They reason that if you try to actively manage your account, you could be out of the market on these good days, thus reducing your return.  Illustrations provided by Wall Street firms cover various periods of time, but they always show only that missing the best days in the market will harm your return, supporting their advice to stay invested at all times.

While the numbers quoted in Wall Street’s sales pieces are usually accurate, this analysis is obviously skewed to fit the viewpoint of the buy-and-hold crowd.  Why?  Because they only illustrate the effects of missing good days in the market, without any consideration for what happens to returns when you miss the worst days.  Unfortunately, many investors buy this argument hook-line-and-sinker without thinking to ask the question, “What happens if you miss the bad days in the market?”

The National Association of Active Investment Managers (NAAIM), of which my firm is a member, is a trade association of active money managers.  Each year, NAAIM publishes its own study in regard to missing the best days in the market.  I just got my updated copy of the study cover the 25 years ending December 31, 2011 and it provides a much more balanced analysis, as I will discuss in more detail below.

NAAIM’s analysis found that a constant investment in the S&P 500 Index (excluding dividends) would have resulted in an annualized return of 6.81%, reflecting the effects of the two bear markets since the year 2000.  However, if you missed just the 10 best days in the market over this period of time, your annualized return would drop to only 3.67%  This is a decrease in return of 46%!  As you increase the number of days missed, the differential becomes greater, to the point that if you missed the 40 best days in the market, your annualized return would actually be negative.

However, the NAAIM study also shows the other side of the coin.  Let’s reverse the assumptions and see what happens.  Instead of missing the good days in the market, let’s say that an active manager allows you to miss only the worst days in the market.  Over the 1987 through 2011 time period, NAAIM’s analysis shows that if you missed just the 10 worst days in the market, your annualized return would have been 10.89% vs. the 6.81% Index return.

That’s a 60% improvement in return!  If you compare that to the 46% reduction in return we get when missing the 10 best days, we find that missing the bad days in the market has actually been more important than missing the good days.  Now that’s impressive!  I’ll bet your buy-and-hold broker never told you that.  As you increase the number of worst days missed, the numbers get even better, resulting in a return of 17.74% if you missed the worst 40 days in the market over this 25-year period of time.

Of course, this analysis is as flawed as the first one, since it assumes that the Advisor is smart enough to be out of the market on all the worst days, but in the market on all of the best days.  We, at least, are willing to point out the fallacies in both arguments.

Since both sets of performance numbers discussed above are skewed to fit one approach or the other, neither is useful to the knowledgeable investor.  However, NAAIM’s study also covers what would happen if an Advisor missed BOTH the best and worst days in the market over the 25-year period.  The results are pretty amazing.

The table below shows the full picture:

(Source: NAAIM, Inc., based on an analysis performed by Hepburn Capital Management, LLC, 805 Whipple St., Suite D, Prescott, AZ 86301. This data is for illustrative purposes only and is not indicative of the actual performance of any investment.  S&P 500 Index returns do not reflect reinvested dividends.)

Thus, while the average annual return percentages showed the results of the recent bear market, the basic result stayed the same: missing bad days in the market can more than compensate for missing out on the good days.  Even when the general direction of the market was downward, missing out on the worst declines still proved effective in enhancing performance.

Putting The NAAIM Study In Perspective

While it may be the goal of every active money manager to be in the market only on the good days and out of the market on all of the bad days, we all know that such a perfect system doesn’t exist.  Over the course of writing my E-Letter through the years, I have discussed that the ultimate goal of market timing, in my opinion, is not necessarily beating the market, but to attempt to control the downside risk of being in the market.

I base my opinion upon studies such as those done by the Dalbar organization that demonstrate the negative effect of emotional trading upon investors’ long-term returns.  We all know how it is when we lose money on an investment.  Should we stay the course, bail out and go to cash, or move to something that seems to be performing better?

The above analysis by the NAAIM organization shows the value of being out of the market on the worst days, even if you miss some or all of the best days.  That’s because the worst days are often far worse (in terms of percentage loss) than the best days are good.

For my company, the practical application of this information is to seek out professional active money managers who are able to miss more bad days than good days and thus provide added value over and above the management fees they charge.  Quite frankly, even most professional active managers can’t accomplish this, but there are some who have done so and it’s our job to find the ones who can.

In January, the unemployment rate fell to 8.3%, the fifth consecutive monthly drop. The number of new jobs grew more than expected at 243,000. The number of unemployed fell to 12.8 million in January, down from 13.1 million in December. The graphic below illustrates the highlights of today’s report, but there is much more to this story just below.

U.S. employment picture

A look at the unemployment rate, change in the number of jobs, and unemployment by sector.

Source: Bureau of Labor Statistics, The Washington Post.

What the mainstream media failed to point out was the fact that the Bureau of Labor Statistics (BLS) adjusted the size of the civilian work force downward by a record 1.2 million people! In one month. Put differently, 1.2 million people who were officially unemployed in December are no longer counted as unemployed – even though they are still out of work.

Source: Bloomberg, ZeroHedge

What you also didn’t hear from the mainstream media is the fact that the Labor Force Participation Rate fell to the lowest level in 30 years. It fell to 63.7% in January. Yet the media claimed this was the best unemployment report in over two years. Not!

Source: Bloomberg, ZeroHedge

While the folks at the BLS are supposedly non-partisan, there are some who believe that they are purposely shrinking the number of unemployed in order to manually bring down the unemployment rate. Time will tell.

Unfortunately, the number of long-term unemployed – those who have been out of work for 27 weeks or more – was little changed at 5.5 million, almost 43% of all unemployed. The number of people employed part-time because their hours had been cut back or because they couldn’t find full-time work rose slightly from 8.1 million to 8.2 million.

Moreover, the number of people the Labor Department classifies as “marginally attached” to the economy held steady at about 2.8 million. The government classifies as marginally attached those people who want to work and have looked for a job sometime in the past 12 months. They are not counted as unemployed because they have not looked for work in the past month.

The good news is that businesses are reducing layoffs and in some cases are actually hiring new employees across several industries. This good news is, however, largely offset by the fact that the BLS chose to remove 1.2 million people from the unemployed rolls, even though they still do not have jobs.

President Obama should be very happy.

Have a great weekend everyone!

The Bureau of Economic Analysis noted that the improvement in the 4Q reflected increases in private investment in inventory, consumer spending and residential and non-residential investment. Negative contributions included a slowdown in federal, state and local spending by governments.

The price index for domestic purchases paid by US residents (formerly the GDP Price Deflator) increased 0.8% in the 4Q, down from 2.0% in the 3Q. Real disposable personal income increased 0.8% in the 4Q following a decrease of 1.9% in the 3Q.

While today’s GDP report was a disappointment, it did show that the economy grew at the fastest pace since the 2Q of 2010. Despite that, stocks opened lower on the day.

Following the GDP report, the University of Michigan Consumer Sentiment Index for January came in slightly better than expected at 75.0, up from 74.0 in the previous report. Overall, consumer confidence has enjoyed a nice bounce in the last few months.

While the 4Q GDP report was somewhat disappointing, it does reduce the odds that the US economy will fall back into recession, barring some significant negative surprise. Speaking of potential surprises, we should keep an eye on Portugal which is having big problems peddling its debt. I’ll have more to say about that in an upcoming E-Letter.

Fed Lowers Outlook For Growth

The Fed Open Market Committee (FOMC) concluded its January policy meeting on Wednesday and in its press release indicated that the Fed Funds rate would be maintained at 0% to .25% until late 2014. Previously, the Fed had stated it would hold the rate at that level only until mid-2013.

Fed Chairman Bernanke stated in his press conference that the FOMC members had revised their economic forecasts downward since the last meeting and indicated this was the reason to keep the Fed Funds rate near zero until late 2014. This was a bit of a surprise.

For the first time, the Fed released its heretofore private economic assumptions. Here are the new forecasts, along with their November 2011 forecasts for comparison:

Even though the economy rebounded somewhat in the 4Q, the members of the FOMC (on balance) elected to lower their growth forecasts for 2012 and 2013. For all of 2012, the Fed expects GDP to grow at an annual rate of only 2.2% to 2.7%. In my E-Letter on Tuesday, I wrote at some length about why GDP growth in the first half of 2012 is not likely to equal that in the 4Q of 2011. This same line of reasoning may explain why the Fed lowered its growth target.

As for the unemployment rate, the Fed doesn’t see it dropping below 8% until sometime in 2013 at the earliest. Keep in mind that the unemployment rate does not count those who have stopped looking for work. However, the positive economic news from the 4Q could make people not looking for work decide to start looking again. If enough people start looking, it could actually make the unemployment rate go UP.

As for inflation, the Fed’s projections did not change materially. They believe that the Personal Consumption Expenditures (PCE) inflation rate – the Fed’s version of the CPI – will remain at or below 2% for all three years. This could be a real stretch because the Consumer Price Index averaged 3.0% for all of 2011. The CPI has been trending lower since September, but it remains to be seen if it will fall to 2.0% or below for all of this year.

The Fed’s pledge to keep short-term rates near zero for another three years is a testament to how worried they are about another financial crisis. It also has bearish implications for the US dollar, not to mention the stress it puts on folks living on fixed incomes. Here’s an interesting perspective on the Fed’s promise to keep rates near zero until 2014:
http://www.realclearmarkets.com/articles/2012/01/25/feds_pledge_cracks_dollars_foundation_99486.html

Obama’s State of the Union Speech

For a president whose job approval rating remains quite low, you’ve got to hand it to him – he’s sticking to his guns. To the surprise of no one, he will campaign against what he will call the “do-nothing Congress,” Republicans and the 1%. I would love to critique his speech but I will leave that to a couple of others in the links below. All I will say is, Obama reportedly used the word “I” 49 times in his SOTU speech. It’s all about him!

Obama’s Empty Words
http://www.realclearpolitics.com/articles/2012/01/26/after_obamas_empty_words_daniels_said_it_all__112924.html

Obama: The State of His Policies
http://online.wsj.com/article/SB10001424052970203718504577181073385102022.html?mod=djemEditorialPage_h

Have a great weekend everyone!

Unfortunately, the Bureau of Labor Statistics revised the number of new jobs created in November to only 100,000, down from 120,000 reported earlier. Today’s report noted that there are 13.1 million unemployed persons in the US as of the end of December. The number of long-term unemployed (those jobless for 27 weeks or more) was 5.6 million or 42.5% of all unemployed.

The number of persons employed part time for economic reasons declined by 371,000 to 8.1 million in December. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job. Another 2.5 million people were not counted as unemployed in December because they had not looked for work in the last four weeks. This understates the official unemployment rate.

Thursday’s report on initial claims for state unemployment benefits also came in better than expected at 372,000, down from 387,000 the prior week. The ADP employment report on Thursday indicated that 325,000 new private sector jobs were created in December, up from 204,000 in November.  As a result, today’s drop in the unemployment rate did not come as much of a surprise. Stocks actually moved lower on the news.

There is mounting evidence that the economy rebounded solidly in the 4Q. The Consumer Confidence Index jumped from 55.2 in November to 64.5 last month. That was well above the pre-report consensus. Holiday spending was also better than expected according to several sources. On the negative side, the Commerce Department revised 3Q GDP downward to 1.8% (annual rate) from 2.0% as previously reported.

Even though growth in the 3Q was disappointing, I am hearing some surprisingly positive estimates for the 4Q. Some forecasters now believe that the economy grew at a rate of 3.5-4% in the 4Q. Once again, we are hearing talk of “green shoots” in the economy, especially in the manufacturing sector. I will be very surprised if GDP was 3.5-4% last quarter.

The economists at Morgan Stanley Smith Barney (MSSB) are similarly not so optimistic on the economy for 2012. Like me, they believe that the European debt crisis is far from over.  Furthermore, they predict that the US economy will slip back into recession this year. You can read the latest research report from MSSB via a link in the story below:
http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20111122/FREE/111129935

Did Obama Violate the Constitution?

Earlier this week, President Obama announced four “recess appointments” including the Director of the giant to be Consumer Financial Protection Bureau (Dodd-Frank) and three similar appointments to the National Labor Relations Board. Recess appointments are allowed only if the Senate is not in session (ie – in recess).

The problem is, the Senate IS in session. Thus, this was a bold power grab that has Republicans, and even some Democrats, howling as they should. The Obama administration apparently believes that if it is challenged in the courts over these appointments, it won’t be until after the November elections.

Whether you are a Republican, Democrat, conservative or liberal, you need to know the seriousness of what has just happened! Be sure to read the following editorial from the Washington Examiner which sums it up very well:

http://washingtonexaminer.com/opinion/editorials/2012/01/obama-thumbs-nose-constitution-recess-appointments/2065421

Many politicos refer to this unprecedented action by Obama as a giant “power grab.” I would argue, on the other hand, that the president resorted to these “non-recess” appointments because he doesn’t have the political capital to get them any other way. It remains to be seen if he will pay a price for this “boldness” come November.

Among the GOP presidential hopefuls, Newt Gingrich still holds a narrow lead over Mitt Romney, but you get the clear feeling that Newt is losing momentum fast. Nationally, Ron Paul is far back of both Gingrich and Romney, yet Paul could win in the Iowa caucuses just ahead. The RealClearPolitics average puts Paul at +3.5 over Romney in Iowa and almost double that over Gingrich. But even if Paul wins in Iowa, it will likely be his last (sorry Ron Paul devotees).

On the economic front, it was another mixed week. Yesterday’s final 3Q GDP report came in at a disappointing 1.8%, down from 2.0% a month earlier. Yet initial claims for state unemployment benefits last week fell to only 364,000 – the lowest reading since April 2008. The University of Michigan Consumer Sentiment Index rose more than expected yesterday to 69.9 this month, up from the previous reading of 67.7.

On the housing front, sales of existing homes were slightly higher in November but well below pre-report estimates. New home sales were only modestly higher in November in line with pre-report estimates. Housing starts were considerably above expectations in November at 685,000 units. The National Association of Realtors admitted earlier this month that, due to a statistical error, it over-counted sales of existing homes from 2007 to 2010 by over 14% – OOPS!

On the European debt crisis front, the European Central Bank issued apprx. 500 billion euro in loans to ailing banks in the region this week in the form of three-year notes at an ultra-low 1% interest rate. Much of that money will be used to refinance existing loans, with only about 200 billion euro in new credit to banks. The ECB has drastically lowered its standards for the collateral it accepts for these loans, so banks get to offload some very risky assets.

Despite that, equity markets generally liked the move by the ECB. The Dow moved back above the 12,000 mark and is now up over 4% for the year, while the S&P 500 is about breakeven for the year-to-date. What a crazy year it has been! I expect it to continue. Here’s a chart of the S&P 500 that emphasizes just how volatile this year has been.

Around this time of year and especially next week, it is not unusual to see stock market forecasters issue bullish claims for the New Year. While it may be that the European debt crisis was given some short-term relief by the latest ECB loans, and the general expectation of more to come, but the underlying issues have not been solved. So I still see the craziness continuing next year.

But I will say this: so many investors bailed out of stocks this year and are hungry to get back in, if there’s any new news they can latch onto. So we could continue to see short periods when stocks rally strongly, followed by sharp selloffs due to bad news from Europe or a variety of other factors.

Here is one last interesting fact I just read yesterday. Very quietly and without much media attention, the US became a net energy exporter in the last calendar quarter for the first time in 60 years. This came about because of advancements in technology that allowed for ways to develop the naturally occurring oil and gas shale in Texas, the Dakotas and the eastern US. This is according to the US Energy Information Administration. Imagine what we could do with an energy-friendly president! Here’s an article on point:

http://seekingalpha.com/article/315669-u-s-poised-to-retake-status-as-net-oil-exporter

Merry Christmas & Happy Holidays!

Let me take this last opportunity to wish you all Merry Christmas (or whatever occasion you may be celebrating in the next few days). Christmas is such a special time for the Halbert clan. Debi has the house decorated like a showplace each Christmas. The Christmas tree is up and decorated, and I got the outside lights done the weekend after Thanksgiving. The kids came cooking lots of good food between now and 2012.

Then there’s our annual New Year’s Eve party when lots of family and good friends join us for more good food and a spectacular fireworks show engineered by one of my best friends who probably missed his calling as a pyrotechnic expert. And of course, lots of football (not that the Cowboys or our favorite college teams will still be playing by then – oh well).

But most of all at this time of year, we are thankful for the “Reason for the Season” and all of His blessings upon us. And we are grateful for YOU, our clients and readers. Without you, none of this would be possible! I sincerely wish you happy holidays, warm memories with loved ones and plenty of good food, of course. 

Essentially, the new treaty would impose automatic sanctions on any country whose budget deficit exceeds 3% of GDP. It is not clear just what the sanctions will entail as this is written. The summit also reportedly produced an agreement to increase funding for the International Monetary Fund by an extra 150 billion euros, an amount far below what is needed should the IMF decide to lead the bailout effort (let’s hope not).

Eurozone leaders also agreed to leverage and rapidly deploy the European Financial Stability Facility, the Eurozone’s bailout fund.  And the so-called European Stability Mechanism, the new bailout fund meant to replace the EFSF, will enter into force earlier than planned in July 2012.

To the surprise of some, Britain rejected the new treaty and thereby refused to adhere to the deficit restrictions noted above. The UK doesn’t use the euro and has no plans to join the Eurozone. Britain’s Prime Minister David Cameron essentially said: Thanks but no thanks!

While US equity markets rallied rather strongly after the EU announcement, it is far too early to cheer that the European debt crisis is settled, even temporarily. It remains to be seen how many countries actually ratify the new treaty after thinking about the required austerity measures that will further weaken their economies. Likewise, there is no guarantee that the sanctions, whatever they turn out to be, will actually be implemented.

Following the announcement, PIMCO’s Bill Gross tweeted his followers: “Oh what a tangled web the EU has wound. Never ending story.  Hard to trust. Risk off.” Risk off means stay on the sidelines in the equity markets.

Ever since my July 19 E-Letter, I have maintained that the European debt crisis would be one of the main drivers of the global equity markets, and that the news would be mostly negative. Today’s EU announcement doesn’t change that outlook one bit.

In other news from the EU today, the European Central Bank cut its main interest rate by a quarter-point to 1%, a move which was widely expected. Elsewhere, the European Banking Authority announced today that Europe’s banks will need to raise 114.7 billion euros in fresh capital in order to be able to weather the debt crisis. This latest estimate was 8 billion euros higher than the EBA’s last estimate in October.

Have a great weekend everyone!

While many of us argue that the first two rounds of Quantitative Easing have had little positive effect on the economy, the Obama administration and many politicos on the left are urging the Fed to do more. The argument is that Europe is heading into a recession, and this can’t help but weaken the US economy just ahead. So what’s holding the Fed back?

Good question. The simple answer may be that Fed Chairman Ben Bernanke knows he has several current voting members who oppose QE3, and he doesn’t want to give the impression of a divided Fed. The Fed Open Market Committee (FOMC) is made up of twelve members–the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining 11 Federal Reserve Bank presidents, who serve one-year terms on a rotating basis.

Each year, four members of the FOMC rotate from “voting status” to “non-voting status.” As you can see in the chart below, four current voting FOMC members – Fisher, Kocherlakota, Evans and Plosser – will rotate to non-voting status. Four current non-voting members – Pianalto, Lacker, Lockhart and Williams – will rotate to voting status starting in January.

While the FOMC is widely considered to be a non-political body, its individual members have differing biases when it comes to monetary policy. Those who tend to vote for slower monetary growth are referred to as “hawkish,” while those who tend to vote for faster monetary growth are referred to as “dovish.”  The doves would be in favor of QE3 whereas the hawks would likely oppose it.

At present, the dovish members of the FOMC have a voting majority. However, notice in the chart below that with the new rotating voters coming in on January 1, the FOMC will then have a dovish “supermajority.” Outgoing FOMC voters such as Fisher, Kocherlakota and Plosser, who have been outspoken against quantitative easing, will no longer have a vote in 2012.

This could be one of the most dramatic rotations in the Fed’s history. Some of the more hawkish members voted against QE1 and QE2. Starting in January, the only hawkish member of the FOMC will be Richmond Fed’s Jeffrey Lacker who is considered only mildly hawkish and has voted with the doves in the past.

The final FOMC meeting of 2011 will be held on December 13. Few, if any, are expecting the FOMC to vote on QE3 at that meeting. It is much more likely that QE3 will come up at the first FOMC meeting of 2012 on January 24-25 when the doves will have almost exclusive control of the vote.

One other note on the subject of the FOMC: Ben Bernanke’s term as Chairman of the Federal Reserve ends on January 31, 2014. My guess is that he will resign at that time and join the lecture circuit where he will hit the jackpot. If President Obama is re-elected and Bernanke resigns, it’s a good bet that Obama will appoint Janet Yellen as the new Fed Chair. You will note in the chart above that Ms. Yellen is considerably more dovish than Bernanke.

As a final thought, if the financial crisis in Europe continues to worsen, the new voting members of the FOMC will be much more inclined toward bailouts for European banks and perhaps Eurozone governments as well. Should this occur, remember that you heard it here first!

Speaking of the European debt crisis, French President Nicolas Sarkozy and German Chancellor Angela Merkel are proposing to renegotiate the European Union Treaty and mandate that member countries limit their budget deficits to no more than 3% of GDP. The two leaders plan to present such a plan by mid-March and hope to have it ratified by mid-May.

Sarkozy and Merkel are expected to outline the plan in a letter to European leaders this Wednesday with a vote on Thursday. They hope that all 27 E.U nations will vote in favor of the plan on Thursday, but the chances of that happening are next to impossible. If the vote fails to even get the 17 countries that use the euro, this will be BAD NEWS for the markets later this week. Here is an article on the new plan:

http://www.washingtonpost.com/world/merkel-opposed-to-speedy-fixes-critics-say-europe-needs-a-breakthrough/2011/12/05/gIQAtXgZVO_story.html

Finally, this morning Standard & Poor’s announced that it is reviewing its AAA credit rating for France, Germany and several other Eurozone nations. Pending the outcome of the summit on Thursday, S&P warned that it may downgrade a host of European nations to a “negative outlook.” This, too, would be quite negative for the markets. Here’s an article on point:

http://www.bloomberg.com/news/2011-12-05/s-p-said-to-place-all-17-euro-nations-on-downgrade-watch-over-debt-crisis.html

Looks like this could be yet another WILD week!

Basically, the Fed and five other major central banks around the world agreed to reduce the interest rate that they charge each other for US dollar borrowing by 50 basis points (half a percent). This action was aimed primarily at European banks, where lending between them has ground to a near standstill.

European banks primarily have euro assets and liabilities. However, because the dollar is an international currency, European banks also make dollar-denominated loans for which they need dollar financing. In “normal” times, European banks can readily access this financing in the interbank funding markets. However, these are not normal times. Because of extensive sovereign debt exposure at many European financial institutions, banks have become more cautious about lending to each other.

In times of financial stress, central banks extend swap lines to each other. The dollar swap lines allow other central banks to borrow dollars from the Federal Reserve, which can supply them in unlimited quantities. Until now the Fed has charged other central banks 100 bps (1%) over the overnight interbank swap rate (OIS). Therefore, the cost—for example, of a European bank borrowing dollars directly from the ECB—has been rather expensive. The extraordinary move on Wednesday slashed the swap rate by 50 basis points.

Stock markets around the world exploded on the upside immediately after the Fed made the announcement early Wednesday morning. The Dow Jones soared over 500 points during the day and closed up 490, the largest daily rise since March 2009.

It is critical to keep in mind, however, that the latest move by the central banks is nothing more than a band-aid on a gushing wound. It does not solve the European debt crisis. CNBC’s Larry Kudlow put it as follows:

“But in terms of Europe’s overall problems, with governments unable to live within their means, and with investors on strike against government bonds and a very shaky banking system, the Fed action is really like taking a Tylenol gel cap. Might help the headache in the short run. But the fundamental illness is unaffected.”

Bottom line: The European debt crisis will continue to buffet equity markets around the world for the foreseeable future. Expect more bad news just ahead.

Lastly, there is a huge argument over whether the Fed’s action on Wednesday was in the best interest of the United States, or was it dangerous. Here’s an excellent article from National Review that tackles that question head-on:
http://www.nationalreview.com/exchequer/284557/fed-pursuing-our-interest-or-banks-interests

Some Good Economic Data, Finally

Amidst all the hoopla over the central bank action this week, there were several better than expected economic reports. On Tuesday, the Consumer Confidence Index for November jumped to 56.0, up sharply from 40.9 in October. This was well above pre-report estimates.  On Wednesday, the ADP Employment change came in better than expected at 206,000 new jobs.

Initial claims for new unemployment benefits, on the other hand, were higher than expected at 402,000 for last week. Then today, the Labor Department reported that the unemployment rate for November fell to 8.6%. This was lower than expected; however, the rate came down primarily because over 300,000 people stopped looking for work last month and are no longer counted as unemployed. So the report was bittersweet.

Rain in Texas at Last!

We are finally getting some precious rain across much of Texas, and it is forecast to stick around for most of the weekend. Beautiful Lake Travis where I live, on the outskirts of Austin, is only about 40% full due to the severe drought, and the water level is apprx. 50 feet below its normal full level. To get to our boat dock, you have to endure about 190 individual steps.

The photo below is the Pedernales River which feeds into Lake Travis about 10 miles upriver from where we live. Normally, it is up to the tree-line on both sides. The structures you see are boat docks that have been sitting high and dry for months.

We are more fortunate in that we live on the main body of the lake where the water is over a mile wide, and our dock sits in very deep water.

The rain we are getting now won’t help the lake level much because the ground in the watershed area is so very dry. But at least it’s a start, and we’re very thankful for it!

Have a great weekend everyone!!

Bloomberg reported that the Italian Treasury received double the amount of bids (€10 billion) for the €5 billion in bills that it auctioned, which dampened some fears that Italy is facing a funding crisis. Also helpful was the announcement by Greece of a new Prime Minister, Lucas Papademos, who is widely seen as a solid replacement for outgoing PM George Papandreou.

It was also widely reported that the European Central Bank bought more Italian bonds ahead of the bill auction and afterward as well. This helped bring the bond rate down below 7%. But the ECB also cautioned that it doesn’t intend to be the buyer of last resort for Italian debt. It won’t be known until Monday just how much in Italian bonds the ECB purchased last week.

Meanwhile, Italy’s Senate is rushing to pass debt-reduction measures that clear the way for establishing a new government. The Senate is set to vote today on a package of measures including asset sales and an increase in the retirement age. The Chamber of Deputies may vote as early as tomorrow, and Prime Minister Berlusconi will resign “immediately,” sources said.

With yesterday’s better than expected bill auction, and with the bond yield below 7%, it remains to be seen if things settle down in Italy following several gut-wrenching days as yields soared to new euro area highs. Frankly, it will surprise me if Italy’s financial firestorm is over, but there are a few things to keep in mind.

First, Italy’s debt-to-GDP ratio of 120% is troubling, no doubt, but Italy’s debt-to-GDP ratio has been over 100% since 1992. The country’s budget deficits have been coming down in recent years, and a modest budget surplus is expected in 2012. If the government can continue to run surpluses (and that’s a big IF) and succeeds in implementing the latest round of austerity measures, some analysts believe Italy can continue to roll over its $2 trillion in debt – assuming yields remain well below 7% and the economy does not fall into a recession.

On the other hand, if bond yields move back above 7% or to 8% and investors head for the exits in droves just ahead, it is hard not to envision more financial chaos and further weakening of Italy’s economy. The next few weeks will be critical as Italy has more large debt auctions around the week of Thanksgiving. Look for Italy to remain the 800-pound gorilla in the room.

Equity markets around the world are booming as this is written, so the roller coaster stock markets continue. As of noon (central time), the S&P 500 has almost recovered all of the losses from earlier in the week. But keep your seatbelts fastened tightly!

** From all of us at Halbert Wealth Management, we send a heartfelt THANK YOU to all the Veterans out there! Your service and dedication to our great country are greatly appreciated.

Investors began to abandon Italian bonds in droves last week as fears intensified that Italy would be the next Eurozone country to experience a debt crisis. As I wrote last week, Italy has a national debt of €1.9 trillion ($2.6 trillion) compared to Greece’s €355 billion. Italy has the eighth largest economy in the world based on GDP and the fourth largest in Europe. Its annual GDP was just over $2 trillion in 2010.

Yields on 10-year Italian bonds soared to 7.4% in late trading in Rome today, a high for the euro era, in the latest sign that investors are fast losing faith in the world’s third-largest sovereign-bond market. Yields might have risen even higher in the past week but for heavy bond buying by the European Central Bank. Another reason for the jump in Italian bond yields is that international clearing house LCH.Clearnet raised margin calls on Italian bonds, making them more expensive to trade.

With the cost of Italian debt soaring, the euro is plummeting and the large-scale debt crisis that we have all been fearing appears to be unfolding before our eyes. At rates of 7-8%, more investors may decide to head for the exits, and Italy could find itself unable to raise sufficient money in the bond markets.

Given the sheer size of Italy’s debt, it may require huge international assistance. The funds potentially available to Italy from Europe and the International Monetary Fund are unlikely to meet Italy’s needs, however. Failure to halt the crisis could lead, in the worst case, to an Italian debt default that cripples Europe’s banks, plunges the region into a slump and roils the global financial system.

Investors Losing Confidence in Italian Debt

With Italian bond yields surging higher, analysts say Italy is at the brink of being unable to afford to borrow in the public markets. Italy has long relied on the fact that its debt level, although high at 120% of GDP, isn’t rising much thanks to Rome’s relatively small budget deficit. But the country still needs to borrow hundreds of billions of euros a year to repay its debts coming due.

Next year, Italy must borrow enough money to repay more than €300 billion in maturing debts and cover a targeted budget deficit of up to €25 billion. If investors aren’t willing to lend Italy such sums, Europe will have to prop up the country with all the money it can muster—with help from the IMF – or risk a global financial crash.

A failure by Italy to honor its debts on time is currently considered a remote prospect, precisely because its impact on Europe’s banking system and other government bond markets would be so disastrous. But it is certainly not as remote a possibility as just a few months ago. European policy makers are scrambling to draw up contingency plans (ie – a bailout) in case Italy can’t attract enough private capital.

So far, Italy has been able to attract buyers for its debt, albeit at rising costs. When Italy launched a new 10-year bond in August, it paid buyers a yield of 5.22%. When it sold more of the same bond in October, the yield demanded was 6.06%. Today it went to 7.4%.

A short-term spike in borrowing costs is a manageable problem for Italy, since only a small part of its debts need to be refinanced at a given time. The problem isn’t necessarily higher yields, but investors’ appetite for holding Italian debt at all. Many investors now fear that Italian bonds will lose further value, inflicting losses on them. This could leave the government with too few buyers of new bonds.

According to the Italian Treasury website, Italy has almost €59 billion in total maturing debt in November and December, some of which has already been rolled over during the last two weeks. The Treasury estimates that it will have to sell apprx. €325.8 billion in various debt over the next 12 months ending in October 2012.

Most importantly, the Italian Treasury has reportedly decided to go ahead with an auction of $5 billion in T-bills tomorrow. With yields on 10-year bonds surging to 7.4% today, it will be critical to see what yields do tomorrow. If Italian yields continue to rise, expect to see some very ugly markets tomorrow morning!

I’ll keep you posted with additional blog posts as needed in the next few days.