David Korn writes "The Retirement Advisor" and "David Korn's Stock Market Commentary, Interpretation of Moneytalk (Bob Brinker Host), Financial Education, Helpful Links, Guest Editorials, and Special Alert E-Mail Service" newsletters. Just ask us for details on how to get a discount on subscriptions to both newsletters. You can read more about David Korn here.
David Korn's Moneytalk Interpretation
QUOTE OF THE WEEK
“The trend is your friend until it ends.”
- Traders adage.
MARKET NUMBERS AS OF MONDAY FEBRUARY 1, 2010
S&P 500: 1,089.18
10-Yr. Bond: 3.65%
STOCK MARKET INDICATORS
Brinker Comment: The S&P 500 had a total return of negative –3.5% for the month of January closing the week at 1,073.87. Bob referenced the January Barometer and said he it has been given a lot of ink, but he doesn’t think the numbers bear it out in terms of forecasting the remainder of the year.
Bob then went on to mention that we are in the second year of the presidential election cycle. Bob said the only year in the presidential election cycle over the last 70 years that jumps off the page is not year number 2, but rather year number 3. The annual rate of return using the Dow over the last 7 decades has been into the teens in the third year (16.5%) which is a very very high number. When you look at years 1,2 & 4 of the presidential cycle, they are nowhere near number 3. All of those are in the range of 3.7% to 5.6%.
EC: Bob has paid a lot of respect to the presidential election cycle and has referenced it quite frequently in his newsletter. And I think it has influenced his timing calls on several occasions. I am going to include a primer on the presidential election cycle in next weekend’s newsletter.
Brinker Comment: Not much happened at the Federal Open Market Committee meeting this week. The fed funds rate stayed in the range it has been in, from 0-0.25%. The Fed also stated that they intend to keep rates at exceptionally low levels for an “extended period.” That particular comment drew the ire from one of the Federal Reserve members who was the dissenting vote. Bob noted that many people seemed to get bent out of shape over whether rates will remain between 0-0.25%. The reality is that is not all that important. If we were to get some normalization of rates and it was accompanied by sustainable and reasonable growth rate with reasonable expressions of inflation, than it would be fine. Whether the fed funds rate is 0.25% or 2% would not me material if we had that reasonable growth and reasonable inflation.
EC: Voting against the FOMC’s policy action this week was Thomas M. Hoenig who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.
Brinker Comment: Bob noted that the FOMC said that economic activity was continuing to strengthen and that the deterioration in the labor market was abating. Bob said there is no question we have had a rebound in the economy, not only in the 2.2% annual growth in the third quarter as measured by real GDP, but also the 5.7% real GDP in the fourth quarter. There has been a lot of inventory restocking contributing to that figure following the end of the recessionary period last summer. The FOMC statement says household spending is expanding at a moderate rate but remains constrained by a weak labor market. It is also true we have a weak labor market, with the unemployment rate above 17% when you include all the discouraged workers. Household spending is also constrained by modest income growth, lower housing wealth, and tight credit. All of this is contributing to the lack of enthusiasm toward the economy. The 5.7% growth for the fourth quarter was a good number, but it was only one quarter and we have not seen the kind of activity we want on the jobs front.
EC: The GDP report for the fourth quarter was the advance estimate so it is subject to further revision. The revised estimate will be released on February 26th. The increase in real GDP in the fourth quarter was based primarily on contributions from private inventory investment, exports, and personal consumption expenditures. Read more about the report at this url:
Brinker Comment: The FOMC’s statement also pointed out that we have had a pick-up in business spending in equipment and software, but investment in structure is is still contracting and employers are reluctant to add to payrolls. All of this is happening when people are tired from a very difficult economic economy. The year 2008 was a very tough economic year, a rough year for the stock market investors and a volatile year for bond market investors who weren’t in mortgage-backed securities. Then we had 2009 which was an outstanding year for stock market and bond market investors, but investors want some stability.
EC: Read the FOMC statement at this url:
Brinker Comment: On the fixed income side, rates remain very low:
• Three-month Treasury Bill is paying just 7 basis points annually.
• The six-month Treasury Bill is paying 14 basis points annually.
• The one-year Treasury is yielding 27 basis points.
• The two-year Treasury Note is yielding 0.81%.
• The Five-year Note is yielding 2.3%.
• The 10-year Note is yielding 3.6%.
• The 30-year Bond is yielding 4.5%.
Brinker Comment: In order to get a handle on inflation, Bob said he compares the Treasury Inflation Protected Securities versus regular Treasuries. Currently, the 10-year Treasury Note is yielding about 3.6% and the 10-year Treasury Inflation Protected Security is yielding 1.27% which gets us an annual implied inflation rate of 2.3% over the next ten years. Looking at a longer time frame, the 20-year TIPS (longest maturity out there) is yielding 1.9% versus the 30-year Treasury Bond which is yielding 4.5% which prices in annual implied inflation rate of 2.6% over the next couple of decades. Bob pointed out that both of these implied inflation rates are currently BELOW the current annual rate of inflation of 2.7% as measured by the Consumer Price Index.
Brinker Comment: The Ten-year AAA Municipal Bond General Obligations are currently yielding 3.25%. if you were in the 35% top federal tax bracket, that would equate to a little over 5.00% taxable equivalent; and starting next January, if you are going to be in the 39.6% highest bracket, your taxable equivalent yield would be 5.4%.
EC: Municipal bond issuance set a new record last month, with $31.7 billion in proceeds from 654 issues. Three of the 10 largest municipal bond issues involved Build America Bonds. More at this url:
DEMOGRAPHICS AND ECONOMY
Caller: This caller noted that there is a theory that demographics hold the key to the economy and is based on the view that people 35-55 years old spend more money than other age groups and this theory predicted you would have a big economic boom between 1980-2005, but now that the baby boomers are moving out of that spending range it is going to have a negative impact on the economy. What’s your take on this? Bob said he would feel better about it if we didn’t have the fiscal situation with out of control spending in Washington. Since the election in Massachusetts, the President has started to talk about fiscal responsibility, but we haven’t seen anything of that sorts. The idea of freezing non-discretionary spending for three years to save $20 billion a year is a drop in the bucket when we are looking at over a trillion each year deficits. The thing to be the most concerned about is fiscal irresponsibility, not demographics. Bob acknowledged that when you demographics can play a role, which makes it more important now than ever before to get our books in order.
EC: Harry Dent, author of “Changing Global Demographics” is one of the big proponents of the view that the caller mentioned. He tracks demographics worldwide to determine consumer spending and has pointed out that the age range of 46-50 year olds will decline in the US for the next 25 years until members of Generation Y enter this age category. A good article that you can read for free online courtesy of the Harvard Business Review entitled, “What Demographics Tell us About the Economy” can be found here:
SEEKING YIELD THROUGH UTILITIES
Caller: This caller said he has been trying to find higher yields for his cash and was considering investing in a utility stock, some of which have higher yields. He knows there is more risk, but thinks those stocks are generally less volatile than others. He is particularly interested in investments in nuclear power although he is not sure what impact a cap and trade law might do. Bob said he wouldn’t be holding his breath on a cap and trade bill being passed at this juncture. Bob said if you want to go into the utility arena, he would prefer going into the exchange traded fund to avoid the risk factor of picking an individual stock. Bob suggested the Vanguard Utilities ETF (Ticker: VPU). Bob said for utility investors this should be given serious consideration and has a current cash yield of almost 4%. It has an annual expense ratio of just 0.25%. Bob said he likes all of that. Bob said you could use a discount broker and this particular ETF has decent volume.
EC: There are plenty of funds to chose from in this area. Morning star lists 23 utilities mutual funds and 19 utilities ETFs. The ETF from Vanguard is the third largest utility ETF. The top two are the Utilities Select Sector SPDR (ticker: XLU) and the iShares Dow Jones U.S. Utilities (IDU). I view any of these three as good options in this area. If you are looking for a mutual fund, the three biggest ones as measured by total assets include Franklin Utilities (FKUTX), MFS Utilities (MMUFX) and Jennison Utility (PRUAX). If you are brave enough to try an individual company, take a look at one of the following:
1. Southern Company (Ticker: SO);
2. Consolidated Edison (Ticker: ED); and,
3. Progress Energy (Ticker: PGN).
Learn more about those companies at this url:
PAY OFF MORTGAGE WITH CASH
Caller: This caller owns a home with a mortgage of $500,000 which has a rate of 5-7/8%. He has a few hundred thousand in cash from the sale of a house and wanted to know if he should pay down the mortgage or invest in GNMAs? Bob said there is a big spread between the mortgage rate and the GNMA yield right now because the yield on the GNMA has come down. Bob said the money is earning close to nothing in cash right now, so paying off the mortgage would earn you a decent rate of return. Bob suggested making sure he had enough cash for emergency needs and to consider the tax deduction he might be getting from the mortgage as well.
EC: Check out the article that addresses when to pay off a mortgage early. It comes from a web site with a name I like — frugaldad.com. Direct link to the article is here:
Brinker Comment: We got some news this past week on the housing market. Home prices in 20 top cities in our country were up for the month of November. This marks the 6th consecutive month of increases, though modest. The S&P/Case-Shiller Home Price Index was up 0.2% from October to November on a seasonally adjusted basis. If you go year-over-year, however, the index is down 5.3%. The big winner in the latest reading was Phoenix, which had seen its prices get creamed in the downturn. There are some signs of stability coming into the housing market. At the same time, housing prices are nowhere near their peak level. This 20-city index peaked 3-1/2 years ago in July 2006. Since then, it is down close to 30% from their highs. That is a lot of money. On a $3000,000 property, that would mark it down to about $210,000.
EC: Read more about the latest data from the S&P/Case-Shiller Home Price Index at this url:
Caller: Do you think we will ever have a resurgence of manufacturing and should the government do something about it? Bob said he didn’t think so and when he heard the President talk about bringing back manufacturing jobs into our country, he just scratches his head. The chief culprit is the cost of labor in our country, including benefits, and that is we have had a secular decline in manufacturing. There are other factors, such as environmental that impact this as well. It is much cheaper, for example, to open up a facility in Mexico where you have far less regulation and the labor is much cheaper. Bob said we have become about a 70% service-based economy. About 20% of the US economy is manufacturing-based which is still important. We have manufacturing in technology in Silicon Valley and New England. And that is important to the cyclical side of the economy. But we are destined to become a service-based economy.
EC: One of the other factors that I see employers going out of the country is because of the cost of litigation in our country in dealing with employees. Not ascribing a moral judgment here, just pointing out that this is another big cost of employing workers in our country where lawsuits are far more frequent than in other parts of the world.
SAVING FOR EDUCATION
Caller: This caller is interesting in setting up for her grandchildren’s education and is considering a 529 or Coverdell. Bob said the 529 plan is designed for college and post-college. You can put a lot of money in there quick as well. The Coverdell Savings Account allow you to use that money for any level of education, including private high school or grade school. On the other hand, you can only contribute $2,000 per child per year. There are income limitations to eligibility and you want to make sure your child is under age 18 when you are contributing. One of the nice things about this account is you can use the money before college, such as for private elementary or secondary school. Bob noted that the web site, http://www.savingforcollege.com has lots of useful information on this score.
EC: Lots of ways to sock away money for your children, grandchildren’s education. 529 plans allow you to invest tax free for college, graduate school and vocational school. There is no annual contribution limit, but each plan has its own maximum contribution limits, some as high as $300,000 for each beneficiary. You can invest it all at once, but the issue you will face is the gift tax because your contributions are treated as gifts.
EC#2: For federal purposes, you do not get a deduction for the money you invest in a 529 Plan but the money is withdrawn tax free when you use it for educational purposes. On the state level, many states offer a deduction against your state income tax for at least some of your contributions if you use your own state 529 plan. There are a couple of states, however, which if you live there and do not use their in state 529 plan and use an out of state plan, even if it comes out tax free for federal purposes, you will have to pay state taxes.
EC#3: If you start a 529 plan, but the child you are saving for decides they do not want to go to college, what you normally would do is change the beneficiary to another family member, whether it be a sibling, a cousin, or even a grandchild. If there is nobody to use the funds, the other option is to take the money out subject to income tax and a 10% penalty. Unlike a gift to a uniform transfer to minors act account, or a contribution to a Coverdell Education Savings account, you can get your money back in the 529 plan if there is an emergency and you need the money. The contribution you made can come out without tax or penalty. The money that was earned in the account, however, would be subject to tax/penalty.
EC#4: The Coverdell Education Savings account allows you to save money tax free for not only college and graduate school, but also for elementary and secondary school. The problem is that the Coverdell expires at the end of 2010 and was not protected like the 529 Plan in recent legislation. More on Coverdell Savings Accounts at this link:
EC#5: As far as the Uniform Gifts to Minors Act (UGMA) is concerned, the money you invest can be used for any purpose for the benefit of the child, but when the child reaches the age of majority, the money belongs to the child outright. There is no contribution limit to the UGMA, but the gift tax exclusion applies as it does to all these types of accounts. More on UGMAs at this link:
Caller: Over the last few months, the yield on the GNMA fund has dropped. When we turn the corner and rates start to increase, would you expect the net asset value to still stay within the $9.50-$10.50, even when the yield starts to go up? Bob said he thought that was a reasonable expectation. Bob added that the GNMA fund is trading near an all-time high, but many investors don’t realize that because they failed to adjust the net asset value in the wake of the 7 cent year-end distribution. The current price is within 1% of the all-time high when you take into account this distribution. If rates rise, you can expect diminution in the net asset value.
EC: The yield on the GNMA fund continues to fall. As of January 22, 2010, the yield is 2.49%.
The Moneytalk guests weren’t worth summarizing. On Saturday, Bob had on Peter Navarro, author of the book, “The Coming China Wars: Where They Will Be Fought and How They Can Be Won.” Learn more about the book at this url:
On Sunday, Bob interviewed Daniel Pink, author of “Drive: The Surprising Truth About What Motivates Us.”
This link brings you to the full economic calendar:
FINAL THOUGHTS FROM DAVID KORN: Go Saints! Have a great week! - David
Background: David Korn and I (KirkLindstrom.com) have been writing about Bob Brinker since the 1990s. I also write about other financial pundits such as Jim Cramer, Bill Flanagan, Gil Gross, Sy Harding, Lynn Jimenez, Suze Orman and more.
It became clear to us that many of the popular TV, internet and radio pundits were too aggressive for those in or about to enter retirement. For example, Bob Brinker had is conservative "balanced model portfolio #3" at nearly two thirds equities when the market peaked and he told a caller on the radio it was not his advice to rebalance the portfolio back to 50% equities and 50% fixed income. David and I formed a partnership and at the start of 2007 we began offering The Retirement Advisor newsletter with our model portfolios that we felt subscribers could "sleep well at night with."
Contrary to Brinker's advice, we rebalanced our portfolios by selling equities and adding to fixed income after a good year for equities in 2007. Thus our losses at the end of 2008 were much less than Brinker's losses from the top so our subscribers could sleep better at night. Then at the start of 2009 we rebalanced again buying equities considerably lower then were we sold at the end of 2007.