the U.S. Department of Energy (DOE) reported that both diesel and gas prices climbed to the highest point in more than 2 years during the prior week. The national average price for regular gasoline increased 7 cents (2.3%) to $3.052 per gallon and diesel increased 4.6 cents (1.4%) to $3.294 per gallon. Crude oil closed Monday at $91 per barrel up $2.19 (2.5%) since last Monday. As the price of gas continues to rise, every 1-cent increase in the price of gasoline decreases the U.S. consumer disposable income by about $600 million per year. Over the last 12 months the price of regular gas has increased from $1.75 to $3.02 a gallon and in turn has taken over $76 billion out of consumers pockets. 


At the peak of crude oil prices in the spring of 2008 the national average for the price of gas was over $4.25 a gallon. If the global economies continue to recover then I would expect world wide demand for oil to increase and in turn the price of gasoline to continue to rise. I believe we can break the previous high in gas prices without going to a new high for crude oil. Keep in mind that the administration wants to add 15 cents per gallon to fund green energy projects. That increase alone, should it go through, would drain an additional $1 billion from the wallets of Americans. 


Stock and Bond Markets

The market is at levels that I feel are unsustainable in the near term and therefore I think we are heading for a serious correction. For 26 weeks this year investors were taking money out of stock mutual funds and switching to bond mutual funds.  Then when bond prices began to fall investors took money out of bonds and went into stocks at close to the near-term high in the stock market.  The stock market continued to rise in the face of rising long-term interest rates. Interest rates and stocks cannot go higher at the same time. One will have to break. I think a decline in stock prices may bring about a short-term rally in bond prices again causing investors to make the switch back to bonds.  


I would expect that the stock markets might well end up 2011 at or near the level at which they closed at the end of 2010. The road to get to he end of 2011 may be full of significant declines that dash hopes and monster rallies that raise hopes.  By the end of 2011 investors will be depleted of energy, and in some cases their money.


Conflict between the Congress and the administration will not help with the decision making process for the leaders in the private sector, including small business people. All the clarity that many people hoped and believed would come about because of the November election may not materialize. Uncertainty will continue about taxes, health-care, budgets, and the national debt. All of this uncertainty will spill over into the currency, commodity and stock and bond markets.


Municipal Bonds may be the story driving markets in 2011

The problems of state and local unfunded liabilities for retirement health care and pensions will take center stage and I think will be in the headlines daily during the first quarter of 2011. The same companies, Moody’s and S&P,  who told us the sub-prime mortgages were not a problem are telling us the municipal markets are fine. They do not see any significant defaults or bankruptcies in 2011. I wish I were as confident as they are.


 I see what many people are saying is a trillion dollar problem not going away. I know that many people feel that the Federal Government will bail out the states but I don’t see where we can get the trillion dollars or more to solve the problems. We have two problems, the unfunded liabilities and the current out of control budgets. 


Other nations around the world are dealing with the same problems of massive deficits and are having to make some serious decisions about how people will be hired and paid and what type of retirement benefits they will receive. That debate is coming to the shores of America and this will be the most influential item in 2011. 


Getting paid while you wait may be the only hope to make money in 2011.


Dan Perkins