Wednesday, January 2, 2013

Fiscal Tiff

The Lame Duck Congress (emphasis on the word “lame”) thinks that they “resolved” the fiscal cliff with a late night New Years day vote.  In fact, all they did was raise taxes, but there is some good news buried in those actions of incompetence.

First, looking at the late December retail sales figures, it looks like consumers ignored the political grandstanding and kept right on spending.  In spite of the uncertainty, and potential anxiety, shoppers were not so put off that they stopped spending.

Second, most of the “fiscal cliff” drama is now behind us.  I think we’ll find that there was more (negative) impact to the economy during the 4th quarter, than there will be in 2013.  The melodrama was costlyEconomic activity did slow as the year ended, but now there are some rules for income tax planning and estate planning that can form the basis for decision making in the future, so maybe it will allow investors to begin making decisions, once again, and start moving forward.  We almost hit stall speed during 3Q 2012.  Personally, I am really happy to put 2012 behind me.

Third, it appears that Congress has re-learned how to compromise.  Rather than letting extremists hold Congress hostage, the Administration (Biden, mostly) and Congressional leadership figured out how to find some agreement near the center, involving both sides of the aisle, in order to forge a majority.  Previous administrations haven’t had such difficulty doing this, but the agreement surrounding tax hikes was the closest thing to a traditional compromise that we’ve seen in at least four years.  That is, after all, how Washington D.C. is supposed to work.  I thought that they’d forgotten.  Maybe now they can repeat the process and come to some agreement on the spending reduction side of things.

Fourth, most of the tax rates determined are “final.”  The accountants have been dealing with temporary estate planning rules since 2001.  Many of the rules established in the fiscal cliff negotiations are actually supposed to be permanent.  Wow.  What a concept. The Alternative Minimum Tax (AMT) fix, indexation, is also permanent.  It’s great to have some sense of finality to the negotiations.

Fifth, in my opinion, the GOP was more successful than I would have predicted.  Especially given that they lost the election in November, so taxes were bound to go up, the impact of these tax increases negotiated over the New Year holiday are relatively limited.  Given a trillion dollar annual deficit, if the tax increases account for roughly $60 billion (only 6% of the gap), that is pretty minimal.  If the rest of the gap gets filled from spending reductions (Ha!), then that would be about $16 spending reduction for every $1 of tax increase.  In reality, I think the deficits will continue ad nauseum, but the basic point remains; given the size of the deficit, the extent of the tax increase was pretty minimal.

There are plenty of things not to like about the upcoming potential for a constitutional crisis related to the debt ceiling debate we’ll be hearing over the course of the next few months.  Still, there are a few good things that came out of the final package that will help investors going forward.  It doesn’t hurt to notice them, too.

Addendum(dtd 1/7/2013):  Fidelity Investments just published a good summary of the recent changes.  Let us know if you would like us to e-mail you a copy of their Crisis Averted report.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

Friday, December 28, 2012

We've Moved. Come Visit!

May-Investments, along with Retirement Outfitters and Kim Last Financial Services, moved into the second floor of the Timberline Bank building where our new space lets us better serve friends and clients.  We continue to share a slightly larger conference room, and we’ll continue with educational workshops to help people understand planning issues and current portfolio strategy.  Our new offices have an elevator.  And the ambiance has us waking up every morning and pinching ourselves, thankful to be blessed by such a warm and friendly working environment.

Being on 24 Road makes us convenient for customers on the Redlands and up north.  We have room to meet with clients in our own offices and the luxurious interior design work is top notch.  Timberline Bank is open 9 a.m. to 5 p.m. daily.  For meetings before or after normal bank hours, we can meet you at the front door to let clients in/out.

Part of the fun of moving is the moving party.  Don’t worry; the heavy lifting is over.  We’re planning an open house in February, but please don’t wait until then to stop by and say hello.  We’ve enjoyed having numerous folks stop by already, and we’re hoping to see you soon, if you haven’t already had the chance to stop in and see our new digs.

In the meantime, best wishes from all of  us at May-Investments for a Happy New Year!
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

2013 Forecast: I dunno

Will interest rates finally go up in 2013, or stay low?  I dunno.  Will the “fiscal cliff” cause the economy to stall, or decline?  I dunno.  In the next decade, what “sustainable withdrawal rate” should retirees use to determine how much to take out of an IRA so that the account isn’t depleted prior to death?  Hmmm.  Don’t know.

Let’s face it.  One reason that economists and financial advisors are sometimes caricatured as not knowing anything is because, well, there IS a lot that we don’t know - in fact, that we can’t possibly know in advance.  When planning for our financial futures, we are forced to operate in the world of possibilities and probabilities, whether we’re looking out 40 years – or 365 days.

So how should investors handle this uncertainty?

First, in financial planning, probability analysis can help us understand what a “worst case” scenario probably looks like.  In our planning, we use what statisticians call a “Monte Carlo simulation” to help us determine the likelihood of running out of money during retirement.  These projections help us keep retirement spending in check so clients get a satisfactory answer to the question, “Do I have enough?”

Second, in market and economic forecasting, we use back-tested models to look for indications about what is most likely to happen in the future.  In 2009, May-Investments developed its own proprietary Leading Economic Index to help us anticipate where the economy is headed.  For the past four years, this indicator has correctly projected that economic growth would continue.  While it can’t be relied upon to be 100 percent accurate, at least the indicator gives us a sense of what is the more likely outlook going into 2013.

Finally, in stock-picking, we look for asymmetrical return distributions in the stocks purchased in the portfolio.  We like to own stocks with the potential for growth in the Price/Earnings ratio that the market applies to the stock.  A company that normally sells for 15-times earnings, if purchased at 10X, has room for 50 percent upside even if earnings stay flat, if only the stock valuation returns to normal. 

Ideally, portfolio companies are experiencing upside earnings growth and also have room for P/E expansion.  By buying stocks with steady earnings growth and relatively low valuations, we should be able to reduce the likelihood of a major decline in the stock price while preserving the potential for significant upside potential.  Or, in English, we are hoping to find stocks with a better chance of going up a lot, even if it means taking a chance that they go down a little.

We don’t want a normal bell-shaped curve where upside and downside are evenly distributed.  We prefer the added protection that accrues to investors who purchase shares at a discount to intrinsic value.  Although we can’t actually know ahead of time how the stocks will perform, we can reduce the amount of risk we’re taking by focusing on good companies whose valuations are already depressed.

Investing and financial planning are long run endeavors.  Only after a series of decisions are made and subjected to the fickle fortunes of chance will the solid plans stand out.  In the short run, luck distorts the results.  In the long run, however, diligent planning pays off.  In fact, having a financial plan is the primary determinant of whether or not people are satisfied in retirement.  And although I’d rather be “lucky” than smart, wisdom suggests that prudent planning helps people take advantage of good fortune and can protect them against misfortune.  More than likely, it is discipline rather than luck that separates winners from losers in the long run.

Our disciplines suggest that economic growth will continue into 2013.  The stock market could have another pretty good year.  The political grandstanding demonstrated by our so-called leaders did more to hurt the economy at the end of 2012 than it will to depress spending in 2013.  Maintaining a 4% to 5% withdrawal rate will likely work for most people, unless they are overinvested in cash equivalents and bonds.  Updating your financial plan will help you keep your spending to a reasonable level.

Will these disciplines work for you as well as they’ve worked for us?  I have no idea.  If we did know, exactly and precisely with crystal ball clarity, we could certainly make more money for clients and ourselves by operating using a lot more financial leverage.  But where do we get one of those crystal balls?  That’s the problem.  I dunno.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

Tuesday, November 13, 2012

When Does It Pay To Delay Social Security?

Retirees can start taking Social Security benefits at any time between the ages of 62 and 70.  Many people start taking benefits as soon as possible, but today’ low interest rate environment has changed the calculus enough that for many folks, that’s the wrong decision.  It almost takes a Ph.D. in Economics to calculate when to file for benefits.  Fortunately, a Stanford Ph.D. recently studied how low interest rates and increasing life expectancies impact this decision.

Retirees who file too soon receive lower benefits that, over a long lifespan, result in significantly lower monthly income late in life.  Because interest rates are low, many retirees should use savings during the early years of retirement and let benefit levels increase (risk free) so that less savings is required during later years.  Marriage, divorce, part-time work in retirement, and other retirement income benefits all complicate the calculation making it impossible to generalize.  The recent National Bureau of Economic Research study did make some general findings that readers will find interesting.

Professors Shoven and Slavov concluded that delaying benefits “is actuarially advantageous for a large subset of people, particularly for primary earners in married couples.”  While many people start taking benefits right away, afraid that something will happen to them before they can get their money back out of the system, the study actually found that, “most households – even those with mortality rates that are twice the average,” need to think about delaying benefits. 

Determining when to start taking benefits is the cornerstone of most retirees’ retirement income plan.  Moreover, without an income plan, people have a difficult time knowing how to allocate between “safe money” and “long-term investments.”  Finally, with the calculus so overwhelming that it takes an econometrician to run the numbers, many retirees give up at the outset, abandoning their planning effort and just accepting the anxiety that comes with not having a detailed plan for how to best tap resources during the retirement years.

May-Investments solution is to tap into sophisticated planning resources that allow us to evaluate the results from various options.  We can adjust when spouses file to claim their resources, adjust whether they claim their own retirement benefits, or tap into “spousal benefits” instead.  For more complicated scenarios, we have a Social Study Analyzer program that helps evaluate more complex situations, including 81 different filing options like “file and immediately suspend benefits.”  Planning software doesn’t make decisions for you, but it does make it easier to analyze alternatives.

We know that having a plan for the retirement years is a key strategy to help people enjoy a successful retirement.  Although having a “plan” is not required, it is one of the key traits that separate successful retirees from those who fail to fully enjoy the retirement season of life.  Looking at the numbers won’t necessarily change them, of course.  Folks who fail to plan for retirement and go into it with inadequate resources won’t suddenly discover new streams of income that weren’t there before.  However, for those who have saved but remain anxious about whether they’ve saved enough, a thorough planning effort brings peace of mind and enjoyment that others, who have failed to plan, rarely enjoy.

If you want to read the full study, “The Impact of Mortality, Interest Rates, and Program Rules,” e-mail me and we'll be glad to forward a copy to you.  Happy Thanksgiving from all of us at May-Investments.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

Wednesday, November 7, 2012

Election Final Results Being Tabulated

The popular vote is in, the Electoral College will confirm the decision, and today it was time for the market to weigh in on the decision.  Gold was up, interest rates, oil prices, and stocks (generally) were down, and I’m still searching for an unbiased and informed observer to help me make sense of what we can expect to see next.  Anyone who is unbiased is almost certainly uninformed, and anyone with a clue is already dug in deep with an entrenched opinion.

So, I am forced to pull myself together and come in from the fiscal cliff in order to sort things out.

First, I don’t think that the President’s re-election was already “priced in” to the market.  I think that the next few days will be about the market re-pricing the long-term outlook for stocks.  The blue investors think that we will be much better off in the short-run.  The red investors think that, as Joe Biden said, “facts matter” and choices have consequences, and that the long-term consequences of fiscal irresponsibility will be negative.  As with so many things about this election, I think that they’re both right.

In the next few days, I think that the long-term costs of living in a banana republic, running up deficits that may exceed $20 trillion before the President’s term is up, will come back to haunt us.  I think that it is possible that Wednesday’s 313-point drop might not be the last down day we see, in the near-term.  Hopefully that won’t happen, but I think that markets do try to price in stocks’ long-run earnings power and that the market’s judgment might be harsh.

On the other hand, I think that the near-term results might lead to a reasonably profitable 2013.

First, the market is already reasonably valued, so any material short-term sell-off should be limited by the fact that stocks will be getting cheap.  Second, one way or the other we will get past the daunting “fiscal cliff” headlines, and the media will be more than happy to pronounce the problem solved and celebrate the President’s achievement.  I think that the President will get pretty much what he wants in negotiations – not because he has a mandate from the voters, but because I believe that he is quite willing to ignore the handcuffs imposed by the debt ceiling altogether.

In years past, President Clinton was willing to consider the option of “just ignoring” the debt ceiling limitations.  The President could just keep cutting checks.  There isn’t a lot of recourse for using Executive Privilege as an excuse to ignore the rules that have bound others to responsible behavior.  In the fall of 2011, President Clinton even went on record recommending that President Obama use this strategy.  With re-election looming, the White House went a different direction.  That time.  Now that President Obama has secured another four years, I think that this president is perfectly willing to make the problem go away simply by ignoring it.

Furthermore, I think that the markets would love it.

The last thing that the markets want is for today’s slow-growth 2% Gross Domestic Product growth to take a 4% haircut, as many analysts predict would happen if we run off the fiscal cliff.  If the President negotiates modest and imaginary spending cuts, or just ignores the debt ceiling completely, I think that the market would sigh in relief and the headlines would treat the President kindly.  Conservatives would throw a fit.  But strict constitutionalists are now just part of the 49%.

In the short run, Obamacare might reduce healthcare costs by paying doctors and vendors less, keeping a lid on inflation in that part of the economy.  With worldwide economic growth contracting, inflation really isn’t a near-term problem.  Ongoing fiscal stimulus will propel some parts of the economy forward, and deficits higher, providing a traditional short-term stimulus to economic activity. 

Third, tax increases are coming.  Obamacare-related increases have been coming down the pike for months.  Businesses are already paying much higher unemployment taxes.  Big government is going to require big taxes, for all.  However, the economic costs of these tax increases may not be immediate, so 2013 might not feel the squeeze.  Those bills will be paid later.

Also, the President’s re-election means that short-term interest rates are here to stay.  The art of Fiscal Repression, mastered by Ben Bernanke in his economic thesis as a way to enrich Tim Geitner’s banking friends at the expense of retirees from coast to coast, is here to stay.  This government can't afford to pay 4% interest rates on $16 trillion in debt.  Financing deficits at 1% interest rates will hopefully keep the whole deck of cards standing upright.  While the costs are hidden from view, the headline risk of "rising interest rates" is gone, at least until the bond market vigilantes say otherwise.

A late-2012 market sell-off might position the market well for a 2013 rally.

The long-run costs could be years out.  That’s the good news.  I’ll defer from listing those negative consequences, which have been filling up e-mail boxes for most of the past 6 months.

As your mailboxes will indicate, as trading confirms are being sent out, you will find that our equity portfolios have been raising cash.  We started selling a few weeks before election day, and we have sold a bit more after the election as well.  These trades were not made in anticipation of the election.  They were made as a result of general market weakness.  As a result of them, for better or worse, we now have a fair amount of cash on the sidelines.  If the market does sell-off in the near-term, we have dry powder available to reinvest at more attractive levels, if we get them.

At present, the May-Investments Leading Economic Indicators have flattened out, after declining from July through September.  If the indicators resume their downtrend, I will be more likely to keep more cash on the sidelines, for longer.  If growth resumes or markets start to recover, we will be glad to take a look at investing in sectors that are acting well.  At present, there are very few sectors whose “uptrend” hasn’t turned down.  One of the few sectors that was acting well – coal stocks – sharply reversed post-election.  We talk about getting out of the way of what’s not working, and right now very little is working well in the stock market, and we have become quite conservative, particularly given that we are still pretty close to market highs as I write this.  If the market really does turn down, these sales will be very well timed.

If the market stabilizes, we will be happy to get back in to enjoy an upward trend.

We have raised a significant chunk of cash, not because of my forecast or view of the election results, but because the market turned around, just a few days before our “all is well” third quarter client letter was dropped in the mailbox.  The problem, I guess, is that “flat markets” really aren’t flat.  They are jagged and dangerous, with small increases matched by quick and ruthless declines.

My “forecast” is for a quick sell-off, which sets the stage for a decent market in 2013.  Rather than structuring the portfolio so it aligns with my opinion, however, we are managing our risk exposure based on the way Mr. Market is treating investors.  In the past weeks, the trends have been turning down.  As a result, we have reduced the amount of risk we are willing to take.

Hopefully this correction, if that’s what we’re having, will – like the election robocalls - be over soon.  While the market weighs in, however, we’ve moved some cash to the sidelines.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

Tuesday, October 16, 2012

Bond Choices For The Timid

With interest rates near all-time lows and about a trillion dollars chasing today’s low yields (it’s more like 3 trillion dollars if you include bond purchases by the central banks), finding decent bond investments is a bit of a challenge, these days.  In general terms, I thought I’d mention some of the types of fixed income securities that we’ve been buying for clients in this low interest rate environment.

Since bond prices and interest rates move in opposite directions, the risk in the bond market is that rates move higher (they can’t move much lower!), which pushes bond prices down.  This risk is much greater in a long bond than it is with a security that matures in just a couple of years.  The Leuthold Group gives the example of a 20-year Treasury bond that sells for a 2.35% yield.  The bond in question has a coupon of 5.625%.  On a $100,000 original investment, it pays $5,625 annually.  To buy that bond in the current low-yield environment, however, investors would have to fork over $140,240.  (Yes.  In the past few years, somebody has already made a 40% profit on that bond.  And they are selling it to you.)

The bond has a price of $140.24.  Should rates go back up by 1.65%, so the bond yields a more normal 4% yield-to-maturity, the price of the bond would decline to $117.10.  If that rate increase happens over the course of the next year, the bond would fall nearly 19% in value.  However, it would spin off income of about 4%, so an investor’s total loss would be about -15%.

While a 15% loss isn’t quite the same magnitude of losses that stock investors experienced during the technology bubble, for someone trying to be “safe” with their money, a 15% loss would come as a rude awakening as to the risk out there in the supposedly “safe” fixed income asset class.  A novice investor might buy the bond thinking that they were getting a “safe” 2.35% return, only to get hit with a 19% loss, instead.  A real rube might think that they were buying a bond that pays 5.625%, but experience that same 19% loss.  In either case, buying a bond for safety, and then losing principal, isn’t going to make folks happy.

A 12-month Treasury bill, by comparison, would not lose money.  However, the return on a 1-year T-Bill is only 0.17%.  It’s almost as bad as losing money, since you’re loaning the money to the U.S. government to buy a lot of things that, well, you probably wouldn’t buy if you had a say in the matter.

We are shopping for reasonably short maturity fixed income investments that provide a better return than T-Bills.  Heck - let’s face it - we’re just trying to find something that will give up a POSITIVE return for the next couple of years.  And we’ve found five different types of securities that we believe offer both positive returns without taking a lot of risk.

In the past, we’ve been a regular buyer of short-maturity junk bonds ever since the high yield market blew itself up in 2008.  With so much money being created by the Federal Reserve, we believe that it makes far more sense to take “credit risk” than it does to take on “interest rate risk.”  The risk of default, we believe, is far lower than the risk that higher interest rates will depress the value of what we own.  However, in 2008 investors could by short-maturity junk bonds with yields of 10% to 20%.  These days, even on junk bonds, short-term yields may be more like 2% to 3% for most names.  It’s tough to take any risk to principal when the investment return is that low.  Still, in a few cases, we’ll buy short-term high yield bonds because we expect to hold those bonds to maturity.  Rather than selling them, we can just let them mature.  If the bonds are backed by hard assets, even in a worst case scenario we foreclose on assets that have value to investors.

Second, a little over a year ago we added a mutual fund that owns short-term government guaranteed mortgage-backed securities in its portfolio.  The bonds aren’t backed by Fannie-Mae or Freddie-Mac, which are entities in guardianship currently because their overpaid traders and executives bought too much junk at the behest of Congress during the real estate bubble.  Instead, we own mortgages that are fully guaranteed by the full faith and credit of Uncle Sam, just to be sure.  Periodically, mortgage market participants blow themselves up by buying sophisticated securities on the premise that they’re a simple investment.  In fact, mortgage-backed securities are easy to buy, but in a crisis they can be very difficult to sell.  It happened after Orange County, California bought too many mortgage bonds in the early 1990’s, and again after the 2008 financial crisis.  As a result, mortgages still offer reasonable returns, but they don’t belong in an individual’s portfolio as an individual security.  They are just too hard to sell.  For this reason, we invest in them through a mutual fund.

The fund we own has bonds in the portfolio that yield 3.09%.  The fund’s 0.55% expense ratio must come out of this return.  The fund’s price (net asset value) has been fairly stable.  The N.A.V. was $10.62 in 2001, fell to $10.16 at the end of 2006, and is currently $11.29.  We actually do expect the N.A.V. to lose some value, but not a lot.  We’re hoping that our investment will earn 1% to 2% during our holding period.  Also, it’s good to have funds around because they can be easily liquidated in the event we want available funds to use to buy long bonds later, after rates have gone up.

Another alternative we’ve started using is an exchange traded fund that owns a broad portfolio of short-term high-yield bonds.  In this case, the bonds in the ETF all mature in 2014, so in two years we expect the ETF to self-liquidate and give us back our money.  It’s similar to owning an individual issue, but with junk bond yields so low, it’s hard to justify taking much of any credit risk.  By using a fund to diversify the investment, we reduce the likelihood that we happened to buy just the wrong bond, and lose a significant amount of principal in return for an insignificant rate of return.

The ETF we own has bonds in the portfolio that yield 5.39%.  The fund’s 0.42% expense ratio must come out of this return.  The fund is diversified across more than 100 individual securities, but trades easily throughout the day so it provides both diversification and liquidity benefits.  In an economic downturn, we might want to sell these short-term bonds in favor of buying longer maturity investments.  In the event of an economic recovery, presumably Treasury rates would move higher and we might want to lock in rates by purchasing longer maturity Treasuries.  In the meantime, we’ll be paid a little to wait, and we hope to be able to have liquidity when the time is right to redeploy funds into different types of securities.

We have also found a few floating-rate bonds to be of interest.  With interest rates so low, floaters whose interest rates are based on short-term interest rate indexes have plenty of room for their rates to increase when interest rates, generally, do start moving higher.  In this case, it’s okay to buy a longer-term bond because the price should be protected (generally) by the increase in the bond’s coupon.  Also, in some cases, the current interest rate is so incredibly low that the bonds are actually selling at a discount (i.e. below maturity value), so in addition to some modest coupon income, the bonds can be expected to appreciate as they move toward maturity.

A typical recent example is when we purchased the bonds of a too-big-to-fail bank which is paying IRA investors 0.55% to invest in a 4-year certificate of deposit.  Although not insured, like a CD, the bank’s bonds pay a floating rate of interest currently set at 0.60%, and the bonds should appreciate from $89.4 to par ($100) between now and June 15, 2016.  Combining the appreciation and the coupon interest should yield roughly a 3.25% return to investors.  If short-term rate indices rise, the coupon on this bond goes up, which helps boost the ultimate return to investors.

Finally, there are a few callable bonds that are of interest.  Callable bonds have a final maturity date, but they can be subject to early maturity at the whim of the issuer (i.e. they can be “called away”) based on current interest rate conditions.  In this low rate environment, most callable bonds are called at the first opportunity because issuers can float new bonds, at lower rates, and use the proceeds to get rid of that old, high-coupon debt.  It’s really not much different than what homeowners have been doing with their old mortgages.  They take out a new mortgage and use the funds to pay off the old, higher rate debt.

The interesting thing about callable bonds is that they trade to the short-term call date.  A bond with a 4% coupon won’t have much of a premium because buyers know that the bond will likely be called in a year or two.  However, if rates increase between now and the call date, it’s possible that it won’t make sense to pay that bond off early, after all.  In that case, the 4% coupon might last a lot longer than originally thought.  The key is to find bonds with coupons that are high enough to be attractive, if kept to maturity, but low enough that it wouldn’t take much of an interest rate increase for it to no longer make sense to call in the bonds.

In today’s bond bubble, with the demand for bonds so much higher than the current supply of new bond issuance, it’s a very difficult place to find value.  Hopefully the securities we’re buying will give us a 2%-3% return without exposing us to a lot of interest rate risk.  We’re looking forward to the day when fixed income investors are no longer treated with contempt by the central banking system, which is looking to retirement savers to subsidize the mistakes made by the central banks and Wall Street bankers during the period leading up to the financial crisis.

In this environment, it’s good to be timid.  It may not pay a lot, but it will likely pay off in the end.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

Wednesday, September 19, 2012

Fed To Punish Savers For Three More Years

Last week, after completing a set of grueling meetings in Jackson Hole, the honchos at the Federal Reserve announced to the market a new round of money printing and extended its policy of denying savers a fair return on their savings.  They worded the announcement slightly differently, but that’s the gist of things.  Faced with deteriorating economic statistics, the Fed decided to continue its current policy of “financial repression” at least until mid-2015.

Critics of this latest round of Quantitative Easing (QE3) accuse the Fed of bowing to political pressure from the White House in advance of the upcoming election in pursuit of policies that debase the dollar and have not helped reduce unemployment or restimulate business investment.  Contrasting current policies with the polar opposite policies successfully implemented by Paul Volcker in 1979,  Obama critic Larry Kudlow wrote, “It’s like history is repeating itself, but in reverse.”

I do believe that the QE3 announcement is confirmation to what the May-Investments Leading Indicators Index is showing; economic fundamentals are deteriorating rapidly and the Fed is worried.  While the critics charge that QE3 will be no more successful than the first two attempts, I believe the evidence on Quantitative Easing is unclear.  While it is clear that interest rates can’t go any lower, so the normal Fed tools aren’t working, it’s hard to know where we would be absent this digital printing press, which is working overtime.  It is entirely possible that absent “Helicopter Ben’s” herculean efforts to spread money we don’t have to random companies throughout the financial sector, we might already be in a Depression.

One reason that Bernanke is doing just the opposite of Volcker is that the 1979 Fed was fighting rising and persistent inflation.  Today’s Fed is petrified of deflation, inflation’s polar opposite.  No wonder it is using a different set of tools.  Rather than blaming the White House, it is fair to say that there is real uncertainty, and honest differences of opinion, about the efficacy of current Fed policies.
 
The real problem is that something other than low interest rates is holding back confidence and business investment.  Indeed, the current policy of keeping interest rates unrealistically low, which boosts bank profitability at the expense of retirees, just forces the elderly, foundations, and other savers to take more risk than they’d like with their nest eggs.  This policy of “financial repression” punishes retirees who had hoped to live off of their savings when they are too old to work.  It is a cold-hearted subsidy of U.S. government borrowing that is forcing people to put off retirement, take more risk than is appropriate, cut back on day-to-day spending, and forces more dependence on Social Insurance programs.  Is it any wonder that confidence is waning?

Most readers don’t spend a lot of time thinking about U.S. government fiscal and monetary policy.  These subjects seem like dry, “intellectual” pursuits with little bearing on daily concerns.  For May-Investments, however, these political economic policies, known in economics jargon as “macroeconomics,” have clear consequences and we see the impact on our friends and neighbors on a regular basis. 

Households forced to choose between lowering their standard of living because their bank savings no longer pay a decent return, or taking on additional risk, are moving out the risk spectrum into securities that have hard to interpret risk associated with them.  When these investments decline in value, as they almost certainly will, scared investors will lock in losses as the frightened herd heads for the door.  While millions blame “the banks” for today’s ills, in reality it is government policies, bureaucrats at the Treasury, and economists at the Federal Reserve who are largely responsible.  True, bankers are the beneficiaries – but it is current macroeconomic policy which is largely to blame.  When we look at this economy and try to assess what “excesses” might lead to a new recession, the clear and obvious candidate is the bond market, which has been pumped up by Federal Reserve policies that have inflated the value of income paying securities.

Markets are a mess, and it is the hyper-regulated banking sector that is mostly to blame.

The politicians in Washington D.C. are focused on arguing about social issues and tiny steps that don’t begin to solve the country’s economic problems.  “Nero fiddles while Rome burns.”  The Fed’s policies of financial repression are doing more harm than good.  QE3 is, at best, a narcotic designed to get us through the next few months.  No matter what your party affiliation, May-Investments urges readers to make your vote count, pay special attention to voting for candidates whose top priority is getting the economy working again, and remember that “all ties go to the challenger.”  Both parties are guilty.  Incumbents really aren’t going to turn the ship around.  If we want a better future, we have to do things differently.  If we want this brain damage to stop, we need to stop letting the folks in power beat our heads against the wall.  If we don’t want the punishment that the Fed has laid out for us, then rather than continue to mask the symptoms, we need to take whatever macroeconomic medicine will lead to a cure.

Vote early.  Vote often.  Make it count.
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .