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Y:\Other\Get the Most Out of Your IRA (5936612) 04/19/23
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1
“The function of economic forecasting is to make astrology look
respectable”
- John Kenneth Galbraith, Economist and Author
© 2011 Morgan Stanley Smith Barney LLC. Member SIPC.
Investing in a “AA+” World, and a “D+” Recovery
Double-Dips, Delinquencies, Despair, Demand Destruction, Deleveraging, Deficits, Debt Downgrades, Defaults, Deflation, Dividends, Demographics and Democracy
THE LEWIS GROUP
Morgan Stanley Smith Barney
John B. Lewis Joseph W. Bartholomew III 901 East Byrd Street, Suite 2000
Family Wealth Director Financial Advisor Richmond, VA 23219
Senior Vice President Vice President 804-780-3396
thelewisgroup@mssb.com
The views and opinions expressed herein are those of the Lewis Group and do not necessarily reflect the views of Morgan Stanley or its affiliates.
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3
Double-Dip Recession?
Everyone is worried about a “double dip” before we even get out of the first “dip”!!!
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First, the bad news…
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This economic “recovery” is NOT rated AA+…
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6
JOBS: Alternative Unemployment Rate (U-6)
The broadest measure of labor underutilization, U6, includes not only all unemployed and marginally attached persons, but also those employed part time for economic reasons.
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JOBS: this time IS different.
We have had “jobless recoveries” before, but this is the weakest on record.
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8
JOBS: jobs growth is NOT keeping up with labor force growth
The U.S. economy needs to create 250,000+ jobs per month just to get back to “even” by 2013. September 2011’s reported change in Nonfarm payrolls: +$103,000.
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9
DECLINE: Home Prices and Home OwnershipThe U.S. homeownership rate has fallen below 60 percent when delinquent borrowers are excluded, a sign of the country’s move
toward a “Rentership Society” - Morgan Stanley analysts, July 21, 2011
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10
A buy & hold stock investor’s worst nightmare too…
DECLINE: Stock Prices and Stock Ownership
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DECLINE: Household Net Worth
American’s financial assets (stocks, bonds, real estate) more than doubled from 1990 to 2000, and then, after a pause, rose nearly another 50% before the bust of 2008. Household net worth then suffered the
largest loss (-$12 trillion) since the Federal Reserve began keep track after World War II.
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DECLINE: Household Net Worth - this time IS different.
This is the weakest “asset recovery” in the post-war era. The S&P 500 is still off -25% from it’s 2007 peak and house prices are down anywhere from -25% to -50% nationwide. Households have not recovered.
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DECLINE: Household Incomes
In addition to balance sheet issues, household incomes have been falling since the year 2000.
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DESPAIR is in the air
No surprise. Consumer confidence is weak and getting weaker.
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DEMAND: there Is little demand for home construction
The housing sector has been a significant driver of recovery from most recessions in the United States since World War II.
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DEMAND: there is little demand for mortgages
Not only are consumers not building new homes, they are not buying previously-owned homes either. This is a major damper on other consumer durable and discretionary
spending (think- appliances, carpets, décor, etc).
Also, with a third or more of homeowners “underwater” on their mortgages, it is very difficult to refinance mortgages in the current environment.
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U.S. Policy Responses…unprecedented.
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FOMC Statement 8/9/2011: “exceptionally low levels for the federal funds rate at least through mid-2013”
The Federal Reserve (Conventional Responses):
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Federal Reserve Policy makers said they will commence a third bond-buying program aimed at lowering home-loan rates. This effort, known as Operation Twist, will replace some shorter-term securities in the central bank’s $1.6 trillion portfolio with longer-term Treasuries. The goal is to twist the so-called yield curve so longer- term bonds such as 10-year Treasuries have lower interest rates. The Fed used the same maturity-exchange program during the early 1960s in a joint operation with the Treasury Department shortly after John F. Kennedy became president.
The Federal Reserve (Unconventional Responses): QE1, QE2, and now ...
FOMC Statement 9/21/2011: “Operation Twist”
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STIMULUS/DEBT: the government is borrowing heavily
In fact, the public sector IS the majority of credit demand!
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STIMULUS/DEFICITS: the government is spending heavily
Expenditures minus Receipts.
2011 deficit is almost 9% of GDP.
2008 budget deficit $ 455
2009 budget deficit $ 1,400
2010 budget deficit $ 1,300
2011 budget deficit (estimate) $ 1,300Source: Budget of the U.S. Government, Mid-Session Review, Fiscal Year 2012, Office of Management & Budget (Aug. 2011)
(in billions of dollars)
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One small problem with this strategy…
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“We believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years.” -Standard & Poor’s Research Update (April 18, 2011)
“There is now at least a one-in-two likelihood that we could lower the long-term rating on the U.S. within the next 90 days. If an agreement on the debt ceiling is reached, but we do not believe that it likely will stabilize the U.S. debt dynamics, we would expect to lower the long-term 'AAA' rating.” -Standard & Poor’s Research Update (July 14, 2011)
“The downgrade reflects our opinion that the debt limit plan falls short of what is necessary to stabilize the government's medium-term debt dynamics. Elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a 'AAA' rating. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending. New revenues have dropped down on the menu of policy options and the plan envisions little change in entitlements, the containment of which are key to long-term fiscal sustainability.”-Standard & Poor’s Research Update (August 5, 2011)
DOWNGRADE. Standard & Poor’s concerns:
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Mandatory Programs(Entitlements) $2,102 (58%)
Interest$216 (6%)
Defense$835 (23%)
Domestic$477 (13%)
Source: Budget of the U.S. Government, Mid-Session Review, Fiscal Year 2012, Office of Management & Budget (Aug. 2011)
2011 Federal Spending ($3.6T) (in billions of dollars)
U.S. DEFICIT DECISIONS AHEAD?
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And more stimulus is still needed?
“There are significant downside risks to the economic outlook, including strains in global financial markets”.
- Ben Bernanke, Chairman of the Federal Reserve, September 21st, 2011
"Without additional near-term support, fiscal policy in the U.S. will be overly contractionary and the U.S. economy will likely grow below its potential in 2012."
- Timothy Geithner, U.S. Treasury Secretary, September 25th, 2011
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What is different this time?Why is the economy not responding?
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DEBT (U.S. Total Credit Market Debt as % of GDP)
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DELEVERAGING [of debt] has just begun.
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Consumers are “deleveraging” and repairing their balance sheets…
DELEVERAGING: this time IS different.
They are increasing their savings.
They are paying down or defaulting on debt .
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And some parties have reached their borrowing limits.
The 18-year Round-trip Journey of Greek Bond Yields
Greece has defaulted on its external sovereign debt obligations at least five previous times in the modern era (1826, 1843, 1860, 1894 and 1932).
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DEFAULTS (Sovereign Countries, 1921-2003)
Sovereign Defaults, 1981-2003
Sovereign Defaults, 1921-1980
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DEFAULTS (Sovereign Defaults, 1820-1920)
Some European countries are in the habit of going bankrupt. For example, Portugal has defaulted on its national debt five times too since 1800!
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DEFAULTS?
Sovereign debt concerns are rattling global stock markets and shaking confidence further.
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How to invest in this new AA+ World.Some things to consider…
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Declines in demand for goods and credit = DEFLATION
A decline in core consumer prices after housing prices peaked can last a decade or more…
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And also can lead to depressing interest rates…
Long term interest rates (and P/E ratios) have stayed low for a decade or more in Japan’s deflationary environment…
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A “lost decade” (or two) is not unprecedented. The stock market moves in cycles.
100 Years of Secular Stock Markets
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A CLOSER LOOK AT 1965-1981
The 1970’s is a perfect example of a volatile, “trading range” Dow Jones…
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DIVIDENDS
Stock dividend yields have recently surpassed the yields on treasury bonds. This is unusual for the recent generation of investors, but it is not unprecedented.
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Corporate Cash
Corporate America is flush with cash. This cash can be used to fuel increases in dividends, increases in stock buybacks, or for mergers and acquisitions.
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DEMOGRAPHIC TRENDS
But follow the Baby Boomers!
New spending trends will form. (Healthcare? Travel?)
“They can't get the baby boomers to take on more debt because of where they are in the spending cycle. It's a time to save, not spend, in their lives. Want a mortgage at record low rates? No thanks - we're already choking on debt! And we hope to retire someday”. – Harry Dent
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Investment Strategy Discussion(for the “New Normal”, “Stall Speed”, “Balance Sheet Recession”, “Muddle Through Economy”)
“Safety and Income at a Reasonable Price”
– David Rosenberg, Gluskin Sheff Chief Investment Strategist
* Large Cap, Blue Chip, Strong Balance Sheets, Reliable Dividend Payers
* Investment-grade Credit Strategies
* Cash Flow, Cash Flow, Cash Flow
“Be fearful when others are greedy. Be greedy when others are fearful”
– Warren Buffett, Legendary Investor
“You make the most of your money in a bear market,
you just don’t realize it at the time”
– Shelby Davis, Legendary Investor
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Like it or not, we are ALL political analysts now!
The Fed is trying to raise inflation expectations.
Expect bouts of inflation?!
The ECB is trying to hold together the Euro.
Expect more bank recapitalizations and nationalizations?!
Expect more Sovereign downgrades, or worse, defaults?!
The President is trying to enact stimulus.
Expect bouts of growth?!
Congress is trying to attack deficits and balance budgets.
Expect tax increases and/or changes to entitlements?!
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DEMOCRACY
Americans are extremely disappointed with their government representatives. Low approval ratings typically precede a change in policies.
“Democracy is the worst form of government, except for all the others”
- Sir Winston Churchill
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