How Healthy is the US Dollar?

The strong dollar policy is long gone, but the greenback isn’t in peril just yet.

A favorite doomsday scenario. Have you heard about the forthcoming collapse of the dollar? Well, if you turn on your computer, your radio and even your TV, you just may. With the Federal Reserve poised to increase the money supply, the commentary on this topic is heating up again.

The scenario has variations, but the basic outline goes like this: An unexpected political or economic event leaves the dollar so weak that all confidence in it is gone. Foreign nations sell Treasuries in a panic and the Fed becomes the buyer of last resort. Traders and individual investors dump dollars for whatever they can get. Interest rates leap. Next stop: hyperinflation. America’s economy suddenly resembles that of Zimbabwe in 2007 or Germany in 1922.

So is there any validity to this scenario? Could the dollar collapse?

Let’s just say that the odds are very long. While the Federal Reserve will likely ramp up quantitative easing in the near future, it is highly unlikely that the dollar will suddenly become too cheap.

Why it is unlikely to happen. Foreign countries don’t want the dollar to collapse. Fundamentally, that is because some of the world’s biggest manufacturing economies rely on a great customer for their exports – the United States of America.

China and Japan currently hold 41% of America’s debt.1 In the worthless dollar scenario, they are the key dominoes that fall. But what incentive do China and Japan have to sell dollars? Their economies are tied to U.S. consumer spending. Selling dollars would not benefit them – it would drive up the prices of their exports to America, it would wreck the economy of their best customer, and it would harm their own economies in turn.

The dollar is also the world’s reserve currency; it has been so since the U.S. abandoned the gold standard during the Nixon administration. While the central banks of China and Russia have argued that it should be supplanted or replaced, no challenger has knocked it off its pedestal. In spring 2010, the International Monetary Fund concluded that the dollar still accounted for 61.5% of global foreign exchange reserves, with the euro coming in a very distant second at 27.2%.2

In a way, the dollar has “collapsed” – and America is still standing. The dollar is much weaker today than it was in the 1990s, or even in the early 2000s. Its value has gradually declined and may decline further despite recent surges. In mid-October, the U.S. Dollar Index had slipped about 7% since August, and was approaching an all-time low set back in April 2008.3

America’s debt was less than $3 trillion in 1990; it has doubled since, and the federal Office of Management and Budget thinks it will hit $15 trillion by 2015.1 The federal government would certainly rather pay those debts back using a declining dollar.

Of course, analysts also talked about the pound collapsing and the euro collapsing earlier this year. All this talk – and expectations about what the Fed will do – sent many investors toward the precious metals market, where gold and silver futures hit new highs.

A little word about diversification. When you hear commentators talking about the oncoming collapse of the dollar, take it with a grain of salt. This much is true so far: a dollar decline has occurred, and the dollar could weaken further. So it might be worthwhile to consider diversifying your portfolio as a cautionary move.

Citations
1 – azcentral.com/news/articles/2010/09/19/20100919debt-of-us-grows-with-debate.html [9/19/10]
2 – businessweek.com/news/2010-06-30/dollar-share-of-global-reserves-declines-imf-says.html [6/30/10]
3 – bloomberg.com/news/2010-10-19/geithner-weak-dollar-policy-seen-as-path-to-recovery-in-contest-with-brics.html [10/19/10]

Mid-Term Elections & Stocks

Historically, these events tend to help equities.

You may have heard that stocks tend to rally in fall and winter. That has often been the case. In fact, the S&P 500 and the Dow have gained repeatedly after the elections occurring in the third year of a first-term presidency.

These elections seem to elate Wall Street. While past performance is no indication of future success, consider this: Wall Street has witnessed rallies after every mid-term election since 1942.1

The Leuthold Group, a Minneapolis-based investment research firm, has determined that the S&P 500 has gained an average of 18.3% in the 200 days following such elections. Widening the window of time, Goldman Sachs finds that the S&P has averaged an 18.1% advance during the 12 months following each of the 15 mid-term elections since 1950. (The gain averages 11.0% when control of Congress changes hands.)1,2

Consider another intriguing statistic regarding mid-term election years: in the five instances since 1942 when an incumbent first-term president was a Democrat, the S&P 500 has gained an average of 21.3% for the year.3

The Dow may get a tailwind from the “third-year effect”. Since 1945, the third year of a presidential election cycle has tended to be very positive for the Dow. As MarketWatch columnist Mark Hulbert noted recently, the DJIA has averaged +24.7% in such 12-month periods (usually measured in fiscal years, i.e., 4Q-1Q-2Q-3Q) since the end of World War II. In fact, the Dow’s average returns in other fiscal years of a presidential term have been puny in comparison: +4.0% in year one, +1.9% in year two and +3.3% in year four.4

Last month, Standard & Poor’s chief investment strategist Sam Stovall told the Wall Street Journal that the DJIA has risen an average of 17.1% in calendar years following mid-term elections since 1945, with less than 10% of these years seeing selloffs.5

Will 2010 follow the historical pattern? Excellent question – after all, no one is clairvoyant. This year, stocks have not followed the longstanding trends. Stocks typically do badly in September, yet September 2010 actually turned the market around. When it comes to November, let’s hope history repeats.


These are the views of Peter Montoya Inc., not the named Representative nor Broker/Dealer, and should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information. www.montoyaregistry.com www.petermontoya.com

Citations.
1 - kiplinger.com/columns/value/archive/how-elections-affect-the-stock-market.
html [10/12/10]
2 - foxbusiness.com/markets/2010/10/05/gridlock-looming-wall-street-
stands-gain/ [10/5/10]
3 - cnbc.com/id/38538007/Midterm_Elections_Produce_Pain_Then_Gain
_For_Stocks [9/27/10]
4 - marketwatch.com/story/mid-term-elections-impact-on-stocks-
2010-10-04 [10/4/10]
5 - online.wsj.com/article/
SB10001424052748704062804575510482714106168.html [9/25/10]

SPEND LESS NOW, LIVE IT UP LATER

A little “delayed gratification” may help you retire more comfortably.

Baby boomers are known for wanting more out of life – and for living life on their own terms. They also get a bad rap as a generation weaned on instant gratification – wanting it all now, wanting to have it both ways.

It is neither wise nor truthful to paint a generation with a broad brush. What we do know in 2010 is that more Americans than ever are poised to retire. In fact, 10,000 Americans will turn 65 each day during the next 18 years.1 Will their retirements match their expectations?

Are boomers in for a collective shock? Many boomers are used to affluence and expect creature comforts in retirement. Yet many may not understand how much money retirement will require. A 2010 study from the non-profit Employee Benefit Research Institute estimates that about half of “early” boomers (those aged 56-62) will face a retirement shortfall – someday, they will have inadequate income to pay medical costs and core retirement expenses. EBRI also estimates that 43.7% of “late” boomers (those aged 46-55) are likely to exhaust their retirement savings as well.2

Investing aside, what about the way we spend? EBRI research director Jack VanDerhei told TheStreet.com that beyond federal policy decisions, “[what is] even more important is to identify which of those households still have time to modify their behavior to achieve retirement security, and how they need to proceed." 2

What is a need and what is a luxury? Now here is where it gets interesting. In a new survey of more than 1,000 boomers conducted by MainStay Investments, more than half the respondents identified “pet care” and “an internet connection” and “shopping for birthdays and special occasions” as basic needs. Almost half checked off “weekend getaways” and “professional hair cutting/coloring” as basic needs. Perhaps the definition of a “basic need” is expanding. Or perhaps we have gotten so used to these perks that we can’t imagine living without them (and not spending money on them).3

Boomers are necessarily growing more pragmatic. The MainStay survey results hint at a shift in their financial outlook. The survey found that 76% of boomers were willing to work longer and save more in pursuit of more retirement comfort.3

Additionally, 40% of those surveyed said they will have to delay retirement in order to afford their desired lifestyle – and 47% said they would be willing to live in a smaller house to have more of the above luxuries/needs. A whopping 84% of respondents indicated they would be willing to allocate a portion of their assets so that they might have consistent lifelong income. However, just 52% of them were in contact with a financial consultant.3

We can learn from our elders. Look at the sacrifices made by the “greatest generation”. World War II demanded so much from Americans, not only in the theatres of combat but at home. For several years, new cars weren’t manufactured, travel was discouraged, and food, clothing and gasoline were rationed. The entire economy was rearranged, and more than 40 million Americans had to start paying federal income tax.4

This generation certainly understood delayed gratification. Yet with all that economic and political upheaval, its members collectively enjoyed the most comfortable retirement in American history (and perhaps the history of the world).

Will we pay for today’s lifestyle tomorrow? Financially, that is a risk we face. Many of us have not saved enough for retirement, and the financial markets have been especially volatile of late. So it only figures that spending less and saving more today could help us out tomorrow. Who knows - if some extra effort is put in now, we may end up with enough money to “live it up” later.

Citations
1 – sacbee.com/2010/08/29/2990176/baby-boomers-signal-shift-in-what.html [8/29/10]
2 - thestreet.com/story/10806795/even-wealthy-face-retirement-shortfall.html l7/15/10]
3 - freeerisa.com/news/fe_daily.aspx?StoryId={66D70228-CEFE-4782-9058-F2F2DAB68DD1} [8/5/10]
4 – nationalww2museum.org/education/for-students/america-goes-to-war.html [10/1/10]

The State of the Economy

The question on the mind of many investors has to be: where is the U.S. and world economy headed? Are we moving toward a double-dip recession, or is the economy in the early stages of a long-term recovery?

At a recent industry conference in San Diego, financial advisors heard a keynote presentation by economist Todd Buchholz, former White House director of economic policy and, before that, economics professor at Harvard University. His presentation was extremely candid, describing the 2008-2009 economic meltdown as "the most tumultuous economic times any of us have ever been through," later noting that it was a period when the Beardstown Ladies investment club outperformed the leading brokerage house investment divisions, when Mattel, the company that makes little hot wheels cars, has more market value than General Motors, which manufactures real ones.

But haven't we emerged from complex economic times in the past without this lingering uncertainty about where things are going? Buchholz said that if you aren't sure what's going on, you aren't alone. Economists are discovering that their economic models have grown increasingly out of touch with the realities of the marketplace. One big reason is that the world has changed dramatically. "When the Berlin Wall was pulled to the ground, millions of workers who had been trapped on the other side were suddenly free to compete against you, me, somebody writing software in San Diego or assembling textiles in North Carolina," Buchholz told the audience. "When you add in India and China, you have billions of new workers in the global workforce, which pushes down labor rates and inflationary forces here at home."

Today, the American worker is caught between two negative forces. It's hard to negotiate for higher wages when more than a billion workers are competing for his/her job. At the same time, newly-industrializing nations like India and China are clamoring for commodities, which raises the world price of everyday items like gasoline, cotton, cement, metals, food and whatever is made from those things.

So where do we stand today? Buchholz applauded the fact that the Federal Reserve Board has taken interest rates to zero and (as he put it) "stomped on the money supply accelerator." He doesn't expect this to lead to high inflation down the road because wages will be kept low by global competition for jobs, and because the new money is actually offsetting the 2008-2009 destruction of value in the real estate markets and the private sector. Unlike some economists, Buchholz believes the fact that housing inventories and home starts are going down is a good thing, because it means that home prices will be primed to rise again.

Jobs? Buchholz conceded that the job market is brutal right now, but he thinks this is normal at this stage of a downturn. "Whenever you have a recession, companies fire people and cut costs," he said. "When business picks up again, as it has in the U.S., they don't immediately call them back. Instead, they say, hey, Bill, can you stay an extra hour? Or: hey, Joe, come in a bit early tomorrow morning?" Recent rises in temporary worker hiring and overtime may be a precursor to hiring back full-time employees.

The bottom line? Buchholz doesn't expect to see a double-dip recession. "Consumers are showing more resilience and more composure than most professional economists anticipated," he said. "This is not a rip-roaring recovery, by any means. But earnings are better than expected, corporate cash on hand is greater than expected. Instead of a recovery that would grow the economy at 4-5% a year, we could see 2-3% growth for a while."

Is there a danger to this cautiously positive vision? Buchholz said that what worries him most is a backlash against capitalism in the U.S. Congress, which might impose trade barriers to protect U.S. industries. "There were three terrible policy mistakes that the government made which caused the Great Depression," he told the group. Two of them are unlikely to be repeated: the Federal Reserve allowed the money supply to collapse by 30%--the opposite of what the Fed is doing today--and Congress raised taxes dramatically across the board. But the third mistake was passing significant tariffs, triggering retaliation from other companies--and suddenly world trade fell by 40%. "I am very concerned today about trade tensions brewing around the world," said Buchholz, "even among friendly countries with the U.S."

At the end, Buchholz said that the most pressing issue, in his mind, is getting our educational system back into the global top tier. He said that increasingly, wealth is measured by the application of education and intelligence, and the world is catching up to the U.S. "Whoever harnesses intelligence most," he told the group, "will prosper most in the 21st century."