Many economists believe the U.S. economy is recovering from the deepest depression since the Great Depression. In sprite of the economist’s opinion, one must wonder if the economy recovery is real, or a simple head fake. In this article we’ll take a look at some hard facts.
The U.S. Economy
The Conference Board recently report the customer confidence index fell to 46.0 in February 2010, down from 55.9 in January.
The Labor Department reported jobless claims jumped the last week in February much higher than expected.
The Commerce Department report the first revision of the GDP for the 4th quarter rose to 5.9%. Good news except that inventory restocking made up 3.9% of the growth. This means that factors like consumer spending advanced far less.. The bad news is that consumer demand is not fueling growth. The evidence of this analysis will be evident in the coming quarter.
The Mortgage Bankers’ Association purchase index fell -7.3% to it lowest level since 1997. This index is a measure of applications through mortgage lenders and is considered an indicator of the strength of the housing market. The decline is a signal of housing market weakness.
The Commerce Department reported that new home sales declined -11.0% in January. This compounds December’s bad news when new home sales fell -7.6%.
The S&P Case-Schiller Price Index fell -3.1% compared to one year earlier. This dims hopes for a recovery in housing prices.
The commercial mortgage default rate jumped to 3.8% in the 4th quarter according to Real Capital Analytics, Inc. The default rate has more than doubled over the past year.
The FDIC reported that bank lending declined last year to the lowest level since 1942. This suggests that bank failures will rise in 2010. In 2009, 140 banks failed. Some 702 banks are at risk.
The National Association of Realtors reported that existing home sales fell -7.2% in January, following December’s drop of -16.7%.
The Commerce Department released the reading on the import/export prices. Import prices rose by 1.4% in January signaling that inflation may be picking up. This is up 11.5% from a year ago. Export prices also rose by 1.4% in January. The offsetting increases indicate a low growth in GDP.
Around the World
Japan, with $768.8 in U.S. securities is now the largest U.S. debt holder according to the Treasury Department. China was the largest, but after selling off $34 billion now holds around $755.4 billion in U.S. Treasuries.
The Office for National Statistics reported that jobless claims in the U,K. rose to 1.64 million in January, the highest level since 1997.
Greek labor unions held a second 24 hour strike to protest the governments’ budget cuts. The budget cuts represent efforts to reduce the deficit from 12.7% of GDP to a level acceptable to the European Union, and will result in salary freezes and bonus cuts.
Bank Rossii, Russia’s central bank, reduced its benchmark refinancing rate by .25% to 8.5% (a record low). The rate cut represents the central bank’s efforts to promote lending.
The Magyar Nemzeti Bank of Hungary is expected to lower its key interest rate to 5.75% (the lowest level since the fall of communism), according to a Bloomberg survey of economists. The rate cut is an attempt to stimulate economic growth.
Housing
Housing starts were up in January which would be good news if it weren’t for the glut of unsold homes already on the market. And if there wasn’t a shadow inventory of houses waiting to coming on the market.
While housing starts are increasing, new homes sales are down 7.6% in December. Recently RealtyTrac estimated that foreclosures will reach 4.5 million this year topping last year’s 2.82 million. And the Congressional Oversight Panel expects an additional 8 million to 13 million foreclosures over the next five years. New homes will sit unsold as the existing home market is cleared up, which won’t happen any time soon with the shadow inventory of homes nearing foreclosure entering the market.
The other problem: the government’s Home Affordable Modification Program simply isn’t working. Marking one year since its inception, the program has temporarily modified over 1 million mortgages, but permanently modified loans for only 116,297 homeowners, according to the Treasury Department. This is well below the program’s target of assisting up to 4 million troubled borrowers. The other problem with this program: for many homeowners, it is not enough. Many in the program still can’t make a mortgage payment (one third of homeowners in the program are delinquent). Ultimately, the program is delaying foreclosures, not preventing them.
With an increasing inventory of unsold homes, prices have one way to go: down. However, housing prices are still historically high, after adjusting for inflation.
Jobs
According to the Bureau of Labor Statistics, in December 43 states and the District of Columbia recorded unemployment rate increases. Until the unemployment starts a downward trend, an economy recovery is not possible.
Representative Debbie Wasserman Schultz, (D-20th District FL) in a recent newsletter to her constituents said the American Recovery and Reinvestment Act (stimulus) had created 112,000 jobs in FL. Florida received about $11.8 billion in stimulus funds which translates into paying about $105,500 to create each job. This cash outflow is not sustainable.
Florida's unemployment rate increased to 11.8 percent, the highest rate since May of 1975 reports the Agency for Workforce Innovation..
And things aren't looking brighter in the short term for Florida, Legislative economist Amy Baker predicted that Florida will lag behind the rest of the nation in recovering from the latest recession largely because of the state's housing surplus where there are more than a half million homes in foreclosure. Baker said Florida's unemployment will likely peak at 12 percent later this year.
Recovery?
A recovery may or may not be in our immediate future. Regardless, whatever the structure or timing of the recovery, many families will not detect a change in their own circumstances. So many jobs have been lost that the unemployment rate will remain high when and if the economy begins to rebound. Large numbers of still jobless Americans have exhausted their severance payments and unemployment benefits, keeping them under great strain even if the overall economy picks up. With a depleted saving backup, there is simply no room for slippage for many Americans.
This material was researched and written by David Snellen. © 2010 USA Living.com, Inc.
Sunday, March 7, 2010
Sunday, January 31, 2010
Bonds: What You Need to Know
Money is flowing into bond mutual funds at a dizzying pace this year. If the trend continues, bond funds will attract more than twice as much new money as they did in 2008 and a stunning 11 times more than investors are putting into stock funds this year.
Bond funds don’t ordinarily have greater inflows than stock funds, but may occur during periods of stock price volatility. This development is not surprising, but it is interesting nonetheless. Here’s why.
Interest rates are low and the Federal Reserve is likely to keep them low for the foreseeable future. As long as joblessness remains a problem, the Federal Reserve will be reluctant to raise interest rate targets and, in fact, has little reason to do so. Interest rates are one way to control the growth of an economy. When the economy is growing too fast and is at risk of high inflation, the Feds can slow it down with higher interest rates. An economy with high unemployment is unlikely to suffer from too-rapid growth and job creation would probably suffer from higher interest rates. Thus higher interest rates are not likely until the jobless rate begins to decline.
Bonds 101
But interest rates will inevitably go up. When interest rates rise, the value of existing bonds typically falls, this may adversely affect a bond fund’s performance. The face value of a bond and the current interest rate is an inverse relationship. And the reason is simple.
A bond is a debt instrument, usually tradeable, that represents a debt owed by the issuer to the owner of the bond. Most commonly, bonds are promises to pay a fixed rate of interest for a number of years, and then to repay the principal on the maturity date. In the U.S. bonds typically pay interest every six months (semi-annually), though other payment frequencies are possible. When interest rates are low the issuer is taking out a loan at a low fixed interest rate. This is no different than a person securing a long term mortgage at the low interest rate.
Bond Valuation
The value of any asset is the present value of its cash flows. So what happens to a bond paying 4% when the interest rate climbs to 8%? It will be valued at a discount to the face value to compensate the buyer for the lower than current interest rate. The longer the term to maturity the less it will be worth.
For example, let assume a new bond today that has:
1) 20 years to maturity
2) face value of $1,000
3) interest rate of 4% paid semiannually
This bond will pay to the holder 4% of its face value in interest each year. Since it pays semiannually, there will be 40 payments of $20 each and the $1,000 will be return at maturity (at the end of period 40). If current interest rates on a CD was 1.5%, then buying this bond for $1,000 may look like a good deal.
Let’s say over the next five years the economy improves, inflation kicks in and the interest rate paid on a CD is 8% and you are thinking about selling this bond. Unfortunately, this bond is only worth $777.63 because it represents an investment at a lower than current rate. A buyer will pay less than face value to compensate for the lower rate. Note, however, that the bond will still pay $40/year in interest and return the face value of $1,000 at maturity. (On the other hand, if the economy in the above example remains depressed and the current yield remains at 1.5%, the value of the bond will rise to $1,176.)
Investors who were smarting from their losses may have soured on stocks and decided the conservative return potential in the debt markets might be more appealing than the chance of suffering further losses in the equity markets. Realize, however that currently issuing bonds will be trading at a steep discount to their face value if interest rates rise.
It’s important to remember that you will receive the interest payment semiannually and the full face value at maturity regardless of current interest rates. The concern is the opportunity lost because you could invest your money somewhere else and earned a higher rate of return.
Bonds vs. Bond Funds
There is a big distinction between bonds and bond funds. An investor who buys individual bonds is typically interested in generating income and preserving principal. Investors who are careful to stagger the maturity dates in their bond portfolios may be able to further reduce the risk of having to reinvest a large percentage of their principal when rates are low. This was discussed in the October 2009 article titled “Managing Volatility with a Ladder”.
Bond funds generally employ a less conservative strategy by trading bonds before they mature in order to pursue gains by taking advantage of fluctuating interest rates. Bond funds will typically turnover their holding from 50% to over 200% each year. This may allow them to offer greater return potential, but sometimes with higher risk. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with the underlying bonds in the funds.
Bonds, bond funds and bond ETFs can play an important role in an investment portfolio, but they shouldn’t be thought of as a safe harbor to park money until the stock market settles down. Bond funds/ETFs are used in a portfolio to balance and compliment the equity investments. In addition, they should be a part of every investor’s portfolio because bond funds/ETFs produce monthly income.
Take for example, the Vanguard Long-Term Bond Index Fund (VBLTX). This fund holds a range of securities that approximates the performance of the long term (15 to 30 year) bond market. It opened in June 1996 and sold for about $9.58/share. It finished December 2009 selling for $11.56/share. In the mean time, it paid around 0.053 cents per share every month in interest payments. A purchase $10,000 of shares in June 1996 would be worth about $12,066 today and would have paid around $55/month, or about $660/year for a total of around $8,900 in interest payments. A nice addition to anyone’s portfolio. Note: The NAV of a bond fund/ETF is the only consideration when evaluating the fund’s performance. Dividends paid are not a consideration.
The decision to purchase a bond fund should be made based on your personal circumstances, such as your time horizon, risk tolerance, and personal goals. Bonds and bond funds come in a variety of forms which were discussed in the August 2009 newsletter in an article titled “Navigating the Bond Market”.
Exchange-traded funds and mutual funds are sold only by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Bond funds don’t ordinarily have greater inflows than stock funds, but may occur during periods of stock price volatility. This development is not surprising, but it is interesting nonetheless. Here’s why.
Interest rates are low and the Federal Reserve is likely to keep them low for the foreseeable future. As long as joblessness remains a problem, the Federal Reserve will be reluctant to raise interest rate targets and, in fact, has little reason to do so. Interest rates are one way to control the growth of an economy. When the economy is growing too fast and is at risk of high inflation, the Feds can slow it down with higher interest rates. An economy with high unemployment is unlikely to suffer from too-rapid growth and job creation would probably suffer from higher interest rates. Thus higher interest rates are not likely until the jobless rate begins to decline.
Bonds 101
But interest rates will inevitably go up. When interest rates rise, the value of existing bonds typically falls, this may adversely affect a bond fund’s performance. The face value of a bond and the current interest rate is an inverse relationship. And the reason is simple.
A bond is a debt instrument, usually tradeable, that represents a debt owed by the issuer to the owner of the bond. Most commonly, bonds are promises to pay a fixed rate of interest for a number of years, and then to repay the principal on the maturity date. In the U.S. bonds typically pay interest every six months (semi-annually), though other payment frequencies are possible. When interest rates are low the issuer is taking out a loan at a low fixed interest rate. This is no different than a person securing a long term mortgage at the low interest rate.
Bond Valuation
The value of any asset is the present value of its cash flows. So what happens to a bond paying 4% when the interest rate climbs to 8%? It will be valued at a discount to the face value to compensate the buyer for the lower than current interest rate. The longer the term to maturity the less it will be worth.
For example, let assume a new bond today that has:
1) 20 years to maturity
2) face value of $1,000
3) interest rate of 4% paid semiannually
This bond will pay to the holder 4% of its face value in interest each year. Since it pays semiannually, there will be 40 payments of $20 each and the $1,000 will be return at maturity (at the end of period 40). If current interest rates on a CD was 1.5%, then buying this bond for $1,000 may look like a good deal.
Let’s say over the next five years the economy improves, inflation kicks in and the interest rate paid on a CD is 8% and you are thinking about selling this bond. Unfortunately, this bond is only worth $777.63 because it represents an investment at a lower than current rate. A buyer will pay less than face value to compensate for the lower rate. Note, however, that the bond will still pay $40/year in interest and return the face value of $1,000 at maturity. (On the other hand, if the economy in the above example remains depressed and the current yield remains at 1.5%, the value of the bond will rise to $1,176.)
Investors who were smarting from their losses may have soured on stocks and decided the conservative return potential in the debt markets might be more appealing than the chance of suffering further losses in the equity markets. Realize, however that currently issuing bonds will be trading at a steep discount to their face value if interest rates rise.
It’s important to remember that you will receive the interest payment semiannually and the full face value at maturity regardless of current interest rates. The concern is the opportunity lost because you could invest your money somewhere else and earned a higher rate of return.
Bonds vs. Bond Funds
There is a big distinction between bonds and bond funds. An investor who buys individual bonds is typically interested in generating income and preserving principal. Investors who are careful to stagger the maturity dates in their bond portfolios may be able to further reduce the risk of having to reinvest a large percentage of their principal when rates are low. This was discussed in the October 2009 article titled “Managing Volatility with a Ladder”.
Bond funds generally employ a less conservative strategy by trading bonds before they mature in order to pursue gains by taking advantage of fluctuating interest rates. Bond funds will typically turnover their holding from 50% to over 200% each year. This may allow them to offer greater return potential, but sometimes with higher risk. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with the underlying bonds in the funds.
Bonds, bond funds and bond ETFs can play an important role in an investment portfolio, but they shouldn’t be thought of as a safe harbor to park money until the stock market settles down. Bond funds/ETFs are used in a portfolio to balance and compliment the equity investments. In addition, they should be a part of every investor’s portfolio because bond funds/ETFs produce monthly income.
Take for example, the Vanguard Long-Term Bond Index Fund (VBLTX). This fund holds a range of securities that approximates the performance of the long term (15 to 30 year) bond market. It opened in June 1996 and sold for about $9.58/share. It finished December 2009 selling for $11.56/share. In the mean time, it paid around 0.053 cents per share every month in interest payments. A purchase $10,000 of shares in June 1996 would be worth about $12,066 today and would have paid around $55/month, or about $660/year for a total of around $8,900 in interest payments. A nice addition to anyone’s portfolio. Note: The NAV of a bond fund/ETF is the only consideration when evaluating the fund’s performance. Dividends paid are not a consideration.
The decision to purchase a bond fund should be made based on your personal circumstances, such as your time horizon, risk tolerance, and personal goals. Bonds and bond funds come in a variety of forms which were discussed in the August 2009 newsletter in an article titled “Navigating the Bond Market”.
Exchange-traded funds and mutual funds are sold only by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
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