Income Inequality? American Savers Treated Like Dogs

By Tony Sagami

One of the hot political topics these days is income inequality, but one of the groups of Americans that’s the most mistreated by Washington DC is the millions of Americans who have responsibly saved for their retirement.

When I entered the investment business as a stock broker at Merrill Lynch in the 1980s, savers could routinely get 7-9% on their money with riskless CDs and short term Treasury bonds.

In fact, I sold multimillions of dollars’ worth of 16 year zero coupon Treasury bonds at the time. Zero coupon bonds are debt instruments that don’t pay interest (a coupon) but are instead traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value.

At the time, long term interest rates were at 8%, so the zero coupon Treasury bonds that I sold cost $250 each but matured at $1,000 in 16 years. A government-guaranteed quadruple!

Ah, those were the good old days for savers, largely thanks to the inflation fighting tenacity of Paul Volcker, chairman of the Federal Reserve under Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987.

Monetary policies couldn’t be more different under Alan “Mr. Magoo” Greenspan, “Helicopter” Ben Bernanke, and Janet Yellen. This trio of hear see speak no evil bureaucrats have never met an interest rate cut that they didn’t like and have pushed interest rates to zero.

The yield on the 30 year Treasury bond hit an all time record low last week at 2.45%. Yup, an all time low that our country hasn’t seen in more than 300 years!

These low yields have made it increasingly difficult to earn a decent level of income from traditional fixed-income vehicles like money markets, CDs, and bonds.

Unless you’re content with near-zero return on your savings, you’ve got to adapt to the new era of ZIRP (zero interest rate policy). However, you cannot just dive into the income arena and buy the highest paying investments you can find. Most are fraught with hidden risks and dangers.

So to fully understand how to truly and dramatically boost your investment income, you absolutely must look at your investments in a new light, fully understanding the new risks as well as the new opportunities. There are really two challenges that all of us will face as we transition from employment to retirement: longer life expectancies; and lower investment yields.

Risk #1: Improved health care and nutrition have dramatically boosted life expectancies for both men and women. We will all enjoy a longer, healthier life, which means more time to enjoy retirement and spend with friends/family, but it also means that whatever money we’ve accumulated will have to work harder as well as longer.

Today, a 65 year-old man can expect to live until age 82, almost four years longer than 25 years ago; the life expectancy for a 65 year old woman is also up—from 82 years in the early 1980s to 85 today.

The steady increase in life expectancy is definitely something to celebrate, but it also means we’ll need even bigger nest eggs.

Risk #2: Don’t forget about inflation. Prices for daily necessities are higher than they were just a few years ago and constantly erode the purchasing power of your savings.

The way I see it, your comfort in retirement has never been more threatened than it is today, and it doesn’t matter if you’re 20 or 70.

The rules are different, and you only have two choices:

#1. spend your retirement as a Walmart greeter (if you’re lucky enough to get a job!); or

#2. adapt to the new rules of income investing.

Today, the new rules of successful income investing consist of putting together a collection of income focused assets, such as dividend paying stocks, bonds, ETFs, and real estate, that generate the highest possible annual income at the lowest possible risk.

Even in an environment of near zero interest rates and global uncertainty, there are many ways an investor can generate a healthy income while remaining in control. Income stocks should form the core of your income portfolio.

Income stocks are usually found in solid industries with established companies that generate reliable cash flow. Such companies have little need to reinvest their profits to help grow the business or fund research and development of new products, and are therefore able to pay sizeable dividends back to their investors.
What do I look for when evaluating income stocks?

• Macro picture. While it’s a subjective call, we want to invest in companies that have the big-picture macroeconomic wind at their backs and have long-term sustainable business models that can thrive in the current economic environment.

• Competitive advantage. Does the company have a competitive advantage within its own industry? Investing in industry leaders is generally more productive than investing in the laggards.

• Management. The company’s management should have a track record of returning value to shareholders.

• Growth strategy. What’s the company’s growth strategy? Is it a viable growth strategy given our forward view of the economy and markets?

• A dividend payout ratio of 80% or less, with the rest going back into the company’s business for future growth. If a business pays out too much of its profit, it can hurt the firm’s competitive position.

• A dividend yield of at least 3%. That means if a company has a $10 stock price, it pays annual cash dividends of at least $0.30 a year per share.

• The company should have generated positive cash flow in at least the last year. Income investing is about protecting your money, not hitting the ball out of the park with risky stock picks.

• A high return on equity, or ROE. A company that earns high returns on equity is usually a better-than-average business, which means that the dividend checks will keep flowing into our mailboxes.

This doesn’t mean that you should rush out and buy a bunch of dividend-paying stocks tomorrow morning. As always, timing is everything, and many—if not most—dividend stocks are vulnerably overpriced.

But make no mistake; interest rates aren’t rising anytime soon, and the solid, all weather income stocks (like the ones in my Yield Shark service) will help you build and enjoy a prosperous retirement. In fact, you can click here to see the details on one of the strongest income stocks I’ve profiled in Yield Shark in months.


Tony Sagami

30 year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here.

To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.

The article Connecting the Dots: Income Inequality? American Savers Treated Like Dogs was originally published at mauldineconomics.com.

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The Fed’s Stealth Tightening

By Bud Conrad, Chief Economist

As expected, the Fed tapered its purchases of mortgage backed securities on Wednesday to $15 billion per month and its purchases of longer term Treasury securities to $20 billion per month. That means total monthly purchases, which were $85 billion last year, are now down to $35 billion. That’s a significant cut.

The Fed also cut the range of its full year 2014 real GDP growth forecast, from 2.8% – 3.0% down to 2.1% – 2.3%. That was no surprise, considering that GDP in Q1 was negative 1%, and it may have been a bit of a warning.

Those who are familiar with my work know my no confidence stance on Fed prognostication. But just to make my opinion clear: I think the Fed is in the business of obscuring the truth. Official inflation numbers vastly understate actual price rises:

• Housing in California is back to its pre-crisis peak;

• Stocks are at record levels;

• Food prices jumped 0.7% in May alone; and

• Anyone who drives knows that a tank of gas is far more expensive than it was a year ago.

The Fed’s claim that inflation is contained and that there is no need to raise interest rates is just a show put on for people who believe the government. If we applied a more accurate inflation rate to GDP calculations, real GDP would not be growing at all. My point is that the Fed and the media tell us things are better than they actually are. Meanwhile, the Fed is taking secret actions that reveal where Yellen and friends really think the economy might be headed.

The Fed’s New Tool: Reverse Repo

Traders have used Repurchase Agreements ("repos") for decades. A repo is essentially a collateralized loan. A borrower sells government securities to a lender and buys them back later at an agreed upon date and slightly higher price. The lender takes on very little risk to earn a small amount of compensation while it holds the government securities as collateral.

Repos can last for any amount of time, but they are often ultra short term. Overnight repos are the most common.

The Fed has announced that it’s using “reverse repos” as a new tool to manage monetary policy. Don’t let “reverse” confuse you: Reverse repos are just a way the Fed soaks up cash from financial institutions. The Fed is the “borrower,” swapping its Treasuries for banks’ cash. You might call it the opposite of quantitative easing: reverse repos drain money from the financial system.

The Fed can also use repos to add money to the system, as it did in the early stages of the 2008 Credit Crisis:

By netting repos with reverse repos, we can see their combined effect on monetary policy over time:

As you can see, the Fed is quietly using reverse repos to drain the money supply. Remember, this is on top of the taper. Net, the Fed is being less accommodative than most are aware of.

How Repos Fit into the Fed’s Balance Sheet

The following chart illustrates how the Fed’s liabilities (sources of funding) changed dramatically during the financial crisis. The Fed funded and continues to fund its quantitative easing programs with bank deposits. Here’s the rundown on how that works:

1. The Fed creates cash from thin air.

2. The Fed buys Treasuries and mortgage backed securities (MBS) from banks with that freshly minted cash.

The Fed pays banks 0.25% interest as an incentive to keep the new cash on deposit at the Fed.

That huge $2.8 trillion in deposits is a risk source, because the financial institutions could withdraw those funds at any time, if they think they can generate better returns than the 0.25% interest that the Fed pays.
Reverse repos are also a source of funding for the Fed: they provide cash for the Fed to continue purchasing Treasuries and mortgage backed securities.

Though reverse repos are only a small portion of the Fed’s balance sheet, they are important. As the growth of the yellow “deposits” has trailed off, reverse repos have picked up much of the slack. In effect, the Fed has sopped up $200 billion in the last nine months in “stealth tightening.” I use the word "stealth," because most investors, and even most Fed watchers, aren’t aware of the effects of reverse repos.
You’re probably wondering, "What’s the Fed’s ultimate plan here?"

I think that the Fed is using reverse repos to build up a hidden source of funding so that it can unwind its tightening quietly, if need be. The Fed now has $200 billion in “ammunition” that it can deploy without much (or any) fanfare, because nobody is following this closely. “Reverse Repos” isn’t the headline grabber that “Quantitative Easing” is.

As a side note, notice that the Fed’s capital is so small that you can barely see it. If the Fed were a bank subject to market forces, the slightest negative surprise would render it insolvent. But of course, it has a monopoly over the printing press, so it needn’t worry about such things.

One last reason the Fed might be secretly building a rainy-day fund: As my analysis in the newest issue of The Casey Report demonstrates, foreigners have recently stopped lending money to the US. That’s a huge problem for a country that had a $111.2 billion trade deficit in the first quarter alone, and will spend half a trillion more dollars than it takes in during 2014.

As I said earlier, the Fed has been very quiet about this repo program, so we can only surmise what its true motivations are. But as the US government’s lender of last resort, the Fed may be raising this source of cash so it can lend more money to the US government as foreign lending continues to dry up.

In conclusion, the credit crisis of 2008 changed our financial system in many ways. Whether this latest repo experiment is just another band aid on the money balloon or something more, it’s well worth keeping an eye on.

You can find my data driven analysis in every single edition of The Casey Report. Start your 90 day risk free trial now to read the current issue plus two more, access all of the current stock picks, and peruse the archives before deciding if The Casey Report is for you. If it’s not, no problem—just call or email for a full and prompt refund.

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The article The Fed’s Stealth Tightening was originally published at Casey Research

Yellen’s Wand Is Running Low on Magic

By Doug French, Contributing Editor

How important is housing to the American economy?

If a 2011 SMU paper entitled "Housing's Contribution to Gross Domestic Product (GDP) quot; is right, nothing moves the economic needle like housing. It accounts for 17% to 18% of GDP. And don't forget that home buyers fill their homes with all manner of stuff—and that homeowners have more skin in insurance on what's likely to be their family's most important asset. All claims to the contrary, the disappointing first quarter housing numbers expose the Federal Reserve as impotent at influencing GDP's most important component.

The Fed: Housing's Best Friend

 

No wonder every modern Fed chairman has lowered rates to try to crank up housing activity, rationalizing that low rates make mortgage payments more affordable. Back when he was chair, Ben Bernanke wrote in the Washington Post, "Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance."

In her first public speech, new Fed Chair Janet Yellen said one of the benefits to keeping interest rates low is to "make homes more affordable and revive the housing market."

As quick as they are to lower rates and increase prices, Fed chairs are notoriously slow at spotting their own bubble creation. In 2002, Alan Greenspan viewed the comparison of rising home prices to a stock market bubble as "imperfect." The Maestro concluded, "Even if a bubble were to develop in a local market, it would not necessarily have implications for the nation as a whole."

Three years later—in 2005—Ben Bernanke was asked about housing prices being out of control. "Well, I guess I don't buy your premise," he said. "It's a pretty unlikely possibility. We've never had a decline in home prices on a nationwide basis." With never a bubble in sight, the Fed constantly supports housing while analysts and economists count on the housing stimulus trick to work.

2014 GDP Depends on Housing

 

"There's more expansion ahead for the housing market in 2014, with starts and new-home sales continuing to rise at double-digit rates, thanks to tight inventory," writes Gillian B. White for Kiplinger. The "Timely, Trusted Personal Finance Advice and Business Forecast(er)" says GDP will bounce back. Fannie Mae Chief Economist Doug Duncan says, "Our full-year 2014 economic forecast accounts for three key growth drivers: an acceleration in spending activity from private-sector forces, waning fiscal drag from the federal government, and continued improvement in the housing market."
We'll see about that last one.

Greatest Housing Subsidy of All Time Running Out of Gas

 

With the central bank flooding the markets with liquidity, holding short rates low, and buying long term debt, mortgage rates have been consistently below 5% since the start of 2009. For all of 2012, the 30 year fixed mortgage rate stayed below 4%. In the post gold standard era (after 1971), rates have never been this low for this long. The Fed's unprecedented mortgage subsidy has helped the market make a dead cat bounce since the crash of 2008. After peaking in July 2006 at 206.52, the Case-Shiller 20 City composite index bottomed in February 2012 at 134.06. It had recovered to 165.50 as of January. However, while low rates have propped up prices, sales of existing homes have fallen in seven of the last eight months. In March resales were down 7.5% from a year earlier. That's the fifth month in a row in which sales fell below the year earlier level.

David Stockman writes, "March sales volume remained the slowest since July 2012." He listed 13 major metro areas whose sales declined from a year ago, led by San Jose, down 18%. The three worst performers and 6 of the bottom 11 were California cities. Las Vegas and Phoenix were also in the bottom 10, with sales down double digits from a year ago. This after housing guru Ivy Zelman told CNBC in February, "California is back to where it was in nirvana." Considering the entire nation, she said, "I think nirvana is not far around the corner… I think that I have to tell you, I'm probably the most bullish I've ever been fundamentally, and I'm dating myself, been around for over 20 years, so I've seen a lot of ups and downs."

Housing Headwinds

 

Housing is contributing less to overall growth than during both the days of 20% mortgage rates in the 1980s and the S&L crisis of the early 1990s. In Phoenix, where home prices have bounced back and Wall Street money has vacuumed up thousands of distressed properties, the market has gone flat. In Belfiore Real Estates' April market report, Jim Belfiore wrote, "The bad news for home builders is they have created a glut of supply in previously hot market areas… Potential buyers, as might be expected, feel no sense of urgency to buy because they believe this glut is going to exist indefinitely."

Nick Timiraos points out in the Wall Street Journal that with a 4.5% mortgage rate and prices 20% below their peak, "… homes are still more affordable than in most periods between 1990 and 2008." So why is demand for new homes so tepid? And why have refinancings fallen 58% year over year in the first quarter?
"Housing's rocky recovery could signal weakness more broadly in the economy," writes Timiraos, "reflecting the lingering damage from the bust that has left millions of households unable to participate in any housing recovery. Many still have properties worth less than the amount borrowers owe on their mortgages, while others have high levels of debt, low levels of savings, and patchy incomes."

More specifically, "So far we have experienced 7 million foreclosures," David Stockman, former director of the Office of Management and Budget, writes. "Beyond that there are still nine million homeowners seriously underwater on their mortgages, and there are millions more who are stranded in place because they don't have enough positive equity to cover transactions costs and more stringent down payment requirements." Young people used to drive real estate growth, but not anymore. The percentage of young home buyers has been declining for years. Between 1980 and 2000, the percentage of homeowners among people in their late twenties fell from 43% to 38%. And after the crash, the downtrend continued. The percentage of young people who obtained mortgages between 2009 and 2011 was just half what it was ten years ago.

Young people don't seem to view owning a home as the American dream, as was the case a generation ago. Plus, who has room to take on more debt when 7 in 10 students graduate college with an average $30k in student loan debt? "First time home buyers are typically an important source of incremental housing demand, so their smaller presence in the market affects house prices and construction quite broadly," Fed Chairman Ben Bernanke told homebuilders two years ago.

There's not much good news for housing these days. For a little while, the Fed's suppression of interest rates juiced housing enough to distract Americans from weak job creation and stagnant real wages. Don't have a job? No problem! Just borrow against the appreciation of your house to feed your family. But Yellen's interest rate wand looks to be out of magic. The government had a pipe dream of white picket fences for everyone. But Americans can't refinance their way to wealth. Especially in the Greater Depression.

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The article Yellen’s Wand Is Running Low on Magic was originally published at Casey Research

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Every Central Bank for Itself

By John Mauldin

“Everybody has a plan until they get punched in the face.”

– Mike Tyson

For the last 25 days I’ve been traveling in Argentina and South Africa, two countries whose economies can only be described as fragile, though for very different reasons. Emerging market countries face a significantly different set of challenges than the developed world does. These challenges are compounded by the rather indifferent policies of developed world central banks, which are (even if somewhat understandably) entirely self centered. Argentina has brought its problems upon itself, but South Africa can somewhat justifiably express frustration at the developed world, which, as one emerging market central bank leader suggests, is engaged in a covert currency war, one where the casualties are the result of unintended consequences. But the effects are nonetheless real if you’re an emerging market country.

While I will write a little more about my experience in South Africa at the end of this letter, first I want to cover the entire emerging market landscape to give us some context. Full and fair disclosure requires that I give a great deal of credit to my rather brilliant young associate, Worth Wray, who’s helped me pull together a great deal of this letter while I am on the road in a very busy speaking tour here in South Africa for Glacier, a local platform intermediary. They have afforded me the opportunity to meet with a significant number of financial industry participants and local businessman, at all levels of society. It has been a very serious learning experience for me. But more on that later; let’s think now about the problems facing emerging markets in general.

Every Central Bank for Itself

Every general has a plan before going into battle, which immediately begins to change upon contact with the enemy. Everyone has a plan until they get hit… and emerging markets have already taken a couple of punches since May 2013, when Fed Chairman Ben Bernanke first signaled his intent to “taper” his quantitative easing program and thereby incrementally wean the markets off of their steady drip of easy money. It was not too long after that Ben also suggested that he was not responsible for the problems of emerging-market central banks – or any other central bank, for that matter.

As my friend Ben Hunt wrote back in late January, Chairman Bernanke turned a single data point into a line during his last months in office, when he decided to taper by exactly $10 billion per month. He established the trend, and now the markets are reacting as if the Fed's exit strategy has officially begun.

Whether the FOMC can actually turn the taper into a true exit strategy ultimately depends on how much longer households and businesses must deleverage and how sharply our old age dependency ratio rises, but markets seem to believe this is the beginning of the end. For now, that’s what matters most.

Under Fed Chair Janet Yellen’s leadership, the Fed continues to send a clear message to the rest of the world: Now it really is every central bank for itself. 

The QE-Induced Bubble Boom in Emerging Markets

By trying to shore up their rich-world economies with unconventional policies such as ultra low rate targets, outright balance sheet expansion, and aggressive forward guidance, major central banks have distorted international real interest rate differentials and forced savers to seek out higher (and far riskier) returns for more than five years.

This initiative has fueled enormous overinvestment and capital misallocation – and not just in advanced economies like the United States.

As it turns out, the biggest QE-induced imbalances may be in emerging markets, where, even in the face of deteriorating fundamentals, accumulated capital inflows (excluding China) have nearly DOUBLED, from roughly $5 trillion in 2009 to nearly $10 trillion today. After such a dramatic rise in developed world portfolio allocations and direct lending to emerging markets, developed world investors now hold roughly one third of all emerging market stocks by market capitalization and also about one third of all outstanding emerging market bonds.

The Fed might as well have aimed its big bazooka right at the emerging world. That’s where a lot of the easy money ran blindly in search of more attractive real interest rates, bolstered by a broadly accepted growth story.

The conventional wisdom – a particularly powerful narrative that became commonplace in the media – suggested that emerging markets were, for the first time in a long time, less risky than developed markets, despite their having displayed much higher volatility throughout the past several decades.

As a general rule, people believed emerging markets had much lower levels of government debt, much stronger prospects for consumption led growth, and far more favorable demographics. (They overlooked the fact that crises in the 1980s and 1990s still limited EM borrowing limits until 2009 and ignored the fact that EM consumption is a derivative of demand and investment from the developed world.)

Instead of holding traditional safe haven bonds like US treasuries or German bunds, some strategists (who shall not be named) even suggested that emerging market government bonds could be the new safe haven in the event of major sovereign debt crises in the developed world. And better yet, it was suggested that denominating these investments in local currencies would provide extra returns over time as EM currencies appreciated against their developed market peers.

Sadly, the conventional wisdom about emerging markets and their currencies was dead wrong. Herd money (typically momentum based, yield chasing investors) usually chases growth that has already happened and almost always overstays its welcome. This is the same disappointing boom/bust dynamic that happened in Latin America in the early 1980s and Southeast Asia in the mid 1990s. And this time, it seems the spillover from extreme monetary accommodation in advanced countries has allowed public and private borrowers to leverage well past their natural carrying capacity.

Anatomy of a “Balance of Payments” Crisis

The lesson is always the same, and it is hard to avoid. Economic miracles are almost always too good to be true. Whether we’re talking about the Italian miracle of the ’50s, the Latin American miracle of the ’80s, the Asian Tiger miracles of the ’90s, or the housing boom in the developed world (the US, Ireland, Spain, et al.) in the ’00s, they all have two things in common: construction (building booms, etc.) and excessive leverage. As a quick aside, does that remind you of anything happening in China these days?

Just saying…...Broad based, debt fueled overinvestment may appear to kick economic growth into overdrive for a while; but eventually disappointing returns and consequent selling lead to investment losses, defaults, and banking panics. And in cases where foreign capital seeking strong growth in already highly valued assets drives the investment boom, the miracle often ends with capital flight and currency collapse.

Economists call that dynamic of inflow induced booms followed by outflow induced currency crises a “balance of payments cycle,” and it tends to occur in three distinct phases.

In the first phase, an economic boom attracts foreign capital, which generally flows toward productive uses and reaps attractive returns from an appreciating currency and rising asset prices. In turn, those profits fuel a self-reinforcing cycle of foreign capital inflows, rising asset prices, and a strengthening currency.

In the second phase, the allure of promising recent returns morphs into a growth story and attracts ever stronger capital inflows – even as the boom begins to fade and the strong currency starts to drag on competitiveness. Capital piles into unproductive uses and fuels overinvestment, overconsumption, or both; so that ever more inefficient economic growth increasingly depends on foreign capital inflows. Eventually, the system becomes so unstable that anything from signs of weak earnings growth to an unanticipated rate hike somewhere else in the world can trigger a shift in sentiment and precipitous capital flight.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – Please Click Here.

The article Thoughts from the Frontline: "Every Central Bank for Itself" was originally published at Mauldin Economics

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