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Tuesday, 30 June 2009

The Great Recession is Over!

Dennis Kneale | CNBC Media & Technology Editor

I said it on our 8 o’clock show on Thursday and Friday and now I’ll put it in writing: This horrible Great Recession is over, right here and right now.

A spate of economic metrics supports this daunting prediction. We'll update this information and topspin it on CNBC Reports tonight at 8 p.m. I'll get to those numbers in a moment.

The more important factor, though, is how we FEEL.

I've said it before, let's put it on T-shirts: Capitalism is optimism monetized. As I put it in my "Parting Shot" on CNBC Reports on Friday night, hope is the magical elixir of capitalism.

And even here, the latest consumer sentiment numbers, out on Friday from the vaunted University of Michigan monthly survey, show that hope is on the rise.

Once we start to feel the risk of layoffs has passed, we will start spending more—consumers and companies alike. I reject the doomsday proclamations that the consumer psyche has been altered permanently; we want what we want.

That's not to say the next boom is here as yet. Growth will be poky and uneven at first. And plenty of obstacles loom, especially in the anti-business, tax-happy policy push of President Obama and his round-'em-up posse.

But if you aren't careful, the aftershocks and recriminations of this terrible tumble will cloud your vision of the rebound underway.

Skim these hopeful numbers:

Leading economic indicators have been up the past couple of reports; durable goods orders are up three of the past four months; businesses’ capital-goods orders just rose 4.8 percent, the largest increase in five years.

The four major indexes for stocks, which often rise to presage an economic rebound, are up 30 percent to 50 percent since early March.
At the end of last week stocks hit the Golden Cross—the 50-day moving average price of the S&P 500 crossed over and above the 200-day average. That often portends a 20% rise in stock prices over the ensuing year.

The Vix fear index on stock-price volatility is down over 40 percent in three months, falling to where it was just before the collapse of Lehman Brothers that set off a worldwide financial panic last fall.

On Friday personal income numbers came out, rising an encouraging 1.8 percent (albeit largely because of a $250 Social Security onetime boost to millions). Personal savings AND consumer spending are up a bit, too.
To me, the compelling conclusion is inescapable—the worst is over. The risk of global financial collapse has been isolated and neutralized, and the rebuilding has begun. Dow 10000 here we come.

Saturday, 27 June 2009

Why Low Earners Relax More

By Rick Newman

If extra schooling seems like a lot of effort, get used to it--the smarter you are, the more hours you're likely to work.

It's obvious that there's a big pay gap between people who have more education and people who have less: Doctors and engineers with advanced degrees earn a lot more than high-school grads working blue-collar jobs. It turns out there's also a growing "leisure gap" between more- and less-educated Americans: The more schooling, the less time devoted to leisure.

In a new study published by the American Enterprise Institute, economists Mark Aguiar and Erik Hurst reveal some fascinating facts about how Americans of different educational levels spend their time. The average American adult spent about 32 hours a week working in 2005, the latest year for which data is available, and about 106 hours a week on "leisure," which includes sleeping, eating, watching TV, and most activities you'd think of as forms of relaxing. Men spent about 40 hours a week on work, 106 hours on leisure, and 13 hours on unpaid work like shopping, housekeeping, and car maintenance. Women spent about 26 hours a week on work, 105 hours on leisure, and 23 hours on unpaid work--about 10 hours more than men.

Many people won't be surprised to learn that the amount of time we spend on leisure is falling. Since 1985, weekly leisure time has dropped by about an hour and a half overall. For women, it's fallen more. That's a reversal of the trend from 1965 to 1985, when overall leisure time increased by 5.4 hours. The reasons for the decline: Women are working more, and women and men both spend more time each week on child care.

The leisure gaps are bigger when broken down by education level. Men with more than 12 years of education--at least some college--spent 102 hours each week on leisure. Men with a high-school education or less spent 110 hours a week on leisure. The differences get more stark up and down the education chain. Men with a college degree or more spent the least amount of time on leisure--just 100 hours a week. That's down 6 hours since 1985, the biggest decline among any educational group. At the bottom of the chain, men with less than a high school diploma spent 113 hours a week on leisure. That's 8 hours more than in 1985, the biggest jump of any group. The gaps are similar for women.

It's tempting to imagine that America's professional class has become so enslaved to their BlackBerrys that their graduate degrees have done little more than turn them into workaholics. Or that there's a class of simple, wholesome Americans who simply treasure their free time and would rather relax with their families than work for any amount of money.

That may be part of the story. But another reason undereducated Americans have more leisure time is that unemployment is higher among those with less schooling: If you're not working, you're spending more time on "leisure," whether it's quality time spent with your kids or mindless hours watching cable and waiting for a recruiter to call. Disability rates are also higher among those with less education, which means less time spent on the job. It may also be true that highly educated people enjoy their work more, so they spend more time doing it. (Since the data are from years prior to the current recession, they don't reflect changes that may have resulted from rapidly rising unemployment over the past 12 months.)

Here are some of the most interesting differences in how less-educated men (with 12 years of schooling or less) and more-educated men (with more than 12 years of schooling) spend their time:

Hours spent each week on: Less-educated men More-educated men
Paid work 36.9 41.9
Child care 2.7 3.4
Total leisure 109.8 102.3
Watching TV 21.6 15.3
Socializing 7.1 6.5
Reading 1.2 2.5
Exercise and sport 2.6 3.1
Hobbies 1.9 2.7
Eating 8.2 9.4
Sleeping 60.1 56.5

The leisure data are more than just an interesting snapshot of how Americans spend their time. One of the troublesome developments in the American economy has been an increase in income inequality: The rich have been getting richer, while others have been stuck in place or falling behind. Some economists, including a few who now advise President Obama, want to change tax rates and other policies so that the wealthy take home less pay and others take home more. Aguiar and Hurst argue that their research may show that lower-earning Americans work less--and therefore earn less--because they choose to, not because the system is gamed against them. If that's true, then efforts to redistribute wealth may be directed at people who don't want it--not if they have to work for it, anyway. That hypothesis seems sure to draw vigorous rebuttals, which means we may end up spending more of our leisure time arguing about leisure.

Mountains of Debt: America's Economic Realities

Charles Wheelan, Ph.D.

Ben Franklin supposedly said that it's better to skip supper and go to bed hungry than it is to wake up in debt. Ben would be quite disappointed in us. We Americans didn't skip dinner; instead, we opted over the past decade to gorge at the buffet and then charge it.

We woke up as the world's largest debtor -- so deeply in debt that our global creditors are getting nervous, and rightfully so.

Here are some economic realities associated with our deepening fiscal hole.

It's bad. As in, $11 trillion bad. That number alone doesn't mean much, at least without context. So here is some context. First, that's roughly $40,000 for every man, woman, and child in the country. Second, our debt is projected to grow to roughly 100 percent of GDP by 2010, meaning that, if we were to devote everything we produce as a nation to paying down debt, it would take us an entire year to pay off what we owe.

Eating Up the Global Capital Pool

Other countries have become more indebted as a percentage of GDP, but they were small countries, so they sucked up less of the global capital pool. There is only so much money in the world, and we have borrowed a shocking proportion of it. The only other time the U.S. has been so indebted was at the end of World War II.

Big debt means big interest payments. The Chinese haven't loaned us a trillion dollars because we're good-looking; they've loaned us a trillion dollars because we pay for the privilege of using that capital. Interest payments now make up more than 8 percent of the federal budget -- meaning that nearly one of every 10 of your tax dollars gets you absolutely nothing in return. No schools, no bridges, no domestic wiretaps. That's just the cost of servicing the debt we've run up.

And we've done nothing terribly productive with all that borrowed money. Debt, after all, is not inherently bad. If you borrow $100,000 to go to medical school, then you've probably done a very smart thing. When you graduate, your earning potential will be higher, enabling you to live better even after you pay off the loans (with interest). In this case, you used borrowed money to invest in something that made you more productive.

Now suppose that you borrowed $100,000 to sustain a lifestyle that you could not otherwise afford: to pay the rent, to buy nice clothes, and to make the payments on your luxury car. When that bill comes due (with interest), you're no more productive than you were when you started borrowing. You borrowed used money for consumption, not investment.

Unfortunately, America's borrowing resembles the latter more than the former. We haven't upgraded our transportation infrastructure or made major investments in alternative energy or financed education for those who could not otherwise afford it.

Stop the Bickering

We need to stop bickering about who got us here. Was it the Bush tax cuts (yes) or the Obama stimulus (yes) or profligate Congressional spending (yes) or voters who continually reward pork more than parsimony (yes)? But analyzing just overcomplicates things. We are deeply in debt because we have routinely spent more than we collect in taxes. That's just a mathematical reality that has become needlessly confounded with politics.

If you're a small government conservative, that's great. But let's say enough of the tax cuts without corresponding spending cuts. Those aren't tax cuts; they are tax postponements. You've just left the bill for future taxpayers, with interest.

And if you believe that government can and should build a stronger America, terrific. I'm sympathetic: I like early childhood education and the high-speed rail and Army sharpshooters who kill pirates. If you want those things, then pay for them.

Big government or small government, the revenues need to equal the expenditures. It really is that simple.

When the Big Bills Come Due

The big bills haven't even come due yet. If the U.S. were a family, we'd be crouched over the kitchen table trying to figure out how to pay the Amex and Visa bills -- and the gigantic Mastercard bill would still be in the mail.

The big bill still in the mail for the United States is for our entitlement programs -- primarily Social Security and Medicare. We've made huge commitments to these programs that are not adequately funded. That Social Security check you're counting on when you turn 65 doesn't show up in the debt figures, but it's still money that we will owe. Lots and lots of money.

And the Chinese are worried U.S. debt, as they should be. All debtors have creditors; ours are all over the world. The biggest one is the Chinese government, which has been buying up U.S. Treasury bonds with all the vigor and foresight of a 1990s Las Vegas real estate developer.

If we don't honor our bonds, China doesn't get to repossess the White House or the national parks; they don't get to carve their own leaders on Mt. Rushmore. Treasury debt is secured by the "full faith and credit of the U.S. government" -- which won't command much at auction, if it comes to a foreclosure type situation.

Chinese officials aren't worried about bankruptcy because the U.S. has an easier and more insidious option -- we can print our way out of the problem. Our debt is denominated in dollars, and the U.S. government has the authority to print those dollars. We could take a page from the Zimbabwe policy manual and just print money to pay our bills -- thereby debasing the currency, creating inflation, and devaluing the real value of what we owe.

Is that a sensible solution? No, as it imposes the costs of inflation on all of us. I don't know anyone eager to revisit the 1970s (in terms of economic performance or fashion).

Is it a possibility? You bet. In fact, I'm surprised that long-term interest rates haven't climbed more than they have. (When long-term lenders fear inflation, they demand higher interest rates to protect against that contingency.)

The solution to all this is straightforward: Spend less than we take in, and use the surplus to pay down debt. At the risk of lapsing into economics jargon, yes, this is going to suck. Think about it: Americans don't like their current tax bills -- which aren't even high enough to pay for our current spending, let alone the bills we've run up from the past. In the future, we will have to pay more and get less.

But we've done it before. We paid off the debt accumulated during World War II. In fact, the ensuing decades saw some of the most impressive gains in wealth and productivity in American history. But it will require a radical change from what we're doing now.

An economic recovery will help. But we can't pretend that will be enough. We need to raise taxes, cut spending, and/or reform our entitlement programs. Probably all three, and in a serious way.

Will that dampen economic growth in the short run? Yes. Will it jeopardize important social programs? Yes. Will it compromise our ability to make important public investments? Yes. Does it limit what we can spend on healthcare reform? Yes.

But as Ben Franklin would have pointed out, we should have thought about that before ordering room service and then charging it to a credit card.

Friday, 26 June 2009

Were the March Lows the Ultimate Market Bottom?

By Simon Maierhofer

As investors, we like to receive affirmation for our decisions. If you buy a certain stock or fund, it sure feels good to find out Warren Buffett did the same thing.

When it comes to owning stocks right now, there's certainly plenty of affirmation. Warren Buffett doubled down on his bet on America, the Fed sees the recession nearing a bottom, and Jeff Mortimer, CIO of Charles Schwab, says that the March lows are a text book bottom.

The ultimate judge however, is the market itself. The market does what the market wants to do, not what the Fed, Mr. Buffett, or anyone else thinks it should do (more about that later).

In an effort to find out where the market is headed, and whether the March lows will hold, we will examine the opinions of some of Wall Street's brightest minds and match those up against long-term indicators with a historic track record of accuracy.

Redemption for Warren Buffett

The 30% spike off the March lows must feel like redemption for Mr. Buffett. In his October 16th, 2008 New York Times co-ed interview, Mr. Buffett stated the following: 'I've been buying American stocks ... If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.'

Since Warren Buffett's October 2008 interview, the S&P 500 (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC) dropped another 30%, while the Financial Select Sector SPDRs (NYSEArca: XLF - News) fell as much as 62%. I wonder if Warren Buffett is already invested 100% in U.S. equities.

Contrary to Buffett's viewpoint, the ETF Profit Strategy Newslettr predicted a 2008 bottom below Dow (NYSEArca: DIA - News) 7,500, and a Q1/Q2 bottom below Dow 6,700 (the Dow bottomed at 7,392 and 6,440).

Regarding the March 2009 lows, George Soros, the billionaire investor who came out of retirement to steer his Quantum fund to an 8% gain in 2008, believes that the worst is over and the risk of a collapse has passed. Mr. Soros is convinced that the government's bank rescue plan will ultimately revive ailing financial institutions, such as represented by the SPDRs KBW Bank ETF (NYSEArca: KBE - News).

A less gloomy Dr. Doom

Nouriel Roubini, one of the few economists who foresaw the financial debacle, follows the same train of thought. In April, he said that, 'Policymakers in the US, Europe, China and abroad have decided to use at maximum all their policy instruments (monetary, fiscal, cleaning up banks, resolving debt problems, helping emerging markets), they are using the bazooka and mid-size rocket, and that policy stimulus eventually will slow down the rate of economical retraction. We are seeing improvements that will get us out of this global recession by the end of the year.'

Mr. Roubini, who previously earned the nickname Dr. Doom, thinks a retest of the March lows is likely but does not expect a serious breach of them.

Interestingly enough, the credit for the recent rally is given to the Obama administration for (successfully?) diverting financial disaster. In reality, the market had begun its rally nearly two weeks before Mr. Geithner announced the Public Private Investment Program (PPIP).

After a 55% decline, some sort of rally was surely overdue. As early as mid-November 2008, the ETF Profit Strategy Newsletter predicted that the 2008 lows would be broken, followed by a multi-month rally. Early in 2009, the target level for a bottom was narrowed down to Dow 6,700 - 6,000 range followed by a 30-40% rally.

Charles Schwab Execs are bullish

From a technical perspective, Jeff Mortimer, CIO at Charles Schwab, says that the March lows are a text book bottom. The market is still undervalued, 'buy the dips' over the next 12-18 months, Mortimer advises.

According to a May 7th interview with Paul Allan Davis, a managing director who manages $4.5 billion for Schwab, the fact that higher risk sectors such as the Consumer Discretionary Select Sector SPDRs (NYSEArca: XLY - News) and Technology Select Sector SPDRs (NYSEArca: XLK - News), along with small-and micro cap stocks, such as represented by the iShares Russell 2000 (NYSEArca: IWM - News) and iShares Russell Microcap (NYSEArca: IWC - News) are outperforming defensive areas, is a bullish sign.

Commenting on Mr. Davis' thoughts, a reader posted the following note: 'Isn't this guy two months too late. Many stocks have already doubled. Getting in now isn't gonna get you the big return. Roubini said L shaped recovery - he was wrong. I listened to the wrong people, I am dumb and mad.'

There is some truth to his words. The doomsday atmosphere reached new levels surrounding the March lows. Where was the financial leadership? How come all the brilliant minds didn't tell us to buy the March 9th lows? It's easy to make judgments months after the fact (we'll see if that judgment will be correct).

On March 2nd, the ETF Profit Strategy Newsletter sent a Trend Change Alert to subscribers on record advising them to start selling short ETFs, and accumulate long and leveraged long ETFs. Depending on your risk tolerance, those ETFs included plain vanilla index ETFs like the iShares S&P 500 (NYSEArca: SPY - News), and dividend ETFs with high exposure to financial, or leveraged financial, ETFs like the Ultra Financial ProShares (NYSEArca: UYG - News).

Also, after the fact, comes Gary Stern's assessment that the Economy is nearing the recession's bottom. Gary Stern is the President of the Federal Reserve Bank in Minneapolis and the longest serving Federal Reserve official. Mr. Stern sees increased consumer spending, partially caused by an uptick in lending activity. This is often the beginning of a new cycle of economic expansion, he points out.

Just a snapshot - not a forecast

You may have noticed that the forecasts by Messrs. Buffett, Soros, Roubini, Mortimer, and Davis are contingent upon successful government intervention, or current data. Data such as consumer spending, retail sales, housing starts, etc. is merely a snapshot of the current situation. As such, they have no 'crystal ball-like' powers.

To the contrary, as we've seen in March and late 2007, news in general tends to be good towards the top and bad towards the bottom. News-based forecasts are subject to change; and who likes adjusted forecasts?

How would you feel if your car dealer told you that it was necessary to 'adjust' your estimate because they didn't figure their cost correctly? 'Adjust' for investors always means losses to their portfolio.

Warren Buffett made a very insightful comment in September 2008, right before he decided to invest in Goldman Sachs. He said he 'believes the proposed federal bailout will get approved and succeed. He further states that if congress fails to approve the bailout, all bets are off and his investment in Goldman Sachs, along with all other investments, will get killed.'

As we know, the bailout did get approved. The initial success rate was close to zero. Mr. Buffett's net worth, along with the stock market, shrunk by some 30%. Is it really smart to base your decision on the success of an event that is completely out of your hands, and entirely unpredictable?

Forward looking analysis based on the market's own internal indicators, tends to be much more reliable than external, often unrelated, projections. Who would you trust to take your body temperature; a doctor sitting right next to you, or a nurse trying to take your temperature over the phone?

The market's internal indicators

Just like the human body, in its own language, the market conveys whether it's overheated, fairly valued, or undervalued. Ironically, most analysts choose to ignore the market's signs. Schwab's Mr. Mortimer, compared the March lows to the 1974 and 1982 market bottom. Despite a discrepancy in P/E ratios (compared to the '74 and '82 lows), Mr. Mortimer believes the market has bottomed.

An analysis of all historic market bottoms over the past 100 years shows that the stock market simply has not reached rock-bottom unless P/E ratios, and dividend yields, reach certain levels.

Just as ice does not melt until temperatures are above 32 degrees, the market does not bottom until those levels are reached. This timeless piece of Wall Street wisdom has protected many investors from financial ruin and will continue to do so.

Students of such faithful indicators can use the market's signals to identify a target range for the ultimate stock market bottom. This target range is not based on current snapshots and opinions; it's founded on historic patterns and what the market is saying. The March and June issue of the ETF Profit Strategy Newsletter contain a detailed analysis of P/E ratios, dividend yields, the Dow measured in gold (NYSEArca: GLD - News), and other trusted indicators, along with target ranges for the ultimate bottom.

The New Way to Crunch Your Numbers

by David Adler

Using liability-driven investing to better meet your retirement goals.

It works for the big dogs, and it might just work for you. "Liability-driven investing," a strategy that has been sweeping the world of pension-fund management, could be the next big trend in retirement planning for wealthy individuals.

LDI, as it's known, calls for matching or at least explicitly considering your future expenses when designing a portfolio, rather than focusing on asset growth alone. The idea is to assemble investments that will generate enough gains, and at the right times, to cover everything from greens fees to a bequest to your alma mater. So far, it's mostly being used for portfolios of the super-rich, but experts say it can work just as well for the merely well-off.

LDI certainly has taken hold among large U.S. pension funds, about half of which now use it or are considering doing so. The big liabilities of these funds -- future payments to retirees -- resemble long-term bonds and are extremely dependent on interest rates. If interest rates fall, it's harder for a fund to earn the money needed to make the payments. Therefore, "the heart of most LDI strategies used by pension funds is to try to take this interest-rate risk off the table, so that assets and liabilities move in lock step when interest rates change," says Mark Ruloff, the director of asset allocation at Watson Wyatt Investment Consulting.

This can mean something as simple as investing the whole fund in bonds with the same interest-rate sensitivities as the liabilities. But liability-driven investing also has more sophisticated variants. For instance, a pension fund may run two separate portfolios -- one focused on hedging interest-rate risk using derivatives such as swaps, the other aiming to grow assets through exposure to stocks or other investments. Combined, the two portfolios remove the unwanted risk of an interest-rate mismatch but still offer the possibility of growth.

Individuals planning for retirement might not need swaps and the like, but they do have plenty of liabilities that need funding, including essential ones like food, health care and housing. Retirees also will want money for theater tickets, hockey games or foreign travel, and they will want some left over to leave a bequest. Put more bluntly, individuals planning for retirement seemingly have irreconcilable goals: money that they need and money that they want. Call it fear and greed.

Which is where LDI comes in: It precisely targets both goals through separate portfolios, making sure that the retiree has enough to live on, but also has the opportunity to boost his principal. In contrast, the traditional approach to retirement investing mashes both aims together in one portfolio, which meets neither goal with precision. Though this single portfolio may implicitly acknowledge future cash flows, liability-driven investing, as its name implies, explicitly keeps the liabilities in mind, creating very different -- and, advocates argue -- better portfolios than are common among retirees today.

"Typically, wealth managers begin by asking what you need to live on. But they are not attentive to the time pattern of the needs or the minimum you can't do without," observes Andrew Rosenfield, CEO of Guggenheim Investment Advisors in Chicago. "And none of this is tightly bound with the question of how to invest the money, which is just amazing."

Perhaps not surprisingly, the moneyed world of family offices has emerged as the first LDI beachhead for individuals. These outfits routinely handle portfolios of $50 million and up. A handful of family offices, including such prominent ones as Guggenheim, already have implemented LDI-style approaches, and asset-manager BlackRock is studying how to bring the approach to a broader swath of wealthy individuals.

"Historically, the wealth-management business has focused on the asset side," says Brian Feurtado, BlackRock's head of wealth management. "Tying investments to liabilities has been long overdue." BlackRock is working with Boxwood Strategic Advisors, a New York consultant, to find the best application to individuals. Their first step is to get a handle on a wealthy client's true balance sheet, including hard-to-value luxury assets like art.

David Rosenberg, chief investment officer of the Threshold Group, a family office outside Seattle that uses the LDI framework, breaks clients' goals into three different categories: lifestyle, risk-taking and legacy. Each carries with it different level of risks and rewards the client is willing to tolerate. Rosenberg then creates distinct portfolios to optimally serve each need.

Take, for example, the cash outflows needed to fund a client's lifestyle. Clients tend to want to immunize themselves from most potential risks when it comes to meeting these basic payments. Taking an approach similar to a pension fund's, Rosenberg has found this liability stream can be fruitfully addressed by matching it with a fixed-income portfolio of similar "duration," a measure of interest-rate sensitivity. For example, if you plan to contribute to a grandchild's college education, you might want four bond investments with different maturites, with one maturing in each year of college.

Moves like that allow you to breathe easier. Says Rosenberg: "With their lifestyle not under the threat of financial stress, clients can begin to make more thoughtful and open-minded decisions about risk with the rest of the portfolio." Since these portfolios are no longer encumbered with having to meet any cash-flow needs, the world of asset classes is opened up, including hedge funds, private equity and other investments with potentially high returns.

Last year, in the darkest days of the financial crisis, LDI fared well. Rosenberg says that his clients were better able to handle the crisis -- both financially and psycho- logically -- than if they had used traditional investment approaches. "Instead of saying the world is falling apart, they could say 'my world is secure, and the rest of world now has lots of opportunities,'" he adds.

Who Should Consider LDI

The LDI framework is most useful when people are living primarily off investment income, which is why it has attracted the attention of family offices. Those outfits also have the resources and technical expertise to create the sophisticated portfolios required. But many retirees with far less wealth also depend on investment income.

The sweet spot for LDI is investors with portfolios in the $500,000 to $10 million range, argues Larry Siegel, research director at the CFA Institute's Research Foundation. Above this level, investors aren't likely to run out of money during retirement, even if it means wriggling out of philanthropic commitments, should the portfolio tank. Below this range, a retiree doesn't really have enough assets to be able to implement the liability-driven investment approach.

A more critical stumbling block for people approaching retirement is the lack of a perfect or easily available liability hedge. There simply is no off-the-shelf product that leaves individuals with perfectly matched assets and future liabilities.

Annuities, with their insurance features, are one excellent way to hedge your longevity risk -- the danger that you will outlive your money. However, they expose investors to the credit risk of the insurance company. TIPS, or Treasury inflation-protected securities, provide inflation protection, but the returns are painfully low. Bonds, for their part, bring interest-rate risk and inflation risk. Individuals might somehow be able to cobble together a bond portfolio that matches their personal liabilities, but it won't be nearly as precise as the efforts of pension plans. That's because pension managers have the know-how and technology to keep durations matched through frequent trading.

Right now, many investors don't even try to match their assets with future expenses. "Just look at their portfolios," says M. Barton Waring, chief investment officer for investment policy and strategy, emeritus, at Barclays Global. "You don't see many attempts to match liabilities with Tips or annuities or long bonds." Instead, he says, many retiree portfolios are simply too equity-heavy.

While traditional retirement portfolios often include bonds to offset the risks of stocks, the payment streams of the bonds are rarely matched closely with future expenses. For instance, a mutual fund benchmarked to the popular Barcap (formerly Lehman) Aggregate bond index would have too short a duration to match such liabilities as long-term care.

Is all this theoretical, or does liability-driven investing really pay? Watson Wyatt's analysis of corporate pension funds found that those who used LDI, rather than traditional strategies, had a higher return on assets over the past two years. But the main argument in favor of LDI is much starker: "Traditional portfolio strategies failed in 2008," says Watson Wyatt's Mark Ruloff. "Simple diversification is no longer the whole story. Hedge funds, REITs and the stock market all went down together."

LDI, though still in its infancy, could be the missing part of the story. It just might put a real shine in the golden years.

Thursday, 25 June 2009



The US could benefit from inflation as long as it doesn't push the government into default

Andy Xie

Updated on Jun 16, 2009

A tide of inflation fear is sweeping financial markets: the oil price has doubled in three months, the US Treasury yield has surged by a third in one month, gold is nearing its record high again and agricultural commodities are all soaring. The rising prices are taking place amid weak demand. Inflation fears are driving the surge.

The market is getting it right this time. The US is targeting a 5 per cent-plus inflation rate for the foreseeable future. It is the only way to speed up relief for indebted American households. Inflation works well when debts are locked into long-term fixed rates and don't need new financing. The recent wave of mortgage refinancing, for example, has put many American households in an excellent position to benefit from inflation. If inflation surges, American household income will rise with it, but the debt will remain locked into the previous low rates. Of course, the people who lent to American households will be robbed by inflation.

However, the US government isn't quite ready for high inflation. It has US$11.4 trillion in outstanding debt, and that is growing by over US$6 billion per day. The average maturity of the federal debt is only four years and, hence, a quarter needs refinancing every year. With US$2 trillion net financing for 2009, the federal government needs to raise about US$10 billion per day. If the Treasury yield continues to surge, the expected interest burden for the federal government may spiral out of control. At some point, the market may stop lending to the US government, if it expects it to go bankrupt.

The government bond market is usually a Ponzi scheme. Governments rarely run budget surpluses to pay off old debts. They almost always borrow new money to pay off the old and spend the difference. A check of modern history will show that most countries have experienced a government debt crisis. These were about defaulting government debts accumulated over decades. Government bonds are usually viewed as safe, as they rarely default. But, that is only the case as long as investors are willing to lend. When the bonds do default, they do so on all the debt they have borrowed. The safety of government debt is a self-fulfilling market expectation. Hence, when interest rates are high and government financing need is great, the expectation bubble can burst.

When the market stops giving money to the federal government, the Fed can step in and print it, to monetise national debt. However, that will almost certainly lead to a dollar crash and hyperinflation. Russia did it in 1998: it did wipe away the national debt but, with investors shunning Russia afterwards, it remained poor for many years. Only surging oil prices have brought prosperity back. Is the US ready to "do a Russia"? I think not. America still has enough credibility to charter a more profitable path that would impoverish its creditors slowly.

The Fed will probably talk tough on inflation soon and may raise interest rates before the end of the year. Though its action may calm bond vigilantes, it could spark panic over liquidity among commodity and stock market speculators. A market crash is likely. The Fed may need to respond to the liquidity panic with soothing words and more purchases of Treasuries. It will have to skilfully navigate between bond vigilantes and liquidity junkies. The idea is to fool both: they should be made to believe in the Fed's determination to fight inflation and later to support growth. The reality will actually be stagflation.

The ideal path for the Fed is for interest rates to stay well below inflation - keeping the real interest rate negative - and for the US dollar to decline gradually. The former minimises the US debt burden and transfers it to foreigners. The latter draws manufacturing back to the US. It won't be easy to pull off such a feat. The liquidity junkies are easy to manage. They speculate with other people's money and desperately want to be fooled. It takes little to make them jump.

Bond vigilantes, however, are not easy to pacify. They are ardent wealth preservers and will run at the first sign of inflation. However, they may not be as tough as before. Everything else is inflated already. When the consumer price index inflates, to devalue money, there are no places to hide. If the Fed performs well, the bond vigilantes could become pussycats too.

"Feeling lucky" must be hard-wired into the human psyche. When Homo sapiens evolved on the African Savannah, the ones with a penchant for trying new horizons prospered. It was the right strategy in an underpopulated world. One group that felt lucky left Africa for Eurasia and got really lucky; they got the ultimate free lunch - the rest of the world for nothing. We are all their descendants. We are all born with the "get lucky" gene.

Today, however, the world has 6.6 billion people. Everything is taken. So we have created financial markets to satisfy our "get lucky" urge. In this virtual world, central bankers play god and print pieces of paper for us to fight over.

Over the next five years, governments and central banks will *censored* investors into subsidising economic growth through volatility. We have seen this in the tech world before. Nasdaq attracts people with its ups and downs. Volatility creates the illusion that one can get lucky and become rich.

Over the past 20 years, hundreds of billions of dollars have been poured into tech space. The money has spawned many technologies to benefit mankind. But investors as a whole have not made money.

The same will happen to the stock market in general. A weak economy needs low-cost capital, preferably negative, to maximise employment. No one will put money into a sure loser. Volatility creates the possibility of winning. Nothing turns Homo sapiens into willing losers like a chance.

Andy Xie is an independent economist

The tide recedes for Asian equities

Goh Eng Yeow examines the stock market's outlook going forward

INVESTING one’s hard-earned nesteggs is serious business.

Still, I must say that I am pleasantly surprised to get so many responses, thanking me for my Sunday Times column "Lessons from the financial crisis" two weeks ago.

Quite a number of readers have also noted that I am an avid tracker of the flow of funds in and out of the various Asian markets. They want to know where they can also find the data to do likewise.

I replied to all the queries by referring to a blog which I wrote last month. I get my report on fund flows from Citigroup every Monday and it has turned out to be one of my most important reading materials for the week.

And readers are reaping the benefit of getting privileged information which only big-time fund managers have access to, when I subsequently reproduce the report as an article.

Today, I wrote another fund flow piece in The Straits Times to report that there had been a net flow of money out of greater China funds last week – the first time this had occurred since March when regional markets bottomed out.

I must thank Citigroup strategist Elaine Chu for kindly sharing the raw data on the fund flows with me. The article would have been impossible to write otherwise.

Going by the manner in which inflow of funds into China funds has been slowing to a trickle, it is only be a matter of weeks before foreign investors start taking money out of them as well.

This will have implications on the Singapore, Hong Kong and Taiwan bourses where a large number of listed firms also have heavy exposure to mainland China.

It looks like the trigger for any sell-off on regional equities will come from Wall Street whose fund managers may need to trim their exposure in Asia in order to offset losses back home.

The only bright spot in the world of equities at the moment is Asia and foreign fund managers will be desperate to display some good results to show to their investors.

With the half-year drawing to a close next Tuesday, some window-dressing is still possible to shore up stock prices at close to their current levels.

After that, it is anyone’s guess how regional stock markets may move.

We will be entering a period which is traditionally shrouded in uncertainties.

August has traditionally been a jittery period for the stock market. The US sub-prime crisis started in August 2007. The seeds for Lehman Brothers’ destruction were sown in August last year.

Looking back over the past 100 years, the First World War started officially on August 1, 1914, while the Second World War commenced at end-August, 1939.

Also coinciding with this uncertain period is the seventh month on the Chinese lunar calendar which starts from August 20 this year – the so-called ghost month.

Even though we live in the space age and has put men on the moon, some deep-seated beliefs still hold fast. Both the property and stock market traditionally slow down during this period and this year will be no exception.

Rich lost 20% of wealth

NEW YORK - THE world's rich lost a fifth of their wealth in 2008 and the number of people with fortunes of more than US$1 million (S$1.46 million) fell 15 per cent as the financial crisis wiped out two years of growth, a study showed on Wednesday.

The total value of the world's wealthy - people with net assets of more than US$1 million excluding their main home and everyday possessions - dropped below 2005 levels to US$32.8 trillion, the 13th annual Merrill Lynch/Capgemini World Wealth Report found.

Nearly 35 per cent of that wealth belongs to so-called ultra rich people with fortunes of more than US$30 million, who account for 0.9 per cent of the rich population. In 2008 the number of ultra-rich people and their value dropped by nearly a quarter.

'There was really nowhere to hide as an investor in 2008,' Dan Sontag, Merrill Lynch Global Wealth Management president, told a news conference. 'No region ended the year unscathed.'

The United States, Japan and Germany are home to 54 per cent of the world's rich and this year China surpassed Britain and now has the fourth largest rich population. Rounding out the top 10 are France, Canada, Switzerland, Italy and Brazil.

The United States saw an 18.5 per cent drop in its rich population, but it still remains No. 1 with 29 per cent, or 2.5 million, of the world's rich. Japan's rich population fell 10 per cent, but Germany lost only 2.7 per cent of its wealthy.

As global markets plunged, wealthy investors fled with the study showing the proportion of cash-based holdings increased to 21 per cent of overall portfolios, up 7 per cent from 2006.

In North America, which traditionally favours equity investments, stocks made up 34 per cent of portfolios of the wealthy in 2008, down from 43 per cent a year earlier.

'That tells you how risk averse people got,' Mr Sontag said.

'Last year was about preservation, not appreciation.' 'The 2008 flight to safety imperative... is easing now,' he said. 'We're encouraging (rich people) to return to higher risk, higher return assets and away from capital preservation instruments as conditions improve.' -- REUTERS

Recession is easing: Fed

WASHINGTON - THE Federal Reserve on Wednesday said the recession is easing, but that the economy likely will remain weak and keep a lid on inflation.

Against this backdrop, the Fed held a key bank lending rate at a record low of between zero and 0.25 per cent, and pledged again to keep it there for 'an extended period' to help brace activity going forward.

Even though energy and other commodity prices have risen recently, the Fed said inflation will remain 'subdued for some time.'

This new language sought to ease Wall Street's concerns the Fed's aggressive actions to revive the economy will spur inflation later on.

The Fed also decided to stay the course on existing programs intended to drive down rates on mortgages and other consumer debt.

Instead, the central bank again kept the door wide open to making changes if economic conditions warrant.

The Fed in March launched a US$1.2 trillion (S$1.8 trillion) effort to drive down interest rates to try to revive lending and get Americans to spend more freely again.

It said it would spend up to US$300 billion to buy long-term government bonds over six months and boost its purchases of mortgage securities.

So far, the Fed has bought about US$177.5 billion in Treasury bonds.

The Fed is on track to buy up to US$1.25 trillion worth of securities issued by Fannie Mae and Freddie Mac by the end of this year or early next year. Nearly US$456 billion worth of those securities have been purchased. -- AP

'No bounce' says Buffett

NEW YORK - WARREN Buffett said on Wednesday that the US economy has 'no bounce' and will take time to recover, but there is no risk of deflation to push it further into despair.

Speaking on CNBC television, the world's second-richest person also praised efforts by the Obama administration and Federal Reserve to jump-start economic activity.

He lamented that the slowdown has hurt his insurance and investment company Berkshire Hathaway, which runs close to 80 businesses and in the January-to-March period had its first quarterly loss since 2001.

'We have had no bounce' in the economy, Mr Buffett said on CNBC television.

Asked whether the economy was still in a 'shambles,' as he had said in February, Mr Buffett said: 'I'm afraid that's true.' But he added: 'I don't worry about deflation at all.'

US gross domestic product fell at a 5.7 per cent annualised rate in the first quarter.

Government efforts to stimulate business activity remain a work in progress, and President Barack Obama on Tuesday again said the nation's jobless rate will rise above 10 per cent.

'They're doing things, but they take a while to have an effect,' Mr Buffett said. 'You can't produce a baby in one month by getting nine women pregnant.'

Buffett nonetheless maintained his long-held belief in the stock market, saying that it is 'attractive over the next 10 years' relative to alternatives.

Asked whether Mr Obama should reappoint Ben Bernanke to lead the Federal Reserve when the chairman's term expires next January, Buffett said: 'I don't see how you could do better.' -- REUTERS

Monday, 22 June 2009

Two Proofs That Global Economy Is Not on the Upswing

Below are two seemingly unrelated articles that tell a similar story: talk that the global economy is on the upswing seems to be premature, to say the least.

In the first report (hat tip to Calculated Risk), the Vice Chairman of General Electric (GE), a company with 14 major lines of business -- appliances, aviation, consumer electronics, electrical distribution, energy, business finance, consumer finance, healthcare, lighting, commercial and industrial markets, media & entertainment, oil & gas, rail, and security -- and a presence in more than 100 countries, states point-blank that they are not seeing evidence of the turnaround that policymakers (e.g., Fed Chairman Ben Bernanke), clueless Wall Street types (see: "The Wall Street Clown Show"), and TV pundits keep referring to.

1. "GE Vice Chair Rice Sees No ‘Green Shoots’ in Orders" (Bloomberg):

General Electric Co. Vice Chairman John Rice said he isn’t seeing an increase in orders even as U.S. economic statistics suggest the world’s largest economy may soon shift to a recovery.

“I am not particularly of the green shoots group yet,” Rice said today to the Atlanta Press Club, referring to a phrase used by Federal Reserve Chairman Ben S. Bernanke that described signs of a nascent recovery. “I have not seen it in our order patterns yet. At the macro level, there may be statistics suggesting the economy is starting to turn. I am not seeing it yet.”

GE is the world’s biggest maker of jet engines, power-plant turbines, locomotives, medical imaging equipment. Rice oversees the Fairfield, Connecticut-based company’s industrial businesses.

“We see a world where good companies and good consumers can’t get all the credit we would like,” Rice said. “Companies with lots of cash on their balance sheet are worried about whether they will get what they need for working capital” and are cutting spending.

2. "Fear the Dark Side of China's Lending Surge" (

Banks loans designed to spark economic recovery have been channeled into asset speculation, doing more harm than good.

China's credit boom has increased bank lending by more than 6 trillion yuan since December. Many analysts think an economic boom will follow in the second half 2009. They will be disappointed. Much of this lending has not been used to support tangible projects but, instead, has been channeled into asset markets.

Many boom forecasters think asset market speculation will lead to spending growth through the wealth effect. But creating a bubble to support an economy brings, at best, a few short-term benefits along with a lot of long-term pain. Moreover, some of this speculation is actually hurting China's economy by driving asset prices higher

Thursday, 18 June 2009

The worst is yet to come: Financial Crisis Part II

European banks: $283B more in writedownsFRANKFURT (Reuters) -- Euro-zone banks will probably need to write down another $283 billion this year and next on bad loans and securities, the European Central Bank said on Monday. The ECB estimated bank writedowns due to securities -- or toxic assets -- would total around $218 billion from the start of the financial turmoil to the end of 2010, while bad loans would account for another $431 billion -- a total of $649 billion, with an estimated $366 billion already announced. The figures were published in the ECB's latest Financial Stability Review, which concluded that risks to the financial sector had increased in the last six months amidst a deterioration in the economic environment which is putting pressure on the bottom line of companies and households.

"The contraction of economic activity and the diminished growth prospects have resulted in a further erosion of the market values of a broad range of assets," the report said. "Connected with this, there has been a significant increase in the range of estimates of potential future writedowns and losses that banks will have to absorb before the credit cycle reaches a trough." The ECB's estimate of $649 billion for the whole period contrasts with a figure of $904 billion from the International Monetary Fund in April.

The ECB said the calculations were surrounded by a high degree of uncertainty stemming from the economic and market outlook, accounting rules allowing banks to delay reporting writedowns and the very uncertain outlook for bank profits. "Against this background, write-off rates could increase by more than currently anticipated," the ECB said. However, ECB Vice-President Lucas Papademos said most big euro area banks "appear to be well-capitalized enough to withstand downside scenarios."

The report outlined a wide range of risks and dangers for the financial sector in the 16-nation region, ranging from the financial situation of firms and households to continued volatility on markets. "Both policymakers and market participants will have to be very alert in the period ahead. There is no room for complacency," ECB Vice-President Lucas Papademos told a news conference. Property prices could be expected to fall further, in some countries at least, and big banks and insurance firms remained vulnerable to a further erosion of the capital base and a loss of investor confidence.

Worse than expected?

The euro area economic downturn could be worse than currently expected and there were increasing signs of a negative feedback loop between the real economy and the financial sector -- although there were also some positives. "Following a weak start in 2009, there have recently been increasing signs from survey data -- both within and outside the euro area -- suggesting that the pace of deterioration in activity is moderating and that consumer and business sentiment is improving, although still remaining at low levels," the report said.

The ECB said the risk of deflation was limited and central bank actions in cutting interest rates and lending banks unlimited funds had helped reduce money market spreads, although these were still elevated for longer maturities. Without commenting directly on the outlook for official interest rates - now at a record low 1% -- the ECB noted households were in a better position to repay debt than earlier. "The interest rate risk faced by households has declined somewhat since (December 2008), and is expected to remain subdued looking forward," it said.

The ECB said the outlook for euro zone government bond yields was surrounded by persistent uncertainty regarding macro-financial developments. "Upward risks for yields could be seen if flight-to-safety flows unwind further or if bond markets have difficulty in absorbing the increased issuance needs of euro area governments," the report said.

As part of its measures to stimulate the eurozone economy, the ECB has been offering unlimited liquidity to banks, and will shortly launch longer-term refinancing operations. However, a debate has begun amongst policymakers about when such extraordinary policy measures need to be unwound. "The current ample liquidity provided by the ECB will not remain in place (forever)," Papademos said. Asked about the ECB's 12-month refi operations which will begin next week, Papademos said he would wait to see the market's reaction. "Then we will see what demand is from institutions ... at this point I will not speculate."

Bubble of Belief’ in China Economy Seen Bursting

By David Wilson

June 17 (Bloomberg) -- Rallies in commodity prices and mining-company shares stem from a “bubble of belief” in China’s economy that is likely to burst, according to Albert Edwards, a strategist at Societe Generale.

“I believe we will look back on the Chinese economic miracle as the sickest joke yet played on investors,” Edwards wrote yesterday in a report. To support his argument, he cited falling earnings at the country’s industrial companies.

The CHART OF THE DAY shows year-over-year percentage changes in profits, as compiled by China’s National Bureau of Statistics. The chart combines monthly data from 2005 and 2006 with a quarterly index, started in 2007, that tracks companies in 22 provinces. This quarter’s report is set for June 26.

Commodity prices climbed 21 percent this year through yesterday, according to the UBS Bloomberg Constant Maturity Commodity Index. Mining stocks paced a 23 percent gain in the MSCI World Materials Index, the year’s top performer among 10 industry groups in the MSCI World Index.

While the Chinese economy expanded 6.1 percent in the first quarter from a year earlier, Edwards wrote that he was skeptical about its ability to sustain that level of growth during a global recession.

“The bullish group-think on China is just as vulnerable to massive disappointment as any other extreme example of bubble- nonsense I have seen over the last two decades,” his report said. “The fall to earth will be equally as shocking.”

Wednesday, 17 June 2009

Andy Xie: Markets are trading on Imagination

A combination of growth optimism and inflation fear has catapulted asset markets in the past few weeks. These two concerns should drive markets in different directions: Inflation fear, for example, should limit room for stimulus and prompt stock markets to retreat. But the investment camps expressing these opposite concerns go separate ways, each pumping up what seems believable. As a result, stock and commodity markets are mirroring the behavior seen during the giddy days of 2007.

Regardless of what investors or speculators say to justify their punting, the real driving force is the return of animal spirit. After living in fear for more than a year, they just couldn't sit around any longer. So they decided to inch back. The resulting market appreciation emboldened more people. All sorts of theories began to surface to justify the market trend. Now that the rising trend has been around for three months globally and seven months in China, even the most timid have been unable to resist. They're jumping in, in droves.

When the least informed and most credulous get into the market, the market is usually peaking. A rising economy and growing income produces more funds to fuel the market. But the global economy is now stuck with years of slow growth. Strong economic growth won't follow the current stock market surge. This is a bear market rally. People who jump in now will lose big.

Over the past three weeks, the dollar dove while oil and treasury yields surged. These price movements exhibited typical symptoms of inflation fear, which is complicating policymaking around the world. The United States, in particular, could be bottled in. The federal government's fiscal stimulus and liquidity pumping by the Federal Reserve are twin instruments for propping up the bursting U.S. economy. The fiscal deficit could top US$ 2 trillion (15 percent of GDP) in 2009. That would increase by one-third the total stock of federal government debt outstanding. Such a massive amount of federal debt paper needs a buoyant Treasury to absorb. If the Treasury market is a bear market, absorption becomes a huge problem.

U.S. Treasury Secretary Timothy Geithner recently visited China to, among other things, persuade China to buy more Treasuries. According to a Brookings Institution estimate, China holds US$ 1.7 trillion in U.S. Treasuries and GSE paper (about 15 percent of the total stock). If China stops buying, it could plunge the Treasury market into deep bear territory. If China does not buy, the Treasury market will get worse. But China can't prop up the market by buying.

In the past few years, purchases by central banks around the world have dominated demand for Treasuries. Central banks have been buying because their currencies are linked to the dollar. Hence, such demand is not price sensitive. The demand level is proportionate to the U.S. current account deficit, which determines the amount of dollars held by foreign central banks. The bigger the U.S. current account deficit, the greater the demand for Treasuries. This is why the Treasury yield was trending down during the bulging U.S. current account deficit period 2001-'08.

This dynamic in the Treasury market was changed by the bursting of the U.S. credit-cum-property bubble. It is decreasing U.S. consumption and the U.S. current account deficit. The 2009 deficit is probably under US$ 400 billion, halved from the peak. That means non-U.S. central banks have much less money to buy, while the supply is surging. It means central banks no longer determine Treasury pricing. American institutions and families are now marginal buyers. This switch in who determines price is shifting Treasury yields significantly higher.

The 10-year Treasury yield historically averages about 6 percent, with about 3.5 percent inflation and a real yield of 2.5 percent. This reflects the preferences of marginal buyers in the United States. Foreign central banks have pushed down the yield requirement substantially over the past seven years. If marginal buyers become American again, as I believe, Treasury yields will surge even higher from current levels. Future inflation will average more than 3.5 percent, I believe. Some policy thinkers in the United States believe the Fed should target inflation between 5 and 6 percent. The Treasury yield could rise to between 7.5 and 8.5 percent from the current 3.5 percent.

A massive supply of Treasuries would only worsen the market. The Federal Reserve has been trying to prop the Treasury market by buying more than US$ 300 billion – a purchase that's backfired. Treasury investors are terrified by the inflation implication of the Fed action. It is equivalent to monetizing national debt. As the federal deficit will remain sky-high for years to come, the monetization could become much larger, which might lead to hyperinflation. This is why the Treasury yield has surged in the past three weeks.

One possible response is to finance the U.S. budget deficit with short-term financing. As the Fed controls short-term interest rates, such a strategy could avoid the pain of high interest rates. But this strategy could crash the dollar.

The dollar index-DXY has fallen 10 percent from the March level, even though the U.S. trade deficit has declined substantially. It reflects the market's expectations that the Fed's monetary policy will lead to inflation and a dollar crash. The cause of dollar weakness is the outflow of U.S. money, in my view. It is the primary cause of a surge in emerging markets and commodities. Most U.S. analysts think the dollar's weakness is due to foreigners buying less of it. This is probably incorrect.

The dollar's weakness can limit Fed policy options. It heightens inflation risks; a weak dollar imports inflation and, more importantly, increases inflation expectations, which can be self-fulfilling in today's environment. The Fed has released and committed US$ 12 trillion (83 percent of GDP) for bailing out the financial system. This massive overhang in money supply could cause hyperinflation if not withdrawn in time. So far, the market is still giving the Fed the benefit of the doubt, believing it will indeed withdraw the money. Dollar weakness reflects the market's wavering confidence in the Fed. If the wavering continues, it could lead to a dollar collapse and make inflation self-fulfilling.

The Fed may have to change its stance, even using token gestures, to assure the market it won't release too much money. For example, signaling rate hikes would soothe the market. But the economy is still in terrible shape; unemployment may surpass 10 percent this year. Any suggestion of hiking interest rates would dampen growth expectations. The Fed is caught between a rock and a hard place.

Oil prices have doubled since a March low, even though global demand continues to decline. The driving forces again are expectations of inflation and a weaker dollar. As U.S.-based funds flee, some of the money has flowed into oil ETFs. This initially impacted futures prices, creating a huge gap between cash and futures prices. The gap increased inventory demand as investors tried to profit from the gap. Rising inventory demand caused spot prices to reach parity with futures prices. Rising oil prices, though, lead to inflation and depress growth. It is a stagflation factor. If the Fed doesn't rein in weak dollar expectations, stagflation will arrive sooner than I previously expected.

Stagflation in the 1970s spawned the development of rational expectation theory in economics. Monetary stimulus works by fooling people into believing in money's value while the central bank cheapens it. This perception gap stimulates the economy by fooling people into demanding more money than they should. Rational expectation theory clarified the underpinning for Keynesian liquidity theory. However, as they say, people can't be fooled three times. Central banks that tried to use stimuli to solve structural problems in the '70s saw their stimuli didn't work. People saw through what they tried again and again, and began behaving accordingly, which translated monetary stimulus straight into inflation without stimulating economic growth.

Rational expectation theory discredited Keynesian theory and laid the foundation for Paul Volker's tough love policy, which jagged up interest rates and triggered a recession. The recession convinced people that the central bank was serious about cooling inflation, so they adjusted their behavior accordingly. Inflation expectations fell sharply afterward. The credibility that Volker brought to the Fed was exploited by Alan Greenspan, who kept pumping money to solve economic problems. As I have argued before, special factors made Greenspan's approach effective at the same. Its byproduct was asset bubbles. As the environment has changed, rational expectation theory will again exert force on the impact of monetary policy.

Movements in Treasury yields, oil and the dollar underscore the return of rational expectation. Policymakers have to take actions to dent the speed of its returning. Otherwise, the stimulus will lose traction everywhere, and the global economy will slump. I expect at least gestures from U.S. policymakers to assuage market concerns about rampant fiscal and monetary expansion. The noise would be to emphasize the "temporary" nature of the stimulus. The market will probably be fooled again. It will fully wake up only in 2010. The United States has no way out but to print money. As a rational country, it will do what it has to, regardless of its rhetoric. This is why I expect a second dip for the global economy in 2010.

While inflation expectations are causing some in the investor community to act, the rest are betting on strong economic recovery. Massive amounts of money have flowed into emerging markets, making it look like a runaway train. Many bystanders can't take it any longer and are jumping in. Markets, after trending up for three months, are gapping up. Unfortunately for the last-minute bulls, current market movements suggest peaking. If you buy now, you have a 90 percent chance of losing money when you try to get out.

Contrary to all the market noise, there are no signs of a significant economic recovery. So-called green shoots in the global economy are mostly due to inventory cycles. Stimuli might juice up growth a bit in the second half 2009. Nothing, however, suggests a lasting recovery. Markets are trading on imagination.

The return of funds flowing into property is even more ridiculous. A property burst usually lasts for more than three years. The current burst is larger than usual. The property market is likely to remain in bear territory for much longer. The bulls are talking about inflation as the bullish factor for property. Unfortunately, property prices have risen already and need to come down even as CPI rises. Then the two can reach parity.

While rational expectation is returning to part of the investment community, most investors are still trapped by institutional weakness, which makes them behave irrationally. The Greenspan era has nurtured a vast financial sector. All the people in this business need something to do. Since they invest other people's money, they are biased toward bullish sentiment. Otherwise, if they say it's all bad, their investors will take back the money, and they will lose their jobs. Governments know that, and create noise to give them excuses to be bullish.

This institutional weakness has been a catastrophe for people who trust investment professionals. In the past two decades, equity investors have done worse than those who held U.S. market bonds, and who lost big in Japan and emerging markets in general. It is astonishing that a value-destroying industry has lasted so long. The greater irony is that salaries in this industry have been two to three times above what's paid in other sector. The key to its survival is volatility. As markets collapse and surge, possibilities for getting rich quickly are created. Unfortunately, most people don't get out when markets are high, as they are now. They only take a ride.

Indeed, most people who invest in the stock market get poorer. Look at Japan, Korea and Taiwan: Even though their per capita incomes have risen enormously over the past three decades, investors in these stock markets lost money. Economic growth is a necessary but not sufficient condition for investors to make money in the stock market. Most countries, unfortunately, don't possess the conditions for stock markets to reflect economic growth. The key is good corporate governance. It requires rule of law and good morality. Neither is apparent in most markets.

It's a widely accepted notion that long term stock investors make money. Actually, this is not true. Most companies don't last for more than 20 years. How can long term investment make money for you? The bankruptcy of General Motors should remind people that this notion is ridiculous. General Motors was a symbol of the U.S. economy, a century-old company that succumbed to bankruptcy. In the long run, all companies go bankrupt.

Property on the surface is better than the stock market. It is something physical that investors can touch. However, it doesn't hold much value in the long run either. Look at Japan: Its property prices are lower than they were three decades ago. U.S. property prices will likely bottom below levels of 20 years ago, after adjusting for inflation.

China's property market holds even less value in the long run. Chinese properties are sitting on land leased for 70 years for residential properties and 50 years for commercial properties. Their residual values are zero at the end. The hope for perpetual appreciation is a joke. If you accept zero value at the end of 70 years, the property value should only be the use value during those 70 years. The use value is fully reflected in rental yield. The current rental yield is half the mortgage interest rate. How could properties not be overvalued? The bulls want buyers to ignore rental yield and focus on appreciation. But appreciation in the long run isn't possible. Depreciation is, as the end value is zero.

The world is setting up for a big crash, again. Since the last bubble burst, governments around the world have not been focusing on reforms. They are trying to pump a new bubble to solve existing problems. Before inflation appears, this strategy works. As inflation expectation rises, its effectiveness is threatened. When inflation appears in 2010, another crash will come.

If you are a speculator and confident you can get out before it crashes, this is your market. If you think this market is for real, you are making a mistake and should get out as soon as possible. If you lost money during your last three market entries, stay away from this one – as far as you can.

5 Reasons to Start a Business in a Recession

Kimberly Palmer

Does becoming your own boss sound especially tempting now, with jobs less secure and benefits being cut? If it does, you're hardly the only one: Research by Federal Reserve economist Ellen Rissman finds that men are almost twice as likely to become self-employed when they are already unemployed. Working for themselves is temporary, however: Within one year, about 2 in 10 workers return to paid employment.

That doesn't mean the recession is leading to huge upticks in those who call themselves self-employed. Overall, the self-employment rate has dipped a bit during the current recession, although it still remains close to 11 percent, where it has hovered for most of the past decade. Steven Hipple, economist at the Bureau of Labor Statistics, says that while some people are drawn to self-employment as a way to avoid unemployment, there are also many self-employed businesses, for example in retail or construction, that are going under during the recession. That's why the net effect appears to be a slight decline in self-employment, explains Hipple.

But don't let those numbers discourage you. Going against the tide and starting your own business in a recession not only lets you escape from the corporate grind, but it also can be easier than it would be during boom times. Here are five reasons to consider going solo now:

Extra protection from dreaded pink slips. In 2004, when Susie Fougerousse was a stay-at-home mother of two, she realized that she loved decorating her children's rooms and she thought she could make a business out of it. She noticed that it was hard to find pieces she liked in the stores near her, so she launched an online business that sells upscale furniture and décor. While the $10,000 in start-up costs was scary at first, she says starting a business is what ended up saving her family financially.

The company, Rosenberry Rooms, is now a multimillion-dollar company, while her husband's former industry, textiles, has all but dried up. "It's a huge blessing," says Fougerousse, 34, who lives in Cary, N.Ca. "He would have lost his job with how things went in that industry. You think you're on the safe track [by working at a big company], but that turned out to be the most risky," she says. Her husband now works full time on Rosenberry Rooms as well.

"It feels very beneficial to have multiple income streams right now," says Michelle Goodman, author of My So-Called Freelance Life: How to Survive and Thrive as a Creative Professional for Hire, who has worked as a freelancer for almost two decades. Goodman has four to five writing gigs a month, including work for ABC News and the Seattle Times. "With a full-time job, if you get laid off, that's the whole thing. But if I got laid off from one of mine, I could still have 50 percent of my income left," she says.

But just because earning money on your own provides income doesn't mean you should ditch your day job just yet. Pamela Skillings, author of Escape From Corporate America and a career coach, recommends moonlighting on the side to test the waters before becoming self-employed full time. She says that approach lets you find out, "Is it something you want to do full time? Does it have market potential?"

You set your own income. If you're working for the man, you have little control over your salary--all you can do is request a raise, which can be turned down. But Skillings says that as someone who is self-employed, "I have full control to shift and come up with a great idea or find a new client. I could double my income with one good idea or connection."

Your start-up costs are lower. "The cost of failure right now to start a company or start something entrepreneurial is very low," says Tim Ferriss, entrepreneur and author of The 4-Hour Workweek. Since the economic situation is so tough, no one would think less of someone who started a company and failed, since so many are failing, he says. He also points out that networking sites Facebook and LinkedIn were both started during the "dot-com depression" of 2000 to 2001. Plus, he adds, advertising and service providers are cheaper because everything is on sale.

Not only does the recession make it easier to find discounts on the capital needed to start a new business, but ithas also brought the old-fashioned practice of bartering back into style. Trading services is a great way to take advantage of the bad economy, says Kimberly Seals-Allers, author of The Mocha Manual to Turning Your Passion Into Profit and creator of, especially if you're starting a new business and need help with website design or accounting, for example. "You'll have a large number of highly qualified individuals [offering their services] who you couldn't have afforded before. It's an opportunity to find talent and negotiate things," she says.

To find a willing partner, visit sites such as and You can post what you're looking for and what you have to offer and then wait for responses.

It's easier to find partners. Fougerousse inspired her younger brother and his wife, Tim Bradley and Anne Morrison Bradley of Ferndale, Mich., to start The Premium Pet, an online pet décor store that launches in August. As they form relationships with vendors, whose products they will sell through their website, they've found that the recession has made vendors more willing to give them a chance. "When things are going well, they're more selective, so for us, it's an advantage right now because we can get more products right off the bat," says Tim Bradley.

It's gratifying. This one is just as true during boom times as during a recession, but becoming self-employed provides a sense of satisfaction that's hard to come by when working for someone else. "The whole construct of going into an office and working 9 to 5 felt too rigid," says Goodman. "I got bored with the monotony of projects."

Skillings says that even though she's working harder than she did in the corporate world, she finds more value and satisfaction in what she does. She says, "In my corporate job, it didn't feel meaningful. It wasn't something that resonated with me."

How Do I Know You're Not Bernie Madoff?

by Paul Sullivan

Tony Guernsey has been in the wealth management business for four decades. But clients have started asking him a question that at first caught him off guard: How do I know I own what you tell me I own?

This is the existential crisis rippling through wealth management right now, in the wake of the unraveling of Bernard L. Madoff’s long-running Ponzi scheme. Mr. Guernsey, the head of national wealth management at Wilmington Trust, says he understands why investors are asking the question, but it still unnerves him. “They got their statements from Madoff, and now they get their statement from XYZ Corporation. And they say, ‘How do I know they exist?’ ”

When he is asked this, Mr. Guernsey says he walks clients through the checks and balances that a 106-year-old firm like Wilmington has. Still, this is the ultimate reverberation from the Madoff scandal: trust, the foundation between wealth manager and client, has been called into question, if not destroyed.

“It used to be that if you owned I.B.M., you could pull the certificate out of your sock drawer,” said Dan Rauchle, president of Wells Fargo Alternative Asset Management. “Once we moved away from that, we got into this world of trusting others to know what we owned.”

The process of restoring that trust may take time. But in the meantime, investors may be putting their faith in misguided ways of ensuring trust. Mr. Madoff, after all, was not charged after an investigation by the Securities and Exchange Commission a year before his firm collapsed. Here are some considerations:

CUT THROUGH THE CLUTTER Financial disclosure rules compel money managers to send out statements. The problem is that the statements and trade confirmations arrive so frequently, they fail to help investors understand what they own.

To mitigate this, many wealth management firms have developed their own systems to track and present client assets. HSBC Private Bank has had WealthTrack for nearly five years, while Barclays Wealth is introducing Wealth Management Reporting. But there are many more, including a popular one from Advent Software.

These systems consolidate the values of securities, partnerships and, in some cases, assets like homes and jewelry. HSBC’s program takes into account the different ways firms value assets by finding a common trading date. It also breaks out the impact of currency fluctuation..

These systems have limits, though. “Our reporting is only as good as the data we receive,” said Mary Duke, head of global wealth solutions for the Americas at HSBC Private Bank. “A hedge fund’s value depends on when the hedge fund reports — if it reports a month-end value, but we get it a month late.”

In other words, no consolidation program is foolproof.

But a blind faith in transparency can also be misleading. The concept has become a buzzword. Would more frequent and detailed reporting have helped Mr. Madoff’s investors when the S.E.C. missed the fraud?

“If a complex instrument is completely transparent, you’re still not going to be able to figure it out,” said Aaron Gurwitz, head of global investment strategy at Barclays Wealth.

He noted that a collateralized debt obligation — a type of security linked to the financial collapse — could be called transparent, while a simple structured note that limits an investment’s losses and gains could be utterly opaque because of the way it was created.

A simpler example is municipal bonds, which have been attracting investor interest because they are perceived as secure. While it is easy to get a price on bonds from large entities like New York or California, the same cannot be said for thousands of smaller issuers. The reason is that there is no designated market-maker for municipal bonds. So getting a price often can mean calling around to several sellers.

Here, though, investors’ fears could be assuaged with more information. However hard they are to price, municipal bonds have a default rate under 1 percent.

SIX RULES FOR HEDGE FUNDS Full information is key to investing in hedge funds now. When times were good, no one was bothered by rules that prevented investors from taking their money out when they wanted. But when the market collapsed in the fall, people suddenly balked at these lock-up provisions.

Mr. Rauchle said he believed that a simple six-step plan could benefit investors and keep hedge fund managers from having to submit to excessive government regulation. The first four points are straightforward: each fund larger than $100 million needs to register with the S.E.C. and have an independent custodian who holds the money, an independent administrator who prices the securities and an independent auditor.

But managers may balk at Mr. Rauchle’s last two proposals: he wants hedge funds to reveal how they price securities and to submit to an independent, quarterly analysis of their portfolios. Up until now, hedge funds have prided themselves on secrecy.

“This is about providing information and letting people decide,” Mr. Rauchle said. “I don’t think we should put an S.E.C. official in every hedge fund office. Nor do I think we should allow fund managers to stay behind this veil of secrecy.”

CHECKING UP While trust that your spouse is not keeping secrets from you is a critical to a sound marriage, trust that your wealth manager is not cheating you is a different story.

Kelly Campbell,an adviser in Fairfax, Va., and the author of a book coming out in July, “Fire Your Broker” (Riverfront Press) suggested calling the firm that actually holds your money to check on the manager. Most independent advisers use a separate custodial firm to hold their funds. (Mr. Madoff was his own custodian, which should have been a red flag.)

“It’s doing a little bit of your own homework,” Mr. Campbell said.

That type of checking is not hard. Dean Barber, an adviser in Kansas City and the host of the radio show “The Wealth Management Show,”said that just about every piece of information an adviser could get a client could get, too.

Of course, shadowing your investment adviser could be as unhealthy as fretting over your spouse’s fidelity. Mike Saghy, director of investments at PNC Wealth Management, said that to prevent this concern he steers clients with at least $1 million into separately managed accounts. This way they know what stocks and bonds they actually own — not how many shares in a fund they have.

“People are showing some angst over mutual fund holdings,” he said. “The want to know that they own a muni bond from the state of Pennsylvania and not a portfolio of muni bonds.”

RESTORING TRUST At the end of the day, living life fearing that the people handling your money are deceiving you is not good for you. Insisting on openness is one way to rebuild trust.

“There are no secrets in our industry,” Mr. Barber said. “If somebody tells you, ‘We have a special way of doing things but we don’t divulge how we do it,’ chances are it’s a scam.”

As harsh as this sounds, the alternative is not practical: even hoarding gold bricks in your basement requires a level of trust. “How do I know it’s not a lead bar painted gold?” Mr. Guernsey asked.

Bankers group sees U.S. recession ending in third quarter

WASHINGTON (Reuters) - The U.S. recession will end in the third quarter, but lingering high unemployment and large federal deficits may pose a longer-term threat, economists advising the American Bankers Association said on Tuesday.

The economists expect the U.S. Federal Reserve would keep interest rates near zero percent until the third quarter of 2010 because a sluggish recovery would keep inflation in check.

They forecast that 2009 real gross domestic product would fall 1.3 percent, with 2010 growth rebounding to 3 percent.

However, they thought unemployment would not peak until the first quarter of 2010, and it may be several years before the economy returns to full employment, which they pegged at 5 percent.

"The economy will return to growth but not to health," said Bruce Kasman, chairman of the economic advisory committee and chief economist for JPMorgan Chase in New York. "Growth in the coming quarters is likely to gather momentum but will not prove sufficiently robust to undo much of the severe damaged to our labor markets and public finances."

The economic advisory committee of the ABA meets semiannually to make their forecast after meeting with the Federal Reserve's Board of Governors. Tuesday's forecast was similar to the consensus forecast in the Blue Chip survey of economists, which was released last week.

Kasman said the committee was largely in agreement on the broad contours of the economic growth forecast, but there was less agreement on the path of inflation and how soon the Federal Reserve would begin hiking interest rates.

Some thought there was sufficient slack in the economy to keep price pressures down, but longer term there was growing concern among some committee members that large federal deficits and a slower pace of economic growth could pose an inflationary threat.

The Federal Reserve wraps up its next policy-setting meeting on June 25, and is widely expected to keep interest rates unchanged near zero percent. However, there is much debate among economists about whether the Fed will announce plans to buy more assets such as Treasury debt to help keep borrowing costs low.

(Reporting by Wendell Marsh; Editing by Leslie Adler)

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