Tuesday, August 30, 2011
TWO NEW IDEAS, ONE INVOLVING A TWIST
The government still has some options to stimulate the economy.
What can Washington do now to help consumers, housing and stocks? Options remain. The Obama administration and the Federal Reserve are reportedly considering two interesting tactics: one first employed 50 years ago, and another that could bloom into a multi-faceted effort to aid homeowners under pressure.
Is a great mass refinancing coming? The August 24 edition of the New York Times mentioned that the White House was mulling over three different proposals to aid the housing market.
• One plan would let homeowners with government-backed home loans refinance those mortgages at today’s 4% interest rates. The potential economic stimulus could be profound: Columbia University professor Christopher Mayer, who first suggested the idea to the Obama administration, thinks it could save homeowners $75 billion in interest a year. While that would be great for Main Street (and personal spending), it might rile the regulator supervising Fannie Mae and Freddie Mac and mortgage bond investors. Banks could applaud this program, which could start without Congressional approval and without drawing down the $45.6 billion in Troubled Asset Relief funds earmarked for aiding homeowners. (Those billions could be redirected for deficit reduction.)
• A second proposal would change criteria for the federal refinancing programs already up and running so that more mortgageholders could become eligible for help.
• A third plan (actually the most developed of the three) would help troubled homeowners rent out their residences to avoid foreclosure. Houses owned by Fannie and Freddie could be converted to rentals or put to other uses. This plan may prove very attractive to investment firms, especially if the federal government lends them money to promote their involvement.1,2
Could the Fed try a new variation on Operation Twist? In early 1961, we were facing a recession. Soon after taking office, President Kennedy convinced the Federal Reserve to sell short-term Treasuries and invest the proceeds into longer-term bonds. This program – known as Operation Twist – was kind of like a small-scale ancestor of QE2. It lengthened the average maturity of the Fed’s holding of Treasuries and it was fairly successful; it had an impact roughly akin to a 1% cut in the federal funds rate.3,4
Operation Twist had two objectives:
• To bump up the yields on shorter-term Treasuries, thereby making them more attractive to overseas investors while aiding the dollar.
• To reduce long-term Treasury yields and stimulate longer-term investments.
Operation Twist was also a weapon against cross-currency arbitrage. The U.S. was on the gold standard then; billions in gold were leaving our shores. Foreign investors were converting dollars to gold and using the gold to purchase higher-yielding assets in Europe.
Today, the playing field has changed – yet a sequel to Operation Twist could potentially increase appetite for risk. If an effort like this manages to reduce yields on “safe” assets, insurance companies, pension funds and other institutional investors could be convinced to put their money elsewhere (i.e., equities).
Lower long-term interest rates could also reduce the cost of capital for companies and encourage borrowing on Main Street: mortgages, auto financing and other consumer loans would be less expensive. JPMorgan economists think that a new Operation Twist could possibly lower mortgage interest rates by .1%. (This projection assumes the Fed passively buys $20 billion in long-term Treasuries per month.)3
Of course, the stock market would prefer to see a full-blown QE3 rather than the comeback of Operation Twist. Yet with GDP so anemic and the stock market and housing sectors both needing boosts, any idea with merit is welcome – and these proposals may go from drawing board to reality this fall.
Citations.
1 - nytimes.com/2011/08/25/business/economy/us-may-back-mortgage-refinancing-for-millions.html [8/25/11]
2 - foxnews.com/politics/2011/08/25/obama-administration-weighs-mortgage-refinance-plan/ [8/25/11]
3 – money.msn.com/investing/can-the-fed-chief-calm-our-fears-mirhaydari.aspx?page=2 [8/24/11]
4 - foxbusiness.com/markets/2011/08/10/is-fed-reserve-operation-twist-20-around-corner/ [8/10/11]
5 - montoyaregistry.com/Financial-Market.aspx?financial-market=wealth-planning-using-the-stretch-ira-strategy&category=4 [8/28/11]
Monday, August 22, 2011
European Debt
Cruising Toward Resolution
Does it ever feel like this: (http://news.yahoo.com/comics/pat-oliphant-slideshow/#crsl=%252Fphotos%252Fpat-oliphant-slideshow%252F20110817-po110817-gif-photo-060208364.html ) to be a stock market investor these days?
Two weeks ago, the markets were rocked by the Standard & Poors ratings downgrade of longer-term U.S. Treasury securities. This past week, it was problems with European debt.
It's not immediately obvious, even for financial professionals, why U.S. stocks should suffer because Greece or Italy have trouble paying their debt obligations. But in a recent posting, Mohamed El-Erian, who serves as co-CEO of the world's largest bond management company, made an interesting analogy that helps to make the situation a bit clearer.
His analogy suggests that we think of the European Central Bank as a Coast Guard cutter in the Mediterranean, and it gets a warning that a relatively small cruise ship called Greece is in trouble. The ship passed through a significant storm called 2008, and now, through poor planning, has run out of food and fuel and is in danger of sinking. True to its mission, the Coast Guard cutter sets out to tow the battered ship back to shore.
But then the rescue shop receives another message. A somewhat larger cruise ship is also in trouble, as a result of the same storm. Another call comes in, another ship is foundering. And then one of the larger vessels, called Italy, announces that it is in trouble as well.
What to do? Nobody prepared for the possibility that more than one ship would be in danger at once, much less four or five. The Coast Guard vessel can think of only one thing to do; it radios the two largest cruise ships in the Mediterranean, called Germany and France, and asks them to participate in the rescue operation, by cutting short their trips, sharing the food and fuel that was set aside for their passengers, and basically rescue the cruise ship business before too many future passengers become disenchanted and cancel their tickets.
The captain and the cruise ship lines (the leaders of France and Germany) are willing to help out, but the passengers are extremely restless. Why should their trip be sacrificed? Why should the food they paid for be shared with the passengers of less stable or thrifty cruise lines? The captains of the France and Germany cruise ships are afraid their passengers will mutiny if they execute a rescue, and afraid of the consequences if there is no rescue and one of the smaller cruise ships goes down with passengers and crew.
The world, of course, is watching. The overwhelming hope is that the larger ships will come and save the day. The fear is that they may not. Meanwhile, El-Erian says, the crew of the struggling rescue vessel is struggling with a once-unthinkable decision: should throw somebody overboard to lighten the vessel and save the rest of the passengers?
This, El-Erian says, is the European Central Bank's situation today. And if we have learned anything since 2008, it is that in such a highly-connected global economy, if one major entity is allowed to go under the waves (think Lehman Brothers), the entire global system will be negatively affected. Hence, investors sell stocks in fear of another 4th quarter of 2008.
How likely is that? El-Erian points out that there are three possible endgames to the European Sovereign debt crisis. One is a disorderly breakup of the eurozone, which would mean temporary economic chaos. This could happen if the countries with the most debt problems--Greece, Ireland, Portugal, Iceland, Spain and Italy--fail to address their fiscal balance sheets due to pressure from their voters. To return to the cruise ship analogy, the people aboard the vessel named Greece believed that they paid for an appropriate ticket, and now the captain is telling them that they will have to sacrifice their vacation and pay back the Coast Guard and the other cruise ships. The response, for some, has been rioting.
A second possibility is a tighter fiscal union among the European countries, which basically means that Germany (and, to a lesser extent, France) reaches into its pocket and bails out the debtor nations to the south. In return, Germany gets more control over over the economic governance of the other members of the European Union. The slogan of this approach: never again will we float unsafe vessels.
And the third? Several economists, El-Erian says, have floated the idea that two or three "peripheral economies" (Greece and Italy) would take a sabbatical from the euro. They would go back to their own currencies, which would allow them to devalue immediately, making their exports more competitive and their debt less costly. Instead of imposing an unpopular new tax on the population, the countries would impose a stealth tax in the firm of higher inflation. Meanwhile, the euro becomes stronger. The motto: fix your own vessels, and then come back to see us when you're finished.
As one of these scenarios plays out, it might become obvious that many American and European stocks are currently being affected more by anxiety and uncertainty than by any direct connection with the Euro's woes. A report recently noted that Apple Computer was worth more than all 32 of Europe's largest banks. If chaos reigns across the Atlantic, there could be a flood of capital looking for a safe, liquid home in the U.S. stock market.
Source:
http://www.project-syndicate.org/commentary/elerian8/English
http://www.cultofmac.com/apple-was-worth-more-than-all-the-banks-in-europe-earlier-today/109642
Does it ever feel like this: (http://news.yahoo.com/comics/pat-oliphant-slideshow/#crsl=%252Fphotos%252Fpat-oliphant-slideshow%252F20110817-po110817-gif-photo-060208364.html ) to be a stock market investor these days?
Two weeks ago, the markets were rocked by the Standard & Poors ratings downgrade of longer-term U.S. Treasury securities. This past week, it was problems with European debt.
It's not immediately obvious, even for financial professionals, why U.S. stocks should suffer because Greece or Italy have trouble paying their debt obligations. But in a recent posting, Mohamed El-Erian, who serves as co-CEO of the world's largest bond management company, made an interesting analogy that helps to make the situation a bit clearer.
His analogy suggests that we think of the European Central Bank as a Coast Guard cutter in the Mediterranean, and it gets a warning that a relatively small cruise ship called Greece is in trouble. The ship passed through a significant storm called 2008, and now, through poor planning, has run out of food and fuel and is in danger of sinking. True to its mission, the Coast Guard cutter sets out to tow the battered ship back to shore.
But then the rescue shop receives another message. A somewhat larger cruise ship is also in trouble, as a result of the same storm. Another call comes in, another ship is foundering. And then one of the larger vessels, called Italy, announces that it is in trouble as well.
What to do? Nobody prepared for the possibility that more than one ship would be in danger at once, much less four or five. The Coast Guard vessel can think of only one thing to do; it radios the two largest cruise ships in the Mediterranean, called Germany and France, and asks them to participate in the rescue operation, by cutting short their trips, sharing the food and fuel that was set aside for their passengers, and basically rescue the cruise ship business before too many future passengers become disenchanted and cancel their tickets.
The captain and the cruise ship lines (the leaders of France and Germany) are willing to help out, but the passengers are extremely restless. Why should their trip be sacrificed? Why should the food they paid for be shared with the passengers of less stable or thrifty cruise lines? The captains of the France and Germany cruise ships are afraid their passengers will mutiny if they execute a rescue, and afraid of the consequences if there is no rescue and one of the smaller cruise ships goes down with passengers and crew.
The world, of course, is watching. The overwhelming hope is that the larger ships will come and save the day. The fear is that they may not. Meanwhile, El-Erian says, the crew of the struggling rescue vessel is struggling with a once-unthinkable decision: should throw somebody overboard to lighten the vessel and save the rest of the passengers?
This, El-Erian says, is the European Central Bank's situation today. And if we have learned anything since 2008, it is that in such a highly-connected global economy, if one major entity is allowed to go under the waves (think Lehman Brothers), the entire global system will be negatively affected. Hence, investors sell stocks in fear of another 4th quarter of 2008.
How likely is that? El-Erian points out that there are three possible endgames to the European Sovereign debt crisis. One is a disorderly breakup of the eurozone, which would mean temporary economic chaos. This could happen if the countries with the most debt problems--Greece, Ireland, Portugal, Iceland, Spain and Italy--fail to address their fiscal balance sheets due to pressure from their voters. To return to the cruise ship analogy, the people aboard the vessel named Greece believed that they paid for an appropriate ticket, and now the captain is telling them that they will have to sacrifice their vacation and pay back the Coast Guard and the other cruise ships. The response, for some, has been rioting.
A second possibility is a tighter fiscal union among the European countries, which basically means that Germany (and, to a lesser extent, France) reaches into its pocket and bails out the debtor nations to the south. In return, Germany gets more control over over the economic governance of the other members of the European Union. The slogan of this approach: never again will we float unsafe vessels.
And the third? Several economists, El-Erian says, have floated the idea that two or three "peripheral economies" (Greece and Italy) would take a sabbatical from the euro. They would go back to their own currencies, which would allow them to devalue immediately, making their exports more competitive and their debt less costly. Instead of imposing an unpopular new tax on the population, the countries would impose a stealth tax in the firm of higher inflation. Meanwhile, the euro becomes stronger. The motto: fix your own vessels, and then come back to see us when you're finished.
As one of these scenarios plays out, it might become obvious that many American and European stocks are currently being affected more by anxiety and uncertainty than by any direct connection with the Euro's woes. A report recently noted that Apple Computer was worth more than all 32 of Europe's largest banks. If chaos reigns across the Atlantic, there could be a flood of capital looking for a safe, liquid home in the U.S. stock market.
Source:
http://www.project-syndicate.org/commentary/elerian8/English
http://www.cultofmac.com/apple-was-worth-more-than-all-the-banks-in-europe-earlier-today/109642
Thursday, August 11, 2011
A Q&A About Our Market Confusion
Here's an amusing graphic that sums up, perhaps in exaggerated form, how some people view the mathematics behind the recent U.S. Treasury bond debt downgrade:
Normally, the very last thing we would want to do is call your attention to daily market movements, because all of the worst investment decisions are made with a short-term focus. But I want you to be aware that we are following, very closely, the market events and their impact on your investment portfolio and ability to fund future goals.
As you no doubt heard in the media echo chamber, the U.S. markets recovered in dramatic fashion on Tuesday after the Monday free-fall. By the end of the trading day, the S&P 500 index was up 4.74%, and the technology-heavy Nasdaq index was up 5.29%. This helps to offset the roughly 16% drop over the past 11 trading days.
What does this mean? Here are some good questions that you may be asking yourself, and the best answers we can provide at the moment.
What was different about Tuesday (when the market was dramatically up) from Monday (when the market was dramatically down)?
Very little from the standpoint of fundamentals. The economy is no stronger or weaker from one day to the next, corporate profits didn't make any radical adjustments, and the underlying worth of the business enterprises and debt obligations that you own have been pretty much the same throughout these Summer doldrums.
The main difference can be found in investor emotion, which is not predictable by any measure that we've been able to find. The Federal Reserve Board gave the optimists something to cheer about when it announced that it would maintain low rates--which tend to stimulate the economy by encouraging banks to lend and companies to borrow (and build factories, and hire workers)--through mid-2013. That means that even though the federal government's expenditures won't be stimulating the economy during this time of highly-partisan belt-tightening negotiations, at least higher interest rates won't slam the economy into recession.
What about the ratings downgrade? Won't that hurt the economy and the markets?
Over the last couple of days, economists and veteran market watchers have been mocking the Standard & Poors rating agency. The kindest things they are saying is that the other rating agencies--Moodys and Fitch--have continued to give U.S. Treasury debt their highest safety ratings. Warren Buffet recently came out with a statement that U.S. government debt is the safest on the planet, and should be given a AAAA rating (which doesn't exist), rather than a downgrade.
Those who are less kind are pointing out that the downgrade came from the same Standard & Poors that rated boatloads of subprime debt as 'AAA', fueling the fire that resulted in the 2008 financial crisis. During that same period, it raised the credit rating of Bear Stearns an astounding 5 notches to AA- in March of 2008--the same month that the brokerage firm declared bankruptcy. Lehman Brothers, as a company, held an S&P rating of 'A' the week they went under, and the rating agency reaffirmed its 'AAA' rating on some of the company's securities just three days before it filed for bankruptcy and basically defaulted on everything. It made similar mistakes with Merrill Lynch and Morgan Stanley (rated A and A+ respectively the week they had to be bailed out), and completely missed the problems with the Republic of Iceland.
Meanwhile, despite the downgrade, the prices of Treasury securities surged for the second straight day, sending the 10-year yield to an all-time low of 2.03% before it settled at 2.19%. Sophisticated investors around the world seem not to be worried that the U.S. will default on its debts.
Is this a good time to sell? Or to buy?
Some economists are saying that the market was oversold on Monday--which means that stocks, in general, were selling at a discount to their true value. But we aren't as confident that we know the true value of stocks in an uncertain economy, and it seems clear that emotions are ruling the recent market moves. It is possible that the emotions will take the markets further down, and it seems equally possible that the optimism we saw on Tuesday will continue.
It is worth remembering that in the first half of last year the market experienced a 17% decline (which was greater than the current downturn), and yet finished the year ahead by double-digits.
What should I do about these uncertain markets?
For now, we recommend that you not make any dramatic moves. Your account statements are reflecting the recent drop in market value, but this is a "paper loss" only. If you were to sell right now, you would be locking in a real loss. As we have discussed in the past, investing is a long-term process, and generally full of unpredictability and surprises. If you look back three years ago, the Dow had dropped to around 6,000. At the end of the day Monday, it was still around 11,000--almost double the low of a few years ago. Think back to all the scary headlines about double-dip recessions, sovereign debt crises in Europe, unemployment and all the rest, and you realize that the headlines were telling you to sell when it was much more profitable to hang on.
Is this time different?
Probably not. The world will come to its senses and hopefully we will be in a better place. However, we never know what is really going to happen, and I have found by planning for the things I can control - sharing time and love with friends and family, and living life fully from a place of love and joy, makes my world a better place while waiting for the rest of the world to get it together.
Sources:
Market rise and Treasury surge:
http://finance.yahoo.com/blogs/daily-ticker/dow-jumps-430-points-stealth-fed-ease-202736590.html
Here's an amusing graphic that sums up, perhaps in exaggerated form, how some people view the mathematics behind the recent U.S. Treasury bond debt downgrade:
Normally, the very last thing we would want to do is call your attention to daily market movements, because all of the worst investment decisions are made with a short-term focus. But I want you to be aware that we are following, very closely, the market events and their impact on your investment portfolio and ability to fund future goals.
As you no doubt heard in the media echo chamber, the U.S. markets recovered in dramatic fashion on Tuesday after the Monday free-fall. By the end of the trading day, the S&P 500 index was up 4.74%, and the technology-heavy Nasdaq index was up 5.29%. This helps to offset the roughly 16% drop over the past 11 trading days.
What does this mean? Here are some good questions that you may be asking yourself, and the best answers we can provide at the moment.
What was different about Tuesday (when the market was dramatically up) from Monday (when the market was dramatically down)?
Very little from the standpoint of fundamentals. The economy is no stronger or weaker from one day to the next, corporate profits didn't make any radical adjustments, and the underlying worth of the business enterprises and debt obligations that you own have been pretty much the same throughout these Summer doldrums.
The main difference can be found in investor emotion, which is not predictable by any measure that we've been able to find. The Federal Reserve Board gave the optimists something to cheer about when it announced that it would maintain low rates--which tend to stimulate the economy by encouraging banks to lend and companies to borrow (and build factories, and hire workers)--through mid-2013. That means that even though the federal government's expenditures won't be stimulating the economy during this time of highly-partisan belt-tightening negotiations, at least higher interest rates won't slam the economy into recession.
What about the ratings downgrade? Won't that hurt the economy and the markets?
Over the last couple of days, economists and veteran market watchers have been mocking the Standard & Poors rating agency. The kindest things they are saying is that the other rating agencies--Moodys and Fitch--have continued to give U.S. Treasury debt their highest safety ratings. Warren Buffet recently came out with a statement that U.S. government debt is the safest on the planet, and should be given a AAAA rating (which doesn't exist), rather than a downgrade.
Those who are less kind are pointing out that the downgrade came from the same Standard & Poors that rated boatloads of subprime debt as 'AAA', fueling the fire that resulted in the 2008 financial crisis. During that same period, it raised the credit rating of Bear Stearns an astounding 5 notches to AA- in March of 2008--the same month that the brokerage firm declared bankruptcy. Lehman Brothers, as a company, held an S&P rating of 'A' the week they went under, and the rating agency reaffirmed its 'AAA' rating on some of the company's securities just three days before it filed for bankruptcy and basically defaulted on everything. It made similar mistakes with Merrill Lynch and Morgan Stanley (rated A and A+ respectively the week they had to be bailed out), and completely missed the problems with the Republic of Iceland.
Meanwhile, despite the downgrade, the prices of Treasury securities surged for the second straight day, sending the 10-year yield to an all-time low of 2.03% before it settled at 2.19%. Sophisticated investors around the world seem not to be worried that the U.S. will default on its debts.
Is this a good time to sell? Or to buy?
Some economists are saying that the market was oversold on Monday--which means that stocks, in general, were selling at a discount to their true value. But we aren't as confident that we know the true value of stocks in an uncertain economy, and it seems clear that emotions are ruling the recent market moves. It is possible that the emotions will take the markets further down, and it seems equally possible that the optimism we saw on Tuesday will continue.
It is worth remembering that in the first half of last year the market experienced a 17% decline (which was greater than the current downturn), and yet finished the year ahead by double-digits.
What should I do about these uncertain markets?
For now, we recommend that you not make any dramatic moves. Your account statements are reflecting the recent drop in market value, but this is a "paper loss" only. If you were to sell right now, you would be locking in a real loss. As we have discussed in the past, investing is a long-term process, and generally full of unpredictability and surprises. If you look back three years ago, the Dow had dropped to around 6,000. At the end of the day Monday, it was still around 11,000--almost double the low of a few years ago. Think back to all the scary headlines about double-dip recessions, sovereign debt crises in Europe, unemployment and all the rest, and you realize that the headlines were telling you to sell when it was much more profitable to hang on.
Is this time different?
Probably not. The world will come to its senses and hopefully we will be in a better place. However, we never know what is really going to happen, and I have found by planning for the things I can control - sharing time and love with friends and family, and living life fully from a place of love and joy, makes my world a better place while waiting for the rest of the world to get it together.
Sources:
Market rise and Treasury surge:
http://finance.yahoo.com/blogs/daily-ticker/dow-jumps-430-points-stealth-fed-ease-202736590.html
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