In 2008, the Federal Reserve famously purchased a lot of subprime bank loans that have been described, in the banking industry, as "toxic waste"--in an effort to clean up the balance sheets of large lending institutions. Since then, the Fed has been an active buyer of Treasury securities and, in its latest (and ongoing) QE3 program, become the single largest buyer of mortgage securities issued by Fannie Mae and Freddie Mac, working hard to drive down their coupon rates.
These dramatic gestures are supposed to help revive the American economy, but what are they costing our nation's reserve bank? The Reuters news service looked at last year's audited results and reports a surprise: the Fed's increasingly complex balance sheet generated $88.9 billion in profits last year. That's far more than the most profitable U.S. companies, like number one Exxon Mobil ($41 billion); number two Chevron ($27 billion), #3 Apple ($26 billion) or Microsoft ($23 billion).
Under Chairman Ben Bernanke, the Fed has gotten in the habit of earning a profit on its operations. In 2011, 2010 and 2009, it took in $77.4 billion, $81.74 billion and $53.42 billion in profits, respectively.
Where does this money go? Does the Fed pay out this largesse to its executives in the form of bonuses, like Goldman Sachs? Fortunately not. The Fed sent $88.4 billion to the U.S. Treasury last year, and gave taxpayers back a comparable percentage of its profits in previous years. The interesting truth is that the most profitable entity in the American economy is run like a nonprofit on behalf of our government.
Sources:
http://www.huffingtonpost.com/2012/03/21/federal-reserve-profit-2011_n_1369354.html
http://www.huffingtonpost.com/2013/03/15/federal-reserve-record-profit_n_2884366.html?utm_hp_ref=business
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Monday, March 25, 2013
Thursday, March 21, 2013
ISLAND OF DEBT
The Republic of Cyprus, with a population of just over 1 million people (slightly more than the city of San Jose, CA) would seem an unlikely place to trigger a global financial crisis. The island nation in the eastern Mediterranean Sea is divided by a U.N.-monitored buffer zone rather less hostile than the one in Korea, and the only news you generally hear is how Greece and Turkey both claim the island once used by Richard the Lionhearted as a staging ground for Crusader attacks on Jerusalem. Now, suddenly, news outlets are declaring that a failed bailout of this tiny nation could shatter the European Union's finances, sending financial shock waves around the world. Shares on European stock exchanges plunged in panic selling, and it remains to be seen whether U.S.-based investors will join this fearful exodus. Meanwhile, the biggest potential losers in this crisis could be Russian mobsters.
What do we need to know about this latest Eurozone crisis? First, that it represents a spectacular display of poor timing. The southern part of the small nation gave up its currency (the Cyprus pound) for the euro in January 2008, just before the global economic crisis hit. The meltdown was followed by a severe financial crisis in Greece--and, since most of the people living south of the U.N. buffer zone are ethnic Greek, it is not surprising that the country's banks would have had substantial holdings of Greek public and private debt.
The restructuring fell like a hammer on the Cyprus banking system. The Washington Post recently estimated that the nation's two largest lending institutions--Cyprus Popular Bank and the Bank of Cyprus--ended up losing $4.4 billion and $3.1 billion respectively on their Greek debt investments--roughly 76 percent of their value.
The reason you didn't read about any of this last year or the year before, during the bondholder-negotiated haircuts, is because the Cyprus government reached into its pocket and provided the necessary liquidity to its banking system--or, in the case of Popular Bank, simply took over the lending institution as a government subsidiary. Unlike its insolvent neighbor to the north (or, for that matter, the U.S.), the Cypriot government takes in more tax revenues than it spends. But when the nation's 10-year government borrowing rates rose from 4.5% to 7%, it became clear that a broader bailout would be necessary.
How much are we talking about? An estimated $12 billion would restore solvency. In negotiations with the European Central Bank and the International Monetary Fund, the Cypriot government agreed to a solution that is (so far) unique in the Eurozone: the government would assess a one-time tax on its country's bank depositors--taking 6.75% of all deposits of 100,000 euros or less, and 9.9% on deposits greater than that amount. This would have raised $7 billion, more than half the needed total, and the IMF and ECB agreed to provide the rest of the cash in the form of loans.
Why the different tax rates? That's a story in itself. The Washington Post reports that Russian companies have been setting up subsidiaries in Cyprus as a way to evade Russia's heavy taxes on money they earn abroad. There are also reports that Russian tycoons have been using the Cypriot banking system to launder dirty money, and using Cyprus to evade U.N. restrictions on sending weapons to the Syrian government. German intelligence reports suggest that at least 20 billion euros of the 70 billion euros deposited in Cyprus's banking system were put there by Russian oligarchs.
Most of those Russian deposits, of course, exceed the 100,000 euro threshold by a few orders of magnitude, and therefore would have been taxed at the highest rate. This explains what might otherwise be a puzzling part of the Cyprus default story: the fact that Cyprus's finance minister Michael Sarris flew to Russia instead of Belgium when the crisis became public, or that Russian President Vladimir Putin took time out of his workday to publicly pronounce the tax levy, in a very small country far from Russian shores, as "unprofessional and dangerous."
You've probably seen, in blaring headlines, reports that the Cyprus parliament ultimately rejected this plan to confiscate billions from the country's savers and foreign oligarchs, causing the rescue package to collapse and triggering yet another global hand-wringing over the fate of the euro. But there are also reports that Russia has offered Cyprus a loan of $3 billion at favorable 4.5% interest rates, and indicated a willingness to sweeten the deal if necessary.
Should you be worried about all this? It depends on whether a big part of your investment portfolio is allocated to the Cyprus stock exchange, which suspended trading on Tuesday and Wednesday while the mess gets sorted out. If not, consider that Cyprus can always go back to its original currency as a last resort, without endangering the Euro banking system the way, say, a Greek or Spanish exit might. And also remember that Cyprus is in the habit of running a government surplus, which means that the country will eventually get back on its financial feet again--probably after the Russian oligarchs and their government have quietly refinanced their private tax haven.
Sources:
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/03/18/everything-you-need-to-know-about-the-cyprus-bailout-in-one-faq-2/
http://blogs.terrapinn.com/total-trading/2013/03/18/cyprus-bailout/?pk_campaign=Blog_Newsletter_total-trading&pk_kwd=2013-03-19&elq=c50aa7457d3a4f8a847dc84e000763e7&elqCampaignId=2766&pk_campaign=Blog_Newsletter_total-trading&pk_kwd=2013-03-19&elq=c50aa7457d3a4f8a847dc84e000763e7&elqCampaignId=2766
http://www.guardian.co.uk/world/2013/mar/19/cyprus-rejects-eurozone-bailout-savings-tax
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
What do we need to know about this latest Eurozone crisis? First, that it represents a spectacular display of poor timing. The southern part of the small nation gave up its currency (the Cyprus pound) for the euro in January 2008, just before the global economic crisis hit. The meltdown was followed by a severe financial crisis in Greece--and, since most of the people living south of the U.N. buffer zone are ethnic Greek, it is not surprising that the country's banks would have had substantial holdings of Greek public and private debt.
The restructuring fell like a hammer on the Cyprus banking system. The Washington Post recently estimated that the nation's two largest lending institutions--Cyprus Popular Bank and the Bank of Cyprus--ended up losing $4.4 billion and $3.1 billion respectively on their Greek debt investments--roughly 76 percent of their value.
The reason you didn't read about any of this last year or the year before, during the bondholder-negotiated haircuts, is because the Cyprus government reached into its pocket and provided the necessary liquidity to its banking system--or, in the case of Popular Bank, simply took over the lending institution as a government subsidiary. Unlike its insolvent neighbor to the north (or, for that matter, the U.S.), the Cypriot government takes in more tax revenues than it spends. But when the nation's 10-year government borrowing rates rose from 4.5% to 7%, it became clear that a broader bailout would be necessary.
How much are we talking about? An estimated $12 billion would restore solvency. In negotiations with the European Central Bank and the International Monetary Fund, the Cypriot government agreed to a solution that is (so far) unique in the Eurozone: the government would assess a one-time tax on its country's bank depositors--taking 6.75% of all deposits of 100,000 euros or less, and 9.9% on deposits greater than that amount. This would have raised $7 billion, more than half the needed total, and the IMF and ECB agreed to provide the rest of the cash in the form of loans.
Why the different tax rates? That's a story in itself. The Washington Post reports that Russian companies have been setting up subsidiaries in Cyprus as a way to evade Russia's heavy taxes on money they earn abroad. There are also reports that Russian tycoons have been using the Cypriot banking system to launder dirty money, and using Cyprus to evade U.N. restrictions on sending weapons to the Syrian government. German intelligence reports suggest that at least 20 billion euros of the 70 billion euros deposited in Cyprus's banking system were put there by Russian oligarchs.
Most of those Russian deposits, of course, exceed the 100,000 euro threshold by a few orders of magnitude, and therefore would have been taxed at the highest rate. This explains what might otherwise be a puzzling part of the Cyprus default story: the fact that Cyprus's finance minister Michael Sarris flew to Russia instead of Belgium when the crisis became public, or that Russian President Vladimir Putin took time out of his workday to publicly pronounce the tax levy, in a very small country far from Russian shores, as "unprofessional and dangerous."
You've probably seen, in blaring headlines, reports that the Cyprus parliament ultimately rejected this plan to confiscate billions from the country's savers and foreign oligarchs, causing the rescue package to collapse and triggering yet another global hand-wringing over the fate of the euro. But there are also reports that Russia has offered Cyprus a loan of $3 billion at favorable 4.5% interest rates, and indicated a willingness to sweeten the deal if necessary.
Should you be worried about all this? It depends on whether a big part of your investment portfolio is allocated to the Cyprus stock exchange, which suspended trading on Tuesday and Wednesday while the mess gets sorted out. If not, consider that Cyprus can always go back to its original currency as a last resort, without endangering the Euro banking system the way, say, a Greek or Spanish exit might. And also remember that Cyprus is in the habit of running a government surplus, which means that the country will eventually get back on its financial feet again--probably after the Russian oligarchs and their government have quietly refinanced their private tax haven.
Sources:
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/03/18/everything-you-need-to-know-about-the-cyprus-bailout-in-one-faq-2/
http://blogs.terrapinn.com/total-trading/2013/03/18/cyprus-bailout/?pk_campaign=Blog_Newsletter_total-trading&pk_kwd=2013-03-19&elq=c50aa7457d3a4f8a847dc84e000763e7&elqCampaignId=2766&pk_campaign=Blog_Newsletter_total-trading&pk_kwd=2013-03-19&elq=c50aa7457d3a4f8a847dc84e000763e7&elqCampaignId=2766
http://www.guardian.co.uk/world/2013/mar/19/cyprus-rejects-eurozone-bailout-savings-tax
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
WHERE WALL STREET SCANDALS COME FROM
Have you ever wondered why, every five to ten years or so, there is a major scandal among brokerage firms? 2008 saw Lehman Brothers and Bear Stearns collapse in a heap of their own failed (and, with the benefit of hindsight, incredibly reckless) bets on exotic mortgage-related derivatives. In 2000, we had Merrill Lynch analyst Henry Blodget writing that certain investment opportunities were "garbage" and worse in his internal memos, and writing glowing recommendations to the investors to whom the company's brokers were selling these IPOs and other investments.
Goldman Sachs VP "Fabulous Fab" Tourre boasted that he sold mortgage securities he knew were doomed to his customers. In January 2008, Jerome Kerviel was arrested in Paris after racking up $6 billion in trading losses for his investment bank, while Nick Leeson's big bets in 1995 cost Baring's Bank in London a total of $1.3 billion. Last year, JP Morgan disclosed $2 billion in trading losses, and in 2011, Switzerland-based UBS Corp, which has a significant presence in the U.S. brokerage world, lost $2.3 billion on a single trader's wayward bets.
An article on the Scientific American website explains the Wall Street scandal machine, saying that skewed (it calls them "assymetrical") bonus systems is the root of the problem. The way brokerage firms compensate their traders, it is actually smart to be reckless on Wall Street.
To see how this works, consider a trader who is making daily, sometimes hourly bets on... it could be anything, and often is. At the end of the year, the trader is paid a bonus which is usually a percentage of the trader's profit--many times between 10% and 15%. The trader takes enormous risks. If he guesses right, and makes $10 million, he takes home a $1 million to $1.5 million bonus, on top of the $200,000 base. He does this for three years, and then, suddenly, his guess turns out to be wrong and he costs the company a lot of money.
The result? By taking huge risks, and costing the Wall Street firm far more than he generated in revenues, the trader takes home between $3 million and $4.5 million in bonus income. He may be fired, but the article says that traders who lost big are often hired by other firms. One could not be allowed to lose $1 billion, it says, unless one was really important.
The author cites a trader who bet his bank's money, and received 15% of the profits. In 2005, he bought obscure and high-yielding corporate bonds, which generated profits of $40 million. The trader's share: $6 million. In 2006, he made $80 million and took home $12 million. In 2007, the markets turned, and his trades lost the firm close to $300 million.
The trader was let go, retired comfortably, and the shareholders footed the bill for the enormous losses.
Multiply that by thousands of traders moving money around for a company's own accounts, and you have one of the most efficient scandal machines ever devised.
We call it Wall Street.
Sources:
http://edition.cnn.com/2011/BUSINESS/09/15/unauthorized.trades/index.html
http://dealbook.nytimes.com/2012/05/10/jpmorgan-discloses-significant-losses-in-trading-group/
http://www.huffingtonpost.com/2012/11/20/kweku-adoboli-ubs-rogue-trader-convicted_n_2163897.html
http://blogs.scientificamerican.com/guest-blog/2013/02/27/why-its-smart-to-be-reckless-on-wall-street/?WT.mc_id=SA_sharetool_Twitter
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
Goldman Sachs VP "Fabulous Fab" Tourre boasted that he sold mortgage securities he knew were doomed to his customers. In January 2008, Jerome Kerviel was arrested in Paris after racking up $6 billion in trading losses for his investment bank, while Nick Leeson's big bets in 1995 cost Baring's Bank in London a total of $1.3 billion. Last year, JP Morgan disclosed $2 billion in trading losses, and in 2011, Switzerland-based UBS Corp, which has a significant presence in the U.S. brokerage world, lost $2.3 billion on a single trader's wayward bets.
An article on the Scientific American website explains the Wall Street scandal machine, saying that skewed (it calls them "assymetrical") bonus systems is the root of the problem. The way brokerage firms compensate their traders, it is actually smart to be reckless on Wall Street.
To see how this works, consider a trader who is making daily, sometimes hourly bets on... it could be anything, and often is. At the end of the year, the trader is paid a bonus which is usually a percentage of the trader's profit--many times between 10% and 15%. The trader takes enormous risks. If he guesses right, and makes $10 million, he takes home a $1 million to $1.5 million bonus, on top of the $200,000 base. He does this for three years, and then, suddenly, his guess turns out to be wrong and he costs the company a lot of money.
The result? By taking huge risks, and costing the Wall Street firm far more than he generated in revenues, the trader takes home between $3 million and $4.5 million in bonus income. He may be fired, but the article says that traders who lost big are often hired by other firms. One could not be allowed to lose $1 billion, it says, unless one was really important.
The author cites a trader who bet his bank's money, and received 15% of the profits. In 2005, he bought obscure and high-yielding corporate bonds, which generated profits of $40 million. The trader's share: $6 million. In 2006, he made $80 million and took home $12 million. In 2007, the markets turned, and his trades lost the firm close to $300 million.
The trader was let go, retired comfortably, and the shareholders footed the bill for the enormous losses.
Multiply that by thousands of traders moving money around for a company's own accounts, and you have one of the most efficient scandal machines ever devised.
We call it Wall Street.
Sources:
http://edition.cnn.com/2011/BUSINESS/09/15/unauthorized.trades/index.html
http://dealbook.nytimes.com/2012/05/10/jpmorgan-discloses-significant-losses-in-trading-group/
http://www.huffingtonpost.com/2012/11/20/kweku-adoboli-ubs-rogue-trader-convicted_n_2163897.html
http://blogs.scientificamerican.com/guest-blog/2013/02/27/why-its-smart-to-be-reckless-on-wall-street/?WT.mc_id=SA_sharetool_Twitter
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.
WHAT DOES THE DOW'S RECORD HIGH REALLY MEAN?
Does it signal anything more than bullish sentiment?
Next stop, 15,000? As the Dow Jones Industrial Average settled at a new all-time high of 14,253.77 on March 5, the psychological lift on Wall Street was undeniable - the market was finally back to where it was in 2007. Or was it?1
For many Americans, the Dow equals the stock market, and the stock market is a direct product of the economy. It doesn't quite work that way, of course. Right now, it is worth examining some of the factors that have driven the Dow to its series of record closes. Does the Dow's impressive winter rally signal anything more than unbridled bullish enthusiasm?
The small picture. Investors should remember that the Dow Jones Industrial Average includes just 30 stocks - 30 closely watched stocks, to be sure, but still just 30 of roughly 2,800 companies listed on the New York Stock Exchange. The S&P 500, with its 500 components, is considered a better measure of the market. When you hear or read that "stocks advanced today" or "stocks retreated this afternoon", the reference is to the S&P. As the Dow kept settling at all-time peaks in early March, the S&P was consistently wrapping up trading days at 5-year highs but still remained about 2% off its 2007 record close.2,3
You could argue that the Dow is even less representative of the broad stock market than it once was. In 2007, Kraft, Citigroup and General Motors were among the blue chips; since then, they've been tossed out and the index has gotten a little more tech-heavy.1
If you add up all the share prices of the 30 stocks in the Dow, you will not get a number over $14,000. The value of the Dow = 7.68 x the total share prices of all 30 Dow components. How did Dow Jones arrive at the magic multiplier of 7.68? It is a direct reflection of the Dow Divisor, which is a numerical value computed and periodically adjusted by Dow Jones Indexes. For every $1 that shares of a DJIA component rise in price, the value of the Dow rises 7.68 (the Dow Divisor, you see, is well beneath 1 - on March 7 it was 0.130216081).4,5,6
The DJIA isn't indexed to inflation, so hitting 14,167 in 2013 isn't quite like hitting 14,167 in 2007. It is a price-weighted index as well (i.e., each Dow component represents a fraction of the index proportional to its price), which also makes a comparison between 2007 and 2013 a bit hazy.1
The big picture. The Dow surpassed its old record thanks to many factors - the resurgent housing market, the Institute for Supply Management's February purchasing managers indices showing stronger expansion in the manufacturing and service sectors, an encouraging ADP employment report, and of course earnings. Perhaps the most influential factor, however, is central bank policy. The Federal Reserve's ongoing bond-buying has stimulated the real estate industry, the market and the overall economy, and fueled the DJIA's ascent. The parallel, open-ended effort of the European Central Bank has diminished some of the anxiety over the future of the euro. In early March, the ECB and the Bank of England again refrained from adjusting interest rates and ECB president Mario Draghi mentioned the need for the bank to retain an "accommodative" policy mode until the eurozone economy sufficiently improves.3
In the big picture, two perceptions are moving the market higher. One is the conclusive belief that the recession is over. The other is the assumption that the Fed will keep easing for a year or more. Pair those thoughts together, and you have grounds for sustained bullish sentiment.
How high could the Dow go? Any time the Dow flirts with or reaches a new record high, bears caution that a pullback is next. Though many analysts feel stocks are fairly valued at the moment, a combination of headlines could inspire a retreat - but not necessarily a correction, or a replay of the last bear market.
While the market has soared in the first quarter, the economy grew just 0.1% in the fourth quarter by the federal government's most recent estimate. That may have given some investors pause: the Investment Company Institute said that $1.13 billion left U.S. stock funds in the week of February 25-March 1, which either amounts to bad timing, an aberration (as it was the first outflow ICI recorded this year), profit-taking or skittishness.7
If the Dow hits 14,500 or 15,000, that won't confirm that the economy has fully healed or that the current bull market will last X number of years longer. It will be good for Wall Street's morale, however, and Main Street certainly takes note of that. Lazard Capital Markets managing director Art Hogan seemed to speak for the status quo in a recent CNBC.com article: "We're certainly in an environment where good news is great and bad news is just okay. The market has just found the path of least resistance to the upside in the near term and it's hard to find something to knock it off there."7
Citations.
1 - business.time.com/2013/03/06/dow-jones-closes-at-record-high-so-what/ [3/6/13]
2 - www.nyse.com/content/faqs/1050241764950.html [3/7/13]
3 - money.cnn.com/2013/03/07/investing/stocks-markets [3/7/13]
4 - www.dailyfinance.com/2013/02/28/dow-14000-economy-meaning-djia-explainer/ [2/28/13]
5 - www.investopedia.com/terms/d/dowdivisor.asp#axzz2MtpUOJVi [3/7/13]
6 - online.wsj.com/mdc/public/page/2_3022-djiahourly.html [3/7/13]
7 - www.cnbc.com/id/100533269 [3/7/13]
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.
GAUGING THE SEQUESTER'S IMPACT
Where and how soon might the cuts be made?
As there was no last-minute agreement between Congress and the White House to postpone federal budget cuts scheduled to take effect March 1, the ax now falls. Unless a bipartisan effort somehow undoes them, assorted federal government agencies will have their budgets reduced by $85 billion between now and October 1, as the initial step in a planned $1.2 trillion deficit trimming over the next ten years. (The belt-tightening could have been more severe: without January's fiscal cliff deal, it would have been $109 billion.)1,2
What gets cut? Broadly speaking, defense programs will take a 13% hit and other federal programs will have budgets decreased by 9%. (This is according to the projection of the White House Budget Office.)2
Government contractors may be among the first to feel the pinch - especially defense contractors, and by extension their vendors. The White House projects the Army, Navy and Air Force having to slash a total of $34 billion this spring and summer, resulting in layoffs or furloughs for 450,000-500,000 workers. USA TODAY forecasts that four states - Virginia, Maryland, Texas and Alabama -will each see between 20,000-35,000 jobs lost as a direct result.3
Some think that the punch to the labor market might end up being double or triple that. A George Mason University analyst recently commented to the New York Times that as many as 1.4 million private sector jobs could be lost when the effects of the sequestration are fully felt, with a third of them coming at small companies.3,4
This potential wave of unemployment wouldn't just be traced back to military cuts: the Obama administration has mentioned TSA agents being furloughed every tenth workday, FAA air-traffic controllers and Bureau of Prisons employees working fewer hours, and job cuts or reduced workweeks affecting the FBI, INS, FDA, NPS, VA and FHA. State programs linked to federal dollars (such as unemployment benefits, Section 8 housing assistance, foster care programs, Head Start and school breakfast programs, and Meals on Wheels and job retraining programs for seniors) could also soon see cutbacks. Cuts for many of these programs would begin in April.1,2,5
What doesn't get cut? While myriad government agencies will face reduced budgets, the cutbacks will not reduce Medicare, Social Security or Veterans Affairs benefits, Supplemental Security Income, Medicaid payments, Pell grants or food stamps. Medicare Part D subsidies won't be cut either.6
That doesn't mean Medicare or Social Security recipients will be totally shielded from the impact of the sequestration. Some SSA offices might be closed certain days of the month or even for weeks or months - and the lines and waits at those offices could get longer. Medicare payments to doctors are slated to be reduced 2%.6
Is there an undo button? Sort of. Congress might find it later this month, or in April. A short-term fix could be arranged, just like what happened at the start of the year when the fiscal cliff bill was passed: taxes could be raised here, pork could be trimmed there, and a little more time could be bought ... time that could be used to improbably craft the "grand bargain" President Obama spoke of in 2012, or to give federal agencies a greater say in what gets cut.
After a few weeks of sequestration, public frustration might become more audible. Or, it might not be: last month, a Pew Research Center poll found that 40% of Americans saw merit in the March 1 cuts, with 70% of respondents saying deficit reduction should be a top federal priority.7
Citations.
1 - www.reuters.com/article/2013/03/01/us-usa-fiscal-idUSBRE91P0W220130301 [3/1/13]
2 - abcnews.go.com/Politics/OTUS/questions-answers-sequester/story?id=18623605&singlePage=true [2/21/13]
3 - www.usatoday.com/story/news/nation/2013/02/19/army-state-by-state-sequester-details/1931051/ [2/19/13]
4 - boss.blogs.nytimes.com/2013/02/21/many-expect-budget-cuts-to-hit-small-businesses-hard-but-not-the-n-f-i-b/ [2/21/13]
5 - www.civilrights.org/census/your-community/funding.html [3/1/13]
6 - aarp.org/politics-society/government-elections/info-02-2013/how-the-sequester-could-affect-social-security-and-medicare.html [2/19/13]
7 - www.cbsnews.com/8301-250_162-57570484/poll-40-say-let-the-looming-budget-cuts-happen/ [2/21/13]
Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022
PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.
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