Will's Blog Has Moved!

I have decided to move my blog to Wordpress and eventually my new website: www.willrwright.com

Please follow this link for the new blog: www.willrwright.wordpress.com

Thanks for reading!!

KC Concert

Thanks Dan for a great time at the Kenny Chesney concert!




A whole lot of John Deer-themed green lighting for She Thinks My Tractor's Sexy:

More Bad News for the future of the USD

More news that the countries which hold the largest US Dollar reserves are beginning to “diversify” into other currencies and investments. Friday’s WSJ has an interesting article ($link) about the future of the Kuwaiti sovereign wealth fund:

The Gulf petro-states control a vast hoard of investable funds, one that is sure to grow vaster. Combined, government investment arms in Kuwait, Saudi Arabia, Dubai, Abu Dhabi and Qatar hold an estimated $1.5 trillion. That gives them potential to sway the course of broad global financial markets, including exchange and interest rates, the now-slowed buyout boom and the global credit dislocations stemming from US subprime mortgages.

The Middle East’s government investment arms are at the fulcrum of a longer-term shift in global financial flows from the West’s developed markets to the faster-growing economies of India, China, Southeast Asia and Turkey, places where many Middle Easterners see their fortunes lying in the future. Mr Al-Sa’ad is cutting the portion of the portfolio invested in the U.S. and Europe to less than 70% from about 90%. “Why invest in 2%-growth economies when you can invest in 8%-growth economies?” he asks.

That shift might lower the appetite for low-yielding investments such as the bonds the U.S. government must sell in large numbers to finance its budget and trade deficits. All else being equal, reduced buying of Treasuries and other U.S. securities would tend to weaken the dollar and make U.S. exports more competitive globally, but also burden businesses and consumers in the U.S. by pushing up interest rates.

I highlighted what I think are the most important takeaways of this news, neither of which is positive for the future of the US Dollar:

1. Because of the massive amount of US Dollars and US Treasuries owned by our trading partners, they probably have as much influence on the US economy as does the Federal Reserve.

2. As countries such as Kuwait and China create “sovereign wealth funds”, they will diversify out of US Treasuries into investments with stronger growth potential.

Credit Crunch

In my post An End to the Debt Bubble, I tried to organize my thoughts and present the big-picture synopsis of the events leading to the current market turmoil.

Over the last few days, just about every newspaper, blog and pundit has opined about the “credit crunch”. So, in the spirit of everybody else is doing it so why can’t I?, here’s my interpretation of what’s going down.

What Makes a Credit Crunch?
In a functioning market, there is a buyer for every seller. When you want to buy or sell GE, MSFT, or a T-Bill, there is usually always someone to buy or sell it to you.

Credit crunches and financial panics happen when buyers disappear, or when banks are unwilling to lend money to good credit risks. In the fixed income markets today, there are no buyers, at any price, for even the highest quality mortgages.

If a bank writes a mortgage greater than $417,000, they cannot sell it to anybody, so they have to keep the loan on their books. (High quality mortgages under $417,000 can be sold to Freddie or Fannie) Over the last few years, there have always been plenty of buyers of high quality mortgages – in today’s market, there are none. Thus, if banks can’t sell their loans, they are severely limited in the new loans they can write.

The crunch is not limited to mortgages. The market has broken down for any instrument that is not an obligation of the US Treasury. In fact, many money market funds, which typically hold all manner of high quality paper, are now exclusively buying T-Bills and not buying any commercial paper. For paper that still is trading, spreads have risen, making the prospect of selling more expensive.

Liquidity Crisis, NOT a solvency Crisis:
A typical Mortgaged Back Security will be a package of many different quality mortgages. As a simple example, it might have 75% prime, 15% Alt-A, and 10% subprime. As an absolute worst-case scenario, let’s assume that all of the subprime and Alt-A loans in this MBS default. So, instead of trading at 100, the bond is now worth something like 75 cents on the dollar. If the market were functioning as usual, there would be investors willing to buy the MBS at a price somewhere around 70-75. The owner of the MBS would certainly take a loss, but at least he/she could sell it to raise cash if needed. In the current market, there are no buyers at all and the few that are out there bidding very low – 45 or 50 to continue with this hypothetical example.

What is the Fed doing about this?
Essentially, the Fed and other central banks around the world are providing liquidity. Through their open market operations they are lending money to banks and accepting high quality mortgages and commercial paper as collateral. In effect, trying to function as the market would normally. This is not a bail-out – the Fed is not actually buying any loans, let alone anything even remotely related to subprime.

For sure, the Fed walks a tight rope when it pumps liquidity into the system because it can encourage risk-taking behavior and lead to inflation, etc. Here’s an interesting quote from Brian Wesbury, in today’s WSJ Op-Ed page ($link):

The best the Fed can do is to stand at the ready to contain the damage. In this vein, their decision to cut the discount rate and allow a broad list of assets to be used as collateral for loans to banks, was a brilliant maneuver. It increases confidence that the Fed has liquidity at the ready, but does not create more inflationary pressures. It was a helping hand, not a bailout.

It also buys some time, which is what the markets need. Every additional month of payment information on mortgage pools, and every mortgage that is refinanced from an adjustable rate to a fixed rate, will increase certainty and provide more clarity on pricing.

Even though many, including Alan Greenspan, continue to argue that the excessively easy monetary policy of 2001-2004 was necessary, it was this policy stance that caused the problems we face today. The current financial market stress is a result of absurdly low interest rates in the past, not high interest rates today. In fact, current interest rates are still low on a both a nominal and real basis. Cutting them again causes a further misallocation of resources, and makes the Fed an enabler of the highly leveraged.

Similarly, even very easy money today can’t put off the day of reckoning for subprime mortgage holders who bought homes with no money down and thought interest rates would stay low forever. It can’t help overly leveraged investors who thought they were getting risk-free 20% annual returns. Providing enough liquidity to allow markets to function, while keeping consumer prices as stable as possible, is the best the Fed can do. It should be all we really ask.

An End to the Debt Bubble?

Credit Crunch
Run on the Bank
Sub-Prime Meltdown
Housing Bubble
Central Banks Inject Liquidity

These terms are being thrown around left and right these days and I’ve read and talked so much about it that my brain is about to explode from serious information overload. Here’s my attempt to present the big-picture synopsis of what’s been happening.

Part I: How We Got Here:

Low Interest Rates:
Starting in 2001, after the dot-com crash and 9-11, the economy was teetering on the edge of recession. To stimulate economic activity, the Fed began to lower interest rates. From the corresponding chart (Bankrate.com), we can see that interest rates across the whole economy fell dramatically.

Along with lower interest rates -- beginning with those set by the Federal Reserve -- there was also a dramatic increase in the money supply.

Since interest rates are lower, demand for money will be higher. The Fed sees to it that money will be available through its “open market operations.” Most often, the Fed will engage in repurchase agreements (repos) with the money center banks (Citibank, JPMorgan, Bank of America, etc.). Essentially a repo transaction is when a bank deposits collateral (loans) at the Fed and receives cash in exchange. This cash is then lent to the bank’s customers who are eager to borrow money at low interest rates.

The other option is for the Fed to buy Treasuries from the banks (outright purchases). The Fed buys Treasuries with freshly printed currency, thus dramatically increasing the money supply. As I understand it, the Fed rarely does this because it is considered more permanent and it can be highly inflationary.

Over the past few years, the Fed was not buying US Treasuries but our foreign trading partners certainly were!

In 2006, the US trade deficit was nearly $764 billion: the US bought $764 billion more stuff from the rest of the world than the rest of the world bought from us.

What happened to all of those dollar bills sent to our trading partners? A great deal of them found their way right back into the USA through the purchase of US Treasuries and T-Bills. Consider the massive foreign currency reserves held by the Chinese government: as of June, 2007 they stood at nearly $1.4 trilion. Of this amount, it is estimated that the vast majority is held US Treasuries and other USD debt instruments.

And let's not forget that the US was not the only country with a stimulative interest rate environment. Interest rates and availability of loans from Japan was another hugely stimulative factor.

Increased Risk Appetite:
With so much money available at such low interest rates, the collective risk appetite of market participants across the globe increased. All of this newly created money had to flow somewhere. Because of China’s willingness to produce consumer goods at such low prices, the increased money did not, by and large, slosh into the prices of consumer goods. Instead it sloshed into asset prices: bonds, stocks, commodities, wine, art, and especially REAL ESTATE.

The new money certainly helped to push home prices higher. The other major factor was the increased risk tolerance and demand for risky loans. Wall Street banks created new “structured products” which were sold to investors all over the world. Leveraged products such as CDO’s & CMO’s were created and promised increased yield with low risk to investors. These products contained lots of subprime and Alt-A mortgages yet they managed to receive AAA ratings from S&P, Moody’s & Fitch.

Typically, banks are very careful about who they lend money to because they want to get paid back. In this latest cycle, the borrower’s ability to repay was irrelevant because the mortgage brokers immediately sold the loans to Wall Street. Because of these new products and the strong market to sell them into, Wall Street had a voracious appetite for risky home loans.

Yesterday’s WSJ has a must-read free article about a family in California who bought a $567,000 house with a combined income of $90,000, and NO-MONEY DOWN. Their mortgage was an interest-only, adjustable rate mortgage. At the start, their yearly payments on the loan were $38,400. After a reset which is coming shortly, the mortgage will cost them $50,000 per year. It doesn’t take a financially sophisticated person to realize that this mortgage is totally unaffordable!

But it’s OK because housing prices only go up, right? Wrong – the price appreciation in many neighborhoods was driven by the hysteria and availability of easy loans. Without that, prices must fall.

To be continued...

Consultant or Employee?

For part-time or consulting work, how are you classified by your employer: as a consultant or as an employee?

Since we're primarily talking about taxes in this post, the difference is that an employee receives a "W2" and the consultant receives a "1099" each year from their employer. These forms -- provided to you and the IRS -- document how much you earned in a given tax year. The type of form you receive is important because the tax treatment of W2 income and 1099 is very different.

Employee:
Hiring you as a consultant instead of as an employee, your employer saves a lot of money in taxes. The biggest is Social Security tax -- employers are required to pay the SSA 6.2% of your salary below $97,500. Medicare tax adds on an additional 1.45% of your pay. And don't forget about unemployment, disability and other taxes which your employer pays on your behalf.

When you get paid as an employee, you pay the other half of your "payroll taxes": 6.2% of your wages for Social Security, and 1.45% for Medicare. If you incur any job-related expenses which you don't get reimbursed for, you can deduct them on your taxes. But there's a catch: your unreimbursed-job-expenses are not an "adjustment" to your income. Instead, they are considered a "miscellaneous itemized deduction", and only reduce your taxes to the extent expenses in this category exceed 2% of your Adjusted Gross Income (line 37 on your 1040).


Consultant:
If you work as a consultant, the tax treatment is very different. You -- and the IRS -- will receive form 1099-misc from your "client" (not employer). Items on the 1099-misc are considered "self-employment income" and you still have to pay 15.3% of your pay in Social Security and Medicare taxes. Just as 1/2 of this amount is deductible by your employer when you are an employee, you are allowed to deduct 1/2 as an adjustment to income. Here's where the real difference comes in: unreimbursed-job-expenses are netted against your consulting income. This can result in a substantial reduction in taxable income for many people. Not surprisingly, the IRS would MUCH prefer companies to pay their workers as employees and not consultants.

The reason I'm writing about this topic now is that the IRS recently reached an important agreement with a soccer league in Connecticut regarding their treatment of coaches. Excerpt from $NYT article:

In a case widely watched by youth sports leagues across the country, the Internal Revenue Service has reached an agreement with the Fairfield United Soccer Association that clarifies the employment status of the group’s coaches, the association’s president said yesterday.

Under the agreement, the Fairfield, Conn., league will begin in 2008 to treat about half of its 30 coaches — those not employed by professional coaching associat ions — as employees rather than as independent contractors, and will withhold taxes from their pay. And the league will pay $11,600 in back taxes, according to Jay Skelton, the group’s president, a fraction of the $334,441 in taxes and fines the I.R.S. had assessed it in 2004.

“We said we tried to comply with the rules, and we thought we were, but we made mistakes, so we agreed to pay the tax due,” Mr. Skelton said. “For 20 years all of these coaches have been reported as 1099 employees for everybody. If you talk to 100 clubs, I guarantee almost every one, if not all, would declare these guys as independent contractors.”

It was not the first time the I.R.S. had fined a nonprofit youth sports league, but the proposed penalty was one of the largest, sending worried sports officials in Connecticut and other states scrambling to review the tax code. Mr. Skelton said that over the last two years, about 200 people involved in youth sports had contacted him asking about the resolution of the case. He said the assessment had threatened to put the Fairfield association out of business. (NYT)

The IRS wants the league to treat coaches as employees because the government will receive way more revenue that way. Here's a simple example to illustrate:

Coaches are considered "consultants" and issued 1099's:
Let's say a coach earns $1,000 in a year. The coach can easily cook up $500 of expenses related to the coaching job -- transportation, equipment, gifts, etc. The result is net self employment income of $500. This $500 is the amount which social security, medicare, & income taxes are based.

Coaches are considered "employees" and issued W2's:
Keeping with our above-mentioned example, let's say the coach earned a salary of $1,000 in a year. First, the employer & the employee would pay a total of 15.3% of the salary in payroll taxes. Second, the $1,000 salary would flow directly to the coach as "ordinary income". The $500 in job-related expenses are not allowed to be netted against this income. It is quite possible that the coach will not be able to deduct the $500 because he or she probably won't have miscellaneous expenses (including unreimbursed-job-expenses such as these) which exceed 2% of AGI.

Bottom Line: How you are classified -- employee or consultant -- makes a big difference for both you and your employer come tax season. Since the government wants you to be an employee (and not a consultant), it could become a little more difficult to keep your status as a consultant. Fortunately, there are some steps you can take to ensure that you keep your consultant status. I'll try to post about that topic soon.

Final Softball Game...Victory!

Congrats to the Trois Pistoles on a great victory to end the season! The game was marked by extraordinary infield play and great hitting. Check out all the pics over at Flickr and the videos on YouTube.

Bad Experience at the Movies

This afternoon I went by myself to see a 4pm movie at the AMC Loews theater on 3rd Ave & 12st:


I got there at 3:40 and I took a seat in a row about seven rows from the front. When I sat down there was nobody to the left, right, or front of me. I tried to focus on my Week magazine and block out the advertisements on the screen. Even though the movie wasn't supposed to start for at least fifteen minutes, the commercials were so loud it was impossible to do anything but watch them.

A few minutes later, a crowd of people descended on my row. Shortly thereafter, an obese woman flopped herself down in the chair directly in front of me, causing her seat-back to slam into my knees. This injustice was a little bit painful but mostly just irritating -- what's worse is that after she settled in, her seat had reclined about two feet into my space. I had no legroom at all at this point.

The only thing saving me was that the seat directly to my right was empty; I shifted my legs over there and got my legroom back. At this point, the previews were over and the movie started. Three minutes later, a man decides to squeeze past everybody in my row and take my legroom seat. So I sat the only way I could: straight back with my legs directly in front of me. Of course, since I was near the front, this meant I couldn't see the screen without tilting my head back a little bit. I was already thinking about busting out of there when the new guy decides he wants to steal my legroom: he does this by moving his hairy leg so that it was touching mine. That was it -- I walked out of there and got my $11 back.

I wouldn't be surprised if the designers of the seats for AMC/Loews also work for United Airlines! At least UAL serves a purpose... going to the movies is supposed to be fun and relaxing, not stressful and painful! Assuming I have the choice, I will avoid theaters like that at all costs. I'll stick to the Regal theater in Union Square if I ever go to the movies again.

I walked out of AMC/Loews and decided I'd see what was happening at the Union Square Barnes & Noble. The store was more crowded than I had ever seen it; almost all the isles were filled with people sitting on the floor, using the bookshelves as back rests:


I was thinking about browsing for books on those shelves but I just laughed and got the hell out of there! Now I understand why people with means always get out of NYC in August!!

Softball 7/15/07

Traditional or Roth 401(k)?

In 2005, Congress passed a law creating the Roth 401(k). What follows is an overview of 401(k) options as well as some thoughts to consider when figuring out which one is right for you.

How a regular 401(k) works:

Contributions to your 401(k) are pre-tax, meaning that the contribution amount reduces your taxable income. Any contributions that your employer makes do not count as income to you. At age 59 and a half, when you are able to start making withdrawals, you will pay tax on the distributions at your regular tax rate.

Example:

Current Year: You make $100,000 per year and contribute $15,500 to your 401(k) and your employer chips in another $5,000. Your taxable income for the year (from your employer) will be $85,000. This reduction in income results in is a substantial reduction in taxes – especially for those of us who live in high tax places such as NYC.

Retirement: Beginning at age 59 and a half, you start to take withdrawals from your 401(k). Let’s say you withdraw $100,000 per year. That $100,000 will be counted as ordinary income and you will pay federal, state & local taxes on the full amount at whatever your tax rate happens to be at the time.

How a ROTH 401(k) works:

Contributions to your ROTH 401(k) are after-tax, meaning that the contribution amount does not reduce your taxable income. At age 59.5, when can start making withdrawals, you will not pay any tax at all on the distributions. By age 59.5, the majority of the money in your account will not be money you put in (principal) but it will be capital gains on the principal. Thus, you will be paying ZERO tax on the massive amount of capital gains and interest that will compound in your account over the next 40 years!

Example:

Current Year: You make $100,000 per year and contribute $15,500 to your 401(k) and your employer chips in another $5,000. Your taxable income for the year (from your employer) will be $100,000.

Note: unfortunately, the employer contribution has to go into a traditional 401(k), not the Roth 401(k)

Retirement: Beginning at age 59.5, you start to take withdrawals from your Roth 401(k). Let’s say you withdraw $100,000 per year. That $100,000 will not be counted as income and you will pay zero tax on the withdrawal.

Which should I choose – the Roth 401k or the regular 401k?

There is no simple answer here – it depends upon the individual and also your belief of what your future holds. Consider this hypothetical situation for Sarah & Jane. These gals have a lot in common: they are both 25 years old, earn $100,000 per year, and can contribute $15,500 to a retirement plan this year:

Sarah: Sarah has big-time career ambitions and plans to have a much higher income in the future. She loves to work and plans to do so, either for a company or herself, until at least age 75. She is an “aggressive saver” and already has substantial non-retirement assets. She loves New York City and plans to stay there forever. Also, she expects to get a substantial inheritance from her parents one day. It is very likely that Sarah will be in the highest tax bracket when she retires.

Jane: Today Jane has the same income level as Sarah but Jane has very different ambitions for her career. Jane plans to stop working at age 65 and live off of her 401(k) and perhaps a part-time job. It is unlikely she will have substantial assets outside of her house and 401(k). Given these circumstances it is likely that her tax bracket will be lower in retirement than it is now.

In this example, Sarah’s contribution to the Roth 401(k) will only be $11,250 (because of the $3,750 in taxes she will have to pay on the additional $15.5k in income.) Jane’s contribution into her retirement plan will be for the full $15,500. All other factors equal, Sarah and Jane will probably end up in roughly the same, after-tax position when all is said and done. This is because Jane’s higher contribution now, will result in a much higher future amount due to the miracle of compounding. However, since Jane will owe a bunch of tax on the future distributions, it probably evens out.

Of course, all other factors are never equal… Since Sarah is going to have substantial assets and income in retirement, her tax bracket will likely be very high. Also, it is quite probable that Sarah can afford to pay the $3,750 in additional taxes out-of-pocket and thus not reduce her current contribution at all. In other words, Sarah will contribute the full $15,500 into the Roth 401(k) – she will find the money somewhere to pay the tax.

If she does this for the next 40 years, Sarah will have $5.3 million (assuming a 9% CAGR) – all of which can be withdrawn completely tax free. If she invests in the traditional 401(k), she could owe 40%+ of this amount to the IRS!

Bottom-line: It is very clear to me that “aggressive savers” with high future earning potential should go with the Roth 401(k). For people not in this category, the answer isn’t so clear.

Follow these links for additional resources:

Bloomberg Calculator: Roth 401(k) or Traditional?
Wikipedia: Roth 401(k)
IRS Publication

Can printing money create "real" wealth?

There is an interesting op-ed by Bob McTeere in today’s WSJ (subscription required): Don’t Dismiss Our Dismal Savings Rate. Excerpt:

The main fallacy in monetary theory and policy is the confusion of money and wealth. Money is wealth from the individual perspective since individuals can usually exchange it for goods and services. Money -- and financial assets easily converted to money -- may not be wealth for society as a whole if the production of goods and services has not kept pace with claims on it. Early spenders may have some success, but inflation will dilute the buying power of others. The bottom line is that real wealth has to be produced; it can't be printed.

The paradox of thrift says that attempts to save more in the aggregate reduce consumption spending, which, if not offset by increases in other spending, will reduce total spending and income. The paradox comes in when attempts to save more results in reduced saving out of lower incomes. The irony is that policy makers advise more saving but those who take the advice will benefit only if most of us ignore it, and policy makers are implicitly counting on that outcome.

A parallel is the farmer who hopes for a good crop year. But, if all or most farmers have a good crop year, the decline in prices may more than offset higher yields. What our farmer really needs is a good cop in a bad crop year. Then he could look for a popular restaurant that isn’t crowded.

A penny saved may be a penny earned, but it matters whether it was earned by producing more or by a rise in price of existing financial assets. A stock or housing market boom creates apparent wealth in the form of capital gains, but trying to convert it to real wealth en masse can make it disappear.

Alan Greenspan has been one of the few economists to explain these matters correctly and understandably, usually in the context of entitlement reforms. He frequently pointed out that any solution to the problem had to include real economic growth. With claims on output growing rapidly, output has to grow equally rapidly or the claims are bogus. Any solution -- to entitlements or the savings rate -- must include a bigger, more productive economy in the future…

The problem goes beyond government entitlement programs. Consider the baby boomers whose IRAs, 401(k)’s and personal investments helped drive the stock market to record highs. What happens when cash-in time comes? There will be a mountain of paper claims on output, but will there be an equally tall mountain of output?

This simple thesis helps to explain a lot of what confuses me about all of this new “money creation” we hear about constantly. For years now global money supply has been increasing much faster than the rate of global growth. Of course, defining “money” has become so much more difficult because of the velocity effects of increased global trade, not to mention derivatives. This is partly why the Fed has stopped publishing the M3 measure of money supply – it’s just too hard to quantify the broad monetary base.

Nevertheless, most of this new money has sloshed into assets, pushing up their prices. I have commented before that rising asset prices are not good for most people. For lower and middle class people who don’t own a lot of assets, they have not benefited much at all. Many of these people are actually worse off because they borrowed a ton of money against an overvalued asset.

Trois Pistoles vs. Construction Company

Yesterday -- Thursday, July 12, 2007 -- the Trois Pistoles were defeated by a construction company team whose name escapes me. Aside from the first inning, where we had a miserable showing, we played very well. Alas, the damage done in Inning #1 was too great to overcome. Follow this link for the softball set in Flickr!
































I know that I'm way late to the party but I have just realized how cool YouTube is. Anyway, it seems that someone using the camera yesterday accidentally (or not?) recorded a video on the camera. So.... here it is.... my first YouTube video!

Calculating the Performance of Your Portfolio

I have been investing in stocks for about 7 years. Until 2007, I have absolutely no idea what my rate of return was and whether I under/over performed the market.

Many of us (myself included) believe that we are better investors than we really are. We vividly recall the success of winning stock picks but somehow forget about the losers. In my case I like to think of all the money I made in PetroBras stock over the last few years. But what about the small fortune I lost trading gold futures in 2006? I almost never think about that – I have subconsciously blocked it from my memory. While it can be fun to live in a fantasy world, it is important to know the truth so that we can make smart decisions.

Why is it so hard to figure out my return? Because I’ve been continuously adding money to my brokerage accounts…. Sure my account is going up in size, but how much is a result of savings and how much from positive returns? I use Excel and the formulas below to easily track my portfolio returns. Now that everything is setup, it takes less than 5 minutes per month.

Monthly Return:

Each month I compute the time-weighted-return of my portfolio. This tells me the return of my portfolio for the month and takes into account any deposits or withdrawals:

Rate of Return = Change in Mkt Value / (Beg Bal + (Net Contributions * Factor of days in Month)

For example, if I contribute $1,000 into my account on the 20^th day of June, I would multiply the contribution by .33 (10/30). This is done because the $1,000 contribution was only in the account for 1/3 of the days in June.

Calculating Compounded Monthly Return:

Use this formula to calculate the compounded monthly (or any period) return in your portfolio:

Return for the Year = (1 + R1)*(1 + R2)……(1 + R12) – 1

In the above formula, R1 = rate of return for January, R2 = rate of return for Feb, etc.

Q2 2007 Portfolio Review

Q1 Update: In my Q1 portfolio review, I said the following:

Notwithstanding the benefits I have derived thus far, it is not smart to put money in the stock market which you will need in the next 1-3 years. So today I liquidated the stocks and bought a Short Term New York AMT-Free Municipal Bond Fund which pays about 3.1%. I have to completely segregate the money into a separate account so that I’m not tempted to trade with it!

As it turns out, this statement was a lie. When I wrote it, I had indeed planned to move the cash into the Short Term New York AMT-Free Municipal Bond Fund the very next day. Instead, I bought a bunch of Japanese Yen. I own the Yen as kind of a contrarian investment. That’s irrelevant though. Point is, I do not have self control – if I have cash in my brokerage account, I just have to mess with it.

Q2 Review: As a result of all this, I am starting to think a lot more about asset allocation and organization. Up to now, my approach to allocation has been haphazard at best. By the Q3 ’07 I want to be treating my accounts as follows:

Taxable Brokerage Account(s):
* In this account I want to have “great” stocks which I hold for long periods of time. Every year, I should sell anything with a short-term loss. Hopefully I will generate $3,000 in short-term loss per year. I will only take long term gains, and only if there is a very compelling reason. In my taxable account I am doing way too much trading!

Roth IRA:
* Here is where I should do all of the trading. By Q3 ‘07, anything that I own in here that deserves to be a core holding should be sold and purchased in the taxable brokerage account.

401(k):
* Today I am invested in international/emerging markets growth mutual funds. I fully expect and hope for lots of volatility in these funds. No action needed here.

Cash Management:
* The goal for this account should be to maximize my after-tax return. Living in NYC, it probably makes sense to put free cash into a muni-fund, but I have to crunch the numbers to be sure.

This is not a perfect setup but I think it will be an improvement over the current arrangement. Now that I have a good system in place for accurately tracking the performance of my accounts, it’s something that can be objectively evaluated at some point in the future.

Here is the YTD performance of my portfolio (which includes the above-mentioned accounts):

2007		My Return	S&P 500
Jan '07		-0.41%	1.51%
Feb '07		-0.22%	-1.96%
Mar '07		1.66%	1.12%
Apr '07		2.80%	4.43%
May '07		1.97%	3.49%
Jun '07		0%	-1.66%
YTD		5.89%	6.95%

Return from Ptown!

Got back to NYC yesterday from a week in Provincetown. It was the best trip ever.... Follow this link for my public Flickr photos (Flickr friends can see pics with people, not just scenery).

What's up with interest rates?

There has been a lot of volatility in the fixed income markets in the past few months. Here are some highlites, and some great links to check out for further reading:

What happened:
* In May, Treasuries sold off big-time, sending yields on the 10-year soaring. This also caused a 10% loss of principal to bond holders.
* Two heavily-leveraged Bear Stearns hedge funds might be imploding. The possible liquidation of the funds -- both of which own risky debt instruments such as CDO's and subprime mortgages -- could have serious consequences for the entire market.


Where do we stand:
* Yields on Treasuries have risen and the yield curve is no longer inverted.
* If you are a "subprime" borrower, it is much more difficult to get a loan
* Despite all of this, interest rates are still very low on a relative (historical) basis. Money/liquidity is still very plentiful -- as is evidenced by the ongoing M&A/Private Equity boom.

My Take:
With interest rates, I think it's important to think about where they're going, not just where they are now. With strong global growth and inflation, I would bet on higher interest rates in the future. If true, this suggests a pretty strong headwind for economic growth and for stocks in particular.

As much as ever, it seems that China and certain Middle Eastern countries control the fate of the global debt markets. The Chinese government holds more than $600 billion in US Treasuries. Their aggressive buying of short term notes is one good reason why interest rates have been so low, allowing US consumers to live way beyond their means for the last few years. In the short-run, this situation works out great for us -- we are able to import a whole lot of stuff and all we give them in return is dollar bills. Even better, we don't even have to pay them back.... You can be sure that the dollars we use to pay our debts back will be worth a lot less than those we are borrowing now.

The Chinese might be perfectly happy with this arrangement though because it creates stability at home... Now that 1 billion people know that it's possible to get rich and improve their lives, they all badly want to do it. Problem is, with an economy that is still largely manufacturing-based, it's very difficult to create jobs for the 20 million graduates Chinese universities pump out each year. The country needs 10% GDP growth rate to keep things stable.

So what do the above two paragraphs have to do with the fixed income markets/interest rates? A lot, I think. The Chinese (along with other major holders of US debt) have an incredible amount of control over the US economy. Not least of which is US interest rates -- witness the inverted yield curve after no fewer than 6 fed funds rate increases; Starting in 2002 when Greenspan raised interest rates to prevent inflation, long term interest rates have actually declined. So, at least for now (and at least through the Beijing Olympics in 2008), China does not want a destabilized bond market.

Follow these links for some excellent, and non-boring, commentary about recent happenings in the fixed income markets:

*Calculated Risk blog post about a great NYT article
*Two articles by Jubak:
* Deepening Debt Crises hits Close to Home
* Can Bond Market Stand to be Exposed?
*Bill Gross commentary

Off to PTown!!

Tomorrow I'm off to Ptown for a week.... My first vacation in 12 months!!

June 22 Linkfest

Economy:

Another Asian Contagion May Be Only a Bad Currency Trade Away: Ten years after the collapse of Asian governments' overvalued currencies in 1997, the remedies they embraced to prevent a recurrence may have only traded one set of risks for another. Their ``never again'' determination has led them to new extremes: artificially low currencies, a record $3.4 trillion in reserves and export-dependent economies. (Bloomberg)

Must read Big Picture post how about how the government is lying to us about inflation:
Delving Deeper into the Inflation Issue: Consider what happens when the BLS looks at rent/OER: "They supposedly net out utility payments. So if your rent payment stays constant but utility bills go up, that yields a lower net implied rent. In other words, utility prices going up caused rental prices and CPI to go down.”

But that's just the tip of the iceberg. Consider the even more bizarre concept of OER as representative of the entire home-dwelling US public. More than three times as many people OWN THEIR OWN HOMES then rent their abodes. So why do we use Rental Measures for measuring shelter inflation? (The Big Picture)

The strong Euro is causing lots of angst in Europe. There is a growing social and political movement against the Euro in a few countries in Europe, Italy and France in particular:
France’s Sarkozy Lashes Out Anew at Strong Euro: French President Nicolas Sarkozy criticised euro strength anew on Wednesday, saying there was no reason why the euro zone should be the only region in the world to be handicapped by an overly strong currency.

In an interesting and somewhat unusual view of a strong currency, Sarkozy argues that a strong Euro decreases the purchasing power of France:
"An overly low purchasing power is the fault of competition from countries with low salaries; of social, environmental, monetary dumping; of the Chinese currency which is too low; of the euro which is too strong; of charges which are too high; of interest rates which are higher than inflation; of house prices which have risen a lot." (Reuters)

As Mercury Rises, Motorists Get Burned: (Will’s Blog)

Rate Rise Pushes Housing, Economy to “Blood Bath”: The jump in 30-year mortgage rates by more than a half a percentage point to 6.74 percent in the past five weeks is putting a crimp on borrowers with the best credit just as a crackdown in subprime lending standards limits the pool of qualified buyers. The national median home price is poised for its first annual decline since the Great Depression, and the supply of unsold homes is at a record 4.2 million, the National Association of Realtors reported.

``It's a blood bath,'' said Mark Kiesel, executive vice president of Newport Beach, California-based Pacific Investment Management Co., the manager of $668 billion in bond funds. ``We're talking about a two- to three-year downturn that will take a whole host of characters with it, from job creation to consumer confidence. Eventually it will take the stock market and corporate profit.'' (Bloomberg)

Inflation:

Commodities Boom Driving Inflation in Latin America: High international commodities prices are becoming a double-edged sword for Latin American countries. After boosting economic growth for years, the high prices are making food more expensive and stoking fears that inflation could accelerate. (Reuters)

Agricultural Commodities – Biofuelled: Every morning millions of Americans confront the latest trend in commodities markets at their kitchen table. According to the United States Department of Agriculture, rising prices for crops--dubbed "agflation"--has begun to drive up the cost of breakfast. The price of orange juice has risen by a quarter over the past year, eggs by a fifth and milk by roughly 5%. Breakfast-cereal makers, such as Kellogg's and General Mills, have also raised their prices. Underpinning these rises is a sharp increase in the prices of grains such as corn (maize) and wheat, both of which recently hit ten-year highs. Analysts are beginning to ask, as they have of oil and metals, whether higher prices are here to stay.

When demand was growing more slowly, farmers could meet it through gradual improvements in their yields. But to cope with today's boom, yields will have to rise much faster, or farmers will have to bring more land into production.

Both are possible. Greater adoption of genetically modified strains of corn and wheat, for example, could improve yields. But they are expensive and politically controversial. There is also quite a bit of fallow land to be sowed, especially in developing agricultural powers such as Brazil and Ukraine. But those countries are far from the biggest markets and their idle land tends to be found in areas with poor transport links. A strong price signal will be needed to overcome such obstacles and induce extra supplies.

Neither seems very likely in the near future. This week America's Congress is debating whether to double its targets for biofuel production.

At the same time, the oil price rose to its highest level in ten months, thanks to a strike and other disruptions in Nigeria. The chaos in the Niger delta, it turns out, has a surprising amount to do with the price of eggs. (Economist)

General Interest:

China Blocks Flickr Photo Sharing Service: Flickr's blockage in China, which seems to affect only the actual photo files, rather than the entire Web site, ironically arrived almost exactly as Wikipedia was suddenly freed from a long stretch in the big house. Several weeks ago, users posted photos of public protests of a new chemical plant in Xiamen, which led to flickr's current blockage. (MarketWatch)

Investing & Trading:

Steer Clear of the Rotting Bond Market: You don't have to believe in collusion between debt underwriters and the ratings agencies, however, to worry that the system isn't working. The criticism here is coming from bond professionals who have produced a series of studies showing that pools of debt called CDOs (for collateralized debt obligations) aren't showing the patterns of return and default that their credit ratings predict. For example, one study shows that tranches of CDOs with the same BBB credit rating, which should trade at roughly similar prices, are instead trading at yields that differ by anywhere from 1.4 to 10 percentage points. At the A and BB levels, the gap is something like 4 percentage points. The U.S. Federal Reserve recently weighed in with a paper that said the ratings for CDOs are riddled with "anomalies." (Jubak’s Journal – MSN Money)

Four CDOs With Subprime Loans May Have Ratings Cut: Four collateralized debt obligations containing subprime mortgages from 2006 and valued at $3.1 billion may have their credit ratings cut by Fitch Ratings. (Bloomberg)

A good acquisition for a stock I own:
Luxottica buys Oakley: Chances are that many of the celebrities' favourite brands are owned by Luxottica, the Italian eyewear group. It is now adding another name, Oakley, the California-based sunglasses maker, to a portfolio that already includes Prada and Chanel. And it is paying a rather fashionable price to do so.

The $2bn, or $29.30 a share, deal does make sense, though. The luxury goods market is booming and, despite a substantial capital expenditure programme, Luxottica has spare cash to invest. It already distributes Oakley sunglasses through its retail outlets and wants to expand in North America, where it made two-thirds of its €4.7bn sales last year. Luxury sunglasses are becoming increasingly popular in the region. According to Luxottica's chief executive, only 15 per cent of sunglasses sold in North America cost $30 or more, but the proportion is growing. (Financial Times)

Housewives Outmaneuver UBS, Deutsche Bank Trading Yen: Yukiko Ikebe, a 59-year-old housewife in Tokyo, in April was indicted for evading about 139 million yen in income taxes while earning 407 million yen trading foreign-exchange, according to the Tokyo District Public Prosecutors Office.

``She must have earned more money than us,'' joked Yuji Saito, head of the foreign-exchange sales department at Societe Generale SA in Tokyo. ``I said to my colleagues, `let's find her and hire her!''' (Bloomberg)

Real Price Gouging At the Pump

I usually roll my eyes at people who make allegations that oil companies are gouging consumers. Most of these people have no evidence, just outrage at the high profits oil companies earn when prices are high. This article from MSN Money actually makes some solid points and shows how gas stations (not necessarily oil companies) are ripping off consumers in the summer months:

As Mercury Rises, Motorists Get Burned: As the temperature rises, gasoline expands, and the amount of energy in each gallon drops. Because gas is priced at a 60-degree standard and gas pumps do not adjust for temperature changes, motorists often get less bang for their buck in warmer weather.

Almost a century ago, the industry and regulators agreed to define a gallon of gasoline as 231 cubic inches at 60 degrees. But as the mercury rises and gasoline expands, it takes more than a gallon of gas to produce the same amount of energy. The opposite is true when gasoline contracts in colder weather.

Gas retailers ignore the temperature swings and always dispense fuel as if it's 60 degrees. As a result, gas is an average of about 5 degrees warmer than the federal standard, according to a study analyzed by Dick Suiter of the National Institute of Standards and Technology.

In frigid Canada, where cold temperatures were giving consumers an edge, many gas stations voluntarily backed a program to add pumps that automatically adjust volumes based on temperature.

During the energy crisis in the 1970s, tropical Hawaii decided to set a base fuel temperature of 80 degrees, meaning that consumers there get more bang for their buck because retailers now dispense 234 cubic inches of gas per gallon rather than 231. The federal government is considering a similar change as well. The National Conference on Weights and Measures is to vote in July on whether to allow temperature regulation by retailers.

The upcoming decision is worrying some fuel distributors, who say the new equipment could force some independent dealers out of business. NATSO, a trade group representing truck-stop owners, estimates that each retrofitted pump could cost between $1,500 and $3,800.

"The average truck stop has 20 pumps," said Mindy Long, a spokeswoman for the group. "The burden on them would be phenomenal."

Lobbyists are paid to represent their constituents, but this Mindy Long must have no shame. Her argument is essentially this: “it would be a phenomenal burden on gas stations and truck stops to treat their customers fairly.” Hahaha!

Her argument is even more ridiculous because, according to the article, gas stations in Canada have retrofitted their pumps. The reason they did so is that they were giving consumers too much gas (because the gas is denser at lower temperatures). So it’s ok for gas stations to retrofit their pumps so they do not get ripped off but it’s a “great burden” for them to retrofit their pumps so the consumer doesn’t get ripped off.

Linkfest

Investing:

Finding Arbitrage Plays in the New Forever Stamp: Buy them now, use them forever. That's the promise of the U.S. Postal Service's ``Forever'' stamp, which went on sale April 14. (Bloomberg)

A safe-money bet? Think Canada: Afraid that the U.S. dollar is in a long-term decline? Want to protect the value of your portfolio over the long term? Looking for bigger gains than you'll get from loading up on Swiss francs or burying gold bullion in your backyard?
Try Canada. I can't think of a better place to stash part of a long-term retirement nest egg than in Canadian stocks. I'll give you three in this column to add to your long-term retirement portfolio after the current sell-off has run its course. (Jubak’s Journal – MSN Money)

Barron’s Round Table: Marc Faber interview: In January you also recommended shorting the 30-year bond. We presume you’re still bearish: Yes, although near-term these bonds are oversold. It is a great error to think that in an economic slowdown, the rate of inflation automatically drops. Don’t tell me your cost of living is increasing only 2% a year.

As for a new idea, I’d try to short the U.S. retailers, excluding Wal-Mart…It won’t do as badly as the rest of the industry. There will come a time when middle-class households exact their revenge and do better relative to the Wall Street crowd. The problem with Wall Street is this: If you take away the fees earned by structured products and investment banking and mergers and acquisitions, there won’t be much left. I admire Wall Street and the banking system, which when faced with collapsing co

mmission rates invested structured products from which to earn so much. But one day it will dawn even on financial institutions, and on state pension funds, that they are paying a high fee for a very large basket of hedge funds. Some hedge funds are superstars. But out of 7,000 hedge funds, not all are superstars. And it’s not just hedge funds. The whole system is geared to taking a lot of money out of the pockets of clients. Where are the customers’ planes? (Barron’s)

Economy:

Yen Drops to Lowest Versus Dollar Since 2002 on Treasury Yields: The yen fell to the lowest against the dollar since December 2002 and declined against the euro as Treasury yields near the highest in five years encouraged investment outside Japan. Japan's currency dropped against all of its 16 most active counterparts tracked by Bloomberg on an increase in carry-trade purchases of higher-yielding assets financed by borrowings in the yen. (Bloomberg)

Carry Over: Time Might be Running Out on the Carry Trade: It is amazing how many people follow a strategy that, in theory, does not work. They do so, of course, because practice outranks theory. And the carry trade, the borrowing of low-yielding currencies to buy high-yielding currencies, has worked in practice. (Economist)

Misc:

Drink Up: LUXEMBOURG glugs more than 15.5 litres of alcohol per person in a year, more than any other country. One explanation is that the duty on alcohol is relatively cheap in the tiny nation, encouraging booze tourism from its more heavily taxed neighbours. No such explanation for the Irish, however, who quaff 13.7 litres a year, according to the World Health Organisation. European countries, with their cultural acc

eptance of alcohol, tend to dominate the top places. In America, where stricter minumum-age requirements apply, the average person drinks 8.6 litres a year. (Economist)

Fat, Glorious Fat, Moves to the Center of the Plate: These are times of bold temptation, as well as prompt surrender, for a carnivorous glutton in New York.

They’re porky times, fatty times, which is to say very good times indeed. Any new logo for the city could justifiably place the Big Apple in the mouth of a spit-roasted pig, and if the health commissioner were really on his toes, he’d draw up a sizable list of restaurants required to hand out pills of Lipitor instead of after-dinner mints. (New York Times)

Wal-Mart theft: $3 billion a year? Shoppers at Wal-Mart stores across America are loading carts with merchandise -- maybe a flat-screen TV, a few DVDs or a six-pack of beer -- and strolling out without paying. Employees also are helping themselves to goods they haven't paid for. The hit is likely to rise to more than $3 billion this year for Wal-Mart Stores (WMT, news, msgs), which generated sales of $348.6 billion last year, according to retail consultant Burt Flickinger III. (MSN Money, AP)

Tainted Food:

The Week magazine has a great briefing about food imports. This is a must-read:
The Dangers of Imported Food: Each month, federal inspectors turn back tons of tainted food imported from abroad, but experts say that far more gets through. How worried should we be about our food supply? (The Week)

F.D.A. Tracked Tainted Drugs, but Trail Went Cold in China: Ten years later it happened again, this time in Panama. Chinese-made diethylene glycol, masquerading as its more expensive chemical cousin glycerin, was mixed into medicine, killing at least 100 people there last year. And recently, Chinese toothpaste containing diethylene glycol was found in the United States and seven other countries, prompting tens of thousands of tubes to be recalled. (NYT)

1,000 Tube of Toothpaste Seized: The Food and Drug Administration earlier this month issued a worldwide alert of toothpaste from China because DEG levels of 1 to 4 percent were found in brands of Chinese toothpaste that the FDA banned June 1. (Pacific Daily News)

Taxes:

The Next Audit Scare: The IRS is planning to Revive Its Random-Audit Program in Hopes of Foiling Tax Cheats; What to do if you’re chosen. (WSJ)

Carried Away: The argument centres on one long-established discrepancy—the gentler tax treatment of capital gains than annual income. Now it is benefiting people in private-equity firms (and to a lesser extent hedge funds), who receive a large part of their pay in the form of “carried interest”—usually 20% of investment gains. In America these are taxed at the 15% capital-gains rate, rather than 35% income tax. In Britain the benefits are even more generous. Those who hold an investment for two years can pay 10% on the gains, compared with a 40% rate of income tax. (Economist)

Rubin, Summers Say Fund Managers Should Pay Higher Tax Rates: Congress should more than double tax rates for many hedge fund managers and private equity partners who classify their pay as capital gains, former Treasury secretaries Robert Rubin and Lawrence Summers said. (Bloomberg)