The week that was…

Most weeks, I choose one topic on which to spout my thoughts and opinions.  But, this week, there were just too many interesting things to ponder, so here are 8 brief points of interest.

1)  Earnings season is over and the results were better than expected.  Revenues didn’t dazzle, meaning that end demand is slow, but cost cuts more than made up the difference.  This just goes to show that companies and the stock market can do well even in a slow economy.

2)  Economic numbers continue to improve.  Unemployment claims improved, railroad loadings are up, leading economic indicators surprised on the upside as did the Philly Fed’s survey.  The economy is improving ever so slowly, but it is improving.

3)  There’s been a lot of speculation that the Fed’s quantitative easing program is merely an attempt to puff up the stock market to get rich people to spend, thus improving the overall economy.  Andy Kessler and Don Coxe made convincing arguments that the Fed is really worried about real estate and the financial institutions that depend on real estate values, and thus quantitative easying may be an attempt to support bank balance sheets.  Why did the economy roll over in 2008?  Oh, that’s right, real estate values tanked and financial institutions froze up.

4)  The mortgage documentation mess promises to have much more lasting impacts than most realize.  This issue goes to the heart of real estate titles and ownership, and the dinosaurs are going toe to toe to find out who will eat losses.  If the banks end up losing this fight, like they should, then we could be right back into a 2008 crisis again.  See 3) above.

5)  Ireland will likely take a bailout from the European Union (EU).  If you think this means Ireland is in a weak position, think again.  When you owe the bank $10,000, it’s your problem; when you owe it $10 billion, it’s the bank’s problem.  The EU is more worried about Greece, Portugal, Spain and Italy than Ireland, so they are hoping to draw a line in the sand at Ireland (after Greece).  Ireland has the stronger hand in this game.  Oh, and by the way, why is another bailout in Europe good news for markets?

6)  China is working hard to slow down their economy, mostly by slowing bank lending, because food inflation is making the natives restless.  China may succeed more than world markets anticipate.  Initially, markets will probably take that hard.  But, over time, this will lower the prices of input commodities, thus improving developing economies.  This may be a case where slowing for them is good news for us.

7)  Many state and local governments in the U.S. look like Portugal, Ireland, Italy, Greece and Spain in terms of fiscal health.  When these issues hit the front page, likely next year or the year after, it will rattle markets and lead to huge bailouts by the federal government.  This will be good in the long run (because budgets are out of touch with reality), but I don’t think many people, especially investors, are paying attention to the short term impacts.

8)  Long term bond yields spiked over the last couple of weeks.  An almost 5% decline in the 10 year U.S. Treasury bond over a couple of weeks should be a wake up call for investors who think bonds are risk free.  It should also give pause to equity investors who should know that stocks should go down when long term bond yields spike.  But, why worry about that, the market is rallying!

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 week that was…

Pension pain

You’ve got to be a bit of a geek to love investing.  One reason is the math–there’s lots of it.  Another reason is that you should enjoy digging through obscure footnotes to financial statements.  Most people would rather get a root canal than read such arcana.

I, however, am a big fan. 

An area that will soon get big attention is pension accounting.  You must dig into footnotes to see this information, and it’s not a pretty picture.

When organizations, whether governments or companies, report their financial situation, they must disclose how much they owe employees through pensions.  Like all accounting information, this is based on assumptions.  One key assumption–that’s way off base–is return on assets.

An organization that owes money to employee pensions must estimate how much they need to pay out and how much return they’ll get on assets to make those payments.  If they assume lower future payments or high returns on assets, then their pension liability magically shrinks!  And you thought Santa was good…

Not surprisingly, most companies and public pensions are making flattering assumptions to make their financial statements look better.

As a simple example, most companies I research (with pensions) assume they’ll get 8% returns on assets.  That may not sound ambitious to you, but it is.  Bonds will probably provide 4% returns from here and stocks will return around 6%.  Assume a pension has a standard 60% equity/40% bond allocation, and you get a whopping 5.2% return. 

So, most companies and governments are under-reporting pension liabilities by around 33%.  This will be difficult for many companies, but they will get by (although shareholders will be less sanguine).  Public pensions, however, will be a nightmare.

Another fact unknown to most is that governments have a different set of accounting rules than companies.  Whereas companies have strict rules about accounting for and allocating assets to pensions, government bodies are much more lax (pay as you go, easier assumptions).

I was reminded of this recently when talking to a lobbyist who works for our local power company.  I asked him if the utility would be bought by a company or taken private, and he said he didn’t think anyone would buy it because they would have to account for pensions differently, and that would wipe out the value of the utility company.  Wow!

Now, picture that occurring all across America.  Most public pensions are grossly under-reporting pension liabilities, and they are in trouble even before reporting that huge liability accurately!

This will make big news at some point, probably within the next 2 to 3 years.  The cause will be interest rates rising (thus decimating bond values) or a big decline in equity prices (hitting pension assets from the other side). 

Mark my words: pensions will cause real pain to shareholders and major pain to state and local governments (which means taxpayers). 

Just when you thought it was safe to go back in the water…

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.

Pension pain

QE2 launched to much fanfare

This was no buy the rumor, sell the news week.  This week, it was buy the rumor, buy the news…whatever you do, just buy, buy, BUY!

The Federal Reserve will create dollars out of thin air and use them to buy debt issued by our Treasury Department, and this was good news to markets.  Everything, except the U.S. dollar, rallied. 

Happy days are here again.  A chicken in every pot, a car in every garage, prosperity for all.  Print away, dear Fed!

Okay, I’m just bitter because I thought  more than 3 people might see election outcomes, quantitative easing part 2, and 9.6% unemployment as less than good news.  I was wrong.

But, the little voice of reason in my head is screaming in protest, “How can printing money with no backing create prosperity?!  I know, for a fact, it can’t!!!” 

A lower dollar means a little extra business for a couple of U.S. exporters.  But, the U.S. imports vastly more than it exports, so it means higher costs for the majority of us. 

If you don’t believe me, look at commodity prices–they’re up 19% since August.  The rocketing price of cotton is jacking up clothing costs.  Oil at over $86 a barrel will translate into high gasoline and heating oil prices.  Copper closing in on $4 means higher prices for electronics.  Et cetera, et cetera, et cetera.

Soon, this will translate into higher costs and lower profits for U.S. companies.  It will also mean higher prices for all U.S. consumers.

Quantitative easing will not create jobs in the U.S. or increase lending to U.S. businesses (although both of those things are occurring completely separate from and despite federal action).  The Fed’s printed dollars are going to find their way into emerging markets, commodities and government bonds.  In the short run, it means “party on, Wayne”; in the long run, it means more inflation.

Oh, by the way, the last 2 times the Fed tried to create prosperity with the printing press (and the economy was not on the brink of financial collapse) ended in the dot-com crash and the housing crash. 

While the party is going, it will seem great, just like the NASDAQ and housing bubbles back in 1999 and 2006.  But, when it ends, and few will see it coming or be prepared, it’s going to hurt like no hangover we’ve ever experienced.

In the meantime, the markets will rally and the prudent will look foolish.  And, yes, I’m looking like a fool.

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.

QE2 launched to much fanfare