July – August 2011

August 26, 2011 12:45 p.m.
Your Retirement Finance Week in Review

It’s up to Congress now. That’s the word from Ben Bernanke in his much-anticipated speech Friday in Jackson Hole, Wyoming. A few people circulated rumors earlier in the week that the Fed chairman would announce a new round of quantitative easing, and that caused a brief burst in stock prices. But that rumor was downplayed by others as the week went on, and stocks declined. Bernanke said the current situation required some fiscal measures and a better fiscal process. The speech was a year overdue. We put up with a lot of distortions in global markets and the economy for the last year because of the quantitative easing experiment. The Fed clearly doesn’t want to try that again unless things become desperate. The speech led to a global slide in stocks.

It was a quiet week in the markets and economy until Thursday and Friday, because of a lack of data and actions from policy makers. But things picked up at the end of the week. The policy makers were quiet until they triggered volatility with rumors that Germany might eliminate short sales of stock triggered a major decline in European stocks Thursday. Another increase in the margin required for gold futures contracts by the CME was preceded by a sharp decline in gold the day before, indicating that someone leaked the upcoming change.

Here are the details about the week’s actions.

The Data

Friday’s GDP report for the second quarter was another disappointment. This second of three estimates of the economy’s growth was downgraded to a 1% annualized, following 0.4% for the first quarter. These disappointing numbers are for activity that occurred before the Fed ended quantitative easing at the end of June. The second quarter’s number also could be downgraded again next month. The good news in the report is that final sales of domestic products were revised up slightly, but they still are at tepid levels.

Consumer sentiment was slightly improved but still at a depressed level. The Sentiment Index was reported at 55.7. It was at 55 in November 2008, the depths of the 2008 financial crisis and market meltdown.

Also on Friday, after-tax corporate profits were reported by the Bureau of Economic Analysis. They rose at a 3.3% annualized rate in the second quarter but were flat over the last yaer.

Earlier in the week, retail sales slowed to the lowest rate in two months, according to two surveys. The housing market continued to deliver bad news. Existing home sales declined, and previous data were revised downward. And the Mortgage Bankers Association index of mortgage applications also declined, despite extremely low interest rates. Even applications for refinancing declined. That shows households still are highly leveraged and aren’t willing to borrow even at today’s low interest rates.

On Thursday, initial jobless claims were reported unexpectedly higher. This is partly attributable to a strike by Verizon workers. The workers since have gone back to work. The report says there’s nothing new in the labor market. We’re basically stuck with unemployment at current levels until business decides it wants to hire more people.

A bright spot in the week appeared to be durable goods orders, showing a much-higher-than-expected increase. But below the headline number the report is not as promising. When defense and aircraft orders are excluded, new orders declined. Also, the data was for July, and all other data indicate the economy slowed in August. Business investment in assets was a major support for the economy since March 2009, so the sluggishness now is worrying.

The Markets

Stock indexes had a mixed week. There was a big increase on Tuesday, apparently because rumors circulated that Ben Bernanke would promise another round of quantitative easing in his Friday speech. But the rally last steam as the rumor was laughed off and other events took center stage. Stocks declined through the end of the week.

The biggest mover in the markets was gold. The CME again tried to restrain gold’s rise by raising the margin requirement on futures contracts, as noted above. Gold actually declined the day before the rule was announced. In the September issue I indicated a decline like this should be expected, because the metal rose 17% in three weeks. I’m watching gold closely for signs that I should raise the sell signal and initiate a sale soon. I’ll be watching technical indicators to determine if the recent high was a bubble or if this is a normal correction in a bull market. So far, I don’t see a reason to sell. The change in margin requirements triggered a two-day decline. Since then, gold’s increased modestly.

Otherwise, our portfolio holdings have been fairly quiet. Long-term treasury bonds took a breather this week. They declined Tuesday and Wednesday, and then rose a bit Thursday. Hussman Strategic Growth is responding well these days. It’s up about 5% in the last month. DoubleLine Total Return Bond is up slightly before considering distributions, as is WisdomTree Dreyfus Chinese Yuan. PIMCO All Asset All Authority is down a couple of percentage points. Cohen & Steers Preferred Securities & Income is down 5% for the last month, before considering distributions. It’s holding up well after a three-day drop in early August.

Another market well worth watching is high yield bonds. These are the key source of financing for young companies. They had a strong couple of years but began to decline in early June. In August they had a loss of 5.1%. The slide really picked up pace in August as stock indexes declined. High yield bonds track stocks more often than they do other types of bonds. But the bonds did not pick up on days when stocks did well this week. Yields on treasury bonds have been declining at the same time, so the gap between yields on the two types of bonds went from very narrow to extremely high in a short time. The spread went from 5.87 percentage points at the end of July to 7.66 points this week. That’s the highest spread since November 2009 and a tremendous move in such a short time. This could be an indicator investors fear a recession is on the way. The change in the high yield bond market means mergers and acquisitions could be more difficult in coming months, and companies could have difficulty refinancing their existing debt.

Some Reading for You

Well worth your time is Vincent Reinhart’s Economic Outlook paper “Is the Economy Freefalling?” Reinhart asserts that the economies take longer to recover after a major financial crisis and that policy makers tend to make the process longer than they need to because they make the wrong moves. He names a few recent actions that will extend the recovery period and indicates what policy makers should be doing.

You also should read this week’s commentary from John Hussman of the Hussman funds. Hussman lists the reasons why quantitative easing didn’t work and actually made things worse. He also lists his reasons why the recent decline in stock prices didn’t do much to improve the outlook for stock market returns.

You also might want to read this piece on “8 New Retirement Rules.” I’m quoted in it, and it follows my book, The New Rules of Retirement.

August 19, 2011 11:45 a.m.
My Weekly Review

Actions by governments and policy makers dominated the news and the direction of markets this week the first part of the week. Several respected people issued statements to the effect that officials in Europe and the U.S. need to be serious, sober, and long-term in their actions on the debt levels. Robert Zoellick of the World Bank and Mohammed El-Erian of PIMCO were foremost among the commentators. Warren Buffett wrote an article for The New York Times that received attention for its call for higher taxes on the wealthy. More important is that within the article Buffett revealed his fear that if real progress isn’t made on the economic problems soon the markets could spiral downward because of uncertainty and a lack of confidence. This is important for Buffett because his insurance companies are backing the guarantees in many variable annuity contracts and similar insurance products. If markets don’t return to their highs, his companies could be on the hook for the difference.

Those looking for leadership and action from policy makers aren’t getting it. The leaders of Germany and France met to discuss the European debt crisis and didn’t come up with a solution or progress toward a solution. Congress appointed its Super Committee members, and then went on vacation.

The main problem with the global sovereign debt problems, whether in the U.S. or Europe, is that an extremely large amount of money is needed to pay the debts. Europe finally put together a mechanism and process for solving the problem, but there isn’t enough money available. To maintain the single currency system, Germany is going to have to come up with a lot of money and give it to the other countries. Some of the debt also is going to have to restructured, which will damage the capital standing of many European banks. So the governments will have to bail them out. Most likely, Greece and perhaps a few other countries will leave the single currency system. That will upset the markets again.

Because of the primary role government actions are taking, currency markets are where much of the action is. The Swiss franc increased so much recently against other currencies that Switzerland actually is trying to reduce the value of the franc. Japan also is trying to reduce the value of the yen. As you know, I expect China to have to go in the opposite direction and raise the value of its currency against the dollar.

Rumors and economic data became the focus on Thursday. Again there were rumors that one or more European banks are having liquidity and capital problems. There were fears of a default by a bank that would lead to a chain of problems for other banks. The economic data for the week was predominantly negative, as I discuss below.

Overall, markets still have three major concerns. The global economy is slowing. There are major debt crises in the U.S. and Europe, which are occurring during a major deleveraging. In the emerging economies, growth is well above capacity. They are trying to slow their economies to restrain inflation and deflate bubbles and emerging bubbles. These major trends continue to move forward while policy makers search for solutions.

The Data

This was a relatively quiet week for data. On Monday the Empire State Manufacturing Index revealed that manufacturing in New York is declining sharply and below expectations. The level of the index indicates a contraction in general business conditions. Weekly unemployment claims rose a bit last week, indicating that the employment market remains locked in the same range its been in for some time.

These negative numbers were offset somewhat by Tuesday’s Industrial Production report. That report showed an increase in July that exceeded expectations. This report by itself indicates the economy could resume some higher growth in the second half, but there are reasons to believe the production report doesn’t reflect the state of the economy. It’s just about the only data that was stronger than expected the last few months, and the production report reflects activity before the recent market turmoil. Other data, especially consumer surveys, were very weak.

Three more reports during the week revealed a continuing weakness in the housing market. The National Association of Home Builders index was unchanged and remains at a very depressed level. Housing starts also declined, after a one-month jump in June. The level is up 9.8% over one year, but much of the gain is from apartments. Existing home sales also were down slightly, while the supply of homes for sale rose. The overall housing market is weak.

Two reports on retail sales gave opposite conclusions. The traditional Redbook survey showed a strong increase so far in August because of back-to-school sales and summer closeouts. But results from different retailers were mixed as usual. The ICSC-Goldman Store Sales report, however, showed a steep decline in retail sales. Analysts appear to generally consider the ICSC Store Sales report to be more accurate.

On Thursday the Philadelphia Fed Survey was released and some gave is credit for shaking the markets. It showed a slight improvement from June. But its level shows only a marginal improvement during the year and a flat economy with little or no growth momentum. Stocks began a fresh slide after the data was released on Thursday.

The Index of Leading Indicators rose, but the factors triggering the change were an increase in the money supply and in the yield spread. In a normal economy these are important. But in a deleveraging economy they don’t have the same effect.

The last important data for the week were the inflation reports. Both the Producer Price Index on Wednesday and the Consumer Price Index on Thursday revealed higher inflation and were significantly higher than expectations. I continue to believe the inflation data will peak soon. The higher prices in these reports stemmed from sector in which there were supply problems, rather than high and rising demand. With the global economy slowing and most commodity prices below their recent highs, the odds are inflation will peak. The bond markets certainly aren’t worried about inflation at the moment.

Outside the U.S., European countries reported GDP growth this week, and it was weak. Germany, the leader of the European economy and the country being counted on to bail out the indebted countries, revealed its economy to have barely grown in the latest quarter.

The Markets

Stocks were having a fairly quiet week until Thursday. That’s when fears of contagion from the European debt crisis surfaced again. The great fear is that key European banks could fail, and this could have a chain reaction similar to the Lehman Brothers bankruptcy in 2008. U.S. regulators were rumored again to be telling U.S. banks and other entities to reduce their exposure to European bank debt. Sweden’s financial regulator publicly stated that the country’s banks must prepare for the debt crisis to get worse. Of course, if banks decide not to lend to each other, that act alone likely will trigger a cash crisis and failure by one or more banks.

A significant move that’s being overlooked is the big decline in high yield bonds. This could be the worst month for high yield bonds in the 25-year history of the index, according to this commentary. And this occurred without major bankruptcies and when default rates are very low. I’m glad we sold our high yield bonds from the Managed Portfolios over a month ago.

Treasury bonds benefited from all the turmoil. Despite the U.S.’s problems, they still act as a safe haven. Over the last month, gold and 30-year treasury bonds have had a close race for the top-performing asset class. Such parabolic rises can be followed by sharp declines. But for now the developments favor holding these investments.

Preferred stocks are making a comeback from a two-day sell off on August 4 and 5.

The rest of our portfolios have been flat to slightly higher. I continue to search for opportunities to enter other investments. But right now capital preservation is the best strategy.

Some Reading for You

The rich are different from most other people, and it’s not just because they’re rich. Karen Blumenthal, a reporter for The Wall Street Journal and author of a book about Sam Walton Wal-Mart, points out some of the key differences. She does this to show the rest of us how we can be more financially secure by adopting these qualities and actions. Some of the points she makes are:

*Have a plan

* Live below your means

* Value cash flow

* Focus on risk, not return

That sounds a lot like what we emphasize in Retirement Watch. We provide these and other general principles, plus a lot of specifics to help you create and maintain financial independence.

2. You shouldn’t have any doubt that politicians and bureaucrats have a greater impact on your financial security than ever before. They’ve made numerous mis-steps during the financial crisis (not to mention the years leading up to it), and we’re nearing crunch time. They need to find a path through the European and U.S. debt crisis without making a key mistake on the scale of letting Lehman Brothers slide into a chaotic bankruptcy. Numerous investment advisers have been saying this publicly, so that policymakers will know what the stakes are. Consider this from PIMCO’s Mohammed El-Erian:

Proper diagnosis is essential if policymakers are to finally get it right. Otherwise they will remain hostages of the type of ad hoc, partial and uncoordinated response that, ironically, fuels rather than arrests a crisis.

So, why is the global economy now risking a system-wide crisis? Undoubtedly, four recent developments have acted as catalysts: the extent to which America’s debt ceiling debacle eroded trust in the political elite; the country’s loss of its triple A rating; the failure of Europe to follow up promptly on summit declarations; and indicators of a synchronised weakening of activity across major regions of the global economy.

That’s why we remain cautious in our Retirement Watch portfolios. That posture served us well so far in the crisis, and we’ll continue taking advantage of margin of safety opportunities and managing our risks until a normal economic cycle appears likely.

3. The Social Security Death Master File is important. Of course, SSA uses it to stop sending benefits to the deceased, and Medicare also uses the file. But many private sector firms and state and local governments also use the file to quickly identify the deceased and take action. Benefit payments will stop. Financial firms often will freeze or close accounts after being notified that someone has died. Unfortunately, Social Security incorrectly names living people as deceased about 14,000 times each year. That’s one in 200 names on the file each year in error or 38 people per day.

“Erroneous death entries can lead to benefit termination, cause severe financial hardship and distress to affected individuals, and result in the publication of living individuals’ [personal identifying information] in the [Death Master File],” the Inspector General said in its most recent evaluation of the database.

Laura Brooks, of Spotsylvania, Va., discovered she had been declared dead when she stopped receiving her disability checks, and her rent and student loan payments unexpectedly bounced.

August 12, 2011 11:45 a.m.
My Weekly Review

The potential for contagion raised its ugly head in the markets the last week, and that led to the most volatile week in stocks ever by at least some measures.

The contagion risk came from European banks. Specifically there were rumors that some French banks were insolvent. There also were reports that U.S. regulators forced U.S. banks to reduce their short-term loan exposure to the European banks and that the Euro banks were unable to replace the capital. The rumors eventually were denied. But the rumors spring from the sovereign debt crisis in Europe. That is nowhere near being solved. Many people are starting to realize that this is the largest sovereign debt crisis ever, that there isn’t enough money to resolve the crisis, and the debtor countries don’t have the usual option of inflating their currencies to pay the debt. Things became so bad that some European regulators resorted to the traditional act of desperation: banning short sales of stocks.

The Fed issued a policy statement on Tuesday, stating that it will hold short-term interest rates near zero until at least mid-2013. That’s probably the only way it could add some stimulus, since a new quantitative easing probably doesn’t have the votes. In taking this action, the Fed explained that the economy was worse than it thought. It finally agreed with us that the recent stumble in the economy is less due to temporary factors (high commodity prices, the Japanese earthquake) and more due to structural problems in the economy.

The Data

There was remarkably little data this week, and the markets didn’t react to most of it. On Tuesday we learned productivity declined for the second quarter in a row and unit labor costs increased. One foundation of the stock rally since March 2009 is record high corporate profit margins. Those margins resulted from high productivity and low labor costs. So this report wasn’t helpful for stocks.

On both Tuesday and Friday we learned that retail sales increased in July. These numbers indicate consumers aren’t withdrawing again, and that likely means a new recession isn’t on the horizon. Some analysts delving into the details weren’t as positive. The bulk of sales now are made at the two extreme ends of the spectrum: deep discount stores and luxury retailers. The vast middle income of America seems to be withdrawing and suffering.

Also on Friday, the University of Michigan Consumer Sentiment Index fell sharply. It is near a record low and is below the worst levels of the 2008 crisis. Both the current conditions and future expectations measures declined. Consumer sentiment numbers have a good record of anticipating future changes in economic growth.

New jobless claims on Thursday were a modest improvement, coming in just under 400,000. That doesn’t really make news and indicates there isn’t much of a change in the labor market.

Thursday’s auction of 30-year treasury bonds was perhaps the biggest news. The auction drew less demand than expected and caused a sharp one-day decline in bond prices.

The Markets

The market action dominated the headlines for most news sources during the week, so I won’t rehash them. What you should know is that our portfolios did quite well, as I reported earlier this week. We’ve been mostly out of the stock market. We were in the leading assets in the capital markets: long-term treasury bonds and gold. These corrected late in the week but still have solid gains for the week, the month, and the year. I’ll be watching them closely for signs of near term peaks and updating our sell signals. It’s normal for assets to correct after the parabolic spikes they had recently.

We also had good returns from DoubleLine Total Return Bond and Hussman Strategic Growth. Cohen & Steers Preferred Securities and Income solid off with stocks early in the week but stabilized as investors became more discriminating later in the week.

We received a surprise boost late in the week from WisdomTree Dreyfus Chinese Yuan, because the Chinese currency was moving higher in the markets were it is allowed to trade on a limited basis and the Chinese government announced a change in the currency’s fix against the dollar.

I’m not going to recommend portfolio changes right now. We should wait for volatility to settle down and for clearer signs of where the economy will turn next and how the European debt crisis will develop. I believe that many investors still underestimate how severe the problem is in Europe and the precarious state of banks that lent money to the peripheral nations.

Some Reading for You

I’ve been telling you for a while that government actions will affect your personal finances and investments more than traditional economic signals in this new era. Michael Spence, a Nobel Economist, wrote an interesting piece making the same point. He says while the economy is weak, government actions are making this worse and increasing market volatility.

John Hussman of the Hussman Funds has been writing some especially good weekly commentaries recently. In one, he made essentially the point I’ve made in the past that policymakers have decided to favor creditors and bond owners over the rest of us during this crisis. They didn’t bail out the big banks, they bailed out the creditors of the banks. They’ve decided bond owners shouldn’t suffer any losses, regardless what it costs the rest of us. That would be fine if they’d say so and explain why, if most of us accept the explanation. Hussman thinks he has a better idea, and I think it’s a good one.

There’s a suspicion that Standard & Poor’s tipped off big banks and their traders before downgrading the U.S. Treasury Bond. The banks were able to get out of the way and even profit from the ensuing turmoil, according to Charles Gasparino of Fox Business.

August 8, 2011 1:30 p.m.
Changes in the Portfolios

Don’t be fooled into thinking the market decline is tied to Standard & Poor’s downgrading of U.S. Treasury debt. Stocks declined considerably the previous two weeks, and treasury bonds are doing just fine. The equity declines are due to a global recognition of two factors. One factor is that the developed countries are carrying more debt than theyshould. This is restraining growth, and there is going to be some kind of default on this debt. The other factor is that the global economy is slowing, and the U.S. economy is slowing rapidly. Stock prices in the U.S. have been sustained by quantitative easing and record high profit margins. The former has ended, and the latter is in question with the economy faltering.

Most of our portfolio holdings have held up well, as I reported Friday. But two holdings fell through their sell signals. In all the portfolios, it’s time to sell TCW Strategic Income (TSI) if you haven’t already. In the Retirement Paycheck Portfolio, also sell Cohen & Steers Closed-End Opportunity (FOF). For now, put the sale proceeds in cash.

August 5, 2011 12:45 p.m.
Reviewing a Dramatic Week

Major market indexes plummet, and our Retirement Watch portfolios rise in value. That’s the power of diversification and risk management. We’ll start with an overview, and then move to a review of the latest data, the market, and our portfolios.

The politicians in Europe and the U.S. finished their work recently. Market and economic fundamentals took over the headlines, and investors decided they didn’t like what they saw. All the headlines about political deals obscured that economies were weak and getting weaker. Nothing really was done to resolve the sovereign debt problems in either Europe or the U.S. Also, fiscal and monetary stimulus are being replaced by tightening. Economies globally are slowing, and investors are worried they appear to be slowing rapidly and there isn’t much policymakers can or are willing to do about it. Overleveraged economies, such as we have in the U.S. and Europe, need to delever, and deleveraging is likely to be a long process with slow economic growth. This was reflected in the latest data.

The Data

We start with the last data of the week, which was the best of the weak. The payroll report, while mixed, was better than the rest. The economy created 117,000 new jobs. That’s higher than last month’s poor number and well above forecasts, but still well below the 150,000 needed to sustain employment due to labor force growth. It’s even further below the 250,000 or so needed to start reducing the unemployment rate. The unemployment rate dropped a notch because some people dropped out of the labor force. More good news was that the growth was in the private sector, while government jobs declined.  The average workweek was stable, at 34.3 hours, while average hourly earnings increased 0.4%.

Other data from the week were less rosy.

The Institute for Supply Management Manufacturing Index dropped unexpectedly and sharply. It was barely above the important 50 level. Before it was issued, John Hussman updated his recession warning composite and concluded:

“From the standpoint of this composite, we would require only modest deterioration in stock prices and the ISM index to produce serious recession concerns.” We had more than a modest decline in ISM and stock prices in the following days. Before you panic, Hussman elaborated:

“For our part, we’ve always believed that the strongest evidence is obtained by combining multiple data points into a single ?gestalt.’ So I have difficulty concluding that the U.S. is on the verge of recession simply because the year-over-year growth rate has stalled. At the same time, we are closely monitoring a much broader set of data, because the deterioration has been very rapid. I should be clear – the evidence is not yet convincing that a recession is imminent, but it is also important to recognize that the developing risks are greater than most investors seem to assume at present.”