Sunday, November 28, 2010

What's up with Ireland

The news that is influencing world stock markets is the financial crisis in Ireland. This blog looks at the situation and what we can learn from it. First is the weekly recap from Vanguard.

Vanguard

As Americans paused to count their blessings this week, there was news to be thankful for on the economic front: The latest figures on GDP growth were revised upward substantially, and far fewer people filed for first-time unemployment benefits than had been expected. For the week ending November 26, the S&P 500 Index fell 0.9% to 1,189 (for a year-to-date total return of about 8.4%). The yield of the 10-year U.S. Treasury note fell 1 basis point to 2.87% (for a year-to-date decrease of 98 basis points).

Ireland

Below are segments from a Reuters article

Ireland promised on Wednesday to cut spending and raise taxes to combat its banking crisis and secure an international bailout. Irish Prime Minister Brian Cowen, whose government is close to collapse, unveiled a 15 billion euro ($20 billion) four-year austerity plan that he said would affect all Irish people.

"The size of the crisis means that no one will be sheltered from the contribution that has to be made toward national recovery," Cowen told a news conference. The plan includes thousands of public sector job cuts, phased-in increases in Ireland's value-added tax (VAT) rate from 2013 and social welfare savings of 2.8 billion euros by 2014, but does not touch the country's ultra-low corporate tax rate.

Dublin's 10-year bonds are trading far below their face value, at less than 75 cents in the euro. On Wednesday they yielded 9.23 percent -- a level at which Dublin could not realistically issue news bonds, and far above the 2.63 percent on the equivalent German bond. Ireland is expected to be pay about 5% on loans from the International Monetary Fund.

So what does this mean? Ireland can not afford to lend money at 9.23% which is the going rate. The reason it is so high is due to a default risk where investors need a much higher return based upon the poor fiscal condition of the country. In comparison to a country that is in good fiscal shape like Germany the interest rate is only 2.63%. So because of this default risk Ireland has to to pay over 3 times higher in interest.

What does Ireland need? They need to borrow money at a lower rate which is 5% from the International Monetary Fund, IMF. Now the people at IMF are only charging 2X of the rate at Germany so this is not really a great rate but a lot better than 9.23%. So the IMF will only lend the money at this lower rate if and only if the Irish government make enough changes in taxes and spending to reduce the risk of default. Today we read that an agreement has been reached so that the Irish government will get money loaned at a lower rate.

What does this mean for us?

* First, I feel sorry for the people of Ireland who now have to pay for bad fiscal policy of the past. These people will be paying higher taxes and getting less in return, it won't be fun to get through this.
* Taking this to a person level this is like a person who has been living beyond their means living on credit and now can not get more credit and it is time to pay.
* It appears that the monetary crisis in Ireland, as well as some other countries like Portugal and Greece, will be resolved and the IMF along with other EU nations will be able to handle this crisis.
* A government that has good fiscal policy get money at the lowest rate while a government that goes deeper in debt pays a higher rate.
* The old saying holds true, people who do not need a loan can easily get one and people who really need a loan many times can not get one.
* According to usdebtclock.org the United States that has about $14 trillion in debt, a federal revenue of about $2.5 trillion, federal spending of $3.8 trillion, and interest paid on the debt of $200 billion per year. If we had to borrow money at 5% this would increase the interest paid on the debt to $700 billion per year increasing federal spending to $4.3 trillion.
* If we have to pay an extra $500 billion per year in interest and we have to reduce our debt to get the money this means that we have to reduce our spending from $4.3 trillion to $2.5 trillion just to break even and not generate more debt. We would have to cut spending about 40% to get to even.

Ireland shows us where we are headed as a country, higher taxes of all sorts and reducing spending everywhere. The best thing that the government can do for us now is to focus on fiscal policy and get the debt under control now and not later. Quit talking about the Federal Reserve and start talking about raising taxes, not cutting taxes, and cutting spending. The longer we ignore this the worse it gets.

Sunday, November 21, 2010

Happy Thanksgiving 2010

Let me be one of the first to wish you a Happy Thanksgiving. At the end is a brief summary of Thanksgiving. The first paragraph is the weekly recap from Vanguard. In the middle is a quetion and answer section where a number of topics are covered.

Vanguard

The week's news suggests that the economy continues to recover at a steady but slow pace. Retail sales were up more than 1% for the month of October, while businesses expanded their inventories to keep pace with shoppers and to prep for the upcoming holiday rush. Meanwhile, last month's slight increase in consumer prices barely registered, sending inflation to its lowest level in more than 50 years. For the week ended November 19, the S&P 500 Index remained unchanged at 1,199 (for a year-to-date total return—including price change plus dividends—of about 9.5%). The yield of the 10-year U.S. Treasury note rose 12 basis points to 2.88% (for a year-to-date decrease of 97 basis points).

Questions and Answers:

Why did I buy General Motors stock this week? Since it has been restructured and the US Government needs the stock price to increase I believe the government wins and I want to be on the winning side.

What did mortgage rates do last week? 30 year mortgage rates rose 0.22% from 4.17 to 4.39%.

Which type of mutual funds are investors buying? The 4 week weekly averages are: bought $3.9 Billion more of stock funds, bought $5.4 Billion more of taxable bonds, sold $489 Million of municipal bond funds, and bought $2.4 Billion of money market funds.

Which type of mutual funds should be avoided? Municipal Bond Funds - lack of tax revenue and the end of stimulus money and Long Term Treasury Bond Funds - rising interest rates during 2011.

Is the Federal Reserve Quantitative Easing 2 a good thing? Based upon the stagnant consumer price index information and high unemployment rate this seems to be good monetary policy. If I was on the Federal Reseve I would do it, we need the economy to grow for numerous reasons. It would be good if the politicians would do something with fiscal policy, you know the taxing and spending part of the government. It will be good when we get good fiscal and monetary policy.

Thanksgiving Information

According to Noell Wolfgram Evans, the first Thanksgiving celebration held in America occurred in 1619. On Decem-ber fourth of that year, thirty-eight English settlers arrived at the Berkeley Plantation in Virginia. Part of their original charter stated that they would set aside that day every year as a day of Thanksgiving. Due to the hardships of those early times, the celebration turned out to be short lived.

The next recorded celebration in Plymouth, Massachusetts in 1621 is also the most famous. The first winter for the Pilgrims in the New World was a brutal one - nearly half of those who came over on the Mayflower died. Times even-tually grew easier. The following Harvest season was so bountiful that the Pilgrims decided to hold a feast to cele-brate. This three-day festival included the participation of nearly one hundred Native Americans. Governor William Bradford had invited them to show his appreciation for helping the colony survive the harsh weather conditions.

The next Thanksgiving celebration did not occur until 1623. This year the Pilgrims were again hit with a great hardship - a draught. In the hope of bringing much needed rain, they gathered in a prayer service. The next morning it started to rain, long and hard for several days. When it became apparent that the crops and the colonists would survive, Governor Bradford declared that they would hold another day of Thanksgiving - the Indians were again invited.

The first national celebration of Thanksgiving occurred in 1777. This one-time only event also served as a way to cele-brate the American defeat of the British at Saratoga. In 1789, George Washington made the first Presidential proc-lamation declaring Thanksgiving a national event. The first Thanksgiving held under this proclamation occurred on November 26 of that year. The pattern was set.

Thomas Jefferson decided against the idea of Thanksgiving and it was not celebrated for nearly sixty years, until Sarah Josepha Hale became involved. A magazine editor, Hale wrote strong editorials in many of the popular magazines of the time. She also wrote letters to anyone who might help her cause. She was concerned with her belief that the coun-try needed to set aside a day to give thanks “unto Him from who all blessings flow.”

Finally, she struck the right chord with Abraham Lincoln and in 1863, Hale saw her dream realized as Lincoln de-clared the last Thursday of November as a national day of Thanksgiving.

For the most part, it is a day that has stayed. In the 1930’s President Roosevelt tried to move the date to extend the Christmas shopping season. Facing immense outrage, he moved the day back with little fanfare. Later in his administration, – 1941 - Congress declared the fourth Thursday in November to be the legal Holiday known as Thanksgiving.

Sunday, November 14, 2010

End of Tax Selling and Mortgage Rate Divergence

This past week had lots of financial news concerning the Fed monetary easing called QE2 where the Federal Reserve is puchasing longer term US treasury bonds. What was not in the news has to do with end of year selling and a Mortgage rate divergence that has never happened before and should never happen again, which I will explain. First is the weekly recap from Vanguard.

Vanguard

Following last week's upbeat jobs report, the U.S. economy continued to show signs of improvement. In a relatively light week for economic news, the trade deficit narrowed in September and initial jobless claims hit their lowest level since July. For the week, the S&P 500 Index fell 2.2% to 1,199 (for a year-to-date total return—including price change plus dividends—of about 9.4%). The yield of the 10-year U.S. Treasury note rose 18 basis points to 2.76% (for a year-to-date decrease of 109 basis points).

End of Year Tax Selling

The US stock market dropped this week and experts on the news were trying to explain it and how it relates to many things like QE2. Quite frankly, I believe the reason was end of year tax selling which is probably going to be heavier than normal this year. This applies if you have a brokerage account, it does not apply to an IRA account or 401(k) account, just a brokerage account.

Every year about this time people sell assets, like stocks or mutual funds, that have lost money so that they can write it off on their taxes. If the person wants to purchase the same asset they have to wait 31 days to repurchase it to avoid the wash sale rule. If you sell and buy it back within 30 days this is call a wash sale and for tax purposes the loss can not be deducted. So people tend to start to sell mid November and buy back mid December to reduce their taxable income.

This year I believe the end of year selling will be much higher due to the uncertainty of extending the Bush tax cuts. As it stands today any capital gain on an asset, like a stock or mutual fund, will be taxed at a higher capital gain tax rate next year. So to reduce the amount of taxes paid assets are being sold now to get a lower tax rate.

What this means is that between now and the end of the year the stock market should have some volatility. For a long term investment this is noise. If you have a short term time horizon you should becoming more conservative.

Mortgage Rate Divergence

Put this date down in the record book, Thursday November 11,2010 something happened that had never happened before. It is so exciting to see a once in a life time event, I wonder why the media didn't cover it more. Here is the big news, the interest rate on a 30 year mortgage was lower than the interest on a 30 year US Treasury bond. Wow wasn't that exciting!!!

This means it is cheaper to borrow from your house than the US Government. This has never happened because of how the mortgage game works. If you want to get a mortgage the provider will purchase a US Treasury bond of the same duration and amount, usually about 1% lower than the mortgage rate. So if the mortgage rate is 5% the mortgage provider has purchased a US Treasury bond at about 4% and that is why they provided the mortgage. This is big business and 1% of $1 Trillion is $10 Billion.

The reason it happened has to do with QE2 and the purchasing of longer term bonds and the time gap between when the US Treasury bond is bought and when the mortgage is converted. Since this has happened, either mortgage rates are going to go up, US Treasury rates are going to go down or both. Probably both is my belief.

When dealing with the Federal Reserve never bet against their policy since they hold the money. This tells me that interest rates are not rising anytime soon. It also tells me that now is a great time to refinance a mortgage as this divergence can not last long. No mortgage provider will stay in business to lose money.

Veterans Day Trivia

Veterans Day is always observed on Nov. 11 with speeches and parades across the U.S. The holiday began as Armistice Day on Nov. 11, 1919, the first anniversary of the end of World War I.

•In 1926, Congress passed a resolution for an annual observance.
•In 1938, Nov. 11 became a national holiday.
•In 1954, President Dwight D. Eisenhower signed legislation changing the name to Veterans Day in order to honor veterans of all American wars.

There were 21.9 million military veterans in the U.S. in 2009. Of those:

•1.5 million were female.
•2.3 million were black.
•1.1 million were Hispanic.
•9.2 million were 65 and older, according to 2008 figures.
•1.9 million were younger than 35, in 2008.

If you know a Veteran, thank them.