Forecasts & Trends

Greece Poised to Default & Exit the Euro

Gary D. Halbert — Tue, 22 May 2012 21:19:00 GMT

IN THIS ISSUE:

1. Overview – Greece Default Risk Accelerating

2. Is An Orderly Default by Greece Possible?

3. Greece’s Upcoming Elections Look Grim

4. G-8 Summit Members Ambush Germany’s Merkel

5. Webinar With Yacktman Capital Group on Thursday

Overview – Greece Default Risk Accelerating

I have maintained all along that the European Central Bank’s loans of apprx. one trillion euros to banks in financially troubled nations in January was only a measure of kicking the can down the road. Like many other analysts, I predicted that another potentially larger crisis would be coming in the not-so-distant future.

The not-so-distant future, many of us worried, would be May 6 when Greece was to hold its parliamentary elections. As many feared, the citizens of Greece ousted those leaders who had agreed to unpopular austerity measures in return for bailout loans from the European Central Bank and the IMF, and voted in candidates that promised to roll back the austerity plans.

The problem is, none of the candidates received a majority of the vote, so a second election will be held on June 17. It is widely expected that the anti-austerity candidates will prevail and Greece will have a left-leaning Prime Minister and top leaders in the Parliament after the elections.

If you keep up with the news even occasionally, you know that there are now widespread predictions that Greece will: 1) default on its debt sometime after the upcoming elections on June 17; 2) withdraw as a member of the European Union; and 3) drop the euro as its currency and replace it with its former currency, drachmas.

We’ve all heard horror stories about the global financial crisis that could unfold if tiny Greece defaults on its debts later this year. There are genuine fears that if Greece defaults, that leaves the door open to similar defaults by Portugal, Ireland and possibly even Spain. Some fear, in this nightmare scenario, that even Italy could default (although I doubt it).

Similar fears of a Greek default and the scenario described above weighed heavily on the global stock markets last summer. This eventually led to the ECB bailout loans of €1 trillion in January. Now the equity markets are again under pressure.

Will the ECB pony up even more taxpayer money for Greece this time around? Most agree that this will be decided largely by Germany. And speaking of Germany, it is reported that President Obama went out of his way to have a private meeting with Germany’s Chancellor Angela Merkel at the G-8 summit over the weekend in Chicago about this very issue (more below).

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Is An Orderly Default by Greece Possible?

Without Merkel’s consent, the ECB is unlikely to make any more loans to Greece, and Greece is literally broke. Bank runs are underway as this is written. If the Greek elections go as expected on June 17, Greece could officially default as early as this summer (unless Merkel has a change of heart).

There is no shortage of predictions on how badly a Greek default would roil the financial and investment markets around the world. Some feel it would surpass the financial crisis of 2008. Last week, however, one well-known analyst, Nouriel Roubini, suggested a detailed plan for Greece to default and exit the euro without causing chaos around the world.

Roubini is a professor of economics at New York University and co-founder of RGE Monitor, an economic consulting firm. Roubini is best known for his predictions that the US housing market was going to collapse and spark a severe recession. Those calls led to his nickname, “Dr. Doom.” But not anymore.

Roubini admits that his plan involves lots of risks and would have to be managed very carefully. Here is the plan Roubini outlined on Friday.

QUOTE:
The Greek euro tragedy is reaching its final act: it is clear that either this year or next, Greece is highly likely to default on its debt and leave the eurozone…

Greece is stuck in a vicious cycle of insolvency, lost competitiveness, external deficits, and ever-deepening depression. The only way to stop it is to begin an orderly default and departure, co-ordinated and financed by the European Central Bank, the European Union, and the International Monetary Fund (the troika), that minimises collateral damage to Greece and the rest of the eurozone.

Greece's recent financing package, overseen by the troika, gave the country much less debt relief than it needed. But, even with significantly more public-debt relief, Greece could not return to growth without rapidly restoring competitiveness. And, without a return to growth, its debt burden will remain unsustainable. But all of the options that might restore competitiveness require real currency depreciation.

The first option, a sharp weakening of the euro, is unlikely, as Germany is strong and the ECB is not aggressively easing monetary policy. A rapid reduction in unit labour costs, through structural reforms that increased productivity growth in excess of wages, is just as unlikely. It took Germany 10 years to restore its competitiveness this way; Greece cannot remain in a depression for a decade. Likewise, a rapid deflation in prices and wages, known as an "internal devaluation", would lead to five years of ever-deepening depression.

If none of those options is feasible, the only path left is to leave the eurozone. A return to a national currency and a sharp depreciation would quickly restore competitiveness and growth.

Of course, the process would be traumatic – and not just for Greece. The most significant problem would be capital losses for core eurozone financial institutions. Overnight, the foreign euro liabilities of Greece's government, banks, and companies would surge. Yet these problems can be overcome. Argentina did so in 2001, when it "pesofied" its dollar debts. The United States did something similar in 1933, when it depreciated the dollar by 69% and abandoned the gold standard. A similar "drachmatisation" of euro debts would be necessary and unavoidable.

Losses that eurozone banks would suffer would be manageable if the banks were properly and aggressively recapitalised. Avoiding a post-exit implosion of the Greek banking system, however, might require temporary measures, such as bank holidays and capital controls, to prevent a disorderly run on deposits.

The European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) should carry out the necessary recapitalisation of the Greek banks via direct capital injections. European taxpayers would in effect take over the Greek banking system, but this would be partial compensation for the losses imposed on creditors by drachmatisation.

Greece would also have to restructure and reduce its public debt again. The troika's claims on Greece need not be reduced in face value, but their maturity would have to be lengthened by another decade, and the interest on it reduced. Further haircuts on private claims would also be needed, starting with a moratorium on interest payments.

Some argue that Greece's real GDP would be much lower in an exit scenario than it would be during the hard slog of deflation. But that is logically flawed: even with deflation, real purchasing power would fall, and the real value of debts would rise (debt deflation), as the real depreciation occurs. More importantly, the exit path would restore growth right away, via nominal and real depreciation, avoiding a decade-long depression. And trade losses imposed on the eurozone by the drachma depreciation would be modest, given that Greece accounts for only 2% of eurozone GDP.

Reintroducing the drachma risks exchange-rate depreciation in excess of what is necessary to restore competitiveness, which would be inflationary and impose greater losses on drachmatised external debts. To minimise that risk, the troika reserves currently devoted to the Greek bailout should be used to limit exchange-rate overshooting; capital controls would help, too.

Those who claim that contagion from a Greek exit would drag others into the crisis are also in denial. Other peripheral countries already have Greek-style problems of debt sustainability and eroded competitiveness. Portugal, for example, may eventually have to restructure its debt and quit the euro. Illiquid but potentially solvent economies, such as Italy and Spain, will need support from Europe regardless of whether Greece exits; indeed, without such liquidity support, a self-fulfilling run on Italian and Spanish public debt is likely.

The substantial new official resources of the IMF and ESM – and ECB liquidity – could then be used to ringfence these countries, and banks elsewhere in the eurozone's troubled periphery. Regardless of what Greece does, eurozone banks now need to be rapidly recapitalised, which requires a new EU-wide programme of direct capital injections.

The experience of Iceland and many emerging markets over the past 20 years shows that nominal depreciation and orderly restructuring and reduction of foreign debts can restore debt sustainability, competitiveness, and growth. As in these cases, the collateral damage to Greece of a euro exit will be significant, but it can be contained.

Like a doomed marriage, it is better to have rules for the inevitable divorce that make separation less costly to both sides. Make no mistake: an orderly euro exit by Greece implies significant economic pain. But watching the slow, disorderly implosion of the Greek economy and society would be much worse.
END QUOTE

The problem I see with the scenario Roubini proposes is that it requires the coordination of the European Central Bank, the European Union member states and the International Monetary Fund – the “Troika” – and a LOT of their money. It would also have to be signed onto by Germany, and the German people are opposed to any additional bailouts.

Now I’m not saying that Roubini is wrong. He may be correct that it will take such a costly and coordinated effort to usher Greece out of the euro with the least amount of collateral damage (ie – financial crisis). But how different, really, is Roubini’s plan from just another large bailout?

Then there is the question of just how much more the ECB can expand its balance sheet. As of the end of February, the ECB’s balance sheet stood at a record €3.02 trillion ($3.96 trillion). At $3.96 trillion, the ECB’s balance sheet is larger than the entire German economy ($3.28 trillion). The ECB’s $3.96 trillion compares to our own Fed’s balance sheet at $2.9 trillion. These numbers are simply staggering!

Greece’s Upcoming Elections Look Grim

Turning back to Greece, polls now indicate that the Left Coalition, “Syriza,” will sweep the elections on June 17. Their campaign promise is to renegotiate the loan terms that have been painfully negotiated with the eurozone lords and the IMF, and demand more bailouts. Yet they also want to roll back many of the austerity measures implemented by previous leaders to qualify for these very same loans. Apparently, they believe the eurozone lords and the IMF will blink. We’ll see.

In the interim, money is gushing out of Greek banks and being converted to the hard currency of choice in other countries. You don’t hear too much about this because you don’t have to stand in line at a bank to get your money these days. You can open a new account(s) at the bank of your choice in another country and simply wire the money out of the bank you are fleeing.

At the end of the day, no one knows what will happen next with Greece. All eyes will be on the June 17 elections, even though it is pretty well assumed that the Syriza party will win. What these new leaders will do remains to be seen, and this uncertainty will, in my opinion, keep a lid on global equity markets. Or worse, it could send them sharply lower, depending on what happens.

G-8 Summit Members Ambush Germany’s Merkel

The latest meeting of the Group of Eight (US, Britain, Canada, Japan, Germany, France, Italy and Russia) was held in Chicago last weekend. It is now clear that President Obama orchestrated a pre-summit strategy among the members to pressure Germany’s Chancellor Andrea Merkel to agree to back off on the austerity demands on European countries including Portugal, Ireland, Italy, Greece and Spain (the so-called PIIGS).

Instead, Obama called on the G-8 leaders to implement new stimulus spending in an effort to jump-start economic growth and create jobs. After all, these same policies have worked so well here in the US (tongue in cheek) that the Europeans should do the same. But from all accounts, Chancellor Merkel held her ground.

As a result, Obama insisted on a private meeting with Merkel on Saturday evening after the summit had adjourned for more arm-twisting. There is no way to know what the two leaders actually said, but it appears clear that Obama didn’t get his wish. Merkel said after the meeting that she would not object to more measures to spur economic growth, but she also insisted that austerity measures aimed at balancing budgets must continue.

One wonders if Merkel reminded Obama that his economic plans have added $5 trillion to our national debt since he took office, the US unemployment rate remains above 8% and the economic recovery is tepid at best. Not exactly a prescription for pulling Europe out of recession!

The point I think that Obama and other sympathetic leaders fail to realize is that Merkel is simply following the statutes of Germany’s Constitution. She does not have unlimited power to print money to bail out the struggling nations of the European Union. As noted above, the German people are steadfastly against more bailout loans, especially to Greece. I applaud Merkel’s refusal to agree to Obama’s demands.

Webinar With Yacktman Capital Group on Thursday

We will be hosting a live webinar featuring Yacktman Capital Group this Thursday at 1:00 p.m. Eastern Time. Yacktman is the latest money manager to be added to our recommended list. Brian Yacktman will make a brief presentation on how the firm’s successful “value-investing” strategy works, and then we’ll open the webinar up for questions from the audience members.

Our webinars are always informative, and this one will be no different. To listen in on Thursday’s live webinar – which is FREE as always – you simply need to register in advance. CLICK HERE to register.

I feel that the biggest question that will be answered in our webinar is why you should consider investing in Yacktman’s value strategy now, even with so much uncertainty in the market. Many investors are adopting a “keep your powder dry” strategy, staying on the sidelines or – even worse – in taxable bond funds awaiting a resolution in Europe and the results of the presidential election.

There are two problems with that strategy. First, if you wait until after the Greek crisis is resolved, you’ll probably be too late. If you are in cash, it won’t get hit if the market tanks, but it also won’t participate in any upward move. If you’re in bonds, at least you’ll have a chance to make some money if the stock market moves down, but what if there’s a rally? Bonds could get hammered.

The second problem with the wait-and-see attitude is that it doesn’t recognize that there are often times that the market often discounts the prices of stocks below their intrinsic values without regard to the overall market environment. I see Yacktman as being a potential solution for any of the following situations:

Investors who are managing their own money and getting hit by market swings prompted by outside news events. Yacktman’s value strategy looks at the underlying business, not technical indicators or other trading tools being hawked on TV commercials;
Investors who have money invested in index mutual funds using an asset allocation approach. If you are tired of your portfolio spiking up and down on every little piece of news about the economy, the Eurozone, etc., then you may be better served by a strategy that seeks value beyond what the indexes can provide;
Investors on the sidelines with money in money markets, CDs or stuffed in the mattress. You need to be positioned to quickly take advantage opportunities in the market. By the time some investors can get money transferred out of cash, the opportunity may be gone; and
Investors who are loaded up on bonds. I have often noted how mutual fund statistics are showing that investors are bailing out of stock funds and herding into bond funds. This can be a recipe for disaster if the stock market improves or when interest rates start to rise.

If you fit any of the above categories, then I urge you to attend the upcoming Yacktman webinar. All it will cost is your time, and you may learn about a strategy that could be a valuable asset in your overall portfolio.

To participate in the live webinar on Thursday at 1:00 p.m. Eastern Time, simply CLICK HERE to register.

If you are unable to join us live, we will have a recorded version of the Yacktman webinar on our website www.halbertwealth.com a few days after the live event that you can view at your convenience.

Wishing you profits in these uncertain times,

Gary D. Halbert

Buy Low, Sell High - Any Questions?

Gary D. Halbert — Tue, 15 May 2012 21:19:31 GMT

IN THIS ISSUE:

1. Value Investing Seizes on Market Inefficiencies

2. Introducing Yacktman Capital Group

3. Yacktman’s Seven Key Insights

4. Yacktman’s Risk Management Techniques

5. Performance Evaluation

Overview

Today we will delve into the world of “value” investing in stocks. Many investors don’t really understand how value investing works, other than they’ve heard that legendary investor Warren Buffett is a value-style investor. Put simply, value investing implies seeking to buy healthy companies that are trading below their “intrinsic value” with the likelihood that their share prices will return to their intrinsic values, if not rise above them, over time.

Intrinsic value is a term you see batted around in the financial media, but the exact definition can be elusive. Contrary to some thinking, intrinsic value isn’t just another name for “book value.” Warren Buffett, for example, has defined intrinsic value as “…the discounted value of the cash that can be taken out of a business during its remaining life.” Thus, intrinsic value relates to the true value of the business underlying the stock without regard to short-term market fluctuations.

The value-style strategy can be very successful if implemented properly. Warren Buffett and many others are examples of that. The problem is that most investors do not possess the knowledge and ability to analyze complicated business financials and detect industry trends that are necessary to determine what the true intrinsic value of any given company really is.

Few investors have an army of analysts to produce all this information as Mr. Buffett does. So if they want a value-style exposure in their portfolios, their only option in most cases is to buy a mutual fund that specializes in value investing. Even then, there are hundreds of so-called value funds to choose from.

Today I will introduce you to a professional money manager that thrives on value investing, one who literally grew up under the roof of one of the most successful value investors of our time.

Value Investing Seizes on Market Inefficiencies

There are some who maintain that the US stock markets are too “efficient” for value-style investing to work. These folks believe that everything there is to know about a company is “already priced into the market.” Successful value investors like Warren Buffett know that’s not true – there always seem to be market inefficiencies one can exploit, IF you know where to find them.

Buffett once said: “I'd be a bum on the street with a tin cup if the markets were efficient.”

These inefficiencies in individual stock prices can be taken advantage of if you have the knowledge to find them. Value-style investing originated with Benjamin Graham, the “Father of Value Investing.” Warren Buffett learned this strategy from Graham while he was a college student and has used it ever since.

Graham argued that because of speculation in the markets, the prices of individual stocks are often driven above or below their intrinsic values. If an investor has the knowledge to correctly determine the true intrinsic value of a company, then buying healthy companies that are trading below that value should be very profitable. Successful value investors have proven that to be true in spades.

Best of all, there are stocks that trade below their intrinsic value in all types of markets – bull markets, bear markets and even sideways markets – thanks to speculators. The trick is how to know what the true intrinsic value is, and that’s why you need a professional on your team.

Introducing Yacktman Capital Group, LLC

So far, we have discussed how Benjamin Graham taught that it’s important to differentiate between speculators and investors and that quality businesses can be purchased at a discount. Warren Buffett improved upon this concept by focusing on businesses that have good prospects for the future, essentially using the same analysis to buy a stock as you would if you were acquiring the entire business operation.

Brian Yacktman, founder and portfolio manager of Yacktman Capital Group (Yacktman) offers a further improvement upon Graham’s and Buffett’s principles by devising a way to set up a portfolio of individual stocks so that it has the potential to protect capital during times of severe market declines while still attempting to produce above-market returns over a full business cycle.

That’s an important point, so let’s say it another way: Yacktman seeks to maximize your risk-adjusted return on capital by employing a strategy that grows your purchasing power over time no matter what economic scenario the unknown future holds.

If the Yacktman name sounds familiar to you, it’s because Brian’s father, Don, founded the Yacktman family of mutual funds in 1992 and built it into a value-style investment powerhouse. While there are lots of eager emerging money managers out there, few have the stock selection pedigree that Brian Yacktman does. Because Yacktman Capital Group was formed in 2007, its official track record is relatively short; however, Brian has over a decade of time spent honing his money management skills in personal and family accounts.

For the millions of investors on the sidelines taking a “wait and see” approach, Yacktman’s value strategy offers a way to re-enter the market with the knowledge that their portfolio will consist of only businesses with stock prices that Yacktman has purchased at a discount to their intrinsic values.

By focusing on capital preservation and superior stock selection, as opposed to matching some market index, Yacktman seeks to produce “absolute returns.” While the details of Yacktman’s methodology are proprietary, we can make some general observations about its management style based on information gathered in our due diligence process.

Yacktman’s Seven Key Insights

We noted above how Yacktman seeks out stocks that are trading at a discount to their intrinsic values, which is far easier said than done. Yacktman knows that the evaluation of a company’s intrinsic value is only as good as the analysis performed on its internal condition. As a result, it has developed an evaluation process that is based on the following seven key insights Brian has gained over his decade-plus experience in managing money:

Insight #1 – High-Quality vs. Low-Quality Businesses: Yacktman has determined that high quality businesses outperform low-quality businesses over the long haul. For Yacktman’s purposes, a high-quality business is one with high profitability, low profit volatility and minimal use of leverage (borrowing). Not only that, but high-quality stocks also tend to outperform lower quality stocks during down markets. The following graph shows the multiple needed to regain stocks’ original values based on the quality of the underlying business during the Great Depression:

Brian notes that the combination of higher returns and better downside protection can potentially preserve principal, even in a bear market scenario. This is why high-quality businesses will always be the vast majority of client holdings in the Concentrated Composite Strategy.

Insight #2 – Treat Stocks Like Bonds: If you study most value strategy approaches, you will find that they seek to determine a stock’s value by predicting all of its future cash flows and then applying an arbitrary discount rate. Instead of using this methodology, Yacktman treats stocks like bonds, in that they calculate the implied return expected from buying the stock at the current price and then determine the predictability of that return.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

While going into the calculations used is a bit involved for this article, the gist is that Yacktman seeks to calculate the stock’s forward rate of return, which then allows it to evaluate the yield spread as compared to stocks of varying quality levels. Brian says that this approach is beneficial in that it forces him and his staff to be long-term thinkers rather than being a hostage to short-term market actions.

Insight #3 – Most Investors Intend to Act Rationally, but Rarely Do: Yacktman has observed that even many professional investors approach the market with the intent to act rationally, but often find that they cannot do so. Why? Yacktman ventures that even professionals sometimes become victims of the old saying that “genius is a bull market.” In up markets, they seek out stocks that may be of lesser quality but appear to have a greater potential return. Benjamin Graham observed that this is when they stop being investors and start becoming speculators.

Yacktman, on the other hand, has structured its clients’ portfolios such that they not only have the potential to withstand market shocks, but actually benefit from these scary periods. In addition, Yacktman may actually buy more quality stocks when this irrational fear drives down the stock price of good businesses.

Insight #4 – Maintain the Proper Level of Concentration: Yacktman’s Concentrated Composite Strategy carries that name for a reason. Yacktman generally limits the number of stocks held under this strategy to anywhere from 15 to 30 holdings. By doing this, Yacktman seeks to maximize returns while minimizing volatility as measured by standard deviation.

Having too few holdings can subject a portfolio to too much risk from a single stock, but too many holdings can dilute the value added by Yacktman’s fundamental analysis. Brian calls the process of holding too many stock positions “de-worsification.”

Insight #5 – Taxes Matter: Unlike many other money managers, Yacktman is committed to earning the bestafter-tax returns possible. Historically, turnover has been low and holding periods usually extend beyond one year, so capital gains tend to be long-term in nature. Many of the holdings in Yacktman portfolios also pay dividends, which are also currently subject to special tax treatment.

Insight #6 – Fees Matter: Absolute return strategies such as Yacktman’s are often found in so-called hedge funds, which typically charge a base fee of 2% plus an incentive fee of 20% of any profits. Yacktman’s management fee starts at 2% and can be even less for larger accounts, and there is no incentive fee on profits. [Also note that Halbert Wealth Management shares a part of the 2% fee, so our involvement does not result in any additional cost.]

Insight #7 – Incentives Matter: Last but not least, Yacktman has observed that many investment managers are more interested in selling products and receiving a commission than in providing solutions. The asset-based fee structure discussed above provides an incentive for Yacktman to grow accounts over time. Plus, Brian notes that he and his staff have virtually all of their own money invested alongside his clients in the various programs he manages.

Brian notes that he has an additional special incentive in that his family (including his father, Don) and friends are also investors in his strategies. Plus, I have my own money invested with Yacktman, just as I do with every money manager that we recommend to our clients.

Yacktman’s Risk Management Techniques

Yacktman defines risk as a permanent loss of capital and seeks to minimize risk of loss in a variety of ways. As noted above, buying stocks at a sufficient discount provides a margin of safety during market declines. The quality of the companies purchased is also an important risk management feature. As a general rule, the better the quality of the company, the quicker it can recover from market declines.

The use of individual stocks rather than mutual funds is another way Yacktman controls risks. The level of fundamental analysis performed by Yacktman does not work if applied to a stock mutual fund, since such funds consist of a constantly changing collection of stocks. Plus, using Brian’s term, a “de-worsified” mutual fund is more likely to follow the major indexes during market downturns, while a portfolio of carefully selected individual stocks may actually rise during down markets, depending upon the types of businesses held and market conditions.

A final risk management feature is that Yacktman invests in stocks without regard to their market capitalization. Yacktman is not “pigeon holed” into any particular size of business, freeing the firm to select only the best opportunities across a wide spectrum of market caps.

It is important to note that Yacktman does not move to cash in bear markets or downward corrections. In fact, they may buy more stocks if the downtrend makes them more attractive from a pricing perspective.

Performance Evaluation

From its inception in November of 2008 through April of 2012, the Yacktman Concentrated Strategy has produced an average annualized gain of 18.4% compared to 13.5% for the S&P 500 Index, with dividends. Yacktman’s worst drawdown was -15.83%, significantly lower than the S&P 500 Index’s drop of 23.24% over the same period of time.

Brian cautions that future drawdowns could potentially be considerably larger than the -15.83% losing period noted above, especially should we have another blowout like the 2007 – 2009 bear market when the S&P 500 Index lost over 50% of its value. However, since Yacktman’s strategy seeks to purchase stocks below their intrinsic value and does not go to cash in down markets, Brian expects that any short-term drops in value would be made up in subsequent rallies, much as was the case in 2009. There are no guarantees, of course.

See the performance information below for more comparisons and detailed monthly returns. All performance information is provided net of all fees and expenses:

Be sure to read Important Notes following my signature.

The minimum account size for the Concentrated Composite Strategy is $100,000. Additional information, including administrative details, fee schedule and Advisor background can be found in the Yacktman Advisor Profile by clicking on the following link:

Click here to view the Yacktman Advisor Profile.

Conclusions

Value investing has been and will continue to be an important strategy for those of us who believe that the market can sometimes be irrational, setting up a potential gain for the knowledgeable investor. With investing legends such as Benjamin Graham and Warren Buffett going before, Yacktman has some big shoes to fill, but we believe this firm is more than up to the challenge.

We feel that one of the most important features of Yacktman’s Concentrated Composite Strategy is that it seeks to preserve capital and make money in any kind of market or economic environment. That being the case, it may be the perfect vehicle for those investors who are still on the sidelines and nervous about getting back into the market.

In the words of Benjamin Graham, “It is far from certain that the typical investor should regularly hold off buying until low market levels appear, because this may involve a long wait, very likely the loss of income, and the possible missing of investment opportunities.” (The Intelligent Investor)

More importantly, if you have money in stocks that you manage yourself, or if you own equity index mutual funds, I would seriously considering moving all or part of that money to Yacktman. While I can’t make any guarantees, I believe Yacktman will do a better job for you than doing it on your own or in equity mutual funds.

All of us have observed that there always seem to be some stocks that do well even in down markets. The problem was that we didn’t know how to find them. With Brian Yacktman and his staff, we now have a guide to lead us to the opportunities that lie undiscovered by most investors.

It is rare to be able to take advantage of an emerging money manager early in his career. It is even more rare to have an “emerging” manager with over a decade of hands-on money management experience. Rarer still is an emerging manager who learned his craft at the feet of an industry legend, his dad. We have all of these things in Brian Yacktman.

To learn more about this promising emerging manager and its value-style approach, contact us in any of the following ways:

Call one of our Investment Consultants at 1-800-348-3601 ;
Send us an e-mail at info@halbertwealth.com;
Check out our website at www.halbertwealth.com; or
Complete our Yacktman online request form.

I also invite you to sit in on a webinar featuring Brian Yacktman and Yacktman’s CEO, Will Kruger, to be held on May 24, 2012 at 1:00 PM Eastern Time (10:00 AM Pacific). The webinar will last approximately 30 minutes and will allow you to hear about this innovative value-style all-cap approach directly from the money manager. Seating is limited, so click on the following link to register today:

Click here to register for the Yacktman online webinar.

Very best regards,

Gary D. Halbert

Will The Bond Mania End Ugly?

Gary D. Halbert — Tue, 08 May 2012 22:19:00 GMT

IN THIS ISSUE:

1. Investors Shun Stocks Like the Plague
2. Bond Funds are the “Darlings” of Today
3. Treasury Bonds are Safe, Right?
4. Is Your Bond Fund Really in Treasuries?
5. How Much Lower Can Interest Rates Go?
6. Let’s Not Forget the European Debt Crisis
7. The Love Affair With Bonds May End Ugly

Investors Shun Stocks Like the Plague

Since the stock market bottom in March 2009, the S&P 500 Index has almost doubled. That’s a gain of apprx. 100% in three years, one of the strongest moves ever. Yet investors have been dumping stocks like they’re the plague over this same period. Actually, this migration away from stocks began even before the Great Recession and the financial crisis of 2008.

One of the best ways to gauge investor behavior is by looking at mutual fund inflows and outflows by category. The Investment Company Institute provides such data on a weekly basis for various types of mutual funds. The chart below illustrates how investors have shunned equity funds in droves since 2007.

I don’t have to remind readers that the S&P 500 Index plunged just over 50% in one year’s time in 2008 and early 2009. This was the worst loss that many investors had ever experienced. Many panicked and bailed out of the market at this time as you can see in the blue bars in the chart above. As you can also see, there have been only a handful of positive months where there were net equity fund inflows since then.

I remember friends telling me back then that if the stock market ever got back to anywhere near the peak, they were going to sell everything and get out to the market for good. But in looking at the chart above, we see that millions of investors bailed out before and after the S&P 500 Index topped 1300 last year. Equity fund outflows were huge in late 2010 and again last year.

Bond Funds are the “Darlings” of Today

It is impossible to know where the millions of investors that have redeemed from stock funds over the last five years put all of their money, but it is very clear that a lot of it went into bond mutual funds. Take a look at the table below.

	Domestic Equity Mutual Funds	Domestic Taxable Bond Mutual Funds

2007	-$65.3 bil.	+$97.4 bil.
2008	-$148.2 bil.	+$21.8 bil.
2009	-$28.1 bil.	+$311.3 bil.
2010	-$94.9 bil.	+$229.9 bil.
2011	-$134.7 bil.	+$136.0 bil.

TOTAL	-$471.2 bil.	+$796.4 bil.

Source: Investment Company Institute

Folks, that is one monster shift in asset classes! Investors have moved en masse out of stock funds, and many have moved to bond funds. And the trend continues this year.

ICI data shows that through the third week of April, investors pulled another $31.7 billion out of stock funds this year, whereas bond funds saw additional inflows of a whopping $100.4 billion in less than four months.

Obviously, the inflows to bond funds represent a LOT MORE investors than just those redeeming from equity funds. Investors have moved into bond funds in droves since the stock market bottom in March 2009.

To be clear, there is no way to know how much of the $471 billion that left stock funds in the last five years went into bond funds. Certainly not all of it went into bond funds. But it’s pretty clear that a lot of it went into bond funds. This has been one of the largest shifts I’ve ever seen.

Take note that of the $796.4 billion in bond fund inflows, $677.2 billion – or 85% – came in only in the last three years after interest rates had fallen to near historical lows. It won’t take much of a rise in interest rates for many of these folks to be underwater.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Treasury Bonds are Safe, Right?

Most people believe that bonds are less volatile than stocks overall. That is not always true. Ask people who owned bonds back in the late 1970s and early ‘80s. As you can see in the chart below, Treasury bonds can be quite volatile.

Most people also believe that Treasury bonds are safe, if held to maturity, because they are backed by the “full faith and credit” of the US government. Yet when you buy a bond mutual fund, you are buying shares in the fund; you do not own the underlying bonds individually. It is the fund manager that decides which bonds to own and when to sell them. In most cases, the investors don’t know when the bonds mature.

The only way to own Treasury notes and bonds with the full faith and credit of the government is to buy them directly from the Treasury or in the secondary market through a broker and hold them in your account until maturity. Bond funds are not as safe as the current public perception, in my opinion.

Is Your Bond Fund Really in Treasuries?

A lot of investors pay little attention to the underlying holdings of the mutual funds they own. Some mutual funds that claim to be bond funds may have little to no exposure to Treasury bonds. Take the PIMCO Total Return Fund, the world’s largest bond fund ($252 billion at last count). This fund is run by Bill Gross (the “Bond King”).

In early 2011, Gross announced that he was selling ALL of the fund’s Treasury bonds. The only Treasuries that remained in the fund were those with maturities of one year or less. This came as quite a surprise to many, including I’m sure, some of his shareholders.

As it turns out, Gross was early. As you can see in the chart above, T-bond yields fell further in the second half of 2011 to below 3% at one point, and the Total Return Fund missed out on some additional profits.

Of course, Gross had no way to know in early 2011 that we would have one of the nastiest debt ceiling debacles ever last summer, or that Standard & Poor’s would downgrade America’s debt rating from AAA, not to mention the worsening debt crisis in Europe. All of these things increased investor demand for Treasuries for safety reasons. This helped to push yields even lower.

I should also note that the PIMCO Total Return Fund is not a Treasury bond fund per se. Gross invests in a variety of bonds and other securities. In an interview in March, Gross said he had resumed buying Treasuries for the fund, but noted that he was still avoiding the longer maturity Treasury notes and bonds.

The point is, if you think you are in a Treasury bond fund, you probably should check the fund’s holdings to be sure.

How Much Lower Can Interest Rates Go?

Fed Chairman Ben Bernanke assures us that short-term interest rates will be maintained near zero until at least late 2014. Let me emphasize that this is the Fed’s intention, but that could change. While Bernanke still has a majority of FOMC members who agree with him, the number that do not is increasing.

Likewise, the Fed appears confident that inflation will remain low over that period as well. This, too, could change. While commodity prices have generally moved lower this spring, there’s no guarantee that they won’t surge again this summer. While the price of crude oil has dipped below $100 per barrel for the moment, it could well soar again this summer.

The Consumer Price Index rose 2.7% for the 12 months ended March, down from 2.9% in the 12 months ended February. That’s still well above the Fed’s supposed target of 2%. If inflation starts to move higher later this year, that could be bearish for bonds.

The question is, how much lower can US rates go? The benchmark 10-year Treasury Note yield is once again below 2%. One wonders how it can go much lower, unless we are headed back into recession.

In my view, the risks favor higher rates from here, not lower.

Let’s Not Forget the European Debt Crisis

Among the things that can rattle the bond market, keep in mind that the European debt crisis not been stabilized. The economies of the most troubled countries have dipped into recession. Unemployment is at record highs. I expect the situation to get worse before it gets better. More bailout loans from the European Central Bank almost certainly lie ahead.

Then there’s the latest presidential election in France in which socialist Francois Hollande defeated President Nicolas Sarkozy. Hollande has promised to roll back planned budget cuts and austerity measures and increase government spending.

To pay for his plans for increased government spending and the rollback of austerity programs and budget cuts, Hollande proposes to increase the income tax rate on those making one million euros or more a year to 75%. Never mind that doing so won’t create enough additional revenue to pay for his spending plans. Wealthy Europeans will find ways to reduce or change the nature of their income or leave the country.

Mr. Hollande’s ability to govern France will be greatly impacted by the outcome of the legislative elections on June 10 and 17. All 577 members of France’s General Assembly will be up for re-election. Currently the UMP (Sarkozy’s party) has a majority in the Parliament and is allied with the Nouveau Centre Union (NC) in forming the government. This allows the governing coalition to appoint the Prime Minister and have strong influence on the president’s cabinet appointments and policies. Should the UMP/NC coalition hold (which is likely) Mr. Hollande will find it very difficult to get anything of substance done.

Nevertheless, Hollande’s election sent shock waves through the European and Asian markets on Monday. The ongoing European financial crisis can have serious implications for our markets, as we have seen in recent months, including the bond market.

The Love Affair With Bonds May End Ugly

Mass migrations of the investment public from one asset class to another have often ended very badly. We can all remember the late 2000-2002 bear market in stocks when the S&P 500 plunged almost 50% and the Nasdaq over 70%. Investors had been in a mania for stocks during the late 1990s.

I believe what we’re seeing today qualifies as a mania for Treasury bonds. After seeing the numbers I showed you above, I suspect you would agree. I’m not predicting that the current bond bubble will end the way the dot.com mania ended, but it won’t take a huge increase in interest rates to put a lot of bond fund investors who came late to the party underwater.

At Halbert Wealth Management, we have several professionally managed bond programs that have the potential to get out of the way should something unexpected occur. One of the bond managers we recommend can go long or short in Treasury bonds.

Feel free to call us at 800-348-3601 or visit our website www.halbertwealth.com.

Three-Way Race: Romney 44%, Obama 39%, Ron Paul 13%

Finally on a political note, many Republicans have expressed serious concerns that Rep. Ron Paul may run for president as a third party Independent. They fear that Paul would drain votes from Romney, thus ensuring President Obama’s re-election.

However, a new Rasmussen poll released this morning has raised some eyebrows! In a national survey of 1,000 likely voters on May 6-7, Rasmussen found that in a three-way race, the results would be Romney 44%, Obama 39% and Paul 13%. The margin of error was +/- 3 with a confidence level of 95%.

This poll has to be a stunner for the Democrats, many of whom have been hoping that Ron Paul would run as an Independent, even though Paul has said he has no plans to do so. You can bet that the Dems are thinking just the opposite after today’s surprising Rasmussen poll!

Rasmussen’s Daily Presidential Tracking Poll taken yesterday has Romney at 49% versus Obama at 44%. This is Romney’s strongest showing this year. Romney has been trending higher against Obama since early March.

As we all know, anything can happen between now and the election in November. As always, it will come down to the Independents, many of whom are disillusioned with President Obama, but they’re not in love with Romney by any stretch. Time will tell.

Wishing you profits,

Gary D. Halbert

Social Security - The Most Neglected Crisis

Gary D. Halbert — Tue, 01 May 2012 21:08:00 GMT

IN THIS ISSUE:

1. Trustees Report: Same Song, Umpteenth Verse

2. Making the Case for a Crisis

3. Crisis? What Crisis?

4. Politicians: On the Fence (As Usual)

5. The Fix Won’t Be Easy – or Popular!

Overview

In what has now become an annual rite, the Social Security Trustees issued their annual report last week saying that the prospects for the “trust funds” are worse than they were last year and that Social Security, Disability and Medicare are all in need of repair. The American people answered with a rousing “ho-hum.” Perhaps the public is getting numb to bad news about Social Security, or maybe it was the result of the mainstream media devoting only 72 seconds of airtime to the Trustees report the day it was issued, according to the Media Research Center.

I have written about the current state of our national entitlement programs on several occasions through the years. One thing they all have in common is that the latest analysis always seems to be worse than the one before it. This year is no different and, in fact, could be seen as much, much worse.

In this week’s E-Letter, I’m going to discuss the findings of the Social Security Trustees and also review their warnings about the future if nothing is done to fix our ailing entitlements. After that, I’m going to briefly outline two schools of thought concerning Social Security’s perceived problems. Unfortunately, we’re going to find that those who can actually do something about entitlement reform will likely only give lip service to the idea.

This is an E-Letter that you need to read and pass on to your friends and relatives because everyone needs to get busy and contact their Congressmen to make sure they don’t use short-term solutions that will create long-term problems.

Trustees Report – Same Old Song

Each year, Trustees of the entitlement trusts established for Old Age and Survivor Income (OAS), Disability Income (DI), Hospital Insurance (HI) and Supplemental Medical Insurance (SMI) make a report to the public regarding the operations of the trusts over the past year and their outlook for the future. As I noted above, each year the situation becomes more dire, yet no one seems to want to do anything about it.

Since the combined Social Security Old Age and Disability Income (OASDI) Trust Funds are the most frequently referenced, I’ll limit my comments to those two in this article. This year’s report shows that the combined Social Security and Disability Income Trust Funds increased a net $68.9 billion to a total of $2.678 trillion as of the end of 2011. Not bad, eh? Well, actually it is. That’s because the $68.9 billion gain includes payments of “interest” of $114.4 billion on the special Treasury bonds held by the Trust Funds.

There are two important factors needed to put this “gain” in perspective. First, interest payments on the Trust Fund debt are made by issuing more of the special Treasury bonds that they already hold. So when the Trustees say interest earned, what they mean is that the government is making an accounting entry to issue itself more IOUs.

Second, without this ledger-entry income, benefit payments and expenses outpaced Trust Fund non-interest income in 2011, as they did in 2010. Total revenues from payroll taxes and other sources came to $690.8 billion while benefit payments and expenses were $736.1 billion. That’s a shortfall of $45.3 billion. Not a huge amount compared to today’s trillion-dollar budget deficits, but the Trustees warn that this deficit will continue throughout its 75-year projection period.

Here’s a link to a summary of the Trustees report, which includes tables supporting the numbers I have quoted above as well as lots of other charts and graphs:

http://www.ssa.gov/oact/TRSUM/index.html

And the bad news doesn’t stop there. According to the Trustees, the combined Social Security and Disability Income Trust Funds are going to be depleted by 2033, two years earlier than predicted just last year. If you don’t combine the two, the DI Trust Fund will be exhausted as soon as 2016.

So what happens on that sunny day in 2033 when the Trust Funds run out of money? Since, by law, benefit payments are not supposed to come from general revenues, the most obvious result is that benefits will have to be immediately cut to a level that can be supported by ongoing tax revenue. The Trustees report estimates this haircut to be in the 25% range, such that benefits will fall to 75% of their previous levels. Of course, this assumes that no remedial action will have taken place by then, which is probably a pretty good assumption.

So here’s the situation in a nutshell:

Social Security is spending more than it takes in if you don’t count interest paid in the form of government IOUs, and by 2020, even these bogus interest payments won’t keep it above water.
The combined Social Security and DI Trust Funds are expected to run out of money in 2033, and probably sooner than that since each Trustee Report seems to move the date closer and closer to the present.
When the Trust Funds begin to be drawn upon, the federal government will have to borrow money from the public (or foreign investors) to redeem these special bonds, adding to the debt that has to be serviced with real money and not just IOUs. (For more information on how this works, see my June 28, 2011 E-Letter.)
The Trustees report estimates that the federal government is on the hook for future promised benefits equal to $8.6 trillion over the next 75 years. This is over and above what the government expects to take in via payroll taxes. The Trustees call this an “unfunded liability,” but I call it a pipe dream.
As has been the case since the beginning of the financial crisis, payroll tax revenues and Trust Fund performance have been worse. Higher unemployment means fewer people working who are subject to payroll taxes. Plus, as I wrote last week, many who have exhausted their unemployment compensation are filing for Social Security disability, putting an even greater strain on that program.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Raising the Alarm

In this year’s report, the Trustees again go on record saying that a solution to Social Security’s funding problems needs to be found, even though it may be politically unpopular. The Trustees put it this way in their 2012 Report:

“Lawmakers should not delay addressing the long-run financial challenges facing Social Security and Medicare. If they take action sooner rather than later, more options and more time will be available to phase in changes so that the public has adequate time to prepare. Earlier action will also help elected officials minimize adverse impacts on vulnerable populations, including lower-income workers and people already dependent on program benefits.”

When I wrote about Social Security back in 2004, I discussed Alan Greenspan’s warning about its future solvency (or lack thereof). No matter what you think of Greenspan’s legacy, his Social Security Commission in the 1980s led to meaningful reforms, passed by a Congress that actually took some action regarding the program’s future solvency. Of course, they subsequently spent all the money and replaced it with government IOUs, so let’s not give them too much credit.

As Congress has now seen fit to spend all of the money in the trust funds, Greenspan’s warnings from 2004 still ring true. Back then, he told Congress that the then-upcoming retirement of Baby Boomers would lead to Social Security experiencing “one of the most difficult fiscal situations” in its history. “This dramatic demographic change is certain to place enormous demands on our nation’s resources – demands we almost surely will be unable to meet unless action is taken.”

Congress’ response then? None (What a surprise!). I do believe that there are members of Congress today who are in favor of reforming Social Security, but the political consequences of trying to do so are very high. Even debating the issues can be risky from a political standpoint.

Numerous other conservative writers and think tanks have also written about the recent Trustees report but, as I noted above, the mainstream media has largely ignored it.

Crisis? What Crisis?

While you might assume everyone would be on the same page in relation to the Social Security Crisis, there are those who are adamant that no such crisis exists. These folks consider the payment of interest in government IOUs to be just as good as gold. One such organization is the National Committee to Preserve Social Security & Medicare (NCPSSM).

While NCPSSM is certainly not alone in having this opinion, I’m going to use its position as an example in this section as it is representative of many other organizations and politicians who firmly believe that Social Security is in no danger of becoming insolvent.

In a recent USA Today article, NCPSSM CEO, Max Richtman” declared, “There’s no Social Security crisis.” In a separate article discussing the latest Trustees report, the NCPSSM noted how positive the report was regarding Social Security’s finances saying the program “remains strong” and is “well-funded.” Did they read the same report that I did? I don’t think so!

Rather than future solvency, NCPSSM’s biggest concern is the talk about changing the automatic cost of living adjustment (COLA), a benefit that was not even part of Social Security until 1975. (Before that, benefit increases literally took an act of Congress.)

Most interesting, however, is the disconnect when talking about cuts. NCPSSM and others contend that changing the way automatic COLAs are calculated would represent a serious cut in future benefits for Social Security recipients. Benefits would still be adjusted upward, just not as much as under the current COLA formula. So, a decrease in an increase is a cut, in their opinion, even if it helps maintain the long-term solvency of the program.

In the very same article, however, NCPSSM notes that “Social Security remains strong, despite the lingering effects of the recession, and will be able to pay full benefits for decades to come - until 2033. Thereafter, there will still be enough revenue coming into the program to pay 75 percent of all benefits owed.” It’s almost like it’s no big deal that benefits might drop 25% after 2033, a short 21 years from now. Other sources maintain that COLA adjustments will have increased benefits to a point that in 2033, the benefit received after a 25% cut will still be more than today’s benefit level, so it’s not really a cut.

Sorry, but that IS a cut and it’s a lot bigger than modifying the COLA formula. It’s like your employer reducing your salary by 25% today but pointing out that you still make more than you did 21 years ago, so it’s not really a cut. It’s one of those arguments that you just have to read and say “Huh???”

So what’s the difference? Isn’t a cut a cut? Well, not when one comes in 2033 and the other would be more immediate. In fact, as you continue to read, you’ll find that this distinction between now and later pretty much outlines much of the debate about Social Security reform.

Politicians: On the Fence (As Usual)

So where are our leaders on this issue? Some can be easily identified as helping to raise the alarm while others are confident that there’s no problem. Many, however, fit in a category that’s all talk and no action (what else is new?). They give lip service to wanting to reform Social Security but do little or nothing to bring it about. Even so, their soothing words are supposed to comfort us as we hurtle toward retirement.

Tim Geithner is one example, who is on record as saying, “The best thing to do is a long-term solution.” Wow, what insight! That’s kind of obvious, isn’t it Tim? The Obama administration is also on record as supporting changes to Social Security that would improve the program’s solvency, but as a recent Wall Street Journal article pointed out, Obama has yet to propose any concrete steps to greater stability of our entitlement programs.

In fact, the same Journal article said that Social Security is yet to emerge in the political debate in this election year because its financial problems remain decades away. Translation: It’s a problem for a future Congress. Plus Gray Americans vote and in large numbers. As Baby Boomers continue to age, the gray generation will just become larger and larger, meaning more and more likely voters.

This brings about a sobering thought: We may have already passed the age demographic where meaningful reforms to Social Security and other entitlement programs are even possible, due to the voting habits of those who would be most affected by any changes.

The Fix Won’t Be Easy – Or Popular

There are a variety of "fixes" for Social Security, some of which I have written about before in past E-Letters. As I have noted above, however, each proposal would hurt someone by either increasing taxes or decreasing benefits (or both), none of which are politically palatable.

Below I have briefly listed some of the major fixes that have been proposed over the years. While these are not my ideas, I have provided some comment here and there. Each of these suggestions could be an E-Letter on its own, so my brief descriptions are not intended to be complete reviews, but rather just an idea of alternatives available to Congress:

Increase the normal retirement age, preferably to age 69 or 70. This option is often met with resistance, but the fact of the matter is that life expectancies are much longer than they were in the past. While some say that this option would not be tolerated, you have to remember that the Congressional response to the Greenspan Commission recommendations gradually increased the retirement age from 65 to 67.
Increase early retirement age to 65 or 67. This might actually be more important than increasing the normal retirement age. When Congress changed the normal retirement age to 67, it did not adjust the early retirement age. Increasing the early retirement age might have a beneficial effect on the program’s long-term stability.
Increase the employer and/or employee payroll tax rate. Increasing taxes is one way to cure the problem, but has a major downside both politically and economically. Increasing taxes during a shaky recovery could lead us back into recession. Plus, higher employment taxes on employers would reduce the bottom line, thus affecting profitability and possibly employment. Payroll taxes are also regressive, so an across-the-board tax increase on all employees would likely put pressure on those least able to afford it. Plus, recall that employees have enjoyed a 2% payroll tax break since January 2011, so even getting back to normal taxation will feel like a tax increase.
As a practical matter, if taxes were to be raised all it would do is provide Congress with another slush fund to spend on its pet projects. Any real solution involving surplus revenues must address the issue of how these are invested so that Congress does not have the power to empty the Social Security coffers again.
Soak the rich. In what has become the most popular cause of the day, where we see even the rich saying to soak the rich, there are various ways to cure the regressive nature of payroll taxes on lower-income workers. One would be to make all wages subject to Social Security taxes. Currently, taxes for all but Medicare stop at $110,100 of earnings. Removing this cap from income subject to Social Security taxes would, proponents say, go a long way in curing the program’s financial ills.
One issue that is usually mentioned when discussing this option is that, under the current system, those making over $110,100 would then have to start getting benefits based on salary in excess of that amount. Thus, while income would increase, so would future benefit payments. To make this work, the government would have to unhitch Social Security from the myth of it being a way to set aside money for retirement so that taxes could be levied without any expectation of a higher benefit.
Needs test Social Security benefits. This option is popular because it also only affects the "rich," who have been demonized of late. This option would involve decreasing or even eliminating Social Security payments for those who have significant other assets. The line of thought goes something like, “Why does Warren Buffett need a monthly Social Security check?”
Of course, this again requires that the myth of saving for retirement be uncoupled from payments of payroll taxes, since even many millionaires will complain that they have “paid in” for this benefit. The government has already made benefits taxable (another form of cutting benefits) for those with higher retirement incomes, so the mechanism exists to scale them back or eliminate them entirely.
The problem with any “soak the rich” alternatives is that there are lots of other tax increases aimed at this demographic group. Means testing would be among the least currently visible changes, but should Obama get his way and impose higher taxes on the rich, the cumulative effect could be significant. So much so that the wealthy might decide to defer compensation, or take it in a different way that might escape payroll taxes entirely.
Modify the cost of living adjustment. Since 1975, Social Security benefits receive automatic annual COLA adjustments to help keep up with inflation. Well, that was until 2010 and 2011 when inflation was so low that no adjustment was made. Even so, there are some, including Alan Greenspan, who feel that the measure of inflation for purposes of increasing benefits should be changed.
The result would be a consumer price index that is somewhat lower than the one currently used. As I noted earlier, this would result in decreasing the increases, which some consider to be a benefit cut. However, even small differences in COLA adjustments could mean huge long-term savings, especially with the Baby Boomers beginning to retire. This is one solution that would be easy to implement, but is strongly opposed by many politicians and senior organizations.
Privatize Social Security. I’m sure you’ll remember the debate about privatizing Social Security several years ago. I won’t go into details, but the idea is that you can invest your money better than the government can, so all or part of payroll taxes should be placed in a fund that you can manage. While some advocates of Social Security reform still support this idea, two bear markets in less than one decade have dampened the thought of sending workers en masse into the stock and bond markets, especially when Social Security is supposed to be a “safety net.”

Again, these are the most common suggestions for reforming Social Security. There are others such as moving Social Security under the general budget to cover its shortfall, but space doesn’t permit mentioning all of the various alternatives. Almost certainly, it will take some combination of the above noted reforms if Social Security is to be saved. The last president to push for Social Security reform was George W. Bush, and he was roundly dismissed.

Of course, options are just that until someone makes the effort to review, analyze and debate which single or combination of solutions is best. There’s no alternative that will result in no one paying more taxes or having benefits cut, so none will be universally popular. However, it’s time for someone to show some leadership. Someone should take a page from President Ronald Reagan’s playbook when, in 1981, he established a commission led by Alan Greenspan to reform Social Security.

Some two years later, as a result of that commission’s work, amendments to Social Security included a provision for raising payroll taxes AND the full retirement age from age 65 to 67, phased in over time. At the time, the Congress cited improvements in the health of older people and increases in average life expectancy as primary reasons for increasing the normal retirement age.

Conclusion

There isn’t much to say in conclusion about a problem that is getting worse every year, except that it is unlikely to be fixed before it becomes a true crisis. My prediction is that I’ll be writing another article about the same subject next year about this time, except that the future prospects will be even worse.

It is for this very reason that my firm often counsels clients, especially those with large nest eggs, to minimize any reliance on Social Security benefits in their retirement planning. That way, if means testing reduces or eliminates their benefit, it won’t derail the plan. And if that doesn’t happen, then retirement income is higher than expected, which is always better than being lower.

Hoping for meaningful reform,

Gary D. Halbert

Is The Economic Recovery Stalling?

Gary D. Halbert — Tue, 24 Apr 2012 21:19:00 GMT

IN THIS ISSUE:

1. Bond Auctions in Spain and France Just OK

2. Fears Rise That the US Economy is Faltering

3. Fed: Is QE3 Really Off The Table?

4. 5.4 Million Join Disability Rolls Under Obama

Overview

Economic reports in recent weeks have been disappointing overall, and there are growing concerns that the economic recovery may be slowing following 3% GDP growth in the 4Q of last year. As I have written in previous weeks, the 3% GDP number for the 4Q was largely buoyed by inventory rebuilding, which is believed to have slacked off considerably in the 1Q of this year.

Thus, all eyes will be focused on this Friday’s first report on 1Q GDP. Only a month or so ago, some worried that the 1Q GDP number could come in below 2% due to the slowdown in inventosry rebuilding. But as you’ll read below, most pre-report estimates for 1Q GDP are north of 2%.

Assuming Friday’s GDP number comes in above 2%, I don’t expect too much of a reaction in the markets. A number below 2% would likely be quite negative, while a number of 3% or more would be a positive surprise. In any event, I will analyze the GDP report in my blog on Friday.

Whatever the GDP number is on Friday, there is a feeling that the economic recovery is stalling a bit. Some of the same spoilers that interrupted the recovery in 2010 and 2011 have emerged again this year, raising fears that the winter’s economic strength might dissipate in the spring and summer.

In addition, the Fed Open Market Committee is meeting today and tomorrow. Since we won’t see the policy statement from the meeting until tomorrow, we can only speculate as to whether the Fed discussed any new stimulus at this meeting. I’ll give you my thoughts below.

Finally, a record 5.4 million workers and their dependents have signed up to collect federal disability checks since President Obama took office. Many unemployed apply for disability benefits as soon as their unemployment benefits run out. There are now a record 10.8 million Americans on disability – double the number since Obama took office.

Before we get into those discussions, I will give you a brief update on the outcome of the debt auctions in Europe last week. In a nutshell, the auctions went a little better than expected.

Bond Auctions in Spain and France Just OK

The good news is that Spain and France were able to sell all the government bonds they wanted to sell at last Thursday’s debt auctions. The bad news is that the rate on Spain’s 10-year bonds rose to near 5.8%, up from 5.4% in January. At least the rate didn’t climb over 6% as it did in the secondary market early last week, as many feared. However the rate did rise to 5.9% in the secondary market just after the auction.

There was one other worrying note to the auction. Spanish banks, fresh with cheap money from the ECB, were the biggest buyers of the bonds, along with other institutions, while foreign investors continued to reduce their holdings of government securities. While the auction was mildly better than expected, Spain is far from being out of the woods. Italy’s next big bond auction is this Friday. There are concerns about that auction as well.

Expect the European debt crisis to continue to make news. Country after country in southern Europe is struggling with debt and austerity measures which are driving their economies into recession. France’s president Nicholas Sarkozy appears to be on his way out, to be replaced by a socialist candidate who promises to reverse some of the austerity measures. The Dutch government appears to be breaking up for similar reasons.

The bottom line is that the European debt crisis is ongoing and may serve as a lid on global equity prices for some time to come.

Fears Rise That the US Economy is Faltering

As noted above, the US economic recovery is facing some stiff headwinds. Those include high gasoline prices, the recession and higher interest rates in Europe and the recent disappointing unemployment numbers in the US, just to name a few.

The apparent slowdown in the recovery recently is in part due to the unusually warm winter, which served to pull economic activity forward in January and February, thus making March and April so far look softer. With this analysis, some in the mainstream media concluded that we don’t have a problem with the economy. Maybe so, but the recovery has had an uneasy feeling about it recently.

The International Monetary Fund (IMF) held its spring meeting in Washington at the end of last week, and it was clear from comments made by the central bankers that they have concerns about the US recovery slowing down. Christine Lagarde, managing director of the IMF said: “There is a light recovery blowing in a spring wind with dark clouds on the horizon.”

The IMF’s chief economist, Olivier Blanchard added: “An uneasy calm remains. One has the feeling that any moment, things could well get very bad again.” He is particularly concerned that the ongoing recession in Europe will have negative effects on the US recovery.

Treasury Secretary Geithner was trotted onto the Sunday talk shows on April 15 and even he acknowledged that the recovery has been slow of late and cautioned that headwinds remain. There’s a real feeling of concern out there when even the White House admits it.

Given that, let’s take a look at some of the latest economic reports.

Housing reports released last week were weaker than expected, leading many forecasters to predict a further drop in home prices later this year. Industrial production was flat in March for the second month in a row, and below pre-report expectations. Construction spending fell 1.1% in the latest report.

Weekly initial claims for new unemployment benefits were significantly higher than expectations over the last two weeks at 380,000 and 386,000 respectively versus 357,000 in the last week of March. The initial claims report for the third week in April will be out on Thursday, and the pre-report consensus is for a number of 373,000. I think that number would still be considered high.

The March unemployment report earlier this month showed that only 120,000 new jobs were created last month, down sharply from 285,000 and 233,000 respectively during the two previous months. All this led numerous forecasters to predict that the national unemployment rate for April will rise above the 8.2% mark for March.

All the news was not negative, however. Retail sales rose a better than expected 0.8% in March. The index of leading economic indicators was up 0.3% last month. The ISM manufacturing index climbed a point to 53.4 in March. And building permits were up a better than expected 4.5% in March.

Of course, this Friday’s 1Q GDP report is critically important. Of the 50 economists surveyed by Blue Chip Economic Indicators, the predictions ranged from a high of 2.9% to a low of 1.8% with an average of 2.2% (annual rate). As this is written, the pre-report consensus is for a rise of 2.5%. The 1Q GDP report will be released on Friday at 8:30 EDT.

As usual, I will analyze the GDP report in my blog on Friday – click here to sign up if you haven’t already – it’s free).

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Fed: Is QE3 Really Off The Table?

The Fed Open Market Committee (FOMC) that sets monetary policy is meeting today and tomorrow in Washington. The markets always pay a lot of attention to the policy “statement” which is released just after the meeting ends in the early afternoon. That will happen tomorrow, and I don’t expect any significant changes to the statement this time.

To get the details on what the FOMC members actually discuss in these closed-door meetings, you have to wait until the “minutes” of the meeting are released. For example, the minutes from the March 13 meeting were released on April 3. Warning: these minutes are very boring, but I have to look at them – at least the policy sections (good thing I’m a speed-reader).

When the latest minutes came out on April 3, there was a fairly broad consensus that the FOMC had ruled out any further quantitative easing, or QE3. In fact it was largely this consensus on QE3 that sent the stock markets lower earlier this month.

I didn’t read the March 13 minutes that way. In my view, the FOMC once again left all options on the table. The specific policy options were unchanged from the previous meeting: 1) Keep the Fed Funds rate near zero at least until late 2014; and 2) continue to extend the maturities of existing securities (“Operation Twist”). But then there is the following paragraph that was unchanged from the previous meeting:

“The Committee also stated that it is prepared to adjust the size and composition of its securities holdings as appropriate to promote a stronger economic recovery in a context of price stability. A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate-consistent rate of 2 percent over the medium run.” [Emphasis added.]

This language clearly suggests, to me at least, that QE3 is still an option. As I discussed at length in my March 13 E-Letter, the Fed is still very concerned about the economic recovery which, as discussed above, appears to be weakening. It will be very interesting to see what the Fed has to say about the recent pace of the economy in its policy statement tomorrow.

Following the last several FOMC meetings, the policy statement noted that the US economy has been expanding moderately. For example, here are excerpts from the March 13 policy statement:

“Information received since the Federal Open Market Committee met in January suggests that the economy has been expanding moderately. Labor market conditions have improved further; the unemployment rate has declined notably in recent months but remains elevated. Household spending and business fixed investment have continued to advance.” [Emphasis added.]

Here are the key points to watch for in tomorrow’s Fed policy statement. It will be very important to see if the Fed alters this language to note that the economic recovery appears to be slowing down in the policy statement tomorrow. It will also be important to see if the Fed alters any of its prior language regarding keeping the Fed Funds rate near zero into late 2014, or if it changes the language regarding Operation Twist.

If the Fed fails to acknowledge that the economic recovery is slowing down in the statement tomorrow, then I think it’s safe to assume that QE3 is not going to happen just ahead. On the other hand, if the Fed does acknowledge that the economy is slowing down, then I would not rule out a decision to enact QE3 (or extend Operation Twist) at the June 19-20 FOMC meeting.

Unfortunately, we won’t see the minutes from this week’s FOMC meeting until the middle of next month. Only then will we know what the FOMC members really talked about today and tomorrow. As usual, I will write about this when the minutes are made public (most likely in my blog on May 18 – click here to sign up if you haven’t already – it’s free).

And one final note on the Fed: Don’t automatically believe the media’s take on the Fed’s policy statement tomorrow. The financial talking heads often misinterpret the Fed’s policy statements. Keep that in mind as you hear the spin tomorrow following Chairman Bernanke’s post-meeting press conference. It will be very interesting to see if he even hints at more QE – I doubt it.

5.4 Million Join Disability Rolls Under Obama

A record 5.4 million workers and their dependents have signed up to collect federal disability checks since President Obama took office, according to the latest official government data. The problem is that discouraged workers who are unemployed are increasingly giving up looking for jobs and taking advantage of the federal disability program.

Since the recession ended in June 2009, the number of new enrollees to Social Security's disability insurance program is twice the job growth figure as you can see in the chart at left. In just the first four months of this year, more than 725,000 put in disability applications, and more than 539,000 (74%) were accepted.

As a result, by April there were a total of 10.8 million people on disability, according to Social Security Administration data released last week.

Even worse, data released by the White House stated that “…workers on SSDI rarely return to the labor force.” [Emphasis added.] To me this is the saddest part of this story: once you go on disability, you’ll probably never get off of it.

This is straining already-stretched government finances while posing a long-term economic threat by creating an ever-growing pool of permanently dependent working-age Americans. Even after accounting for all those who've left the disability rolls – some 700,000 drop out each year mainly because they hit retirement age or died – that’s up 53% from a decade ago.

The biggest factor in the recent surge is the slow pace of the economic recovery after the severe recession. That has kept the unemployment rate above 8% and created an enormous pool of long-term unemployed and discouraged workers. More than 5 million people have been jobless for 27 weeks or more, nearly twice the previous high set in 1983, according to the Bureau of Labor Statistics.

Boston College's Center for Retirement Research says that a lot of unemployed people apply for disability as soon as their unemployment insurance expires. The number of disability applications last year was up 24% compared with 2008, according to Social Security Administration data.

The explosive growth in disability enrollment also helps explain some of the drop in the labor force “participation rate” – the share of working-age people who have or are looking for a job. The participation rate has fallen to 63.8% compared with 65.7% at the start of Obama’s term.

Ironically, this drives down the unemployment rate, which simply measures how many people are looking for work but haven't been able to find it. When people quit looking or sign up for disability benefits, they no longer count as unemployed.

As noted above, the problem is that few people who get on disability will ever participate in the labor force again. As a result, the rapid increase in the number of disabled is a huge drag on the economy and will be for a very long time.

How Do So Many (74%) Qualify?

At this point, you are probably asking, how did so many of the unemployed qualify? As noted above 74% of all disability applicants were accepted so far this year. Has some mysterious force caused more people to become disabled than ever before? Hardly.

No, given the fact that unemployment has remained so high for so long, more and more Americans are seeing their unemployment benefits expire. Many view disability insurance as an extension of their unemployment benefits.

In reality, many applicants are turned down during the initial medical screening process, especially those who apply on their own without legal assistance. Increasingly, however, applicants who are turned down initially decide (or are advised) to appeal the decision, which they have a right to do.

Also more and more applicants are appealing with the help of lawyers. Apparently, if you get a lawyer, you get accepted pretty much automatically. I’m sure you’ve seen TV ads for such attorneys, usually on late-night TV (what else is new?).

Reasons for applying can be as vague as simple “pain and discomfort” or “multiple non-severe ailments” or “mental illness.” These and many other claims are difficult to disprove. According to a study by the National Bureau of Economic Research, many applicants who were denied initially returned with lawyers and claimed different ailments than they cited on the first application. Again, if you get a lawyer, you get accepted virtually automatically.

Reform ideas that would cut the ranks of those on disability have been bandied about for years. They include tightening eligibility rules, giving workers more options other than full-time disability and offering tax incentives for disabled workers to stay in the workforce. So far, the reform ideas have spurred little action.

So along with a new record number of Americans living in poverty (a topic for another time), we have an all-time high number of Americans on disability. This is a travesty on so many levels!

Very best regards,

Gary D. Halbert

European Debt Crisis Never Went Away

Gary D. Halbert — Tue, 17 Apr 2012 22:13:00 GMT

IN THIS ISSUE:

1. Spain May Become Greece, Only Much Bigger

2. Europe Can’t Kick the Can Much Further

3. Spain Could Send Global Equities Into a Tailspin

4. There Are Times to be Defensive

Spain May Become Greece, Only Much Bigger

US stocks are having a big day today, with the Dow up just over 200 points as this is written. But there are problems lurking in Europe that could be quite negative for global equities over the next several weeks. There are fears that Spain and perhaps Italy will need more bailout loans in the weeks just ahead. That’s our topic for today.

In December and January the European Central Bank (ECB) took the unprecedented step of loaning apprx. 1 trillion euros to European money center banks in an effort to buy some time for the banks to recapitalize. The loans had three year maturities, and the interest rate was an incredibly low 1%.

It is widely believed that the banks used most of the 1% ECB money to buy sovereign bonds of their own governments at much higher interest rates. Instant profit, crisis solved, some believed. By February of this year, interest rates on European government debt had retreated to “normal” levels. Most analysts predicted that the massive ECB loans would buy at least a year, if not longer, for the troubled countries which, in the meantime, would implement serious austerity measures to hopefully get their fiscal houses in order.

Yet over the last few weeks, the unexpected has happened – bond rates in countries like Spain and Italy have started to rise again to dangerously high levels. Ten-year Spanish bond yields climbed to the highest level since the ECB started allocating three-year loans in December. As you can see in the chart below, Spain’s 10-year bond yield soared to near 7% late last year, and many feel this is the reason the ECB finally implemented the €1 trillion of emergency loans.

Yields on Spanish bonds spiked last week and yesterday on news that Spain’s major banks increased borrowing from the ECB by almost 50% in March, reaching the most on record. The increase in Spanish yields caused rates to rise in other countries in the region. Italy’s 10-year rate rose above 5.5%. All of this is causing renewed fears that the financial crisis in the Eurozone is intensifying.

Making matters worse, Spain’s economy has moved back into recession. Finance minister Luis de Guindos confirmed that Spain has tipped back into recession, with a 0.3% GDP contraction in the 1Q. He expects the economy to shrink by 1.7% this year. Among others, Citigroup believes that the recession in Spain could be much worse. Overall unemployment is already 23.6% and for those under age 30, the rate is 50%. The Spanish stock market has plunged 30% over the last year and fell 3.6% last Friday alone.

To put what has happened over the last few months in perspective, let’s turn to a good (and understandable) analysis of the situation by Desmond Lachman, writing for RealClearMarkets.com last Thursday.

QUOTE:

Europe Can't Kick the Can Much Farther

By Desmond Lachman

Evidently EUR 1 trillion does not buy very much in Europe anymore. Judging by the financial market's renewed unease about Italy and Spain over the past week it would seem that all that the European Central Bank's EUR 1 trillion liquidity injection in the European banking system bought was around four months of relative market calm.

In December 2011, in response to signs of acute funding problems for the European banking system, as well as in reaction to a marked increase in Italian and Spanish bond yields to unsustainable levels, the European Central Bank (ECB) embarked on a highly aggressive new round of quantitative easing. It did so by providing European banks, in two installments, unlimited amounts of three-year financing at a 1 percent interest rate through its Long-Term Refinancing Operation (LTRO). By February 2012, the European banks had availed themselves of this cheap ECB funding to the tune of a staggering EUR 1 trillion.

Yet, by early April 2012, Italian and Spanish bond yields were again rising towards unsustainable levels. Indeed, after declining to a low of around 4.8 percent in January 2012, the 10-year Spanish bond yield has again risen to 5.90 percent. Meanwhile Italian bond yields are back up to over 5.5 percent. Most economic analysts would consider that these bond yields are inconsistent with Italy and Spain's long-term public debt sustainability.

More ominously still, despite the European Central Bank's staggering largesse, the Italian and Spanish economies have now moved back into recession. Furthermore, high frequency data suggest that those economies' recessions are now deepening. The IMF current projection that those two economies will each contract by around 2 percent in 2012 might very well prove to be overly optimistic.

The increase in Italian and Spanish interest rates, coupled with the continued slump in their economies, sits very oddly with recent claims by European policymakers that the worst of the European economic crisis is behind us. To be sure, the ECB's LTRO program did avert a massive funding crisis for the European banking system by providing them with vast amounts of secure and very cheap three-year ECB funding. And the LTRO program also provided temporary support to the Italian and Spanish bond market and gave a sense of calm in the European financial markets by encouraging Italian and Spanish banks to use the cheap ECB financing to buy their governments' bonds.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

However, what the LTRO program has not done is to restore the conditions for economic growth in the European periphery. In particular, it has not relieved countries in the European periphery from having to undertake draconian fiscal adjustment as part of the European Union's recently agreed fiscal pact. That pact is requiring countries like Ireland, Italy, Spain and Portugal to cut their budget deficits by between 2 to 3 percentage points of GDP a year in both 2012 and 2013. And this is being required of them in the middle of major domestic economic downturn and a deteriorating external environment, without the benefit of a currency devaluation to help boost their exports.

The LTRO program also has done nothing to address the European banks' capital shortage problem, which last June the European Banking Authority estimated at around EUR 115 billion. The latest ECB bank lending survey clearly shows that this capital shortage is inducing the European banks to restrict credit, which is compounding the deleterious impact on economic growth of major fiscal austerity. As the European economy sinks deeper into recession, one has to expect that the European banks' loan losses will only increase, which will cause these banks to cut back further their lending.

Far from being fickle as European policymakers are wont to portray them, markets are now correctly sensing that Europe's policy mix is highly pro-cyclical in nature and that weakening economies will make it very difficult for countries like Italy and Spain to address their public finance programs within the Euro straitjacket and without a debt restructuring. If the past is prologue to the future, however, one must expect that the European policymakers will blame the markets for delivering the message while they will continue to remain in denial about the bankruptcy of their policy approach to the European debt crisis.

Instead one must expect that the European Central Bank will find a way to pull yet another big rabbit out of the bag to kick the can further down the road. However, given how rapidly the effects of their massive LTRO program has faded, one would think that even the ECB must recognize that they are running out of road down which to kick the can. [Emphasis added.]

Desmond Lachman is a resident fellow at the American Enterprise Institute.
END QUOTE

Mr. Lachman suggests at the end of the article that the ECB may be willing to extend more cheap loans to Spain and the other periphery nations of Europe, in addition to the €1 trillion it has recently doled out. That may be true but as we are now seeing, the perceived benefits of these bailout loans are increasingly fading.

The bond market is the ultimate arbiter on the subject of how much debt is too much. We saw it in Greece. We may be seeing it now in Spain. Italy may not be far behind, what with the recession unfolding across these nations and others in Europe. The same will be true in the US at some point, but that’s another subject for another time.

Spain Could Send Global Equities Into a Tailspin

On Thursday, Spain will auction another round of 2-year and 10-year government bonds. If the rate on these bonds rises above 6%, which is quite likely, this could put the European debt crisis right back on the front pages. If that is the case, this could roil stock markets around the world.

Italy has its next large bond auction on April 27. Spain has another large bond auction on May 3. Traders around the world will be watching these debt auctions very closely. Thus, it will not surprise me if the European debt crisis – which was supposed to be a non-event at least through the end of this year – roars right back onto center stage, if it hasn’t already by the time you read this.

Greece was one thing; Spain and Italy are quite another. Greece’s GDP is $301 billion; Spain’s GDP is $1.4 trillion; Italy’s is $2 trillion. As my old friend John Mauldin wrote in his letter on Saturday, “Spain is too big to fail and too big to save.”

The latest decline in the US stock markets began just as news of rising European bond rates began to surface earlier this month. Most everyone was surprised by the latest news which started making headlines last Friday. Here’s an S&P chart from freecharts.com:

If the upcoming debt auctions in Spain and Italy don’t go well, I expect this news will weigh heavily on stock markets around the world, especially since this problem was thought to be “fixed” for at least a year. This is precisely why you are not hearing a lot about this in the media. But if the yield on Spanish bonds is well above 6% on Thursday (two days from now), you will be hearing quite a lot about it very quickly.

There Are Times to be Defensive

In my February 21 E-Letter, I presented the performance records for the 13 professionally managed programs that I recommend. If you recall, all 13 have outperformed the S&P 500 Index from their inception dates through the end of 2011. More importantly, all 13 did so with significantly smaller losing periods along the way. All of the money managers I recommend lost much less than the S&P 500 did in the bear market of 2007-2009, and most lost less than half. As always, past performance isn’t a guarantee of future results.

I don’t know if the European debt crisis is going to explode into the headlines in the next few weeks, but we may know the answer in the next two days. I don’t know if Spain and Italy will become the next Greece, but we may know in the next few weeks.

What I do know is that if either of these things come to pass, it will almost certainly be very bearish for the US and global equity markets.

US stocks just recorded the best 1Q since 1998, with the Dow Jones Industrial Average up 8% in the first three months of this year. So who am I to rain on this parade? But the stock markets began to decline earlier this month, just as news of rising interest rates in Spain and Italy began to emerge.

Making matters worse, trading volume on US stock markets has been the lowest in more than four years so far this year. Why is this important? When trading volume is low, it doesn’t take much to spark a new trend – in either direction.

Contrary to Wall Street’s mantra of “buy-and-hold” forever and ride out the losses, I believe that there are times when it pays to be have some of your money out of the market or at least hedge long positions. If Spain and/or Italy experience more problems selling their debt, it will almost certainly be bad news for equity markets around the world.

Maybe now is the time to seriously consider allocating some of your buy-and-hold money to the professionally managed programs I recommend.

If you would like more information about the actively managed investment programs offered through Halbert Wealth Management, feel free to contact us in any of the following ways:

Give us a call at 800-348-3601 and ask to speak to one of our Investment Consultants;
Send an e-mail requesting information to info@halbertwealth.com;
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Click on the following link to access our online information request form.

Join My “Between The Lines” Blog

If you haven’t already, I would encourage you to sign up for my blog. Each week, and sometimes more often, I write about topics that are interesting to me – so the subject matter varies quite a bit. Last week, for example, I summarized the Fed’s “Beige Book” which gauges the economy around the country. The latest survey was definitely upbeat. CLICK HERE to read last Friday’s posting.

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Wishing you profits,

Gary D. Halbert

Will Baby Boomers Wreck the Market? (The Sequel)

Gary D. Halbert — Tue, 10 Apr 2012 21:29:00 GMT

IN THIS ISSUE:

1. Boomers and the Stock Market – Six Years Later

2. A Few Statistics

3. Reasons Boomers May Crash the Market

4. Gloom-and-Doomers Get an Unexpected Ally

5. Alternative Viewpoints

6. Conclusion: Headwinds Aplenty

Boomers and the Stock Market – Six Years Later

Almost six years ago, I wrote an E-Letter asking “Will Baby Boomers Wreck the Market?” There has always been a fascination with the Boomer generation due to its enormous size and its potential to bring change to the economy, lifestyles and even politics. Oddly enough, this years-old article continues to be one of the most requested archived issues of my Forecasts & Trends E-Letter.

When I wrote this E-Letter back in 2006, there were many gloom-and-doom predictions that the Baby Boomers were going to wreck the stock markets when they started retiring within the next few years. However the stock markets were on their way to bouncing back from the 2000 – 2002 bear market and the housing bubble was in full swing, so I concluded that it was too early to tell whether the Baby Boomers would be a major threat to the market or not. Here’s part of what I said:

“A closer look at demographic trends, as we’ve seen in this article, suggests that Boomer demand for equities is likely to continue to remain high well beyond 2008-2010, the period when many gloom-and-doomers seem to think the stock markets will go over a cliff.”

As we all now know, the stock market did fall off a cliff in 2008 but not because of the investing habits of Baby Boomers. At an investor level, portfolios that were growing healthy in 2006 were dashed again by the 2007 – 2009 bear market, with many investors’ statements showing losses of 40% to 50% or more. Experiencing two major bear markets in less than a decade caused many Baby Boomers to exit the market for good. Even today, others are just waiting to “get even” and then they’re going to bail out.

Will this new aversion to equities on the part of Baby Boomers wreck the market? This week, I’m going to revisit the issue to see if my conclusions are the same as back in 2006. Then we’ll discuss what you should do about it.

Background – A Few Statistics

As most of you already know, the Baby Boom generation is made up of those born in the years 1946 through 1964, and accounts for something over 78 million people according to the US Census Bureau. At present, Boomers represent about 28% of the US population. I’m not going to go through all of the statistics on Baby Boomers as most people are already familiar with them. If you want more information, on Boomer basics, you can refer back to my 2006 E-Letter for more details.

The following statistics relate to information about Boomers since my earlier E-Letter:

In 2006, the oldest Baby Boomers were beginning to turn age 60. Today, 10,000 Baby Boomers reach age 65 every day, and will continue to do so for another 18 years or so. The Baby Boom effect on Social Security and retirement is no longer a future event – it’s here!
Some studies estimate that Baby Boomers now control over 80% of personal financial assets (of course this includes both stocks and bonds, among other assets).
Boomers also account for over 50% of total US consumer spending, and consumer spending accounts for nearly 70% of our GDP.
A MetLife study found that Boomers are expected to inherit over $11.6 trillion from parents/grandparents in their lifetimes. (Side note: With this much money being transferred from one generation to another, forget any serious consideration of an estate tax repeal.)
For the first time, people over 45 years of age represent a majority of the voting age population… and they vote! In the 2008 election, the US Census Bureau reports that 59% of all Baby Boomers voted, with older Boomers being more likely to vote than younger ones. Boomers over age 55 had a voter turnout of over 70%.

The Baby Boom generation is “back-loaded” in regard to the number of births. In other words, the bulk of births occurred during the last half of the Baby Boom period – 1955 to 1964 – and fewer were born in the earlier years. This is important when considering the effect of Baby Boomer retirement on the markets, as I will discuss in greater detail below. Here’s a chart that tells the story:

Reasons Baby Boomers Might Crash the Stock Market

The basic premise behind the idea that Baby Boomers might lay waste to the stock market makes sense intuitively. The idea is that as Boomers retire, they will shift assets away from stocks to less risky alternatives such as bonds, annuities, CDs, etc. and begin living on the interest. All of this selling activity, the story goes, will put downward pressure on stock prices and lead to a major selloff.

One of the “prophets of doom” that I featured back in 2006 was Harry Dent, who is most famous for his prediction that the Dow would reach the 40,000 level by 2010. However, Dent also predicted that the bottom would then fall out of the stock market as Baby Boomers hit retirement and started cashing in stocks in favor of more stable investments. As I noted back in 2006, Dent predicted a 12 to 14 year bear market and depression after 2010.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

We did have a major bear market and severe recession, but not for the reasons Dent predicted. However, I thought it would be interesting to see what Mr. Dent is saying now regarding his prediction that Boomers would crash the market. Suffice it to say that he hasn’t changed his mind about what might eventually happen in the future.

Dent argues that the European sovereign debt crisis will pull the US into a new recession, which will be made worse by lower spending by retired Baby Boomers. Even those not yet retired will likely continue to pay down debt and reduce consumer spending. He looks to Japan as the model of what might happen, where their stock market is still down 80% from its high 20 years after its financial crisis.

Dent may have a point in regard to retiree spending habits. As I noted in my blog last Thursday, the era of low interest rates has not only failed to stimulate business, but has also reduced the income of those who depend upon interest earnings, primarily retirees. What wasn’t recognized back in 2006 was that lower consumer spending by retirees would be mandatory, due in large part to the plunge in interest income, not discretionary.

Much more importantly, a MetLife survey in recent years found that 69% of retirees overestimate how much they can withdraw from their retirement savings annually, with 43% saying they can withdraw 10% per year while still preserving principal. This puts them on a collision course for running out of money, at which time their spending will definitely be cut. Until then, however, consumer spending by retirees may remain high.

Prophets of Doom Get an Unexpected Ally

Retiree spending aside, there’s still the issue of cashing in stocks to either spend or place in less risky investments. In 2011, the gloom-and-doom crowd got an unexpected ally – the San Francisco Federal Reserve Bank. Last year, Fed researchers Zheng Liu and Mark M. Spiegel released a paper predicting that retiring Baby Boomers will be likely to shift from buying stocks to selling stocks to finance retirement. The bottom line, according to the report, is, “Statistical models suggest that this shift could be a factor holding down equity valuations over the next two decades.”

Needless to say, this non-product-oriented report from a “neutral” Federal Reserve Bank got a lot of attention – and is still making the news. To be fair, the SF Fed paper doesn’t predict a market crash, but does see a major uphill battle for stock prices in the years ahead. However, that hasn’t kept the financial press from using terms like “sinking” or “crashing” the stock market when reporting on this Fed paper.

Target-Date Funds: Another factor related to Baby Boomers wrecking the market involves “automatic” adjustments that will be made by specialized retirement products and distributions from employer pension plans. Almost everyone is now familiar with “target-date” mutual funds, also known as “lifestyle funds.” These funds invest based on a person’s age or assumed date of retirement. As the shareholder gets closer to retirement, the asset mix in the fund automatically adjusts to increase bonds and decrease stocks.

Some have said that the popularity of the target-date funds (they are found in over 80% of larger 401(k) plans) could affect stock values in the future as they automatically shift from stocks to bonds. But given the predictability of these shifts, I don’t think there will be much of a problem. The market will likely price in these shifts since it will know when to expect them. Also, current target-date assets are only about 11% of total 401(k) assets, so I don’t see a major problem caused by target-date funds in the near future.

Lump-Sum Distributions: Another potential stock market disruption could come in the form of lump-sum distributions from employer pension plans. Even though most pension plans are set up to pay a monthly benefit, many permit retiring participants to take a lump-sum payment instead of a monthly check. In that case, the money goes from being managed by a group of trustees or other money managers to being managed by the retiree inside a Rollover IRA. Aside from the concern that a retiree may spend too much too soon, there’s also the possibility that allocations to stocks will be lower in self-directed IRAs than under professional management. Of course, the converse could also be true.

Either way, the risk from lump-sum distributions may also be too small to affect the overall market. One reason is that, as noted above, not all employer plans offer this option. Plus, recent legislation has made it harder to get a windfall lump-sum distribution from a pension plan. I also expect pension rules to be tightened to discourage lump-sum distributions in the future, especially if early Boomer retirees start running out of money.

Rob Arnott Weighs In: One final warning about Boomers and the stock market comes from Robert D. Arnott, a highly respected researcher and portfolio manager. Arnott agrees with the premise that Boomers will sell stocks to fund retirement income. He says that this selling activity coupled with fewer younger investors to buy these securities, will “keep a lid” on prices.

Arnott notes that less than 10 years ago, there were 10 new additions to the workforce for each new senior citizen. This year marks the first time that the population of senior citizens will rise faster than the working-age population. Read this carefully: In 10 years, the working vs. retired ratio will reverse so that there are 10 new senior citizens for each new working-age individual. This demography can’t be good for the markets, according to Arnott. I agree.

In addition to muted returns from stocks, Arnott continues to see strong spending demand from Boomers, which will have the potential to fuel inflation. This inflation along with slower economic growth brought about by demographics, debt and deficits could mean real returns close to zero. Arnott is quick to point out that he’s not painting a gloom-and-doom scenario, but for anyone to continue to expect 8% or 10% a year from their stock portfolio is “naïve.”

Alternative Viewpoints

Since my previous article, we’ve had a global financial crisis in which home and financial asset prices plummeted. Government intervention in the banking system and the markets has occurred that would have been thought impossible in 2006. As a result, we have also become quite familiar with the “T word” (trillion) when talking about both ongoing federal government deficits and the amount of wealth that has simply vanished into thin air. Has this changed my opinion and that of other experts?

As a general rule, no. Experts still disagree about the potential negative effect of the Baby Boom Generation on stocks. I have listed below a number of arguments against the gloom-and-doom scenario, as well as my own comments. I think you will find them useful.

Boomers, as a whole, are more familiar with investments than any previous generation. That means they may be more likely to consult a professional or seek out independent advice in publications or on the Internet to help them allocate their portfolio. If that is the case, I don’t know of many asset allocation programs that completely exclude equities in retirement portfolios. That’s likely because most professional money managers know that bond prices can be just as volatile as those of equities, and sometimes even more so.
Evidence from earlier retirees does not support the idea that Boomers will immediately cash in stocks upon retirement. A 2009 CBO study found, in part, “…empirical evidence about the behavior of earlier groups of retirees suggests that baby boomers will not sell their accumulated assets quickly after they retire.” The important thing to note here is that the CBO did not use assumptions to reach its conclusion, but rather habits of actual pre-Boomer retirees.
Will inheritance save the day? Some have suggested that the transfer of an estimated $11 trillion of wealth over Boomers’ lifetimes will help with retirement income. However, I think this is a false hope. While inheritance may make a difference to some Boomers, studies show that 80% of this $11 trillion of wealth is concentrated in only 10% of the pre-Boomer generation. This uneven distribution of wealth means that the bulk of future wealth transfers will go to those who need it least. An AARP study put it this way: “…inheritances are unlikely to make a significant contribution to the retirement savings of most Boomers.”
As shown in the birth chart above, the number of Baby Boomers in each year is back-loaded. As a result, it is a false assumption that all Boomers will suddenly cash in their stocks at one time. In fact, early Boomer retirees are more than offset by Boomers still in the accumulation phase of their retirement savings. This might mean more demand for stocks instead of less, at least until we start seeing these larger groups of Boomers retire.
When I wrote my previous Boomer article in 2006, the market was in full bull mode. Now, however, Boomers have been hit with two major bear markets in less than a decade, as well as a generous helping of uncertainty about the future. Reviewing mutual fund inflow and outflow data, it is my opinion that at least some of the migration out of the stock market has already occurred. To the extent that this is true, there will be less of an effect on the stock market as these Boomers retire.
When analyzing population data, one variable that cannot be accurately estimated is the number of immigrants that may come to the US to fill jobs or the effects of foreign investment in US stocks. The SF Fed paper specifically notes that foreign investment could “…potentially alleviate the adverse impact of US demographic trends on stock markets.”
Finally, it is widely expected that many Baby Boomers will have to delay retirement as a result of not saving enough for retirement and losses incurred during the two bear markets since 2000. According to AARP, 69% of Baby Boomers plan to delay retirement and work beyond age 65. While working longer, these Boomers will likely continue to save and invest rather than cash out their stock holdings.

The above list is not exhaustive as there are obviously other good reasons why retiring Baby Boomers will not singlehandedly bring the stock market to its knees. However, I think you can see from the discussion above that for every argument that the market will crash when Baby Boomers retire, there’s another that says it won’t. Unfortunately, it’s impossible to tell which argument will win out in the end, but there are ways to invest with the potential to handle virtually any scenario.

Conclusions – Headwinds Aplenty

I find it interesting that my conclusion today is much the same as it was almost six years ago. Here’s what I said back in 2006:

“While I’m sure there are other arguments for and against a Boomer-caused market meltdown, I think you can see from those listed above that there is hardly agreement on the subject. In fact, if I had to say there was a consensus among the experts, it would probably be that there is no consensus about what will happen when the Baby Boom generation retires.”

I have yet to be won over to the side of the Baby Boomers wrecking the market. Having lived through the “Y2K” scare back in the late 1990s, I am suspect of any wide generalization about what will have an impact on the stock market. The Boomer retirement demographic is much like Y2K – it makes sense intuitively but is not likely to result in the worst case scenario.

However, that doesn’t mean that I think the market will continue to do well in the years ahead. There is no shortage of other factors that could affect the stock market. High gas prices are siphoning away money that could be spent for other consumption. Record deficits and a growing national debt also have the potential to crater the stock market, with or without the Boomer effect. I believe these factors will have more negative effects on the stock markets than the retirement of Baby Boomers.

Add to that the Eurozone crisis and other global uncertainty, especially with Iranian nukes, and you may have another reason why retail stock mutual funds are still showing outflows while taxable bond funds are still attracting assets. The absence of QE3 from the Fed thus far is another headwind to the market going higher. And of course I’d be remiss if I didn’t mention the potential effect of this year’s election on the stock market.

It is my opinion that the US stock market will continue to struggle, perhaps partially due to Baby Boomer retirements, but more so in reaction to all of the other headwinds noted just above. As a result, I think it’s going to be hard to make much progress in passive index-based mutual fund investing over the next couple of decades. If stocks generate near-zero growth after inflation as Rob Arnott suggests, these programs may be lucky to just move sideways.

The question then becomes what you need to do to protect your portfolio and actually achieve some growth. Space prohibits me from detailing a course of action with the potential to help you navigate the uncertain markets ahead. However, over the next few weeks I will be sharing with you some investment ideas that definitely deserve your consideration.

I’D LIKE TO HEAR FROM YOU! If you are a Baby Boomer and are either just retired or approaching retirement, I’d like to get your opinion of the stock market and what you intend to do in relation to your investments. Papers and surveys are fine, but nothing beats real-life examples to let us know what’s going on in relation to retirement. Just send me an e-mail to gdh@profutures.com with “Boomer” in the subject line. I look forward to hearing from you.

Best regards,

Gary D. Halbert

Our National Debt Is Scarier Than You Think

Gary D. Halbert — Tue, 03 Apr 2012 21:38:00 GMT

IN THIS ISSUE:

1. National Debt Surpassed GDP in 2011

2. Obama Deficits Double Previous Presidents’

3. Interest & Maturity on Our Outstanding Debt

4. US Joins Greece, Spain & Portugal

5. Fed Was the Largest Buyer of Treasury Debt in 2011

6. Bernanke Hints There Will Be QE3 After All

Overview

What if I told you the US national debt is now larger than our $15.1 trillion gross domestic product? It is, at $15.6 trillion and rising by well over a trillion a year for the last three years. What if I told you that the average interest rate on our national debt was down to only 2.2% as of the end of February? It was. What if I told you that even with such a low average interest rate, the government paid $454 billion in interest alone in FY2011? It did.

What if I told you that the average maturity of outstanding Treasury debt is only 62.8 months? It is. That’s less than six years. What if I told you that almost $6 trillion in outstanding Treasury debt must be rolled over in the next five years? It will. What if I told you that 71% of the privately-held Treasury debt will have to be rolled over in the next five years? That’s true.

What if I told you that the Federal Reserve Bank purchased 61% of all net Treasuries issued in 2011? It did. All other purchasers combined purchased just 39%. Staggering! What if I told you that China decreased its holdings of Treasury debt by $156 billion from July to December last year? It did, according to the Treasury Department. That’s troubling! Or at least it could be (more to follow).

OK, enough with the what if’s. The eight what if’s above give us all more than a little to worry about. It should make for some interesting discussion today. Because of the significance of the information contained in this E-Letter, I encourage you to share it with as many people as possible.

National Debt Surpassed GDP in 2011

The US national debt stands at just over $15.6 trillion as compared to the $15.1 trillion gross domestic product in 2011. This means that our national debt is now 103.3% of GDP, a feat which has not happened in the Post-WWII era. To put $15.6 trillion into perspective, this means that every man, woman and child in America owes just over $50,000 toward the national debt.

If we use an estimated budget deficit of $1.1 trillion for 2012, the national debt will have grown by just over $5 trillion in the last four years. President Obama’s supporters argue that the 2009 deficit of $1.4 trillion was not all Obama’s fault. He did inherit President Bush’s budget which included a large deficit, but Obama promptly announced his $800+ billion “stimulus” package, which ballooned the 2009 deficit up to $1.41 trillion. Here’s an interesting chart based on data from the CBO, OMB and the Treasury Department.

While it is not my intent to go political today, the facts are what they are. Our national debt is soaring out of control. The CBO says that President Obama’s proposed federal budget for FY2013, if adopted (not likely), would add another almost $1 trillion to the deficit next year. That would put our national debt at around $16.6 trillion – if the CBO is accurate.

Our mountain of Treasury debt has two components: 1) debt held by the public; and 2) debt held by various government agencies. Here’s how those two break down:

Debt held by the public comprises securities held by investors outside the federal government, including that held by investors, the Federal Reserve System and foreign, state and local governments.
Intra-government debt is comprised of Treasury securities held in accounts administered by the federal government, such as the Social Security Trust Fund.

Sometimes you will hear the debt held by the public referred to as the “marketable debt,” and the debt held by the government agencies as the “non-marketable debt.” There are four types of marketable Treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS) – all of which are very liquid and are heavily traded each day on the secondary market.

There are several types of non-marketable Treasury securities including Government Account Series debt issued to government-managed trust funds, State and Local Government Series (SLGS) and savings bonds. The non-marketable securities, including savings bonds that are issued to individual subscribers, cannot be transferred through market sales.

As of late March, Treasury debt held by the public was $10.8 trillion and debt held by intra-government agencies was $4.8 trillion. Total debt $15.6 trillion.

Editor’s Note: You will often see references to the national debt that only include the debt held by the public. They often imply that the debt held by government agencies should not be included in the national debt because, they say, that’s money we owe to ourselves. Hooey! The debt held by the federal agencies is real and it has to be repaid and rolled over periodically. If you read that our national debt is only $10 trillion or so, don’t buy it.

Interest & Maturity on Our Outstanding Debt

In order to fund the government, the Treasury Department periodically auctions Treasury securities with various maturities ranging from 30-day Treasury bills to 30-year Treasury bonds, with 2-3-5-7-year and 10-year Treasury notes in between. It used to be that the bulk of Treasury borrowing was done in the longer-term instruments with maturities of at least 10 years.

In more recent years, however, this trend has shifted more toward shorter-term Treasury securities. There are pros and cons to both strategies. Generally speaking, the shorter maturities are considered more risky since short-term interest rates can vary frequently. Shorter-term maturities obviously have to be rolled over much more often. That raises the risk that there might not be enough buyers when the government needs them.

Despite those risks, as interest rates have fallen significantly, especially on the short end, the Treasury Dept. has migrated to shorter-term securities, which now pay very little interest. For example, a 5-year Treasury note only pays 1% today.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

On February 29, Bloomberg reported, based on data from the Treasury Dept., that the average interest rate on all of the Treasury’s outstanding debt had fallen to only 2.2% (excluding Treasury Inflation Indexed Securities). I must say, that number surprised me! (Maybe this explains in-part why President Obama wants to borrow so much money – because it’s so cheap.)

Bloomberg also reported that, as of the end of last year, the average maturity on the Treasury’s outstanding debt was only 62.8 months. That’s less than six years on average. And here’s the really scary part: the US is now in the precarious position of having to roll over 71% of the debt held by the public in the next five years! (And it gets even scarier below.)

US Joins Greece, Spain & Portugal

The US is now more dependent on short-term funding than many of Europe’s highly indebted countries, including Greece, Spain and Portugal, according to the Center for Financial Stability (CFS), a non-partisan New York think tank that focuses on financial markets.

Some argue that the US had a lot more debt in relation to the size of its economy following World War II than it does today. That may be true on a percentage of GDP basis, but the structure of that post-WWII debt was far more favorable than today due to much longer maturities. Today, only 10% of the public debt matures outside of a decade according to CFS.

CFS also calculates based on the current structure (low rates and short maturities), a 1% increase in the average interest rate would add $88 billion to the Treasury’s interest payments this year alone. With most of our debt in shorter maturities which pay next to nothing, we could easily see a rate increase of 1% or more. If market interest rates were to return to more normal levels, say 3-4%, the results would be ominous.

Again, with short rates at next to nothing, this increases the rollover risk. Lenders don’t like to put their money at risk for such low returns, especially when the borrower is spending record amounts of money it does not have. This is exactly what happened to Greece and Portugal and Argentina before them. Do our leaders just think this can go on forever?

Fed is Now the Largest Buyer of Treasury Debt

I said earlier that it gets even scarier. The Federal Reserve purchased 61% of the net Treasury issuance last year, according to the bank’s quarterly flow-of-funds report. That means we’re seeing a decline in demand from just about everyone else, including banks, mutual funds, corporations, individuals and foreigners.

In a Wall Street Journal article last Wednesday, Lawrence Goodman, a former Treasury official and current president of the Center for Financial Stability, stated that foreign investors like China and Japan are now shunning US debt. According to CFS, foreign buyers scooped up over $90 billion in Treasury debt in 2009. In 2011, by contrast, CFS says foreigners purchased only $13.6 billion in Treasuries.

Scariest of all, China decreased its holdings of US debt in the last half of 2011. According to the Treasury Dept., China purchased no new Treasury debt from July to December last year, thus shrinking its holdings of US debt by $156 billion in six months! China is the largest foreign holder of our debt, followed closely by Japan. Fortunately, China did buy some additional US Treasuries in January (see link in Special Articles below).

Fed intervention in the government debt market makes demand for Treasury bonds appear higher than it really is, as foreign creditors and other investors in US government debt are increasingly looking elsewhere until the government makes serious attempts to curb spending and narrow its gaping deficits.

With a shrinking base of U.S corporate and bank buyers, not to mention foreign buyers, the Treasury has had to resort to the Federal Reserve itself to make the purchases. But you don’t see this scary fact reflected in the media – they would have us believe this is simply a decision by the Fed. The Fed purchasing has not only made up for the shortfall in demand; it has also served to keep interest rates artificially low (see more on this in Special Articles below).

Bernanke Hints There Will Be QE3 After All

In my March 13 E-Letter, I argued that the Fed might well be considering additional quantitative easing (QE3), even though the prevailing wisdom at the time was that QE3 was off the table. I further argued that if the Fed was indeed considering QE3, which it knows would be unpopular, it would need to do it soon so as not to be an issue in the November presidential election.

The Fed Open Market Committee (FOMC) met on March 13. Its official policy statement afterward noted that the economy had improved somewhat, but the unemployment rate was still unacceptably high. As a result, the FOMC reiterated that it would keep the Fed Funds rate near zero until late 2014, and that it would continue “Operation Twist” (moving to longer-term Treasury holdings in its massive portfolio). The FOMC also stated once again:

“The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.” [Emphasis added.]

As I noted in my March 13 E-Letter, most of the economic growth in the 4Q of last year was due to inventory rebuilding, which has slowed significantly this year, and most forecasters now believe that 1Q GDP growth will only be around 1%. Here was my thinking on March 13:

It would not surprise me if they announce another stimulus program at either the April 24-25 meeting or the June 19-20 meeting. Perhaps the most likely scenario would play out as follows. For today’s one-day FOMC meeting, the Fed probably elects to keep all options open in its policy statement later today, just as it did in January, as discussed above... Then at the April 24-25 FOMC meeting, they could begin to get more specific as to what they might be considering in the way of more stimulus.

As noted above, my line of reasoning was widely dismissed in the financial media, primarily because Bernanke made some comments in January and February that gave the impression that QE3 was not on the table. However, in comments made in March, Bernanke seemed to be suggesting that QE3 may indeed be on the table as I suggested.

In speeches over the last month, Bernanke has emphasized that the improvement in the unemployment number has been the result of “a decline in layoffs rather than an increase in hiring.” In effect, what the Fed Chairman did was to throw a bucket of cold water on the recent declines in the unemployment rate.

The other thing Bernanke said last month, unlike previous speeches, was that the continued rise in oil and gas prices is “a major problem.” Previously, he had suggested this was only a temporary phenomenon. Some now agree with me that he may be setting the table for QE3.

Late Note: The minutes from the March 13 FOMC were released this afternoon, and QE3 was not discussed in the meeting. Many analysts took that to mean that the FOMC will not consider QE3 in the months just ahead. The stock markets reversed lower soon after the minutes were released as many investors apparently concluded QE3 is once again off the table.

However, if you read the minutes carefully, you will see that the FOMC clearly left the door open to additional stimulus going forward if the economy starts to sag:

So in my view QE3 is still on the table, especially if upcoming economic data is disappointing. Bill Gross of PIMCO happens to agree with me:
http://au.ibtimes.com/articles/319419/20120326/pimco-s-bill-gross-qe3-coming.htm

Now, let’s look at the timeline. The next FOMC meeting is on April 24-25. Our first look at 1Q growth doesn’t come until April 27. So, I doubt the FOMC will announce QE3 (or an extension of Operation Twist) in the April 25 policy statement. However, it won’t surprise me if the subject of more stimulus is discussed at the April 24-25 meeting. But we won’t know that until the minutes of the April meeting are made public around May 15.

The bottom line is, I think it’s still possible that the Fed could announce QE3 (or maybe an extension of Operation Twist) at the end of the June 19-20 FOMC meeting. The US stock markets had their strongest 1Q in more than a decade over the last three months – at a time when most people thought QE3 was off the table.

It remains to be seen what will happen just ahead if the perception changes to QE3 being back on the table. I’ll keep an eye on all this and will keep you posted as we go along.

Finally, let me encourage you to share today’s E-Letter with as many people as you can. Some of the facts in today’s letter are not disclosed in the mainstream media, so we need to get the word out.

Anyone can subscribe to my weekly E-Letters for FREE at www.forecastsandtrends.com. Be assured that we never sell, rent or otherwise share your e-mail address with anyone.

My latest blog post: Supremes Say Maybe Not On Obamacare Mandate

Very best regards,

Gary D. Halbert

Is The US Headed For A Fiscal Cliff in 2013?

Gary D. Halbert — Tue, 27 Mar 2012 22:39:00 GMT

IN THIS ISSUE:

1. U.S. Cruises Toward a 2013 Fiscal Cliff

2. Automatic Spending Cuts Begin on January 15

3. Could Tax Hikes & Spending Cuts Spark A Recession?

4. Another Debt Ceiling Fight This Year?

5. Supreme Court Tackles Obamacare Mandate

Introduction

There are two prevailing views among economists and forecasters these days when it comes to our soaring national debt, which is now over $15 trillion. One view, held largely by conservatives led by Wisconsin Representative Paul Ryan, is that we must cut government spending significantly, and the painful process must begin sooner rather than later.

The other view, largely held by progressives, is that if we cut federal spending significantly, it will definitely slow the economy and very likely lead to a recession. Their answer, of course, is to continue spending and raise taxes on the wealthy to reduce the deficits.

The reality is, however, that both sides are on track to swallow a bitter pill beginning on January 1, 2013. Under current law, the Bush tax cuts expire at the end of this year – for everyone. President Obama only wants the Bush tax cuts to expire for those individuals making over $200,000 a year and joint filers making over $250,000. Chances are probably good that he’ll get his way, and only the so-called “rich” (as defined above) will see the tax increases. But Congress has to act to extend any of the Bush tax cuts.

On the federal spending side, you probably remember the 2011 Budget Control Act which includes “sequestration,” or across-the-board spending cuts, to all federal departments if Congress can’t design and pass a budget that more specifically outlines spending cuts totaling $1.2 trillion over the next 10 years.

It’s becoming more and more obvious that the Senate is not going to pass a budget this year, for the third year in a row. The latest budget submitted by Paul Ryan in the House has no chance of passage in the Senate. So the sequestration is set to kick in on January 15, 2013 and alarm bells are increasingly being sounded by Democrats and Republicans alike.

The question is, what will the effects be on the economy due to the combination of tax hikes and spending cuts starting next year? How bad will it be? We’ll discuss all of this as we go along.

U.S. Cruises Toward a 2013 Fiscal Cliff

Headline: As tax cuts expire and spending falls, the economy could be hit with a 3.5% decline in gross domestic product that could throw us right back into a recession next year.

Income taxes are set to automatically go up next year for everyone if the Bush tax cuts expire at the end of this year. President Obama says he wants the Bush tax cuts to expire only for those individuals making over $200,000 a year and families making over $250,000. But without congressional action, all of the Bush tax cuts will expire.

If Congress does take action, and gives Obama what he wants, those making over $200,000/$250,000 will see their tax rates go up as high as $39.6%. Plus the first ObamaCare tax of 3.8% on investment income for these same “rich” people also kicks in starting next year. For those who make over $200K/$250K, and all of their income is from their investments, their tax rate will go as high as 43.4%!

Plus, President Obama wants a new law that will require anyone making $1 million or more to pay a minimum income tax of at least 30% (more on this below). Many of these people are key job creators. Obama also wants dividends taxed as ordinary income (39.6% for many), up from 15% today. He also wants the capital gains tax rate increased from 15% to 20%.

And there are other changes scheduled for the end of this year that qualify as tax hikes. The 2% payroll tax holiday expires at the end of this year unless it is extended again. At some point, presumably on January 1, the repeated extension of unemployment benefits has to be reduced, perhaps significantly. A reduction in benefits will have much the same effect as a tax hike.

Again, the question is, how bad will this be for the economy? But there’s more.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Automatic Spending Cuts Begin on January 15

As part of the deal ending the acrimonious debate over raising the national debt ceiling last August, the president and Congress created the bipartisan Joint Select Committee on Deficit Reduction, commonly known as the “Super Committee." It was charged with finding ways to trim at least $1.5 trillion from projected deficits over 10 years.

Mindful that the committee might not prove to be that super, Congress stipulated that formulaic spending cuts of $1.2 trillion would kick in automatically if the committee failed. To make this threat even more frightening, Congress aimed half the $1.2 trillion in spending cuts straight at the Defense Department. The Committee failed anyway, and those automatic cuts are headed our way starting January 15 next year.

Many in Washington are starting to get very nervous that Congress may not be able to figure out a way to wriggle out of these mandatory cuts before the end of the year. There is a growing sense that Congress is not going to pass anything major until after the election.

In the absence of progress between now and Election Day, the lame duck Congress will have less than eight weeks left – including Sundays, Thanksgiving, Christmas and New Year’s Eve – to address the tax hikes and automatic spending cuts before the end of this year. No wonder people are getting nervous!

Could Tax Hikes & Spending Cuts Spark A Recession?

There is no doubt that a combination of tax hikes, the end of the payroll tax holiday and curtailment of unemployment benefits, along with the automatic spending cuts, will be a drag on the economy. The question is how much of a drag?

It is widely agreed that the FY2013 federal budget is going to have the biggest impact of any budget in decades. That’s because the fiscal headwind comprised of both tax increases and spending cuts under current policy totals more than $500 billion, or 3.5% of GDP, so say the Congressional Budget Office and the White House’s Office of Management & Budget. Simply put, that’s a huge headwind!

Alan Blinder, an economics professor at Princeton University and former Vice-Chairman of the Federal Reserve, has been studying this matter intently. With regard to the 3.5% contraction in GDP, he cautions:

“That's a big fiscal hit, roughly as big as what a number of European countries are trying to do right now, though with limited success and with notable collateral damage to their economies. An abrupt fiscal contraction of 3.5% of GDP would be a disaster for the United States, highly likely to stifle the recovery.”

Martin Feldstein is a well-known economist I have read for many years. He is currently an economics professor at Harvard, is the former president of the National Bureau of Economic Research and was the chief economic advisor to President Ronald Reagan. In a recent article in The Financial Times, Feldstein focused on the negative effects of the upcoming tax hikes on the US economy:

"The Congressional Budget Office predicts that, under current law, the revenue of the federal government will rise from $2.4 trillion in the current fiscal year, which ends in September, to $2.9 trillion in the following fiscal year. That increase of $512 billion is equivalent to 2.9% of GDP, bringing federal revenue as a share of GDP from 15.8% this year to 18.7% next year.

The higher revenue would reflect an increase in personal tax rates, higher payroll taxes, as well as higher taxes on dividends, capital gains and corporate incomes. [Federal] Revenue would continue to rise in future years – as a share of GDP it would increase to 19.8% in 2014 and would stay above 20% for the remainder of the decade.
A sustained tax increase of that magnitude would push the U.S. into a new and deep recession next year. So, it is important to recognize that legislation is required to prevent such a tax rise.”[Emphasis added.]

Feldstein believes getting that legislation passed will be difficult. He adds:

“Mr. Obama has said he wants to keep the high rates for upper income taxpayers and to raise total taxes on corporations and other businesses. The Republicans in Congress and the Republican presidential candidates have indicated they want to avoid all of the increases that are specified in the current law and to start a process of tax reform. So the 2013 tax rates will depend on the outcome of the presidential elections in November.”

I think Feldstein is correct that it all hinges on the election. If President Obama is re-elected, it will be next to impossible for the Republicans to roll back the tax increases that are already written into the law. Even if the Republicans gain a majority in the Senate and manage to hold onto the House, it will still be difficult since Obama could veto such a move.

Another Debt Ceiling Fight This Year

We all remember the bitter debt ceiling debate in Washington last summer, the one that resulted in the first-ever downgrade of the US credit rating. Well, another showdown could be in the offing sooner than planned.

The deal cut last August to end the debt ceiling standoff provided for a $2.1 trillion increase in the country’s legal borrowing limit to $16.394 trillion. At the time, it was estimated that such an increase could carry the Treasury Department safely beyond the contentious presidential election season and into early 2013.

But now that Congress has extended the payroll tax cut, emergency unemployment benefits and the so-called Medicare “doc fix” – only some of which was paid for – there is a greater chance that US borrowing could reach the debt ceiling sooner.

Treasury Secretary Geithner recently told lawmakers that even with the recent passage of the payroll tax bill – which will add an estimated $101 billion to the deficit in fiscal year 2012 – he doesn't expect the debt limit to be reached “until quite late in the year.”

He presumably means sometime after the November 6 elections, but that remains to be seen. Even if we manage not to hit the ceiling until a few days after the election – which I’m sure Geithner will do everything in his power to make happen – the looming battle will be an election issue that no politicians wanted to have to deal with until next year.

More importantly, if we hit the debt ceiling in November or December, that will be smack dab in the middle of the fight over tax hikes and spending cuts discussed above.

Obama’s “Millionaire Tax” aka the “Buffett Rule”

On January 24, President Obama said that America needs a new tax system, but one that is aimed only at people who make $1 million or more a year. Obama said:

"Tax reform should follow the Buffett Rule. If you make more than $1 million a year, you should not pay less than 30 percent in taxes. And my Republican friend Tom Coburn is right: Washington should stop subsidizing millionaires. In fact, if you're earning a million dollars a year, you shouldn't get special tax subsidies or deductions."

Basically, the President is proposing a new "Super Alternative Minimum Tax" of 30% for anyone making over $1 million. So if your income is above $1 million, you have to pay at least 30% of your income in taxes, even if that income came from capital gains or dividends, which are currently taxed at 15%.

Like the regular Alternative Minimum Tax – which was enacted in 1969 to prevent a handful of millionaires from paying less on their taxes but now impacts over 3 million Americans – this new Super AMT would reduce any deductions that might reduce your effective tax rate below 30%.

The details on how this new tax increase will be implemented, assuming it is passed into law, are not yet clear. I may revisit this issue when we know more about the details, again if it is passed.

You might intuitively assume that anyone making a million dollars or more a year would automatically be in the highest income tax bracket, currently 35% but on its way to 39.6% or more if Obama gets his way. But there are many millionaires who do pay less than 30% in income taxes because most of their income is from capital gains and/or dividends that are taxed at 15%.

The widely respected Tax Foundation estimates that the Buffett Rule would be the equivalent of raising the top marginal rate from 35% to 44% for those earning over $1 million per year. The Tax Foundation believes that the average effective tax rate for millionaires is around 25% today (although I’ve seen higher estimates elsewhere).

Using the Tax Foundation’s figures, based on the current amount of deductions millionaires take, in order to raise their effective tax rate up to 30%, you would have to raise the top marginal tax rate to 44%. On a static basis, they estimate that this policy would raise only about $40 billion a year – assuming that taxpayers don't change their behavior – which they will. Compared to a $1.1 trillion deficit next year $40 billion is a drop in the bucket!

The Obama administration knows this, but the President continues to push for the Buffett Rule only because he thinks it’s “fair.” If he’s re-elected, the Buffett Rule is almost a certainty.

Supreme Court Tackles Obamacare Mandate

The Supreme Court began deliberations yesterday on the Obamacare mandate that all Americans would be forced to buy health insurance. The High Court will debate whether or not the mandate is constitutional. While the arguments will end tomorrow, a final decision on the matter is not expected until late June at the earliest.

This topic was the subject of my blog on Friday, so I won’t repeat it again today. But you can read it byCLICKING HERE.

Here’s another good argument on the constitutionality, or unconstitutionality, of the Obamacare mandate from National Review that just came out yesterday:

http://www.nationalreview.com/articles/294370/constitution-vs-obamacare-editors

Join Me On My Blog

If you have not signed up to receive my weekly blog, let me encourage you to join us. My blog posts, which typically come out on Fridays, are much shorter than my E-Letters. Topics vary widely as you might expect, and there is no advertising. Access to my blog is FREE, of course.

So please join us and let me know what you think. To register, CLICK HERE. Remember, we will never sell, rent or otherwise share your e-mail with anyone.

Very best regards,

Gary D. Halbert

Why Convertible Bonds Should be Part of Your Asset Allocation

Gary D. Halbert — Tue, 20 Mar 2012 22:47:00 GMT

IN THIS ISSUE:

1. The Best Asset Class You’ve Never Heard About

2. Greg Miller: An Asset Class to Consider

3. Convertibles – NOT for Hot Money

4. Frequent Trading Hampers Principal Protection

5. The “Secret Sauce:” Convertible Bonds with Put Options

Introduction

It is certainly no secret that I highly respect and value Greg Miller and his staff at Wellesley Investment Advisors. Of all of the professional money managers we recommend at my company, I have my largest personal account with Wellesley, and even most of my kids’ trust money as well.

Yet, there are many of my clients and readers who have not yet requested information on this successful investment strategy. In talking with some of them who had not requested information on Wellesley, I found that the number one reason was the fact that they did not understand how convertible bonds work. I hope to change that today!

It’s not because convertible bonds are secretive and mysterious like some hedge funds. In fact, they are very straightforward financial instruments available on public exchanges and with full transparency. Yet, the characteristics of convertible bonds make them one of the more unique investments available, and certainly able to provide additional diversification in virtually any portfolio.

This week, I’m going to let you hear directly from Greg Miller about convertible bonds. Not only will Greg tell you how they work, but also why they can be an important diversification technique in your portfolio – even now when other types of bonds are falling out of favor.

I hope you will read what follows because I believe that many of you will want to have convertible bonds in your portfolio before long. The interest rate increases we’ve seen over the last couple of weeks may be a sign that the long bull market in traditional bonds is rolling over to the downside. Convertible bonds offer opportunity even during periods of rising interest rates!

Without further delay, let’s hear what Greg has to say.

An Asset Class to Consider: Advantages of Investing in Convertible Bonds
By Greg Miller, CPA

QUOTE:

The cover of the January 30, 2012 Barron’s boldly states:

DON’T LOSE MY MONEY!!!
Despite the recent rally, investors still worry about preserving capital. More than ever,
investors want advisors and money managers to preserve their capital.

Who can blame investors for wanting principal protection? During the last twelve years investors have witnessed: the blow up of the dot.com and tech bubbles; a global debt implosion resulting in a severe crash and bear market; the demise of major financial institutions including Lehman Brothers, Bear Stearns, and MF Global; the demise, or near demise, of former blue-chip companies like Eastman Kodak, General Motors, Ford, Citigroup, Enron, WorldCom, and AIG; the multibillion dollar investment scam of Bernie Madoff; high oil prices; falling house prices; a European solvency crisis; and one of the worst recessions in American history. Investors brave enough to remain in the markets have very recently ridden out extreme volatility, two steep bear markets, and one frightening free-fall “flash crash.”

Barron’s recently stated that investors want advisors to make sure they don’t lose their clients’ money:

“Investors may be resigned to diminished returns, what with bond yields plumbing historic depths and banks paying almost no interest, but their biggest priority remains to avoid, at all cost, a repeat of the 2008's disastrous losses.”

To rise to that challenge, advisors should consider the asset class of convertible bonds. Convertibles can offer unique features: unlimited upside potential, and the downside protection so important to investors right now. A convertible’s fixed income value, the bond portion of a convertible, can act as a “floor,” offering downside protection and limiting downside exposure to declines in the underlying stock. Since convertibles can be exchanged for the underlying stock, a convertible can serve as an equity surrogate, a fixed-income debt instrument, or a combination of both. The relationships among current price, conversion value and investment value determine a specific convertible’s performance and price movements.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

The conversion value of a convertible bond is usually a straightforward calculation. It is the number of common shares for which the bond may be exchanged, multiplied by the price of the common stock.

Calculating investment value, however, is not as simple. “Investment value” is the value at which a straight, non-convertible debt instrument would trade if the instrument did not have an equity call option. In general, most of the time, buyers of convertible bonds accept lower yields than those associated with straight debt instruments of the same company with the same maturity dates. This is in exchange for the warrant or conversion privilege, which offers a possible play on the underlying common stock. Often, companies issue convertible bonds since they can acquire capital at a rate that is 1% to 2% below the interest or dividend rate that would have to be paid on a straight bond or stock. Investment value is more difficult to calculate since it depends on a number of factors including maturity, call risk, and the issue’s investment grade or quality of the bond.

Advantages of a Convertible Bond Investing Program

There are many advantages to a program of investing in properly selected convertible bonds. Properly chosen and managed, convertible bonds can offer the safety and principal protection of a bond, coupled with a call option on the underlying stock. In a downward-trending stock market, convertibles generally will tend to hold their value as bonds, and in rising markets, convertibles can derive a majority of their value from the appreciation of the underlying common stock.

Unlike dividend-paying stocks, interest on a convertible bond cannot be lowered at the whim of the board of directors. Properly selected and managed, convertible bonds can provide investors with a laddered guarantee of return of principal, something dividend stock investors only dream of. Many high dividend paying blue chip stocks have never, and may never, return an investor’s original principal, even if the company continues to survive. A convertible bond portfolio can be structured to offer a complete return of principal, barring issuer defaults. Convertibles’ higher yields may also be a draw for many investors. The average convertible bond currently has a current yield of 4.01%, whereas the average yield from the stocks underlying the convertible bonds only pays dividends of 1.11%.¹

Barron’s recently wrote:

Coming so soon after a lost decade of returns, investors can be forgiven for fretting about their investments. Hobbled by the bursting of the tech and debt bubbles, the S&P 500 ended the 2000s with a total return of -0.96%, the worst decade since the 1930s’ 0.33% haul… Investors, too, should start rethinking what constitutes a safe, productive portfolio.

Value Line states:

Historical studies show that on a total return basis, convertibles generally offer competitive returns to equities (though slightly lower depending on the time frame) with much less risk. As a result, on a risk-adjusted basis, convertibles offer one of the highest reward/risk ratios of all investment instruments^.²

_____________________________
¹ The Value Line® Convertible Survey, February 13, 2012
² The Value Line® Convertible Survey, January 23, 2012

UBS, in a white paper entitled The Benefit of Convertible Bonds, sums up why every investor's portfolio should own convertible bonds:

This, in our view, is the basis for the attractive risk/return relationship convertible bonds have exhibited in the past, and why we expect … this attractiveness to continue into the future. Therefore, we think allocating to convertible bonds within a diversified portfolio is a pragmatic and valuable investment decision that allows the investor not only to gain convexity and diversification benefits, but also exposure to the attractive risk/return properties of convertible bonds^.³

Investors have suffered a veritable financial Armageddon over the past ten to twelve years. As they work to rebuild both wealth and trust, advisors should heed client mandates for increased attention to protection of principal. The asset class of convertible bonds presents advisors with new and interesting ways to accomplish exactly that.

__________________________
³UBS Global Asset Management, The Benefits of Convertible Bonds, White Paper Series ©2007

Convertibles – Not For Hot Money

Like many investment professionals, we have always believed that accomplishing positive, repeatable and sustainable returns over time requires a long-term investment horizon. We leave the short term strategies to others, while we focus on five or more years as an appropriate and meaningful timeframe.

Investing in convertible bonds while also deploying an absolute return investment strategy makes this especially true. Convertible bond investors need to have a reasonably long-term investment focus for two important reasons: (1) the high cost of trading, and (2) the inability to fulfill an absolute return goal, if not investing for the long-term.

Investor Time Horizon Key to Success in Convertible Bond Investing

A sacred principle in investing involves consideration of risk tolerance and time horizon. Both are important, but time horizon becomes paramount in the bond world, where frequent traders can get killed by spreads.

All securities trade with a “bid” price, an “ask” price and a “bid/ask” spread. In comparison to stocks, most bonds have much broader bid/ask spreads. Bonds are generally less liquid than stocks, and often do not trade electronically or on listed exchanges. Larger spreads on individual bonds make them more costly to trade with frequency, or even to periodically rebalance.

Convertible bonds, especially many of the more attractive, smaller issues, typically have significant bid/ask spreads. Trading convertible bonds in small lots, or very frequently is not recommended for this reason.

In recent years, some of the most compelling convertible bonds have been part of smaller debt issues of under $300 million. These bonds trade at the greatest spreads, and frequent trading or trading in small lots is inadvisable. Trades of ultra-small lots – say, under $10,000 – can produce very poor results, as spreads in this case can be as high as 2%.

However, for longer term investors with time horizons of five years or longer, the bid/ask spread may only represent 50 basis points or less: a worthwhile sacrifice for the possibility of accomplishing superior returns. The possibility exists: the Bank of America/Merrill Lynch Convertible Bond Index (V0A0) has returned almost 7% over the last 15 years, outperforming most other markets. As a convertible portfolio matures, it will tend to hold bonds that have significant appreciation due to a rise in the underlying common stock. In these cases, liquidating and giving up a small piece of a larger profit can be a small price to pay for good results.

Convertible bond investors, like investors in many other types of investments, should have an investment perspective of five years or longer to accomplish the best possible results.

Frequent Trading of Converts Hampers Principal Protection

The primary goals of an absolute return strategy deploying convertible bonds are:

To obtain positive returns during both bull and bear markets, and
To outperform both equities and fixed income over complete market cycles

This strategy involves two important steps:

Purchase only convertible bonds with No Loss To Worst (“NLTW”), and
Purchase only convertibles with short-term maturities or that have puts of less than 7 years

Purchasing convertibles with NLTW means that if a convertible bond pays 3% interest and the bond has a maturity of five years, the buyer would be willing to pay up to 115 or $1,150 for the convertible bond, but not more.

Here’s why:

At a price of $1,150 per bond, the investor’s principal is 100% protected, if the bond is held to maturity and assuming no default. The interest on the bond at 3% or $30 per year would total $150 over five years. The interest payments, plus return of principal would completely repay the original investment, providing “absolute” return of, in this case, $0 (no return, but no loss), even if the underlying stock price did not increase, or even if it fell. The objective, of course, is not to simply break even. However, breaking even on a bad stock selection is better than losing!

Inherent in this strategy, however, is the concept of time. If the underlying stock does not rise enough to create a corresponding rise in the bond value, or if in fact the stock price falls, the best thing for the investor to do may be to wait and to continue to collect the interest payments. However, the investor who constantly trades can severely handicap the principal protection component and ultimately, decrease his chances of accomplishing true absolute return.

Most investors and financial professionals have had the disappointing experience of selling a security, only to watch it take off shortly thereafter. If only we had known! With convertibles, we do know, and it usually pays to be patient. Failing to hold convertible bonds until the next liquidity event can result in permanent losses, and worse, squanders the opportunity for principal protection of the overall portfolio.

Investors with frequent liquidity needs, frequent traders, or those who do not have the appropriate time horizon still have options. Although we still caution against investing funds that will be needed in the shorter term, a better solution can be to invest in a convertible bond mutual fund. Open-end convertible bond mutual funds usually have smaller bid/ask spreads than separately managed accounts based on their economies of scale.

Convertible Bonds with Put Options

In 1995, Merrill Lynch and Waste Management issued a zero coupon convertible bond, with a put option embedded in the prospectus. That is the first instance of convertible bonds having a put option that we know of, and since then, more and more convertible bonds have put options. A put option on a convertible bond gives investors the opportunity, at a time prior to maturity of the bond, to force the issuer to repurchase the debt at a predetermined price. The put option enables investors to sell the bond back to the company on specific dates for specific prices, usually at par or $1,000.

Years ago, put options mainly were offered only with convertibles that were issued as zero coupon bonds, or at a deep discount to par. However, the picture has radically changed and now, most convertibles issued with maturities of over seven years have put options. Most convertibles that come to market today with maturities of over 20 years or more also have put options, giving investors in convertible bonds the ability to effectively shorten the life of the bond.

There are two types of puts: “hard” and “soft.” With hard puts, the issuing company pays the bondholder cash upon settlement, usually par value. With soft puts, the issuing company can settle the put in cash, stock, or notes, and/or a combination of these, at the option of the issuing company. Hard puts are usually preferable because even though the stock, notes and cash from soft puts must equal the stated value of the put, there can be no guarantee the stated value will actually be realized when the securities are sold at a later date.

Put options are a very attractive feature for investors because they can, at the bondholder’s option, shorten the maturity date, with different redemption values. The yield to put calculation (“YTP”) can result in a number vastly different from the issue’s yield to maturity (“YTM”). Many times the YTP is greater than the bond’s YTM, making it preferable to exercise a put on the specified date, rather than hold the bond to maturity. Puts also give the convertible bond holder the right to put back “busted” convertibles where the probability of receiving more than yield to the next put or maturity may be unlikely because the underlying stock price has dropped significantly, with little perceived chance of rebound.

Another benefit of a put in convertible bond investing is that investors who buy bonds with positive YTW can reasonably be assured of a positive return, providing the company remains financially sound. The lesser of the YTP and the YTM are referred to as yield to worst (“YTW”) in the convertible world.

The value of a convertible bond is derived from the levels of its conversion and investment values. Theoretically, a convertible bond should not trade below its investment value because fixed income investors should support its price at this value. Convertibles with put features have two investment values: one based on the put price and the other based on maturity. The put price creates a second investment value “floor” below which the bond should not trade, offering convertible bondholders additional safety.

Convertible investors should realize that if a bond is trading on its YTP and the put date passes, the bond price will drop to a price supported by either its YTM or, the next put (if another put exists). If a bond’s YTP is higher than the current yield or YTM, and it is not supported by the issue’s conversion value, as the put date draws near, it may be wiser to sell or put the bond back instead of holding the bond, as the price of the bond can drop significantly after the put date passes.

Convertibles with puts can provide holders with a “floor” value that reduces downside risk. Put options are a very unique and appealing feature that help anchor principal and allow investors a broader slate of options. Such choices can become complex, however, and most individual investors can benefit from the expertise of an investment professional that specializes in convertible bond management. END QUOTE

Conclusions

At this point, I usually try to summarize what has come before but I think it’s unnecessary in this case. In the above article, you have learned about convertible bonds from one of the top experts in the US on these investments, so much so that the Morningstar organization named Wellesley Investment Advisors as the top performing convertible bond manager in America for the last 15 years.*

It seems that everyone today is seeking top-performing money managers that seek to provide absolute returns with controlled risk. Here’s the good news – you just found one!

To learn more about the Wellesley organization and its Limited Risk Investing program, contact Halbert Wealth Management in any of the following ways:

Give us a call at 800-348-3601 and ask to speak to one of our Investment Consultants;
Send an e-mail requesting information to info@halbertwealth.com;
Visit our website at www.halbertwealth.com and click on the “Contact Us” link at the top of the page; or
Click on the following link to access our Wellesley online request form.

Best personal regards,

Gary D. Halbert

Is the Fed Now Leaning Toward QE3?

Gary D. Halbert — Tue, 13 Mar 2012 23:06:00 GMT

IN THIS ISSUE:

1. Fed May Be Rethinking QE3

2. Timing: This is a Big Political Year

3. ECB Bailout Loans Top Three Trillion Euros!

4. Greece Avoids Ugly Default – For Now

5. When Does the Debt Day of Reckoning Come?

Fed May Be Rethinking QE3

Even before the latest report showing that 4Q GDP rose a more than expected 3% (annual rate), there was a consensus that the Fed would not embark on a third round of quantitative easing, or QE3 this year. But upon further inspection, we find that the latest 4Q GDP report was higher than expected almost entirely due toinventory rebuilding, which has faded this year.

Analysts note that were it not for inventory rebuilding in the 4Q, the GDP number would have been only around 1%. This is leading forecasters to reduce their estimates of 1Q GDP growth. As I wrote last Tuesday, Wells Fargo expects 1Q GDP growth of only 1.5%. Morgan Stanley now expects only around 1%.

As a result of these lower GDP forecasts, the continued rise in oil and gasoline prices and continued high unemployment, the thinking is shifting regarding whether the Fed will undertake QE3 this year after all. In fact, if you look at the actual minutes from the last Fed Open Market Committee (FOMC) on January 24-25, you find that the subject was indeed discussed:

“The Committee also stated that it is prepared to adjust the size and composition of its securities holdings as appropriate to promote a stronger economic recovery in a context of price stability. A few members observed that, in their judgment, current and prospective economic conditions--including elevated unemployment and inflation at or below the Committee's objective--could warrant the initiation of additional securities purchases before long.” [Emphasis added.]

It is clear from the Fed minutes above that the FOMC is still concerned about deflation when they comment that if inflation falls below their target (of 2%), that could warrant more QE. So if the economy stalls, or if inflation starts to dip, or both, it seems obvious that the Fed would not hesitate to enact QE3.

The Fed knows that QE1 and QE2 were unpopular. No one wants to see the Fed’s bloated balance sheet of apprx.$2.9 trillion today soar to $3.5 trillion or more. One other option would be to expand and extend the so-called“Operation Twist” that the Fed launched last fall.

Operation Twist as you may recall is an exercise where the Fed sells short-term Treasuries such as T-Bills and purchases longer-term Treasuries such as T-Notes and T-Bonds. This operation is designed to put downward pressure on longer-term rates, without expanding the Fed’s huge balance sheet.

Timing: This is a Big Political Year

It remains to be seen whether the Fed feels compelled to enact another round of monetary manipulation. Likewise, if the Fed feels it needs to do more stimulus, it remains to be seen whether the FOMC decides to do QE3 or an extension of Operation Twist.

But when it comes to the issue of timing – assuming the Fed does something – we can narrow the window down fairly closely. Let me explain. First, since QE3 or Twist2 will be politically unpopular, it makes sense that the Fed would want to move sooner rather than later, given that this is a presidential election year – specifically, not in the last half of this year.

Such policy decisions are almost always made at FOMC meetings. The upcoming FOMC meetings are as follows:March 13 (today), April 24-25 and June 19-20. I would be surprised if the Fed votes to enact QE3 or Twist2 at today’s FOMC meeting; they need to allow a transition period. However, it would not surprise me if they announce another stimulus program at either the April 24-25 meeting or the June 19-20 meeting.

Perhaps the most likely scenario would play out as follows. For today’s one-day FOMC meeting, the Fed probably elects to keep all options open in its policy statement later today, just as it did in January, as discussed above. [Note: We won’t see the actual minutes from today’s FOMC meeting for about three weeks, when we will know what exactly was discussed today.]

Then at the April 24-25 FOMC meeting, they could begin to get more specific as to what they might be considering in the way of more stimulus.

Keep in mind that we will not get the first government estimate of 1Q GDP until the end of April. If the Fed is considering another round of stimulus (QE3 or Twist2), I would think they would want to see the official estimate of 1Q growth before they act. If the advance estimate of 1Q GDP growth is weak, then that could be the green light for the Fed.

So in this scenario, the most likely time for another round of QE3 or Twist2 might be at the June 19-20 FOMC meeting. That way, they get it out in the open in the first half of the year, with several months for the political negatives to die down well before the election. And, the Fed could then keep a low profile throughout the election season.

The Fed watchers at Morgan Stanley believe that if the FOMC decides to enact QE3, the amount will be $500-$700 billion, and would include not only Treasury purchases but also mortgage-backed securities. Or if the Fed elects to go with Twist2, Morgan Stanley expects that would be at least $400 billion. Obviously, these are just guesstimates.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Of course, no one knows for sure that the Fed will do anything just ahead. However, let’s assume that all (or most) members of the FOMC agree that it’s possible the economy could stall out in the next few months. If they also agree that they don’t want to make any unpopular moves after the middle of the year, they could decide to resort to QE3 or Twist2 just ahead – even if they prefer not to.

Richard Fisher, the outspoken President of the Federal Reserve Bank of Dallas, has made it no secret that he opposes quantitative easing by the Fed. Speaking to the Dallas Regional Chamber of Commerce last week, Fisher said:

“I would suggest to you that, if the [economic] data continue to improve, however gradually, the markets should begin preparing themselves for the good Dr. Fed to wean them from their dependency rather than administer further dosage… I am personally perplexed by the continued preoccupation, bordering upon fetish, that Wall Street exhibits regarding the potential for further monetary accommodation — the so-called QE3, or third round of quantitative easing.”

But as noted above, Fisher has opposed QE from the very beginning. I would also point out that Fisher is not a voting member of the FOMC this year, which explains why he can be so vocal.
I readily admit it is speculation on my part to suggest the Fed may be rethinking QE3. You could also make the point that Fed Chairman Bernanke made no mention of QE3 or Twist2 in his recent Senate testimony. In fact, his failure to address the issue made many analysts assume that QE3 or Twist2 are off the table. However, if QE3 or Twist2 are off the table, I would have expected Bernanke to have made that clear in his testimony.

My objective today is simply to make sure my clients and readers are not surprised if the Fed makes another major policy move just ahead. Now that the European Central Bank’s (ECB) balance sheet has soared above $3 trillion, maybe our Fed feels the need to top that number. I say this somewhat in jest, but you just never know.

I will update you on this situation when we get the minutes from today’s FOMC meeting in early April. Those minutes will tell us definitively whether QE3 or Twist 2 are still on the table and how concerned the FOMC members are in regard to the economy.

ECB Bailout Loans Top Three Trillion Euros!

The European Central Bank (ECB) has engaged in a massive bailout program of banks in the region over the last year. To put this shift into perspective, we have to remember that in 2010 the ECB was on a mission, or so it thought, to combat fears of rising inflation in Europe. It was intent on raising interest rates and reducing the size of the monetary base.

The ECB completely missed the deflationary implications of the global financial crisis. However, the ECB finally recognized that it was fighting the wrong battle just in time and reversed policy, but it was then playing a game of catch-up. And catch up it did!

The ECB did a dramatic 180 and implemented its own version of QE to the tune of 3 trillion euros (US$3.9 trillion) over the last year or so. The ECB eventually realized that the major European banks were essentially insolvent. Given that realization, the ECB reversed course and embarked on a massive program of printing money to save the banks.

The plan was to loan massive amounts of money to European banks to help them recapitalize and survive the financial crisis. The huge bailout was a series of three-year loans to the banks at an interest rate of near 1%. The major banks jumped on this opportunity.

In a statement released last Thursday, the ECB admitted that its latest round of loans to euro-area banks jumped 310.7 billion euros to 1.13 trillion euros in the week ended March 2. The ECB’s balance sheet has now swelled to3.02 trillion euros, topping that of our own Fed at $2.9 trillion by more than one-third.

Klaus Baader, chief euro-area economist at Societe Generale in London, warned:

"With the dramatic expansion of its balance sheet… the ECB has become the most active central bank in the world. The ECB's measures are absolutely justified, but it has to be aware of the risks on its balance sheet and think of an exit strategy." [Emphasis added.]

While many have welcomed the ECB’s massive lending efforts, Baader and others worry that the central bank is taking too much risk. In particular, the ECB loosened the rules on the collateral it accepts against loans, increasing the risk that taxpayers would have to foot the bill if one or more banks default.

ECB council member Jens Weidmann, who heads Germany’s Bundesbank, said the unprecedented three-year loans are "at the limits" of the central bank’s mandate and warned of "substantial risks," Spiegel magazine reported on March 3.

The ECB relaxation on acceptable collateral mirrors what our own Fed has done in recent years. The question is – how and when will the Fed and the ECB ever unload these questionable assets the banks dumped on them without causing another potentially worse financial crisis? Yet no one asks publicly, as if we don’t want to really know.

Greece Avoids Ugly Default – For Now

The headlines tell us that Greece narrowly avoided a nasty default on its debt late last week. We are told that 83% of Greek bondholders agreed to swap apprx. €100 billion in old bonds for new, longer-dated bonds at a reported haircut of 53%. But if you look at where those new bonds are trading, the haircut is over 70%.

The Greek government put in place “Collective Action Clauses” late last week to force the remaining bondholders to accept the new bonds as a requirement to qualify for the pending bailout loan of €130 billion ($170 billion). Euro-area finance ministers are expected to approve the loan as soon as tomorrow.

The party line among euro finance ministers is that this second bailout loan of €130 billion will enable Greece to get its debt-to-GDP ratio, which is currently at 160%, down to near 120% by 2020. That will be next to impossible, and everyone knows Greece will need even more bailout money as soon as it burns through this latest loan.

Greece is in its fifth year of recession, with GDP contracting by a reported 6.9% in 2011, in large part due to the severe austerity measures forced upon the country. The unemployment rate is north of 20%, and the youth unemployment rate is above 50%.

The terms of the new bailout loan require Greece to make even more spending cuts, wage cuts and impose even higher taxes. This will ensure that the economy remains in a recession, or worse. Greece will hold national elections in late April or early May, and the mood of the electorate is livid.

While Greece may be off the front pages for now, it won’t be for long.

When Does the Debt Day of Reckoning Come?

At the end of the day, most of the developed nations of the world are accelerating their indebtedness at alarming rates. The US in recent years under President Obama has seen its national debt skyrocket, as I have warned repeatedly in these pages. This cannot continue indefinitely.

Currently, domestic and international investors remain content to purchase US Treasury securities at historically low rates of return. The US is still considered to be the safest borrower in the world, or so it would seem. Most of my respected sources believe that this alarming debt trend will continue for several more years at least, and the CBO deficit projections certainly bear this out.

Frankly, it is easy to embrace this view that a US debt crisis will not unfold until at least several years from now. After all, US interest rates across the board are at or near all-time lows. 10-year Treasury Notes are at 2% or below. 30-year Treasury bond rates are near 3%. Yet foreign demand for our Treasury securities is near all-time highs. So what’s to worry about?

Foreigners are still lining up to buy our debt despite the fact that our current President seems indifferent to trillion-dollar annual budget deficits or the fact that our national debt has recently surpassed our Gross Domestic Product for the first time in over 50 years.

But does anyone believe that the US can continue to ratchet up our national debt indefinitely without major financial consequences? I doubt that many, if any, of my clients and readers do. I certainly don’t. If we are correct, then we are simply counting the days until another potentially worse financial crisis unfolds.

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Best personal regards,

Gary D. Halbert

The Truth Behind High Gasoline Prices

Gary D. Halbert — Tue, 06 Mar 2012 22:34:21 GMT

IN THIS ISSUE:

1. 4Q GDP Came in Better Than Expected

2. Bernanke Defends Quantitative Easing

3. The Truth Behind High Gas Prices

4. How US Could Become World’s Largest Energy Producer

Introduction

Being in the business I am, people frequently ask me why gasoline prices are so high. Of late, people have also been asking me if President Obama has any idea whatsoever about how the energy markets work. As it turns out, the Heritage Foundation just released an excellent report that addresses both questions. It also lists five specific actions that Congress and the Obama administration should undertake to increase energy production in this country.

But before we get to that, I will summarize the latest economic reports which continue to give mixed signals. While the latest report on 4Q GDP came in a bit better than expected, most economists agree that growth in 2012 will not be as good as the 4Q of last year. Following that, we look at some remarks from Fed Chairman Ben Bernanke in his recent Senate testimony. While he defended quantitative easing, it doesn’t sound like the Fed is going to do QE3 anytime soon.

4Q GDP Came in Better Than Expected

Last Wednesday the Commerce Department released its second estimate of 4Q GDP. The number was a bit better than expected 3.0% (annual rate), up from 2.8% in the advance estimate. The report once again confirmed that the biggest driver by far in the economy in the 4Q was inventory rebuilding, typically a temporary phenomenon, followed by growth in consumer spending. It was the strongest growth in a year and a half.

Most economists agree that growth in 2012 will not be as good as the 4Q of last year. The consensus among the 50 economists surveyed by Blue Chip Economic Indicators (BCEI) is that the economy will grow by only 2.3% in 2012. Specifically, the consensus predicts growth of 2.1% in the 1Q, 2.2% in the 2Q, 2.4% in the 3Q and 2.6% in the 4Q. For 2013, the consensus predicts growth of only 2.6%.

Other groups individually think the BCEI consensus is too optimistic. Wells Fargo economists expect GDP growth of only 1.5% in the 1Q and 1.9% for all of 2012. Goldman Sachs revised its estimate of 1Q GDP for the second time last week to below 2%.

The BCEI consensus on the unemployment rate for all of 2012 is 8.3%, followed by 7.9% in 2013. The official unemployment rate for February will be released this Friday, and the pre-report consensus is 8.3%. As explained by Abbott & Costello in last week’s E-Letter, the real unemployment rate is around 16% if we include those who have stopped looking for work.

The number of people filing for new unemployment benefits fell fairly significantly over the last month with initial claims of 351,000 in the week ended Feb. 25 and 353,000 the week before. If indeed the economy is growing slower than in the 4Q the recent dip in initial claims may be bottoming at these levels.

On the bright side, the Consumer Confidence Index rose to a much better than expected 70.8 in February, up from 61.5 in January, the highest reading in a year. The University of Michigan Consumer Sentiment Index also rose to 75.3 in February, up from 72.5 earlier in the month. The Conference Board’s CEO Confidence Index rose by 7.0 points in the 4Q, from 42 to 49 (a reading of more than 50 points reflects more positive than negative responses).

In other economic reports of late, perhaps the biggest surprise was in new orders for durable goods which plunged 4.0% in January. That’s a very big swing following the increase of 3.2% in December. The number was expected to fall by around 1.3% due to the expiration of a tax credit for businesses at the end of December, but 4% was quite a surprise.

Retail sales and personal spending were both modestly higher in January, but both were below the pre-report consensus. On the manufacturing front, the ISM Index for February, which was expected to rise, actually fell to 52.4, down from 54.1 in January.

On the housing front, US home prices fell in December from a month earlier, ending 2011 at the lowest levels since the housing crisis began in mid-2006, according to the Case-Shiller home-price indexes. During the 4Q, home prices reached new lows, falling 3.8% sequentially and 4% year-to-year. Prices are down 33.8% nationally from their peak in the 2Q of 2006.

The BCEI consensus for inflation this year is 2.1%. I find that number to be optimistic, especially since the CPI was up 2.9% for the 12 months ended January. If oil prices remain above $100 per barrel, I don’t see inflation averaging only 2.1% this year. As this is written, crude oil is near $105.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Bernanke Defends Quantitative Easing

In testimony before the Senate Banking Committee last week, Fed Chairman Ben Bernanke predicted that the US economy will see “modest growth” this year. Many interpreted this as a signal that there will not be another round of quantitative easing, or QE3. When questioned about the positive effect of QE2 which began in late 2010, Bernanke noted:

"But since November 2010, we have had… the QE2 and the so-called Operation Twist, we have had about 2-1/2 million jobs created, we have seen big gains in stock prices, we have seen big improvements in credit markets, the dollar is about flat, commodity prices excluding oil are not much changed, inflation is doing well in the sense that we are looking for about a 2 percent inflation rate this year.”

As noted above, I think 2% inflation this year is quite optimistic, especially if oil prices remain above $100 per barrel. Bernanke also noted that the Fed is no longer worried about deflation as it was in 2010 and said that the economy is: “back to a more stable inflation environment.”

Perhaps the only surprise in Bernanke’s testimony was when he warned that the US recovery could come off the rails in late 2012 if Congress fails to take action to address a “massive fiscal cliff” of tax increases and mandatory spending cuts due to kick in in 2013. He noted: “I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date.”

As always, Bernanke warned the Senators that the US is on an “unsustainable fiscal path” and if it continues, we will face a “fiscal and financial crisis.” As for European risks, Bernanke said that most large US banks have exposure to European sovereign debt, but that most of that debt is “well hedged” (we’ll see). All in all, not much new from the Fed Chairman.

Heritage Foundation: The Truth Behind High Gas Prices

As noted earlier, being in the business I am people frequently ask me why gasoline prices are so high. More recently, people have also been asking me if President Obama has any idea whatsoever about how the energy markets work. As it turns out, the Heritage Foundation just released an excellent report that addresses both questions. It also lists five specific actions that Congress and the Obama administration should undertake to increase energy production in this country. Enjoy.

QUOTE: The national average for gas prices is almost $3.60 per gallon, increasing 40 cents from a year ago and jumping 20 cents from just one month ago. Prices are already surpassing $4 per gallon in some states and could threaten the country’s economic recovery. Higher gas prices drive up production costs for goods reliant on transportation, and more money spent at the pump means less money spent at restaurants and movie theaters. Buying fewer goods and services tightens the economic vice and holds back job creation.

Almost 70 percent of the price of gasoline comes from the price of crude oil, with excise taxes, refining costs, and retail/distribution making up the other 30 percent. Exporting refined petroleum products comprises a small percentage of total domestic gas production and marginally impacts prices. Despite demand for oil falling in the United States as a result of a weaker economy and a warm winter curbing the use of heating oil, the industrial rise of China and India continue to put upward pressure on the price of oil. The threat of Iran restricting oil exports to Europe is also driving up the global price, impacting gas prices in the U.S.

President Obama addressed these issues Thursday, February 23, in a speech on gas prices in which he continued to take many facts out of context. While the President said that there is no quick fix to high gas prices and the nation cannot drill its way out of the problem, he creates a false dichotomy that suggests that micromanaging the solution from Washington by subsidizing uneconomical technologies and sources of energy would work. This approach would do little to provide America with new, reliable, and economical sources of energy and in fact would cause more harm than good to the consumer and taxpayer.

America knows what works to effectively combat high gas prices: allowing the market to work by opening access to the country’s own oil and gas reserves, reducing onerous regulations, and allowing producers and consumers to respond to energy prices without Washington’s interference. Here are five half-truths that one continually hears about gas prices and five actions that Congress and the Administration can take to effectively combat high gas prices.

Half-truth #1: Oil production is the highest it has been in eight years.

Increased oil and gas production in the U.S. is a great development, but this is a result of increased production on private lands in North Dakota, Texas, and Alaska. On federal lands and offshore, the story is much grimmer. Production on federal lands and offshore could have yielded more output, increasing supply and therefore putting downward pressure on oil prices. Poor administrative decisions—such as refusing to open areas to exploration and production, cancelling or delaying lease sales, and the offshore drilling moratorium and subsequent “permitorium”—significantly reduced oil production, destroying jobs and reducing economic activity in the process.

If there is an economic interest to produce this oil, Washington should allow companies to do so. In North Dakota, oil production is booming and unemployment is low. There should be more stories like this.

Half-truth #2: Increasing oil production takes too long and would not impact the market for at least a decade.

This has been the mantra of the anti-drilling crowd for years, and the longer politicians listen to the message, the longer the nation’s oil resources will remain undeveloped. If access to areas that are currently off limits is increased, it will take time to explore and extract that oil. But that does not change the fact that the nation needs it today and also in the future. Furthermore, some of this oil can reach the market in much less than a decade if the permitting process is streamlined and the Keystone XL pipeline—which could bring up to 830,000 barrels of oil per day from Canada to the Gulf Coast refineries—is built.

Half-truth #3: Oil is not enough. America has only 2 percent of the world’s oil reserves.

President Obama frequently uses this number to push federal investments in alternative sources of energy that cannot stand the test of the market. The reality is that he uses this number deceptively. According to the Institute for Energy Research:

Although the U.S. is said to have only 20 billion barrels of oil in reserves, the amount of oil that is technically recoverable in the U.S. is more than 1.4 trillion barrels, with the largest deposits located offshore, in portions of Alaska, and in shale in the Rocky Mountain West. When combined with resources from Canada and Mexico, total recoverable oil in North America exceeds 1.7 trillion barrels, or more than the world has used since the first oil well was drilled over 150 years ago in Titusville, Pennsylvania. To put this in context, Saudi Arabia has about 260 billion barrels of oil in proved reserves.

One reason to view “reserves” estimates with caution is the fact that they are constantly in flux. In 1980, the U.S. had oil reserves of roughly 30 billion barrels. Yet from 1980 through 2010, it produced over 77 billion barrels of oil. In other words, over the last 30 years, the U.S. produced over 150 percent of the proved reserves that it had in 1980. If the massive quantities of U.S. oil are made available to explore and produce, the current estimated reserves of 20 billion barrels would certainly increase, providing much more production over decades to come. In other words, reserves are not a stagnant number.

Half-truth #4: Oil is not enough. The country needs an “all-of-the-above” approach to reduce its dependence on oil.

President Obama mentioned this approach in his 2012 State of the Union address, saying, “This country needs an all-out, all-of-the-above strategy that develops every available source of American energy.” But a market-based strategy is the only all-of-the-above approach. It allows all energy sources to compete, drives innovation, and results in the best possible supply and pricing. Sadly, all-of-the-above is often just an excuse to subsidize uneconomical and politically preferred technologies and energy sources, which leads to a “pigs-at-the-trough” strategy.

Whether they are for biofuels, electric vehicles, or natural gas vehicles, subsidies for alternative fuel and vehicle technologies waste taxpayer dollars, misallocate labor and capital, and create a dependence on government that promotes crony capitalism. The world petroleum market is a multi-trillion-dollar one; whatever technology can capture a portion of that market will not need help from taxpayers.

Half-truth #5: Speculators are driving up the price of gas, and they need to be reined in.

Finger-pointing at speculators and investigating prices at the pump ignore the real cause of rising gas prices: supply and demand. Oil futures markets can affect prices at the pump by changing the amount of gasoline delivered to gas stations. If producers anticipate higher prices in the future, they might take some oil off the market today and wait to sell it later. This may be happening to some degree (although there has been little historical evidence of this), especially given Iranian threats to cut off supply to European markets, but it would cause only a marginal short-run increase in prices, because at some point businesses have to unload the inventories they accumulate.

Five Actions for Congress and the Administration

Congress and the Administration should:

Get moving on permits. As the only country in the world that places a majority of its territorial waters off-limits to oil and gas exploration, the U.S. should at the very least be drilling in the areas where access is permitted. Removing the de facto moratorium on drilling would immediately increase supply, create jobs, and bring in royalty revenue to federal and state governments.
Require lease sales when ready. Congress should open areas that are off-limits: the eastern Gulf of Mexico, the Atlantic and Pacific coasts, Alaska’s offshore, the Alaska National Wildlife Refuge, and lands out West. Congress should require the Secretary of the Interior to conduct lease sales if a commercial interest exists to explore and drill. Congress should also provide the funding necessary to lease new onshore and offshore areas to oil and gas companies. Although it would take time for the federal government to lease these areas and for the energy companies to develop them, at least the process could begin.
Create a sensible review processes. Placing a 270-day time limit on environmental reviews would ensure a quick review process for energy projects on federal lands. Construction projects on federal lands take an average of 4.4 years. The 270 days would allow for a thorough environmental review process but would not prevent investments from moving forward.
Remove regulatory delays and limit litigation. Environmental activists delay new energy projects by filing endless administrative appeals and lawsuits. Creating a manageable time frame for permitting and for groups or individuals to contest energy plans would keep potentially cost-effective ventures from being tied up for years in litigation while allowing the public and interested parties to voice opposition or support for these projects.
Approve the Keystone XL Pipeline. Congress should use its authority to regulate commerce with foreign nations to accept the State Department’s conclusion that construction of the pipeline would pose minimal environmental risk. Approving the pipeline would create jobs and increase energy production—both of which the nation desperately needs—from a friendly supplier and ally.

Let the Market Work

The market would respond if Congress and the Obama Administration allowed it to work. Oil companies would respond by increasing their production, and consumers would switch to more fuel-efficient cars without any need to mandate more fuel-efficient trucks and cars. If the price of gasoline continues to rise, it will make alternative technologies all the more economically competitive. But policies that restrict oil exploration, refining, and production should not artificially drive that price higher. END QUOTE

How US Could Become World’s Largest Energy Producer

Along the same line, I read another excellent report from Mark Kiesel at PIMCO last week. It’s a very good read and includes a number of interesting graphics. Here’s just one quote from the article to whet your appetite:

“In combination, we believe increasing natural gas and onshore oil production could potentially see the U.S. overtake Russia as the world’s largest energy producer in the next ten years, and over time America should make great progress in becoming more energy self-sufficient as a nation.”

CLICK HERE to read the full article.

Best personal regards,

Gary D. Halbert

Will the Bond Bubble Burst This Year?

Gary D. Halbert — Tue, 28 Feb 2012 22:04:00 GMT

IN THIS ISSUE:

1. Bonds: The Trend is Your Friend (Until It’s Not)

2. Reasons Why Bond Rates Could Move Higher

3. Is the Fed Herding Savers Into Risk Assets? YES

4. They Don’t Ring a Bell at Market Tops

5. What is Driving the Stock Markets Higher?

6. Abbott & Costello on the Unemployment Rate

Bonds: The Trend is Your Friend (Until It’s Not)

I don’t know who first uttered this classic line – The trend is your friend (until it’s not) – but it is timeless. It seems especially appropriate today in light of the massive shift we’ve seen from stocks to bonds since the financial crisis and bear market of 2008-early 2009. Millions of investors have moved from stocks to bonds and consider themselves “safe.”

Today, there are more people invested in US bonds (of all types) than ever before. The degree to which this shift occurred in the last few years is simply stunning. To demonstrate this, let me quote some figures from the Investment Company Institute (ICI) which has long tracked inflows and outflows from US mutual funds.

To the surprise of no one, investors began to flee equity mutual funds in a big way in late 2007- 2008. For the period from 2007-2011, ICI reports that a net total of $408 billion was redeemed from US equity mutual funds – that’s huge! Question is, where did all that money go?

Can you say bonds and bond funds? ICI reports that a net total of (drum roll) $792 billion in new money was invested in US bond funds in 2007-2011. A shift of this magnitude has never happened before. While not all of the equity outflows immediately went into bond funds, this represents a shift of over $1 trillion in five years!

And remember, we’re just talking retail mutual fund investors here – the numbers above do not reflect what large institutional players did with their huge sums of money during the same period. I’ll have more on what institutions have been doing near the end.

For many years, studies have shown that the investment public at large does not make the greatest decisions regarding which asset classes to be in at which times. The Dalbar Studies [Dalbar.com] and others, which I have written about for years, have shown that most investors tend to switch at the wrong times, usually buying high and selling low.

As someone who has often been a market “contrarian,” I look at mass market migrations such as we’ve seen from stocks to bonds over the last four years, and I begin to wonder just what might go wrong with this picture.

The reasons for being invested in US bonds seem to be compelling, right? US interest rates have been falling for 30 years. The Fed promised in 2011 that it would keep short-term interest rates near zero through mid-2013. Then in late January of this year, Bernanke promised to keep short rates near zero until at least mid-2014.

What could possibly cause bond yields to go up, right? So buy more bonds. And investors did just that again in 2011. $136.5 billion flowed into taxable US bond mutual funds in 2011 alone.

US interest rates are at historical lows. Take a look at the 10-year Treasury Note that has traded below 2% for the first time in decades, reaching a record low of 1.695% on September 21 last year. The 30-Year Treasury bond now yields around 3%, the lowest rate in over 50 years. How much lower do bond investors think rates can go? Remember, bond yields have to go down for returns (prices) to continue to go up.

Reasons Why Bond Rates Could Move Higher

Forgive me for stating the obvious: the US is running trillion-dollar budget deficits and our national debt is exploding. This year, our national debt will exceed our annual GDP. How long will it be before China and other foreign creditors start demanding higher rates to purchase our debt?

I find it very curious that virtually every analyst I read (with the exception of the gloom-and-doomers, of course) believes that the US has at least 3-4-5 years or more before we become Greece. They seem to believe we have that long to get our financial house in order.

First of all, there is no guarantee that we have that long in any scenario. Those suggesting we have 3-5 years to get our house in order must assume that there won’t be another financial crisis or recession in the next several years. I wouldn’t make that bet.

At the risk of criticism from my more liberal readers, I would remind everyone that if President Obama is re-elected in November, it is very unlikely that we will get our deficits under control in the next five years. I should add that the odds don’t increase much if the Republicans win either.

Moving on, inflation as measured by the CPI rose 2.9% in the 12 months ended in January. Fed Chairman Ben Bernanke assures us that the rise in inflation over the last year was a temporary phenomenon, and the Fed has adopted an official inflation “target” of 2% or less going forward. Rising inflation, if it continues, is bearish for bonds.

Next, the US economy is showing more signs of recovery. More and more forecasters think we’ve turned the corner and that growth will improve later this year and next year. I’m still not onboard with this outlook, but if the economy does improve, that will not be bullish for bonds.

Finally, the European debt crisis is far from over. The bailout measures enacted since last summer do NOT solve the problem, and arguably make it even worse long-term. I expect the European debt crisis to be front-and-center again by this summer at the latest. This, once again, will not be good for bonds. I will focus more on Europe in an upcoming E-Letter.

Is the Fed Herding Savers Into Risk Assets?

As we all remember, the Federal Reserve slashed its key short-term Fed Funds rate to near zero in late 2008 in the depth of the financial crisis. The rate has been there ever since. Historically, the Fed Funds rate has been the central bank’s key tool to spur the economy, but it remains to be seen if it works this time around.

In August of last year, the Fed announced that it would keep the Fed Funds rate near zero until mid-2013. Then earlier this year on January 25, Bernanke announced that the rate would be held near zero until at least mid-2014. Wow, they must really be scared!

The fact that short rates will remain near zero for another two years or more is almost a guarantee that returns on risk-free investments will remain next to nothing, as has been the case since late 2008.

So, can a case be made that the Fed is driving investors out of CDs, money market funds and other risk-free or near risk-free instruments? I would have to say the answer is YES. More and more investors, especially retirees on fixed incomes, are moving into higher yielding bonds.

And we’re not talking only about Treasury bonds. Just last week, cable TV network Viacom raised $250 million by selling 30-year bonds at an astoundingly cheap 4.5%. Note that these bonds are not secured, yet they were snapped up at a premium of only 1.5% above Treasury bonds which are guaranteed by the government.

I only hope that investors realize the increased risk they are taking in buying traditional bonds of all stripes at this point.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

They Don’t Ring a Bell at Market Tops

I have been in the investment business for almost 35 years. One of the first things I learned way back when is that no one knows in advance when market (or economic) tops or bottoms will occur. We identify those major trend changes only well after they actually happen. As the old saying goes, they “don’t ring a bell.”

Second, we’ve all seen in recent years that markets move with increasingly more volatility, both on the upside and the downside. Surprises come around more and more often. Increased volatility and surprises are highly correlated with the increase in government debt (maybe I will write more on this subject at a later date).

My point today is that the multi-year bull market in bonds could suddenly come to an end this year. I don’t believe we have 3-5 years to get our financial house in order. For reasons outlined above and others, I fear that the bond market could get hit hard this year.

As always, I could be wrong about the bond bubble bursting this year, but think about it. Do you really believe you are “risk-free” in bonds or bond mutual funds? Do you understand that the longer the maturity your bonds or bond funds have, the higher risk you have? The answers to these questions are critical.

I just don’t want any of my readers to incur big losses this year
if bonds are the next asset class to get hit hard.

Short Commercial: There is one bond manager I recommend above all. The company is Wellesley Investment Advisors. They specialize in “convertible bonds” which most investors know little about, but convertibles can be a great hybrid of bonds and equities.

Wellesley has an outstanding track record. If you haven’t considered Wellesley, and you share my concerns about traditional bonds, you should consider this strategy now. I have my largest personal investment with Wellesley. To learn more about Wellesley, CLICK HERE. (As always, past performance is no guarantee of future results.)

What is Driving the Stock Markets Higher?

Some equity market observers assume that retail investors are the driving force behind the remarkable run-up in stocks since the lows in March of 2009. They would be wrong. As discussed above, retail investors bailed out of stocks and flocked to bonds and bond funds in 2009, 2010 and 2011. Take a look at the following chart from Bloomberg:

The green line in the chart above shows money flowing out of the stock market in “non-block” trades for the period shown. The vast majority of non-block trades are from retail investors. While the chart only shows activity since August 2011, the trend has been virtually the same since 2008. While retail selling did slow down in 2009, it accelerated again in 2010 and 2011.

Also note that the trend in outflows reversed to modest inflows earlier this month. It is impossible to know if this will continue, but with the recent improvement in investor confidence, it would not be surprising. As noted above, retail investors have a history of buying on strength rather than on weakness. Let’s now compare the chart above to what institutional investors have been doing over the same period:

Here we see that institutional investors have been adding money to stocks almost continuously over the period shown. The vast majority of block trades are executed by institutions, and this pattern has been ongoing since 2009.

The conclusions are obvious. Institutions have been adding money to equities since 2009, while retail investors have continued to bail out even as prices rose significantly. One wonders what the markets will do if retail investors decide to come back in a big way. I find that doubtful, however, but you never know.

Abbott & Costello on the Unemployment Rate

COSTELLO: I want to talk about the unemployment rate in America.
ABBOTT: Good Subject. Terrible Times. It's 9%.
COSTELLO: That many people are out of work?
ABBOTT: No, that's 16%.
COSTELLO: You just said 9%.
ABBOTT: 9% Unemployed.
COSTELLO: Right 9% out of work.
ABBOTT: No, that's 16%.

COSTELLO: Okay, so it's 16% unemployed.
ABBOTT: No, that's 9%...
COSTELLO: WAIT A MINUTE. Is it 9% or 16%?
ABBOTT: 9% are unemployed. 16% are out of work.

COSTELLO: IF you are out of work you are unemployed.
ABBOTT: No, you can't count the "Out of Work" as the unemployed. You have to look for work to be unemployed.
COSTELLO: BUT THEY ARE OUT OF WORK!!!
ABBOTT: No, you miss my point.
COSTELLO: What point?
ABBOTT: Someone who doesn't look for work, can't be counted with those who look for work. It wouldn't be fair.
COSTELLO: To who?
ABBOTT: The unemployed.

COSTELLO: But they are ALL out of work.
ABBOTT: No, the unemployed are actively looking for work. Those who are out of work stopped looking. They gave up. And, if you give up, you are no longer in the ranks of the unemployed.
COSTELLO: So if you're off the unemployment rolls, that would count as less unemployment?
ABBOTT: Unemployment would go down. Absolutely!

COSTELLO: The unemployment rate goes down just because you don't look for work?
ABBOTT: Absolutely it goes down. That's how you get to 9%. Otherwise it would be 16%. You don't want to read about 16% unemployment do ya?
COSTELLO: That would be frightening.
ABBOTT: Absolutely.

COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?
ABBOTT: Two ways is correct.
COSTELLO: Unemployment can go down if someone gets a job?
ABBOTT: Correct.

COSTELLO: And unemployment can also go down if you stop looking for a job?
ABBOTT: Bingo.
COSTELLO: So there are two ways to bring unemployment down, and the easier of the two is to just stop looking for work.
ABBOTT: Now you're thinking like an economist.

COSTELLO: I don't even know what the hell I just said!

And now you know the real reason unemployment figures are improving!

Hoping you’re not overloaded in bonds,

Gary D. Halbert

12 Market-Beating Investment Strategies

Gary D. Halbert — Wed, 22 Feb 2012 00:22:00 GMT

IN THIS ISSUE:

1. A Message From Our Sponsor

2. All of Our AdvisorLink® Programs Have Beaten the Market

3. And They’ve Beaten the Market With a LOT Less Risk

4. The Numbers Don't Lie, So Why Not Join Us?

5. Getting Started is Easier Than You Think

6. Why You Should Make a Change Now

Introduction

In case you didn’t notice, the S&P 500 Index hit a milestone last week. It reached the point where it had gained 100% from the lows of 2009. While the S&P 500 is still well below its all-time high above 1500 recorded back in late 2007, many investors interpreted last week’s strength as a sign of “happy days are here again” in the stock market.

Last week the S&P 500 Index also broke above 1350, a key resistance level and remained above it at the end of the week. This is important because over the past 13 years, the S&P 500 Index has crossed this important threshold six times, but has yet to remain above it and go on toward regaining its October 2007 peak value above 1500.

While all of this may appear to be good news for the market, there are many investors who are not considering this to be the perfect time to enter the market, but are doing just the opposite. Investors have endured two major bear markets within a decade, and many have decided that if the stock market ever gets back near what they had at the peak, they will cash out and walk away from stocks forever, or at least that’s what they say.

While I can certainly sympathize with the buy-and-hold investor who has been on the scariest roller coaster ride imaginable since the turn of the century, there are few alternatives to place their money in once they get out of stocks. Savings accounts and money markets pay little interest and bonds are sometimes just as volatile as the stocks they are leaving behind.

There are, however, actively managed investment programs with the potential to provide solid long-term opportunities for those who seek alternatives to the terrifying losses so common in traditional buy-and-hold stock market strategies promoted by Wall Street and the big mutual fund families. This week, I want to revisit these programs with you. Why? Because every one of the AdvisorLink® programs I recommend has beaten the S&P 500 Index since their various inception dates and all with significantly less risk (as measured by drawdowns).

Unfortunately, most investors don’t think of risk management until after they have lost a significant part of their money. If you have a buy-and-hold strategy and are thinking of making a change, I would argue that NOW is the time for you to consider actively managed strategies. Even if you’re happy with your current portfolio, now may be an excellent time to consider diversifying your portfolio into active strategies.

A Message From Our Sponsor

We depart today from our usual menu of topics as I reflect on something I'm very proud of regarding my investment business (i.e. - my real job). As regular readers know, I am in the business of finding successful money managers and recommending them to my clients all across the country. Today we have nine independent money managers who offer 12 actively managed strategies that my firm recommends, and I am pleased to report that every one of them has outperformed the S&P 500 Index since their inception. Of course, there are no guarantees that future results will be similar.

If that doesn't pique your interest, I don't know what will. But I'm getting ahead of myself. As regular readers also know, I am not a big fan of Wall Street's mantra that the best approach to successful investing is "buy-and-hold" for the long-term, and be willing to ride out gut-wrenching losses along the way. This old strategy dealt losses of 40-50% or more to millions of investors in the bear market of late 2007-early 2009.

I admittedly don't have the strongest stomach for riding out severe market losses, and for years studies have shown that most investors don't either. So for over 15 years, my company has been on a mission to find independent professional money managers that have strategies to reduce the downside losses of being in the market. Frankly, the only way to avoid big losses during bear markets is to get out of the market from time to time (or being able to hedge long positions).

Wall Street brokerage firms and the big mutual fund families tell you that it is not possible to "time the market." Well, I'm here to tell you that they are WRONG - what else is new? While successful active managers are hard to find, they do indeed exist. Over the last 15+ years with a lot of hard work and money spent, I have found an impressive group of successful tactical asset managers and offer them to investors through our AdvisorLink® Program.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

All of Our AdvisorLink® Programs Have Beaten the Market

It always gives me pleasure when I’m able to prove the mainstream conventional wisdom wrong, and this is certainly no exception. As noted above, Halbert Wealth Management recommends nine successful professional money managers. I would like you to take a look at the table just below, and you will see that every one of them has outperformed the S&P 500 Index since their inception.

The performance shown below is real, not hypothetical, and is net of all fees and expenses since the inception of the programs. The following track records range from just over six years to more than 17 years of actual trading experience. Take a look please.

And They’ve Beaten the Market With a LOT Less Risk

If I do say so myself, it is quite a feat to sponsor a dozen professionally managed investment programs that all beat the S&P 500 from their inceptions, but that's not even half the story! These programs beat the S&P 500 Index with a LOT LESS RISK along the way (as measured by drawdowns). In the bear market of 2008-early 2009, the S&P 500 Index lost just over 50%. Take a look at the worst losses incurred by the money managers I recommend since their inception - again, these are actual numbers. This is the real story!

There are some money managers, and even some individual investors, who have beaten the S&P 500 Index over certain periods of time. But I would challenge you to name any that have outperformed the S&P 500 Index AND did so with much less downside risk along the way. The numbers speak for themselves.

Controlling the losing periods - "drawdowns" - as we call them, is the most important element of successful investing in my opinion. Yet Wall Street firms and the big mutual fund families argue to the contrary and preach that if you can ride out the gut-wrenching downturns, it will pay off over time. Maybe so, but millions of investors couldn't stand the heat in 2008-early 2009 and bailed out near the bottom - and never got back in. That is really sad.

My overarching philosophy has always been that avoiding huge losses is the first priority, and it's not rocket science why I have long held this view. Put simply, the greater the loss, the harder it is to recover. The following chart demonstrates this in spades; this is why I reprint it frequently.

I have made it my career goal to seek out professional money managers that, above all, have delivered on the goal of limiting losses. Not only have all 12 actively managed investment programs I recommend beaten the S&P 500 since their inceptions, they all have done so with a lot less downside risk along the way.

The Numbers Don't Lie, So Why Not Join Us?

Since I began writing this E-Letter almost a decade ago, it has always been a mystery to me why more of my readers didn't take advantage of the investment programs I recommend. Goodness knows, we spend a lot of money every year searching for truly successful money managers. And regular readers know that I have my own money invested in EVERY program I recommend. I always put my own money in before I suggest that you do.

We know that most of our readers are intelligent, high net worth individuals who have investments. Maybe most of them are in that small, rare bunch that has beaten the S&P 500 on their own. I hope so, but the historical studies on investment behavior suggest otherwise.

It may also be an issue of short-term performance. Obviously, no management strategy is going to do well in every market environment, including those that I recommend. Over shorter periods of time, they may underperform the market periodically. This is why I’m showing you the long-term results from the inception of each program. Investing is a marathon and not a sprint, so the best results are those viewed over extended periods of time encompassing multiple market cycles.

If you are happy with your investment returns, then congratulations to you! But if you are not satisfied, it is almost certainly because you have incurred some big losses along the way. As you can see in the tables above, my team of recommended Advisors has outperformed the market averages and has done so with much lower drawdowns along the way. This is a formula for success - no guarantees of course.

Getting Started is Easier Than You Think

Here’s how a new client relationship begins. Typically, the new person has been referred to us by a friend or relative. The first step is a phone conversation with one of my Investment Consultants (who are salaried, not on commission) to determine which of our recommended programs may be suitable for them.

Once the manager(s) has been determined, paperwork to open an account is sent to the new client. The account(s) is in the new client’s name and is held at a major custodian (such as Fidelity, Rydex, TD Ameritrade, Trust Company of America, etc.).

The money manager selected is given authority to buy and sell securities within the new client’s account. There is 100% transparency with the activity in the account. The custodians noted above all provide online access to the account. Likewise, the account can be closed at any time – there are no lockups or required holding periods.

The manager charges an annual management fee (usually 1.75% - 2.5%) which is deducted from the account, usually on a quarterly basis, and the client can see these fee transactions as well. The manager then shares a portion of that fee with Halbert Wealth Management on an ongoing basis for referring the new client and for ongoing management of the relationship. (Note: all of the performance numbers we provide are NET of all fees and expenses.)

At my company, we track every program we recommend on a daily basis. We can do that because I have my own money invested in every program we offer. And we stay in close contact with all of the money managers we recommend.

Account minimums vary among the various money managers in our stable. They range from as little as $25,000 to up to $250,000, depending upon the type of program offered.

On a final note, some readers are reluctant to invest with us because they live in some other part of the country than Texas, where we are located. Frankly, that is not a problem. We have clients in almost every state in the nation, and we have never met most of them in person. Don’t let the fact that you live somewhere else keep you from participating in these risk-managed strategies!

Most important, if you become a client, I will always take your phone call if you ask for me, or call you back promptly if I am on the phone or out of the office. I am always happy to talk to a client!

Why You Should Make a Change Now

By now, I hope I have convinced you that the traditional buy-and-hold approach to investing may not be appropriate for your entire portfolio. And that avoiding big drawdowns should be at the foundation of your overall investment strategy. But now I would like to take a moment to tell you an inside story that I think you’ll appreciate.

Let me tell you about how and when most investors come to us for help. Many new clients come to us, unfortunately, when the markets are down and they have experienced losses, often big losses. They typically say, “That’s it, I can’t do this anymore, put my money with your professional Advisors who have done much better than I have.”

Candidly, the ideal times to consider the actively-managed programs we recommend are times like TODAY, when the markets are strong. Think about it, the S&P 500 Index has risen 100% since the bottom in early March of 2009. That’s a double in less than three years! It’s precisely at times like these when you need to diversify with professionals that have the flexibility to move to defensive positions if the major trend reverses.

There’s a reason why every professional manager we recommend has outperformed the S&P 500 Index since their inception. We select them very carefully. For all these reasons, I invite you to consider the actively-managed, S&P 500 Index-beating programs I’ve shown you today.

If you would like more information about the actively managed investment programs offered through Halbert Wealth Management, feel free to contact us in any of the following ways:

Give us a call at 800-348-3601 and ask to speak to one of our Investment Consultants;
Send an e-mail requesting information to info@halbertwealth.com;
Visit our website at www.halbertwealth.com and click on the “Contact Us” link at the top of the page; or
Click on the following link to access our online information request form.

Wishing you smaller drawdowns,

Gary D. Halbert

On Obama’s 2013 Budget & the Crisis in Greece

Gary D. Halbert — Tue, 14 Feb 2012 23:13:00 GMT

IN THIS ISSUE:

1. Obama’s 2013 Budget Targets the “Rich”

2. Is a Greek Debt Default Inevitable?

3. Greek Parliament Approves Latest EU Bailout Demands

4. Default Averted For Now, But Elections Loom in April

Introduction

Some weeks there is so much to write about, it is difficult to know where to start. Today, for example, it is so tempting to write about President Obama’s attempt last week to require the Catholic Church and all of its hospitals and universities to provide free birth control, abortion and sterilization for women, only to walk it back a few days later.

While many Americans viewed Obama’s reversal as a victory, it was not. Unwilling to accept defeat, Obama merely shifted this healthcare burden to the health insurance companies. Does anyone believe the insurance companies are going to provide all these extra services for free? Not! I could write for hours on this topic, but I will leave that to others.

Instead, we’ll focus on President Obama’s new federal budget proposal for fiscal 2013 which was announced on Monday. It’s an annual ritual for me to criticize presidents’ budgets that increase spending every single year. For newer readers, please note in advance that I criticized every one of President George W. Bush’s budgets for eight years, so I’m not breaking new ground today.

Following that discussion, I will share my thoughts on the latest decision by Greece’s Parliament on Sunday night to approve a new round of severe austerity measures and spending cuts in order to receive yet another huge bailout loan from the European Union and the IMF.

Obama’s 2013 Budget Targets the “Rich”

Yesterday morning the Obama Administration unveiled its federal budget request for FY2013 which begins on October 1. As expected, the budget request was record-large at $3.8 trillion, up from $3.73 trillion in the request for FY2012. The latest budget forecasts a federal deficit of $1.3 trillion for FY2012. That will make a record four consecutive annual budget deficits over $1 trillion under Obama. The budget deficit estimate for FY2013 is $901 billion. We’ll see.

The latest budget was seen by many as a re-election campaign document in that it frames Obama’s economic pitch to voters and seeks to shift the focus from deficits to economic growth. The myriad of tax increases embrace his recent theme of “fairness" and “shared responsibilities.”

The president’s annual budget request is only that - a request. Congress is under no obligation to accept the president’s annual budget request. However, Congress is required to at least give it an up or down vote. Typically, the vote is down since members of Congress prefer to craft their own budgets for federal spending each year - at least until the last few years, that is. The Democrat-controlled Senate, for example, has not been able to produce a federal budget in almost three years, which is an embarrassment.

Last year, Obama’s record-large budget request of $3.73 trillion for FY2012 was roundly rejected in the Senate by a vote of 97-0! The budget request the Obama administration released on Monday, which is even bigger and more complex, is likely to face a similar fate. Even if it is voted down, Congress will come up with something similar, sadly.

As the new budget was rolled out yesterday, President Obama called for aggressive spending to boost economic growth and for higher taxes on the “rich” – those individuals making over $200,000 a year and families making over $250,000 a year. For them, the Bush tax cuts will disappear at the end of this year (unless Congress votes to extend them).

Never mind that those making $200K/$250K a year make up just 3% of all taxpayers, and this 3% pays more in taxes than the other 97% combined!!

The president’s new budget would also change the tax code such that dividend income, now taxed at 15%, would be taxed as ordinary income. Currently, dividends are taxed at the corporate level at a maximum rate of 35%, then taxed again at 15% at the individual level. That’s a 50% combined tax rate.

Under Obama’s budget and the already-passed Obamacare law, the effective maximum tax rate on dividends would soar to 78.4%, of which 35% is corporate tax rate, 39.6% is personal tax rate and the upcoming 3.8% Obamacare rate for couples with investment income over $250K.

Popular tax deductions such as mortgage interest and charitable giving would be “capped” for those making over$200K/$250K a year. These changes, Obama promises, would increase government revenues by $1.5 trillion over a decade.

Compare the projected savings of $1.5 trillion over 10 years – which won’t happen by the way – to the deficit of $1.3 trillion this year alone. Obama knows well that raising taxes on those making $200K/$250K won’t close the budget gap.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Although not officially in yesterday’s budget, Obama still plans to impose the so-called “Buffett Rule” which would require any person or household making $1 million or more a year to pay at least 30% of that in income taxes. Obama also wants “carried interest” taxed as ordinary income rather than at the capital gains rate of 15%, a move aimed at hedge fund managers and other money managers.

The latest budget includes an extra $800 billion in spending for infrastructure, education, manufacturing, job training, etc., with an extra $30 billion for hiring more teachers and first responders. Another $476 billion is in the budget proposal for a six-year plan to improve surface transportation, which is a big increase over current levels and much more than other proposals being considered in Congress.

At the same time, the White House had to comply with the spending caps enshrined in the Budget Control Act last year, which total in the neighborhood of $1 trillion in discretionary spending cuts over a decade. The budget details 210 places where programs will supposedly be cut or eliminated, for savings of $24 billion in 2013 and $520 billion over a decade.

The president’s budget does little to address how to curb the growth in entitlement spending. The budget would cut only about $360 billion from Medicare, Medicaid and other health programs over a decade. That’s a drop in the bucket when compared to the rapid expansion of costs expected for entitlement programs. As a result of the failure to address entitlements, our annual budget deficits will be more than $500 billion a year over the next decade.

A couple of final points about the new budget and 10-year projections:

1) A spending cut is not always a spending cut. Due in large part to “baseline budgeting,” funding for the various government agencies rises every year, in most cases. If lawmakers merely slow the rate of growth in funding, they can (and do) claim that this is a spending cut. Only in Washington!

2) These budget proposals almost always include economic assumptions that are too optimistic. In Obama’s latest budget, they estimate that GDP will rise to 4% in 2014 and remain at least that level until 2022. And no recessions between now and then either. Reminder: I criticized George W. Bush for doing the same thing in every one of his budgets as well.

Is a Greek Debt Default Inevitable?

The answer is YES, but last Sunday night the Greek Parliament pushed the day of reckoning down the road for a while longer, assuming there is enough infrastructure left that has not been burned down by angry mobs all across Greece as we saw last weekend. Today, let’s step back and look at what has happened in Greece in recent months and what is likely to happen just ahead.

Concerns over the European debt crisis had abated in the last 2-3 months after the European Central Bank took measures (in effect, quantitative easing) to recapitalize its major banks. However, events over the last week have focused on Greece (surprise, surprise) and renewed fears that it would default on its debt on or before March 20.

The Greek debt crisis, as you know, has been unfolding for over two years with multiple European Union and IMF bailouts. Until recently, EU leaders have been resolute in their efforts to avoid a Greek default and its ouster from the EU and the euro. That position seems to have changed very recently, specifically last week.

For weeks now, Greece has been negotiating for a new EU/IMF bailout loan of €130 billion ($173 billion) to avoid a bankruptcy next month that could send shockwaves through the global financial markets. The EU/IMF demanded that Greece implement additional austerity measures and deep spending cuts in return for the new bailout loan.

Greece reluctantly agreed to the terms, including a haircut of up to 70% for Greek bondholders (including numerous major European banks), despite widespread protests and violence occurring in cities within Greece. Early last week, it looked as though the deal would get done.

But as Greece’s Prime Minister finally agreed to the terms dictated by the EU/IMF, the EU/IMF tossed in a surprise requirement for even more concessions at the last minute. Greece would have to agree to additional spending cuts of €325 million this year alone. Furthermore, Greece would have to provide ironclad promises that all of these austerity measures and spending cuts would be enacted regardless of the outcome of Greece’s government elections just ahead.

The fact that the EU/IMF changed the terms of the deal at the last minute has set off increased riots and protests within Greece. Several high ranking members of Greece’s government have resigned. Over the weekend, the future of Greece’s leadership hung in the balance. No one knew what would happen next. This explains why global equity markets sold off last Friday.

The fact that the EU/IMF changed the terms of the latest agreed upon bailout deal at the last minute calls into question whether or not European leaders would now just as soon see Greece default and leave the Eurozone. While Greece is a very small country, a default on its debt next month would have major market implications, too many to discuss in this limited space.

Greek Parliament Approves Latest EU Bailout Demands

A majority of Greece’s Parliament voted to accept the EU/IMF’s latest bailout demands at midnight on Sunday (Greek time). This key vote was watched closely by news sources around the world. Had Greece’s Parliament voted down the bailout measures, a default by Greece was almost a certainty.

The latest round of austerity measures includes implementing additional steep cuts in private sector wages, sacking public-sector workers and additional deep government spending cuts this year alone.

If you watched any news over the weekend, you probably saw that hundreds of thousands of protesters filled the streets of downtown Athens rioting and burning down dozens of buildings, including several historic sites near the Parliament building. It was extremely chaotic.

Sunday's protesters included trade unionists, youths with shaven heads waving Greek flags, communist activists and left-wing sympathizers, many of them equipped with gas masks.

They denounced what they described as “blackmail” being imposed by the international troika of the EU, the IMF and the European Central Bank in return for the bailout.

Because the Parliament voted in favor of the additional austerity measures, despite the mass protests, that paves the way for the next EU bailout loan of €130 billion. And just in time. This Friday, February 17, Greece is planning to make a final bond-exchange offer to its private sector bondholders. It is expected that private sector bondholders will be asked to accept a roughly 70% haircut on the value of their bonds.

The bond exchange offer to private sector creditors is designed to shave apprx. €100 billion off of the country’s €360 billion debt. The bond swap exercise is expected to run for about three weeks, but it could take even longer if there are collective-action [class-action] legal filings.

Following that, on March 20 Greece must pay back an outstanding €14.4 billion bond that it can’t pay without the new bailout loan from its European partners and the IMF. Following the Parliament vote Sunday night to accept the latest austerity measures, it would seem likely that the new €130 billion loan will be in place ahead of the March 20 bond redemption.

Default Averted For Now, But Elections Loom in April

Parliamentary elections are scheduled to be held in Greece in April of this year. They were originally scheduled to be held in 2013 in accordance with the constitution; however, due to an agreement to form a new coalition government in November 2011 in order to ratify and implement the decisions agreed to with other Eurozone countries and the IMF in October, one of the conditions was to hold an early election.

It is almost a given that most Greek leaders will be ousted from office in the April elections, especially in light of the mass protests that played out all across Greece last weekend. Those legislators that were hunkered down in the Parliament last weekend had to know that their vote in favor of the latest round of austerity measures was a death threat, politically speaking.

Conditions in Greece were already dire even before Sunday’s passage of the new austerity measures. Last week, Greece reported that its GDP was down 11.3% from the same month a year earlier. Unemployment just hit 22% and is almost 50% among young people. With the new austerity measures, there will be a 22% cut in the minimum wage, pension cuts of $396 million, a freeze on private sector salaries and reportedly a cut of 150,000 from a public sector of 800,000 employees.

Given that the Greek people will very likely vote most of their current leaders out of office a couple of months from now – presumably replacing them with a new cast that agrees with them – this raises serious questions. Most notably, will the new leaders vote to overturn the latest round of austerity measures and spending cuts adopted on Sunday?

It will be very interesting to see how the EU/IMF structures the new bailout loan of €130 billion. Will they give it all to Greece at once, what with elections coming up in April? Or will the bailout be given in stages? At this point, we do not know. EU leaders are scheduled to meet in Brussels tomorrow to discuss the terms of the bailout loan.

Either way, Greece will find itself on the edge of default once again, perhaps before the end of this year. While the spotlight may be off of Greece for a while, there will be another crisis and another bailout will be needed. In the meantime, keep an eye on Portugal which may be the next flashpoint in the European debt crisis.

Happy Valentine’s Day,

Gary D. Halbert