Is Greek Tragedy Contagious?

I’ve written several blogs touching on Greece’s problems over the last 5 months (please see: Sovereign Subprime, Bonds and Cash Just Aren’t That Safe, Going Greek, Return of the Bond Market Vigilantes). But, as one of my long time readers noted, given recent events, it’s time for an update.

First, a review. Greece’s fiscal deficit is hitting double digits. When deficits get this large, countries find it difficult to issue debt and keep their currency from sliding in value. Greece, however, is in a unique position as a member of the European Union (EU) that also utilizes the euro as its currency. Greece’s fiscal and debt problems are not just their own, but an issue for the entire EU. This means more fiscally responsible countries like Germany and France are feeling compelled to bail out Greece. If they don’t, their economies will suffer, too, and the political/economic experiment that is the EU will go into the dustbin of history (as have all other pseudo-unions of this sort).

As I’ve remarked elsewhere, Greece’s tragic movie is coming to theaters near you, because Greece’s issues are and will be repeated the world over. This includes western Europe’s sick brothers: Portugal, Italy, Ireland, and Spain; several eastern European countries; several South American countries; and will soon feature such first world countries as the United Kingdom, Japan, and the United States.

If this sounds like hyperbole to you, I don’t blame you. But, let me explain.

Greece’s problems are not a product of bad luck or bad timing, but are self-imposed. Like Bernie Madoff’s Ponzi scheme, Greece’s government promised benefits it couldn’t possibly pay out. Greece’s economy is saddled with a huge public sector that has overly generous pay, benefits and pensions. Now that Greece needs to trim back those benefits to get its fiscal house in order, public sector employees are taking to the streets in violent protest. This is shutting down its economy. This may be hard to believe for Americans, but Greece’s Air Force protested by not coming to work this week! When the defense sector goes on strike, things are out of hand.

How can Greece solve its problems? It must cut public spending and grow the economy. Only then can it pay back its debt burden. This is no more complex than a family running up too much credit card debt–the solution is to spend less, make more money, and pay off debts. But, Greece’s family is refusing to cut spending while its public sector is preventing growth. Not a pretty picture.

Greece is not alone in having made such unfulfillable promises. Close on its heels are Portugal and Spain. What made news this week was what debt markets noted months ago: the credit worthiness of Greece, Spain and Portugal is degrading–the rating agencies snapped out of their stupor and finally downgraded Spain, Portugal and Greece. In fact, Greece was cut all the way to junk.

So now Greek tragedy is spreading to the weaker brothers of Europe. Who is next in line? Italy and Ireland, and then eastern Europe, and so on. The problem is that this could feed on itself. If the EU, primarily Germany and France, don’t nip this in the bud, the problem will grow over most of Europe. What turns this into a negative feedback loop is that when credit ratings are cut and interest rates soar, it becomes more difficult to cut spending and grow your way out of the problem.

How does this impact the U.K., Japan and the U.S.? All three have made promises they can’t keep; all three hope to grow beyond their obligations instead of cutting benefits; all three assume they can grow by selling products to places like Europe, China, etc. All three face Greece’s problems, but at an earlier stage. If they don’t reduce cut spending or grow strongly enough, they will before long find themselves in their own Greek tragedy.

If you don’t think the U.S. (or the U.K., or Japan) has such a problem with its public sector, check again. Our states and municipalities have made enormous promises to public sector employees–promises that almost any actuarial accountant will tell you are unfulfillable. How do you think teachers, policemen, fire-fighters, motor vehicle administrators, etc. will react when we say we need to cut their pay, benefits and pensions? Perhaps not with violent street protests, but certainly not with simple resignation.

Greece’s overwhelming problems will not visit us tomorrow, but they will come over time. Even if Greece’s problems are solved, which will probably cost the EU (and International Monetary Fund (IMF)) 180 billion euros over the next 3 years, the EU still has to deal with Portugal, Spain, Italy and Ireland. How many hundreds of billions of euros before France and Germany are pulled down, too?

Greece’s problems are turning into Spain and Portugal’s problems, which are turning into France and Germany’s problems, which will eventually hurt the U.K., Japan and U.S.

With all that, what are the investing implications?

1) Buying sovereign bonds or holding cash is more dangerous than it may seem. If you must hold bonds, hold corporate or inflation protected bonds. If you must hold cash, gold is the way to go.

2) The world economy is likely to continue growing despite these issues. Fiscal stimulus from Europe, Japan, the U.S. and China will not run out until later this year, and until that happens, sovereign subprime will be a side issue. But, markets are likely to be more volatile than they have been over the last year, so owning something that does well in more volatile markets will probably be beneficial.

3) For the long run, buy blue chip, franchise companies and lowest cost commodity producers. Great companies have pricing power and not much debt, so they will be able to grab market share, grow, and adapt to changing times. When longer term sovereign issues raise their head more significantly, interest rates will spike, currencies will tank, and commodities will thrive. Owning lowest cost producers will be very profitable.

4) The timing on these issues coming to a head will be almost impossible to get right. If Germany decides to be nationalistic and kicks Greece out of the EU, markets will react right away. If the EU bails out Greece, then Portugal, then Spain, then Italy, etc. this could drag out over a long time. If you can read minds and know how sovereign powers will react, you can get the timing right; for the rest of us mortals, trying to time the markets will prove to be a fool’s errand.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Unexciting expectations.

The stock market is a puzzle to most people. It zigs when everyone expects it to zag. It goes up on a bad unemployment report one day, then down when a report shows the economy is booming the next. It can leave us frustrated and angry on such occasions.

Although I agree it’s a mystery in the short term, it’s much less of a puzzle over the long term. At any point in time, it’s possible to provide a reasonable range of returns for the next 5 or 10 years. The market doesn’t end at a precise point over that time frame, but it does follow a logical path.

The market’s underlying logic is based on fundamentals. They include: 1) profits, 2) growth, 3) dividends and 4) how much people are willing to pay for those three. The first 3 are straightforward; the third is erratic over the short run, but tends to revert to the mean over the long haul.

No crystal ball needed. No eye of newt, or rat tail. Just an understanding of the underlying logic and the discipline to realize that’s where things will head over time.

What does my “crystal ball” show for market returns over the next 5 to 10 years? A pretty unexciting picture. Over the next 5 years, I expect returns of -4% to 11%, with an average tendency of 3%. See, unexciting. Over the next 10 years, it looks like 2% to 10% annualized returns with an average of 6%. Assuming inflation in the 3% range, that leaves 0% to 3% real, annualized returns over the next 5 to 10 years. Probably a lot less than most people are expecting or planning.

The path to that range and those averages is likely to be much more “exciting.” If anything was learned over the last 2 1/2 years, it’s that a boring long term path may prove terrifyingly exciting over the short run.

The market peaked in October 2007, plunged 57%, then climbed 79% to today. That’s a 23% decline from fall 2007, and an annualized loss of 10% a year. Our path going forward may prove similarly breath-taking.

How do you avoid such “excitement”? Don’t invest in the stock market. But, beware that inflation and defaults may make cash and bonds just as terrifying.

Is there any way to do better? Yes, but it means being more selective than buying “the market.” Over almost any time period, some stocks do well. Finding them isn’t an easy task, but it can be done. Wal-Mart and Johnson & Johnson, which I held for clients and myself during the downturn, did quite well.

This doesn’t eliminate risk, or volatility. That’s just part of life (and especially investing). But, better long term returns are possible. They’re unlikely to shoot out the lights, but they can put you in a much better position when the next real bull market begins.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The iPad is good–no GREAT!–for cable and phone companies.

I don’t own an Apple iPad, but I do own an iPod Touch, so I can well imagine how great the Apple iPad will be.

However, I strongly disagree with those who believe it’s the death-dell for cable and phone companies (full disclosure: I own Comcast and Verizon stock both for clients and myself). In fact, I believe the iPad, and other devices like it, will be a huge boon to phone and cable companies. Now, let me explain why.

First off, let me be clear: the iPhone, iPad and iPod Touch are revolutionary. If you’ve used any of these, you know what I’m talking about. Whether you use it to surf the net, play games, download apps, whatever, it’s amazing.

But, something new and amazing doesn’t necessarily mean the end of everything else. I don’t believe I’ll be eating dinner off an iPad in 5 years because plates will become obsolete (any more than I believed the Internet would change everything–EVERYTHING–10 years ago during the dot-com bubble).

Innovations are hard to predict, and their impact on other things is even more difficult to forecast. So, let’s all just take a deep breath…

Back to the subject at hand: I’ve read many articles over the past 5 years saying that cable and phone companies will go the way of the dodo because of Internet and wireless advances. Will cable and phone companies be impacted? You betcha! Will they become obsolete over night? No way. Is it possible they may adapt to this new landscape and thrive? Indeed, it is possible, maybe even likely.

I even read one article where the author claimed 50% of all video would be watched on phones. Perhaps that author knows something I don’t, but I’m having a hard time imagining a family watching a movie on a phone, or even the amazing iPad. I could be wrong…

The other problem I have with the “all land-lines are dead” vision of the future can be summed up in two words: reliable bandwidth. Does anyone really believe that wireless cell phones are currently capable of handling high-bandwidth video? Did dropped calls suddenly disappear and I didn’t get the memo? Will people really watch streaming video, like live sports, over such an unreliable service? At some point in time, yes, but not yet.

Let’s keep in mind, the phone company carrying iPhone can hardly handle people downloading apps and making phone calls, and somehow that same network is going to handle live sports videos? I’ll believe it when I see it. And, if I do, I doubt it will be within the next 3 years.

The iPad brilliantly illustrates my point. So far, it doesn’t work through cell phone coverage (although it will very soon). What does it work through? WiFi, or short range wireless. Which is connected to what? Oh, that’s right, a phone or cable line.

The secret to successful wireless technology is to get it on a land-line as soon as possible. Why? Because wireless is no where near as reliable and secure, nor does it have the same 2 way bandwidth, as wireline. And, guess what, that won’t change any time soon.

So, if you want to watch movies and live sports and downloads apps and whatnot, you’ll be doing it over a big fat land-line pipe. Guess who will provide that pipe? Phone and cable companies.

The usual reasoning I see from here is that cable and phone companies make their money with land-lines by selling us a bunch of channels we don’t want or need. Wrong.

Phone and cable companies have to pay an arm and a leg to buy content to put on their networks, and the margins they make on that business are much smaller than the margins they make bringing high bandwidth Internet access to your home or office.

When every home has 3 iPads, 4 wireless computers, movies sent to the TV over the Internet, etc., people will want higher bandwidth than 1.5 Mbps (Mega bits per second). They’ll want huge bandwidth. And, cable and phone companies will be happy to provide 50 Mbps, 100 Mbps, 1,000 Mbps! But, for a price. If people really want all that bandwidth, they’ll be happy to pay for it.

If the phone and cable companies were smart, they’d be more focused on bringing the highest bandwidth possible to the home and reducing their business expenses to the bone. That’s what they’re doing.

They know they can make more money with an all digital, high bandwidth network. They know that paying an arm and leg for content doesn’t make sense in the long run. They also know that many, if not most, of their customers will take several years to adapt to this new reality. They see the future, and probably better than I do.

The iPad is great for cable and phone companies because they can make more money selling customers high bandwidth Internet, and the best way to get there is to have millions of consumers realize they need more…More…MORE bandwidth to do what they want with their shiny new iPads.

I say, the more the merrier! Buy tons of iPads, use them to do everything you want over the net. But, realize, too, that you’ll be doing it all over a fat land-line, and that cable and phone companies will be bringing that to you.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Renminbi revaluation.

Be careful what you wish for, you just might get it.

The U.S. Congress has been trying to get the Chinese to allow their currency, the renminbi (or yuan), to appreciate versus the U.S. dollar. Timothy Geithner, our Treasury Secretary, rushed off to the far east to broker such a deal a couple of days ago.

Whereas most see this as a wonderful beginning, I believe it will end in tears.

Chinese currency is called renminbi. The word means “people’s currency” (in direct contradiction of those who believe China has anything to do with capitalism). It’s more commonly and historically called the yuan (which means round, after the shape of coins).

The Chinese peg their currency to the dollar. This means they buy and sell dollars and yuan to keep the 2 currencies marching in lockstep. The yuan was pegged to the dollar from 1997-2005 at 8.27 yuan to the dollar. It was allowed to float somewhat freely (“managed peg”) from 2005 to 2008, where it appreciated (in a very controlled manner) from 8.27 to 6.83 (fewer yuan to dollars means the yuan is going up in value). That managed peg lasted until the crisis of 2008, when it was put back on a fixed peg at 6.83 yuan to the dollar, and remains there still.

The Chinese are not mean-spirited in pegging their currency. They partially do it to maintain their trading relationship to the U.S. It’s easier to conduct trade, both for people in the U.S. and China, when you know what the exchange rate will be. They also peg their currency because they are a controlled economy. In other words, they don’t have the mechanisms to let their economy manage itself because it’s not a free market.

Many think this gives China an unfair advantage (sarcastic comment: just like it gives Alabama an unfair advantage over Michigan to have the dollar in Alabama the same as the dollar in Michigan). Such folks believe we must force China to remove its peg so we can compete more “fairly” (unless, of course, the people in Congress think they are losing, then they don’t want it to be fair).

I don’t believe forcing China to revalue its currency will be all good news.

It will be good for U.S. companies who compete with China. If Chinese and U.S. companies are competing for the same business, China has an advantage by manipulating its currency. But, China does not compete with the U.S. for high-end manufacturing, they compete with the U.S. at the low end, mostly. So, it will benefit low-end manufacturing in the U.S.

But, this will be bad for U.S. consumers. Letting the yuan appreciate will make all those Chinese goods we buy cost more (and we buy a LOT of Chinese goods). It also means China will have a more valuable currency to compete with U.S. dollars in buying goods all over the globe. In other words, it will lead to higher prices for commodities, goods, probably everything.

A small minority of U.S. businesses, with buddies in the Congress, will benefit at the expense of the vast majority of U.S. consumers and higher-end U.S. businesses. Isn’t that nice.

The fallout will not be pretty, to be frank. It’s bad for bonds because it means higher interest rates. And, those higher rates will hit U.S. consumers, U.S. businesses, and, of course, the biggest debtor of all: the U.S. government.

It will be good for commodity investments. It will be good for U.S. businesses in competition with Chinese businesses. That seems like more downside than upside to me.

To top it off, it won’t solve the U.S.’s fiscal problems–it will make them worse. Higher interest rates and inflation will not reduce the U.S.’s debt, or reduce our burden of future social programs. Nor will it help employment. For every new job in low end manufacturing, we’ll lose 2 or more elsewhere. It will lead to larger public finance problems, and sooner.

The U.S.’s problem is that it spends too much and it pays with debt. That’s not China’s fault. We need to save more, spend less, and make products that others want. We won’t beat China with low-end manufacturing, but we can at the high-end. But, a depreciating dollar relative to an appreciating yuan won’t help that.

No, getting the Chinese to allow the yuan to appreciate will not help the U.S., it will help China. Is that what we really want?

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Self-imposed retirement delusion.

The American dream is financial independence, but we aren’t saving or planning enough for retirement. Everybody knows this, but we aren’t doing enough about it. Frankly, the gulf between what people know and what they’re doing has progressed beyond “inadequate planning,” it’s outright delusional.

How much do you need? Around 20 times your annual spending needs. That will allow you to withdraw 5% a year and still handle the bumps and bruises that markets will inevitably serve over time. Conservatively, I use 22 times my desired retirement spending needs, and that doesn’t include income from any source other than savings.

If you have a pension or fixed annuity, you can subtract that from your annual needs to do the calculation. If you’re older than 50, you can probably plan to receive the social security benefits you’ve been promised. If you’re 40 to 50, be ready to give those benefits a significant haircut. If you’re below 40, like me, don’t count on it (by the way, the more you save, the less likely you’ll be to get it).

Assuming the average John and Jane Doe need around $40,000 a year to live on, they’ll need $800,000 to retire. Americans aren’t even on a glide-path to reach that point–they’re on a different planet.

According to the Employee Benefit Research Institute’s 2010 survey, 54% of those currently working have less than $25,000 in savings and 88% have less than $250,000. Those already retired are even worse off: 56% with less than $25,000 and 88% less than $250,000.

It’s not just a matter of not having saved enough, it’s a matter of even having thought about it. Both retirees and workers are confident they have or will have enough to retire. And, this is from a group where only 46% have even tried to calculate how much they’ll need! Delusional.

How do workers and retirees expect to get by? That’s where the survey gets scary. 66% of workers expect to keep working past 65. The percent of actual retirees that work past 65? 39%. In other words, people expect to keep working past 65, but don’t–not because they don’t want or need to, but because they can’t. Why? Because they get fired, can’t find work, or, most frequently, have health issues that make working impossible.

A startling 70% of those currently working expect to continue working in retirement to pay the bills. The percent of retirees who actually manage to do this: 33%.

The average worker expects his retirement income to come from working in retirement and a pension (even though the vast majority admit they don’t have pensions and won’t because few companies offer them). Where do actual retirees get most of their retirement income? Social security.

So, most people are planning to keep working, but the data clearly shows that won’t happen for most. And, most expect to get a pension even though they don’t have one and have no clear path for getting one. The reality is that most retirees rely on social security, but only 30% of people working and 52% of those currently retired expect social security to be available. This fantasy will turn to farce, but it’s won’t be funny.

The stock market–by itself–won’t bail us out, either. Trend-line growth of 6% plus a 2% dividend yield means we should expect only 8% returns (which includes 3% inflation). But, most people won’t even get those returns because they’ll pay too much in fees and then they’ll chase performance (selling what “didn’t work” to buy what’s recently “been working”). The reality is that most people will get returns that simply match inflation.

What’s the real solution? Save more, save more, save more (which conversely means: spend less, spend less, spend less). I’m 39 and have 20% of the savings I’ll need in 26 years (assuming 65 retirement, whether I like it or not!). Assuming I can get market returns (even though I’ve beat the market by 5% on average, annually over the last 14 years), I’ll need to save 10% of my annual income to get there. I’m saving 20%. In other words, I’m not planning to get there with just enough if everything goes right, I’m assuming things won’t go right and building a margin of safety into my plan.

It’s time to drop the delusion and act. That action means saving more, spending less, investing wisely, and planning to have more than needed. The benefits are more than simply having peace of mind, it’ll be food on the table and a roof over your head when you’re too old to fix past mistakes.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.