May 18, 2010
Austerity, Playing in a State Near You Soon
The Investment View from Prescott, Arizona
If you’ve never been here, Prescott is a beautiful town nestled high in the mountains of Arizona. Tall trees, clean air, clean water and 100 mile views.
This week, while staring out my office window at the imposing face of Granite Mountain, I even had a vision of Europe – but it was not a pretty sight.
The Greek budget deficit crisis has brought about riots and social unrest attributed to “austerity measures” being implemented there. But what exactly are austerity measures? More importantly what’s it got to do with us?
Briefly, austerity means that a lot of government and union workers are being laid off. Folks, who until recently, thought they had it made for life. The people that are keeping their jobs have been issued stiff pay cuts, shorter hours and reduced vacation schedules. Government services are being slashed in all areas, and taxes on everything from electricity to booze are being hiked – a lot. The Greek government is also being forced to return certain nationalized industries, like health care, to the private sector.
And all of this is happening at the same time – all of a sudden.
No wonder there are riots. As a package, all of that is quite a shock.
This was brought on by weak-willed politicians who kept promising benefits to just about everyone to buy votes. Of course, the country did not have the money to pay for what they promised, so they borrowed and borrowed until no one would lend to them any more. Their deficit spending could no longer be sustained.
Well, now it’s payback time, so everyone who benefited from those earlier perks now gets to pay for them at the same time as the benefits are withdrawn. Forced austerity is a double whammy – maybe triple.
The potential for this problem to bleed over into other countries is very real. French banks own $78 billion of Greek bonds. If Greece walks away from their debt like an upside down homeowner might, French banks will be in jeopardy. This could create a domino-like series of cascading defaults that could affect the French government, the Euro-zone countries, the United States and yes, even China.
The real eye-opener in this situation is that while our 2008 financial crisis was focused in the housing market and defaulting mortgages, this one is focused on entire countries and their bond defaults (called Sovereign defaults). First there was Dubai. Now Greece. Next maybe Spain, Portugal, Ireland or very possibly California. They are as “underwater” as a sub-prime borrower in Detroit.
Abu Dhabi bailed out Dubai. The European Union bailed out Greece (only after the US gave Europe a $1 trillion guarantee). But who will bail out the next wave of failing countries? Each default has been of a larger entity, and takes more money for a rescue. Is the US going to have to bail out the entire world? Who will be left to bail us out?
Nobody. That’s who.
With the path we are on, we could be forced to accept austerity here, just like in Greece. Taxes will have to be hiked in a big way, at the same time all of the government goodies we are becoming addicted to would be cut dramatically to save even more money.
Will this really happen here? That is the $64,000 question, isn’t it? I’m an optimist, so I’m hoping it doesn’t.
But my insight from on top of the mountain here in Prescott is that the scene playing out in Greece is the very same debt crisis that banks had two years ago, but it has grown one degree larger as it moved from companies to countries. If it spreads from small countries like Greece and Dubai to larger countries like France or states like California (which has the 8th largest economy in the world) the debt crisis will be moving to yet again one degree larger.
Just about the only degree larger that will be left is the United States. Gulp.
As practical matter, though, what can you and I really do about it?
Take a little dose of austerity now. It would be smart to pay down debt and avoid taking on any more.
Cash flows are being interrupted everywhere for reasons no one could imagine, suddenly making loans impossible to repay. You must protect yourself from an interruption in income that until recently might have been unimaginable.
California is already paying some of its debts with IOUs because they don’t have any real money. What if all you get one day is an IOU and your mortgage company wants cash and won’t accept the IOU as payment?
Beyond paying down debt, stay invested only in investments that can be moved out of harm’s way on short notice or turned into cash (to pay debt) on a daily basis. I already take care of this part for my clients. If you invest elsewhere, look at what you own. Cash will be king and flexibility will be golden as this next financial crisis unfolds.
And demand a little austerity from your government, too. Unrealistic promises from politicians are what got Greece in trouble. Does that sound familiar? It should, because our politicians are trying to buy votes here just like the Greeks did over there.
A little austerity now might just avoid a lot later on.
Q: If a man carried my burden, he would break his back.
I am not rich, but I leave silver in my track.
What am I?
A: A snail
The Magic Number is 1,110
On December 15, 2009 I wrote about Leonardo Fibonacci, an Italian mathematician who, in about 1200 A.D., predicted the stock market would turn around at 1,110 on the S&P 500** which it did 9 times in November and December.
In doing some analysis this weekend, I noticed that the stock market decline now called the “Flash Crash” bottomed on May 7th at . . . drum roll please . . . 1,110 on the S&P 500**. And that was the third turnaround at 1,110 since January.
This can be an amazing business.
My hat is off to Leonardo Fibonacci.
How to Deal With Stock Market Crashes
Getting Your Statements?
You should be receiving account statements either monthly, or at a minimum quarterly, directly from your account custodian. These statements are your proof of ownership of your account(s).
If for some reason you are not getting statements on your accounts, please call us immediately at (928) 778-4000 so we can track them down for you.
Economic Trends of Interest
– Consumer households assets held in brokerage accounts is $14.0 trillion, a decrease of almost 30% since its peak in 2007.
[Wow – the average investor is still down that much? Ugh.]
– Consumer households have $3.9 trillion in bonds, an increase of almost 50% since 2002.
[Unsophisticated investors are buying bonds thinking they are a “safe” alternative to stocks. In the process they are setting themselves up for painful losses if interest rates rise.]
– Taxes paid by illegal immigrants will close about 15% of Social Security’s long-term deficit.
[Finally!! Some good news on the illegal immigration front.]
Statistics from Tiburon Strategic Advisors Consumer Wealth Report, May 14, 2010.
A Healthy Alternative
The Spider Ranch is a 50,000 acre rough country spread north of Prescott, managed by my good friend Gail Stieger for Barbara and Gene Polk.
For a working cowboy, Gail is an amazing guy. Very well read, Gail is a world class videographer whose work can be seen on PBS. And, he’s an astute stock trader which is maybe why we enjoy each other’s company so much.
I’ve had the great pleasure to spend a couple of Thanksgivings out at the ranch, and eat some of the fine beef raised there.
Gail has recently begun offering his range fed beef, lean and free of feed-lot antibiotics, directly from his web site www.spiderranchbeef.com
If you are interested in saving money and enjoying a healthy alternative to feed-lot beef, check out the Spider Ranch and its direct sales of beef.
What’s Going On In Your Portfolio?
Fortunately, over the past few weeks we have been reducing our stock holdings, and our Careful Growth* portfolios were almost half in the money market fund during what is now called the “flash crash” of May 6th. We still hold 10% in gold and 42% in stocks, a couple of which were still at all time highs as recently as Thursday, May 13th. Cash in the Careful Growth* model is at 48% as of the close of business on May 14th.
Socially Screened* portfolios hold 35% cash and 65% in stocks and SRI mutual funds.
Our Flexible Income* portfolios have seen our high yield bond funds begin to slip over the past few weeks and several of these funds have been sold off raising our cash position to 47% for that model.
The market is clearly under pressure and risk is high right now. However, corporate earnings continue to improve, so I think we may see more market strength over the next few months. However, regardless of what I think, the facts are that the stock market is pretty nasty right now, so I am taking a conservative approach for all portfolios by raising cash levels.
If this soft market turns back up again, we will be in a position to invest our cash in the new market leaders. If it keeps heading south, we’ll continue to sit in cash and a good portion of your money will be out of harm’s way.
Municipal Income* accounts remain fully invested as its holdings are at all time highs.
Our Spotlight Strategy
The Municipal Income Strategy seeks a high level of tax-favored income consistent with capital preservation.
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* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.