Will's Blog

Will's Blog Has Moved!

2007-09-04T18:10:00.000-07:00

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

2007-08-31T17:45:00.000-07:00

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

2007-08-24T19:57:00.000-07:00

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

2007-08-20T18:14:00.000-07:00

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?

2007-08-17T07:56:00.000-07:00

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?

2007-08-14T18:47:00.000-07:00

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!

2007-08-13T17:02:00.000-07:00

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

2007-08-04T16:28:00.000-07:00

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

2007-07-21T11:12:00.000-07:00

Traditional or Roth 401(k)?

2007-07-20T18:59:00.000-07:00

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?

2007-07-17T20:00:00.000-07:00

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

2007-07-13T17:14:00.001-07:00

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

2007-07-10T18:59:00.000-07:00

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

2007-07-09T16:33:00.000-07:00

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!

2007-07-08T05:21:00.000-07:00

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?

2007-07-05T10:13:00.000-07:00

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!!

2007-07-01T18:38:00.000-07:00

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

June 22 Linkfest

2007-06-23T10:19:00.000-07:00

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

2007-06-20T18:35:00.000-07:00

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

2007-06-17T06:06:00.000-07:00

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)

Friday, June 16, 2007: Trois Pistoles vs. Bloomingdales 59th Street

2007-06-15T19:14:00.000-07:00

Today's game was the Trois Pistole's first true victory.

The game was held at Field #7 in the North Meadow of Central Park. It was scheduled to start at 5:30 and we barely assembled the team by the 5:45 cutoff point. When I arrived at 5:10, the entire Bloomies team was already there practicing; it looked like they had been there for a while too.

A word about the other team: they were intensely competitive but lacked the skills to match. They made this pitcher extremely tense with their overt desire to walk... instead of hit. In slow pitch softball, the idea is to have fun: when I get up to bat, I want to hit the ball, not watch perfectly good pitches float over the plate. Alas, Bloomies did not share the sentiment.

After starting out the first couple of innings behind by a few runs, the Pistoles' staged an impressive comeback. Samantha is the clear MVP of the game. Her strong hitting and excellent base-running is the reason we won tonight!!

Another standout performance: Michael Bolger showing up early even though he could only stay for a few minutes because of dinner plans. His selfless sacrifice ensured that we were eligible to play.

By the 6th inning the score was 15 to 12 in our favor. Due to time constraints, the Ump announced that this would be the last inning: Bloomies would have to score a bunch of runs or the game was over. In softball, scoring 2 runs is quite simple, especially if you get a couple of people on base. After walking a batter, and allowing a base hit, it was not looking too good.

With impressive infield play we kept them to 1 run and the game was over. The drama was just beginning, though. The Bloomies were a feisty and cantankerous bunch: they yelled and screamed because we were late and thought they should have been awarded a victory because of it. Regardless, the rules are clear that team's are given a 15 minute window in which to assemble. The confrontation resulted in a yelling match between us, Samantha, Bloomies, and the Ump. There was no argument though, we had won fair and square.

This narrative does not do our victory justice, so please feel free to comment freely. Also, Flickr friends can follow this link for all the softball pics.

Softball

2007-06-11T19:37:00.000-07:00

I was hoping to write a story of the Trois Pistole's first-ever softball victory tonight. Alas, it wasn't meant to be: not a single member of the other team showed up!

Nevertheless, our team of NYC professionals made a very impressive appearance: the entire team made it to the field early for a 5:30 game... on a Monday afternoon!

The field (if you could call it that) was on Houston Street & FDR drive. It is a tiney space between the highway and the East River. Left field was so shallow it would've been easy for even the worst hitter to hit a home run on every at-bat!

The umpire patiently waited around until 5:45 when he called the game in our favor. After that, we practiced for a few minutes and then went to the bar for happy hour.

We were drinking and carrying-on for about three hours until we requested the check. It came to $550. We felt this was a bit high but nobody really thought too much of it. On closer inspection, Kara noticed that a veggie burger -- which we didn't order -- had made its way onto the tab. We presented this evidence to the waitress who re-crunched the numbers and presented us with a bill for only $260!!

So with two losses and two forfits, we are well on our way to the playoffs. Enjoy the pictures!

June 9 Linkfest

2007-06-09T13:05:00.000-07:00

Investing:

The Consequences of Asia Rising: Perhaps the most important lesson to be learned from the Asian experience is that economic growth is not a zero sum game where the winners take jobs and opportunities away from the losers. The growth of China, India, and Indonesia is helping all the countries in Southeast Asia. Singapore gets more shoppers from neighboring countries and Hong Kong believes it will remain the financial capital for a burgeoning China since its open and transparent markets can attract more investors.

Similarly the U.S. has much to gain from the growth in Asia. Brand names are very important to the Asians and the consumer market in these developing countries is just opening up.

If we shut ourselves off from developments abroad, we will be the major ones to suffer. Opportunities abound in these developing markets. You can be sure that if the U.S. does not catch them, others most certainly will. (Yahoo! Finance)

U.S. economy’s fate in Saudi hands: Saudi Arabia is running the U.S. economy.
I'm not sure the Saudis want the task, but they've got it. Because the United States still doesn't have a national energy policy, we've thrown decisions about how fast our economy grows and whether our standard of living rises or falls into the hands of Saudi Arabia's oil ministry. (Jubak’s Journal – MSN Money)

How Ethanol Bites you in the wallet: Ethanol is attractive as a solution to high gasoline prices because it promises a free lunch:

* U.S. farmers would grow corn.

* U.S. ethanol companies would turn the corn into ethanol.

* U.S. consumers would go about business as usual.

* And everyone in the U.S. would be less dependent on foreign oil producers.

* But, repeat after me: There is no free lunch.

So far, this not-so-free lunch has resulted in higher food prices and rising U.S. dependence on fertilizers produced by, you guessed it, foreign oil and natural gas producers.

The costs are just starting to work their way through the U.S. and global economies. But it's none too early for investors to revise their portfolios to take account of the costs of this free lunch.

On June 4, corn (No. 2 Yellow, Central Illinois) sold for $3.77 a bushel. A year ago, the price was just $2.25 a bushel. That's a 67% jump in price in a year. (The futures markets say prices will stay here, too, with corn for December delivery selling at $3.83 a bushel on June 4.) (Jubak’s Journal – MSN Money)

Economy/Inflation:

Years of Global Growth Raise Inflation Worries: For the past decade, low-priced labor from China, India and Eastern Europe has helped much of the world enjoy economic growth without the sting of inflation. Now that damper on prices is beginning to reverse -- and global inflation pressure is starting to build. (WSJ)

General Mills Raises Price on Line of “Big G” Cereals: General Mills Inc. is expecting consumers to pay more for fewer Cheerios. By reducing the size of its cereal boxes, General Mills will be selling less for more. The new, smaller boxes will mean a low single-digit percentage increase in the price per ounce of such well-known cereal (WSJ)

Hot Commodities Ignite “Agflation” fears in Europe: Red hot agricultural markets are pushing food prices up in Europe, putting central bankers on alert for a new phenomenon economists have termed "agflation". (Reuters)

Bank of England May Need to Move Faster on “Sticky” Inflation: The Bank of England, which left interest rates unchanged yesterday, may have to move faster to curb the U.K.'s worst bout of inflation in a decade. (Bloomberg)

Globalization Creates Secular not Cyclical Inflation: The conclusion that this round of inflation is cyclical rather than structural is ridiculous. It brings us to the central debate – is globalization inflationary or deflationary? As the article implies, the growth of low-cost India and China has been a deflationary force on labor prices and certain manufactured goods. While this is undoubtedly true, this growth also has created inflation in many other sectors of the global economy. (Will’s Blog)

General:

Why So Many Suicides in Japan: Japan's agriculture minister hanged himself Monday amid allegations of bid-rigging and padding government expenses. The following day, an executive allegedly linked to one of the scams leapt to his death. In 2005, 32,552 people killed themselves in Japan—one of the highest suicide rates among industrialized nations. Why are there so many suicides in Japan? (Slate)

Iran Adding Attack Boats in Persian Gulf: Iran is increasing its fleet of small attack boats capable of challenging warships and disrupting oil traffic in the Strait of Hormuz, the sea route for two-fifths of the world's daily supply of crude oil, the U.S. Navy says. The boats -- up to 70 feet long and capable of speeds up to 57 miles per hour -- are armed with torpedoes and rocket- propelled grenades as well as cruise missiles and also are used to lay mines. The U.S. estimates Iran has 5,000 sea mines. (Bloomberg)

Gay Lawyers Come Out as Clients Demand More Diversity: The number of openly gay, lesbian, bisexual and transgendered lawyers increased by more than 50 percent from 2002 to 2006, according to the National Association for Law Placement. (Bloomberg)

Hong Kong Winters May Vanish in 50 Years: Hong Kong's winters could vanish within 50 years, with the number of cold days declining virtually to zero due to global warming and urbanization, the head of the city's weather observatory warned on Friday. (Yahoo! News)

Personal Finance

More Advice Graduates Don’t Want to Hear: While there may be a debate among economists about how much 50- and 60-year-olds should be saving for retirement, there is little dispute about how much the young should save: more. (NYT)

Globalization Creates Secular not Cyclical Inflation

2007-06-07T19:02:00.000-07:00

Excerpt from a Financial Post article today:

When Tata Consultancy, the giant Indian computer services firm, says it is hiring 5,000 workers in Mexico because rising wages are pushing up costs at home, it is little wonder investors are beginning to get queasy about inflation.

Only a month or so ago most economists figured the U.S. Fed would cut interest rates to fight off spreading housing doom. Now even long-standing bears Merrill Lynch and Goldman Sachs have rubbed out their forecasts for U.S. cuts, the European Central Bank is hinting at further increases after yesterday's hike, the Bank of Canada is poised to pull the rate trigger, and investors are beginning to worry that even low-cost giants such as India and China are losing their disinflationary might.

But before markets succumb fully to a good old-fashioned inflation scare, it is worth taking a dispassionate look at where global inflation is actually heading. While it may be heading up after several years of gangbuster global growth, the uptick is likely more cyclical than structural.

The long-term forces that have been holding inflation down -- globalization, the adoption of free-market policies and more sophisticated central bank policies -- are unlikely to unravel overnight. (Though the biggest dividends from falling inflation may behind us.)

The conclusion that this round of inflation is cyclical rather than structural is ridiculous. It brings us to the central debate – is globalization inflationary or deflationary? As the article implies, the growth of low-cost India and China has been a deflationary force on labor prices and certain manufactured goods. While this is undoubtedly true, this growth also has created inflation in many other sectors of the global economy.

India and China are consuming massive quantities of energy and other commodities. Since the supply of commodities is not unlimited (unlike the capacity of Chinese companies to produce junk for Walmart), their prices have risen dramatically across the board. As they grow richer, they become accustomed to a higher standard of living and they have more money to spend on food and other consumables. This is why we’ve seen increases in everything for which supply/capacity is not very elastic: energy, food, metals, transportation, construction, etc. The net result is a dramatic increase in aggregate demand.

Globalization has also had a major impact on asset price inflation. The increase in trade (and a host of other factors) has led to a massive increase in the money supply. Much of this new money has sloshed into stocks, bonds, real estate and other “assets.”

As prices for energy, food, shelter, and commodities rise, it’s only a matter of time before wages rise along with them. We are seeing this in a dramatic fashion in India and China, where wage growth in many sectors is in the double digits.

This phenomenon is not a cyclical trend, it is a structural trend and one we will be facing until India & China are done “emerging” and become mature economies.

Sunday Linkfest

2007-06-03T07:03:00.000-07:00

Here is delayed version of this week's Linkfest. I apologize for the bad formatting -- I'm working on a weird computer.

General Interest:

Making Yourself More Likeable at Work: Ask yourself: Do people like me? You get promoted in this world because people like you, not because you get work done. There's always more than one person who can get a job done. But everyone's personality is different, so when you want to differentiate yourself at work, focus on your personality. (Yahoo! Finance)

The Best Novels You’ve Never Read: A few ideas for beach reading. (New York Magazine)

Economy:

Another reason why rising real estate values are not a good thing:
To the Barricades! Property Taxes Spur Revolts: John F. Wasik: In a rising market, the local assessor will raise his estimate of your home's worth, which usually results in a higher real-estate tax bill. Nowhere has the burden incensed more taxpayers than in New Jersey. The state has the dubious honor of having the highest property-tax bills in the country, averaging $6,300 last year, a 7 percent increase over 2005. (Bloomberg)

Here is a fascinating article about oil shale and its potential as a huge new source of oil:
Colorado, Utah Rival OPEC Reserves, Lure Chevron, Exxon, Shell: Colorado and Utah have as much oil as Saudi Arabia, Iran, Iraq, Venezuela, Nigeria, Kuwait, Libya, Angola, Algeria, Indonesia, Qatar and the United Arab Emirates combined.

That's not science fiction. Trapped in limestone up to 200 feet (61 meters) thick in the two Rocky Mountain states is enough so-called shale oil to rival OPEC and supply the U.S. for a century.

``The breakthrough is that now the oil companies have a way of getting this oil out of the ground without the massive energy and manpower costs that killed these projects in the 1970s,'' said Pete Stark, an analyst at IHS Inc., an Englewood, Colorado, research firm. ``All the shale rocks in the world are going to be revisited now to see how much oil they contain.'' (Bloomberg)

5 Myths About That $3.18 Per Gallon: Here are five common myths about why we're paying so much at the pump. (Washington Post)

Investing:

Investors Learn a Lesson as Stock Index Hits High: The Standard & Poor's 500 index — a stock market benchmark for the retirement savings of millions of Americans — hit an all-time high Wednesday, raising hopes that Wall Street's 4 1/2 -year rally will keep on rolling.

But for many average investors, the event is a painful reminder that a key part of their portfolios has done little better than break even over the last seven years. The S&P index has just regained the last of its nearly 50% decline from 2000 to 2002, when plummeting shares of technology companies led the market down in the worst slump since the Great Depression. (LA Times)

Nikkei Climbs to 3-month closing high, techs up: Market participants said the Nikkei's rise may also be a sign that investors are reevaluating Japanese equities. The share average has inched up just 3.8 percent so far this year, making Tokyo one of the world's worst-performing equity markets. "If there is a global sell-off, Japan is likely to see the least amount of damage. The markets have yet to advance this year." (Reuters)

Kuwait Kicks Sand on the Dollar: The combination seems to be heading toward a jury-rigged global monetary system. This system doesn't rely on market mechanisms to adjust the relative value of currencies. Instead, individual countries opt in and out of those market mechanisms as they choose with their policy moves designed to maximize their own return from the rules of the market. (Jubak's Journal -- MSN Money)

Technology:

Google Street Level View Maps. This is incredible! Here's a picture of my apartment from the site:

Health:

Ex-China Drug Regulator to be Executed: China's former top drug regulator was sentenced to death Tuesday in an unusually harsh punishment for taking bribes to approve substandard medicines, including an antibiotic blamed for at least 10 deaths.

The sentence was unusually heavy even for China, which is believed to carry out more court-ordered executions than all other nations combined — and likely indicates the leadership's determination to deal with the recent scares involving unsafe food and drugs.

According to the official magazine Outlook Weekly, a survey by the quality inspection administration found that a third of China's 450,000 food makers had no licenses. Also, 60 percent of the total did not conduct safety tests or have the capability to do so, the survey found. (Yahoo! News)

DRM Controversy

2007-06-02T06:49:00.000-07:00

[rant]

When you buy a song or a software program, who really owns it? You or the company who sold it to you?

Songs purchased from Itunes or other sites often come with Digital Rights Management which puts all sorts of restrictions on what you can do with the file. For example, you can't just give it away to all your friends or download it to 300 Ipods.

DRM restrictions are so annoying to me that I refuse to buy any music if it comes with them. I believe that if I buy a song, it is mine and I should be able to do whatever I want with it. As far as I'm concerned, there is no fundamental difference between digital files and CD's. Sure, it's way easier to distribute electronic files than it was to make CD copies but that is beside the point. Steve Jobs certainly agrees and has been trying (with some success) to get the record companies that supply music to Itunes to drop their demands that the music come with DRM protections. So, for music, I think DRM will eventually go away.

For software though, it seems to be here to stay. Have you ever tried to download Turbo Tax, Microsoft Office or Windows on more than one computer? Well, you can't... you have to buy a second copy at full price. This is annoying but tolerable.

What's far worse is usage restrictions on software that you already have downloaded on your computer. Last year, at great expense to my then-employer, I enrolled in the Becker CPA review course. It comes with software which has review questions and practice tests. You have exactly one year to use the software after you download it onto your computer. After that, it stops working and there's nothing you can do about it. To get it reactivated, I was offered a "returning student discount" of $450!

What an insult!! We are talking about basic software, not an online course. What if book publishers put limitations on how long you could read a book before the internal explosive mechanism destroyed it? Obviously, nobody would buy books from that publisher! There is no fundamental difference here. If they wanted to put time restrictions on the practice questions, they should have put the entire thing online. Your access to the website would expire after one year. This is my software and I should be able to use it forever.

Getting By in New York City

2007-05-30T17:35:00.000-07:00

The New York Times is lately running lots of articles about the high cost of living in NYC. A May 10 article by Christine Haughney sums up my situation nicely:

As the apartment-hunting season begins, fueled by college graduates and other new arrivals, real estate brokers say radical solutions among young, well-educated newcomers to the city are becoming more common, because New York’s rental market is the tightest it has been in seven years. High-paid bankers and corporate lawyers snap up the few available apartments, often leading more modestly paid professionals and students to resort to desperate measures to find homes.

I fall into the “modestly paid professional” category. In my observation there are three types of people under 30 who live in “nice” Manhattan apartments:

1. Bankers & Lawyers who easily make more than $200k right out of college or law school

2. People who are subsidized with Daddy’s money

3. Modestly Paid Professionals who squeeze lots of people into apartment. For example: three or four people living in an apartment that was originally designed to be a one-bedroom

For the rest of us who want to live here, we have to fight with each other to live in conditions which would be considered squalor in any other city in this country. Demand is fierce and supply of apartments is severely constrained by too many rent-controlled apartments and lack of new buildings with “affordable” units.

To live in the East Village in a trendy neighborhood, I live in a 5^th floor walkup, <500 style=""> We share a bathroom and our bedrooms are big enough for a bed and nothing else... including windows.

But I’m not complaining; I consider myself lucky to have such a great living situation. My roommates are awesome and my rent is less than $1,000 per month. How many people living in Manhattan can say that? Also, it allows me to live below my means and save money – things which are more important to me than living in a doorman building.

A Great Run in New York City

2007-05-29T06:28:00.000-07:00

My favorite way to experience cities is to run through them. Yesterday I spent a few hours running through the East & West Villages in NYC. Seems like every time I do this I run across something that I can't wait to tell someone about.

Yesterday I found a great bluegrass band (along with their Chevy Rambler) playing on Clarkson Street near the West Side Highway. They setup under an awning of an old meat packing plant.... the acoustics were perfect. I watched for about a half hour before I moved along.

Base Metals in the Nickel Are Worth More Than a Nickel

2007-05-26T12:54:00.000-07:00

We first hit on this subject last summer in my old blog. One year later and the nickel is worth even less. The details are in this week’s Barron’s (Nickels Are the New Dimes – Subscription Required):

According to United States Mint Specifications, the U.S. nickel must weigh five grams, be 21.21 millimeters in diameter and consist 25% nickel and 75% copper. It’s the latter metallic value that’s of most interest. Earlier this month, the nickel reached a value of 9.7 cents as a result of the rising value of its constituent copper and nickel.

But lest you think of collecting bushels of nickel and melting them for a tidy profit, don’t. The Mint introduced interim rules late last year to head off any such shenanigans and profiteering. Violators can be punished with a fine of up to $10,000, five years in prison or both.

The obvious truth is that the USD, as illustrated so perfectly by the nickel, has been “debased.” But let’s look at the flipside of that argument: since the Dollar is a fiat currency, it is not based on anything tangible such as gold or silver. Therefore, it would make sense for the government to create the currency from the cheapest, most readily available materials, provided they met stringent durability requirements. The nickel just so happens to be made of nickel and copper, which today are very pricey. They could just as easily make the nickel out of clay or pig iron… it would be still be worth 5 cents because the US government says so.

May 26 Linkfest

2007-05-25T04:43:00.000-07:00

Links to some interesting articles I read this week. My comments are in italics.

Economy

A commodities boom makes itself felt in the supermarket: Agricultural commodity prices are often volatile, in part due to weather fluctuations that affect crops. But what is unusual about recent price increases is that so many prices - everything from grains to ground nut oil - are rising simultaneously. Economists worry that the sudden increase in the cost of such a basic good as food will fuel inflation.

Meanwhile, humanitarian agencies are worried that a sustained rise in prices will make it more difficult to feed people in the poorest countries. Greg Barrow, spokesman for the UN's World Food Programme, says rising demand for raw materials from China, as well as a weaker US dollar and higher transportation costs, are making its food purchases more expensive.

Economists worry that the sudden increase in the cost of such a basic good as food will fuel inflation. James Paulsen, chief investment strategist at US financial advisor Wells Capital Management, says the rise in non-energy commodity prices could presage an increase in core consumer inflation later this year. (wsj)

Lots of China Stories this Week:

China to Diversify Foreign Currency Reserves: Authorities have said the country will diversify part of its foreign exchange reserves, which amounted to 1.02 trillion dollars by the end of March and are believed to be invested mainly in dollar bonds. (Xinhua)

Hmm…where to put the money??? Aha! Private Equity!!
China Puts Cash to Work in Deal With Blackstone: The landmark deal signals China's determination to earn higher returns on its reserves and gives Blackstone a potential advantage in doing deals in China. (WSJ)

Investing:

Marc Faber Says Financial Markets in “Final Stages of a Bubble”: Not if, but when: global markets are in a bubble and will crash one of these days. The only asset he would buy now: farmland in Argentina, Brazil, Africa, New Zealand, Australia (Bloomberg)

Dividends or Share Buybacks?
Essentially, companies have four things they can do with their free cash flow: 1) reinvest in the business; 2) pay back debt; 3) issue dividends; 4) buy back stock.

The relative merits of each option vary widely. Lately, share buybacks are in vogue. While this has undoubtedly (in my opinion) contributed to rising stock prices, I don’t think it’s necessarily a good thing for long-run oriented shareholders.

In a May 8 article, my favorite financial journalist Jim Jubak, makes a compelling argument that cheap debt is the fuel for the share buybacks:

How Cheap Debt Overinflates Stocks: Take the practice of using borrowed money to buy back shares. Bet you thought all those buybacks that companies are announcing were funded out of current cash flow. Think again. Even big players such as IBM Corp. are piling on debt to repurchase their own shares.

Since 2003, IBM has purchased 203 million of its own shares at a total cost of $30.7 billion. That's a huge percentage -- about 52% -- of the company's total operating cash flow of $59.5 billion during the period. It looms even larger if you add in the $17 billion IBM spent during this period on capital expenditures, the $8.8 billion it spent acquiring businesses and the $5.3 billion it spent paying dividends to investors. All that -- added to the spending on buying its own shares -- comes to 104% of operating revenue.

Or look at it another way. In 2006, IBM used the equivalent of 67% of its total net income to buy back shares. In 2005, the percentage was 82%. In the two years before that, 64% and 42%, respectively.

If you add in dividends, 2006 payouts to investors came to 85% of total net income at IBM. (Jubak’s Journal – MSN Money)

As a follow-up article, Jubak lays out sectors where there are fewer and fewer shares available due to share buy backs and buyouts:
3 Sectors Where Shares are Scarce: The supply crunch in the overall market is astounding. First, thanks to buyouts that take public companies private and acquisitions that merge one company with another, the number of publicly traded stocks is shrinking. Second, even when companies stay public, they're buying back their own shares, reducing the number of shares trading in the public markets. Add stock buybacks to buyouts and acquisitions and, Standard & Poor's estimates, a total of $1 trillion in stock will exit the public stock markets in 2007. (Jubak’s Journal – MSN Money)

The Dividend Dearth: Still Too Stingy: The waning importance of dividends in the States reflects the rise in the past two decades of institutional investors, who tend to see stocks as vehicles for capital gains, not income. Historically, however, dividends have been crucial to investors. Since 1928, stocks have returned 10.4% annually, with 40% of that generated by dividends. (WSJ)

Personal Finance:

Get More Miles for Your Money: Tips for reducing gas costs. (Yahoo! Finance)

Taxes:

Supreme Court to Address State Tax Breaks for Bonds: In a case with the potential to rattle, if not reshape, the market for state and municipal bonds, the Supreme Court agreed on Monday to decide whether states can continue to exempt interest on their own bonds from their residents' taxable income, while taxing the interest on bonds issued by other states.

The preferential tax treatment for in-state bonds is longstanding and very common, offered by nearly all the states that have an income tax. State and local governments issued more than $350 billion worth of bonds a year from 2002 to 2006.

Book Review Part I: The Great Wave by David Hackett Fisher

2007-05-21T19:45:00.000-07:00

All major price revolutions in modern history began in periods of prosperity. Each ended in shattering world-crises and were followed by periods of recovery and comparative equilibrium. (page 9)

In this fascinating book, Fisher documents four different periods of European history in which prices rose steadily for decades, followed by periods of relative “equilibrium”:

1) Later-Medieval: 1180-1350

2) 16^th Century Price Revolution: 1470-1650

3) Industrial Revolution: 1730-1815

4) 20^th Century Price Revolution: 1896-present

His primary thesis is that the fundamental cause of inflation is an increase in aggregate demand due to population growth. Once the secular inflation begins, prices rise in a long wave until a crisis of some sort leads to a reduction in population and thus in aggregate demand.

Note: quotes from the book are in maroon italics.

Each wave has similar characteristics:

1. Each wave begins after a period of relative “equilibrium”: After decades of flat prices, population growth begins to put pressure on aggregate supply, especially of food, fuel, land and shelter. Naturally, it is more expensive to bring new supply to market because the “low hanging fruit” has already been picked. As a result, returns on capital begin to increase. If eggs are worth more, it stands to reason that the hen would be more expensive too. Same thing for land, slaves, coal mines, oil wells, real estate, etc.

The rich benefit enormously while everybody else suffers a decline in real wealth. In the beginning of the wave, the secular nature of the price increases is imperceptible. In fact, the price rises might be mistaken for general price volatility. To be sure, in times of price equilibrium, prices fluctuated due to any number of factors – largely supply driven – but they returned to normal once the supply disruption ceased. Instead, this is a demand-driven rise in prices.

2. Money supply begins to increase soon after prices start to rise. Many forces drive money supplies higher. Velocity of money increases: more money changes hands and more things, such as credit instruments, are used as money. Second, governments try to create more money to mitigate the rise in prices. It makes sense that if there is more money chasing the same number of goods, the prices for those goods should fall. Another method of increasing the money supply is to debase the currency. Fischer describes the money debasement methods of the Medieval price wave:

Metal coins were also systematically debased. In

Italy

and

France

particularly, mint-masters reduced the content of silver in their coins, and increased the quantity of base metal.Individuals acted in other ways to diminish the value of money that passed through their hands. Coins were clipped, filed, scraped, and washed despite ferocious penalties (page 25)

This growth in money supply fuels and aggravates the already-existing inflation. With all the ways – public and private – that the money supply is increasing, the supply of it
invariably rises more and faster than what would have been required to keep prices down.

3. Material decreases in the standard of living for the poor: The economic situation for the poor and middling classes gets steadily worse as they lose purchasing power. By this point, there is widespread understanding that prices are rising. The social order begins to break down – there is more crime, domestic violence, and wars.

4. Eventually, as a result of years of social and economic crisis, populations begin to decline. Since population has declined, so too has aggregate demand. During this period of equilibrium, real wages for the poor and middle class increase and returns on capital fall. The gap in wealth between rich and poor shrinks.

5. After some period of relative equilibrium, which is not surprisingly marked by social and political stability, populations rise again and the cycle starts anew.

I’m sure that many economists would strongly disagree with some of Fischer’s conclusions. In particular, monetarists such as the late Milton Friedman have argued that “inflation is always and everywhere a monetary phenomenon.” Fischer might say “inflation is always and everywhere an aggregate demand phenomenon.”

Before reading this book, I used to subscribe to the monetarist logic because it has a certain intuitive appeal. Essentially, if the supply of money goes up faster than the supply of goods available to purchase them, prices will go higher. Fischer is trying to explain why money supply tends to go up in the first place.

In tracing the roots of the 20^th Century Price Revolution (which continues today), Fischer acknowledges the monetarist argument but concludes that the root of the price wave was an increase in aggregate demand, not growth of the money supply (see pages 184 – 186):

Some attributed the increase in price levels to an expansion in the supply of gold and silver. In 1886, the fabulous gold mines of Johannesburg had been discovered, entirely by accident. In 1890, gold was found on Cripple Creek in Colorado.... Canadian gold began to flow from the Klondike in 1896. The Alaskan gold rush began in 1898. But these events were part of a long continuum of gold discoveries that had happened through the nineteenth century without rising prices. The rate of growth in gold production throughout the world was roughly the same before and after 1896. Moreover, the pace of secular increase in silver production actually declined during the 1890’s.

Monetary factors would play a major role in the price-revolution of the twentieth century, but the great wave itself grew mainly from a different root. It was primarily (not exclusively) the result of excess demand, generated by accelerating growth of the world’s population, by rising standards of living, and by limits on the supply of resources, all within an increasingly integrated global economy.

The demand-driven inflation argument does so much to explain today’s inflation. The government pretends that there is practically no inflation through hedonically adjusting the CPI and through its reliance on the "core" number. In other words, there is lots of room for the government to mess with the numbers to arrive at an inflation number favorable to them.

To be continued in Part II

May 19 Linkfest

2007-05-20T19:27:00.000-07:00

Links to a few interesting articles I read this past week:

Economy

Too Much Cash Pouring Into Emerging Markets: Overseas investment will flood emerging markets with $469 billion this year, according to the Institute of International Finance in Washington. That will bring the total since 2005 to almost $1.5 trillion, twice as much as in the prior three years. While fueling growth, all that cash is bringing side effects that threaten to turn booms into busts. (Bloomberg)

Want to Measure Actual Inflation? See the Core/Headline CPI Spread: One way to actually measure how absurd the US core inflation measure is to look at what has happened to the spread between headline CPI and Core CPI. If Core CPI is understating inflation, than the spread should be widening. If it is accurate, the overall ratio between the two should be relatively steady. What does the data show? The spread has increased substantially since the US adopted an ultra low rate/easy money policy under Greenspan.

Whenever I hear the phrase "excluding volatile food and energy" I just laugh. Can a pricing group be considered volatile if it merely goes up each month in an orderly fashion -- for years and years? That's not volatility, thats a trend. (The Big Picture)

Insight: Dollar story no thriller, but it’s compelling: Jim O’Neil writes in the FT that the USD, despite its present weakness is not that awful compared to European currencies. Compared to BRIC currencies though, the LT trend is almost certainly down. (Financial Times)

Investing

The New Era of Tech Investing: Three great rules of technology investing:

Look for the Hockey Stick: This has nothing to do with sports. Instead, the “hockey stick” describes a highly desirable pattern in a company’s sales growth.
Look for the Killer App: the software program, piece of hardware, product improvement or whatever – that everyone has to have is the key to hockey-stick growth.
Look for a company with sustainable high margins

These days you won’t find many companies in the technology sector which fit into the above-mentioned rules. But in the energy sector, the three rules of technology are still a great fit. Take a look at Color Kinetics (CLRK), Transocean (RIG), Satoil (STO), Tenaris (TS) and Johnson Controls (JCI). (Jubak’s Journal – MSN Money)

Why Investing is Safer Overseas: With U.S. markets growing more risky and global markets looking safer every year, savvy investors need to recalibrate their views. Here’s how to assess the new world order.

I think you need to compare markets one by one to look for those where investors, who tend to stick with the conventional wisdom until something whacks them over the head, have mispriced risk. The countries that I find particularly interesting as investment targets are those that have made the biggest strides in getting their houses in order. Of course, you still need to find good companies in those markets, but when you do, I wouldn't let old prejudices against risk cause you to pass up higher returns because they used to be more risky. (Jubak’s Journal – MSN Money)

Health

Too much of a good thing? Vitamin link with cancer: Men who pop too many vitamins in the hope of improving their health may in fact be raising their risk of the deadliest form of prostate cancer. In men who took too many multivitamins, the risk of aggressive cancer increased by one third, and the risk of fatal prostate cancer doubled compared to those who took no multivitamins, according to the study, published in the Journal of the National Cancer Institute.

No studies have yet found that people benefit from taking multivitamin and mineral supplements, and some studies have found that vitamins like A and iron are toxic at high levels. Beta-carotene has been found to increase the risk of lung cancer in smokers. (Reuters)

SDI Plan

2007-05-14T17:10:00.000-07:00

I recently signed up for Supplemental Disability Insurance through my employer. I read through the exclusions section of the policy and found the following:

"we will not pay benefits for: 1) loss caused by war or any act of war, whether war is declared or not."

This is purposely vague wording. I asked the insurance rep and got the following answer:

William,

I went to the insurance carrier and they confirmed that 9/11 and the London Bus Bombings were NOT Acts of War. The most common provision states “your plan will not cover a disability due to war, declared or undeclared, or any act of war.” “War” is generally interpreted to involve hostilities between two or more governments or sovereign nations. So, the war exclusion would generally not apply to acts of violence by individuals or political groups who are not employed by or acting on behalf of a sovereign or currently ruling government.

The war exclusion could apply if a terrorist group is allied with or acting in concert with another nation, sovereign or government in attacking the United States, or should the United States be the aggressor and declare war or attack another nation, sovereign or government.

This doesn't completely answer the question but I am satisfied. It's not a pleasant thought but I guess that's the whole point of having insurance.

Asset Price Inflation is Not a Good Thing for Most People

2007-05-12T13:07:00.000-07:00

What's not to love about rising asset prices? The Fed has oft argued that to the extent they do not cause an increase consumer prices, lofty home values and stock markets do not lead to inflation. Thus, central banks only aim to stop consumer price inflation, not asset price inflation/appreciation. Given that central banks operate in democracies, this is a politically wise move. However, asset price inflation is not benign and is indeed inflationary. The Buttonwood column of this week's Economist, gives a few examples of why this is true.

The victims of rising asset prices:

Rising home prices are great for "middle-class people who started climbing the property ladder 20 years ago. But they make life difficult for young people wanting to buy their first home and for those trying to create affordable housing for low paid, but vital, workers, such as nurses."

For young people starting out in places such as DC, CA, NY/NJ, & Boston, this necessarily means that they have to load up on debt in order to afford an over-valued house. Presumably they will save even less because a large portion of their income goes to pay the mortgage.

High asset prices Now imply lower Future returns:

"The second problem is that, when asset prices are high and yields are low, future returns are likely to be subdued. It thus takes a lot more effort to generate a given lump sum for retirement."

Given today's rich valuations in nearly every single asset class I can think of, perhaps "past performance will not be indicative of future results." Indeed, the best performing asset class for the next ten years is most likely not even on the radar of the ordinary investor in the developed world.

Conclusion: high asset prices are exacerbating the looming retirement crisis

As defined benefit pension plans go the way of the dodo, the rich world will be split into four categories of retirees:

"Haves"

Already wealthy people
Government workers whose retirement is funded by taxpayers

"Have Nots"

Private sector workers who did not save enough
Poor people who rely on government for their subsistence

"The more numerous losers may demand higher taxes to penalize the lucky winners. What the market hath given, investors may find a future government taketh away."

In one way or another, this almost certain to be the outcome in the United States. The first step could be to take away Social Security and Medicare benefits from the "haves." The tax code could be modified to penalize people who have "too much" socked away in tax-advantaged accounts. Or perhaps people with passive incomes might have to start paying some form of payroll taxes.

So if this looming retirement crisis is worsened by asset price inflation, then why doesn't the Fed do something to stop it? Two reasons I can think of. First, there would be blood in the streets if the housing market declined markedly. Same thing if the Fed set out to crash stock & bond markets. The second reason is that, as a nation, we have way, way too much debt. Lower asset prices is deflationary -- there is nothing worse to a heavily indebted person (or government) than deflation. To the contrary, inflation is a gift for debtors because it shrinks the "real" value of the debt and interest payments.

Business or Hobby?

2007-05-09T19:58:00.000-07:00

An article in today’s WSJ reminds me of an ongoing discussion I am having with a friend who has a website business. Recent legislation is making the distinction between business & hobbies a little grayer. The IRS published a fact sheet in April that is supposed to clarify the rules:

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business…. Generally, an activity qualifies as a business expense if it is carried on with the reasonable expectation of earning a profit.

My friend’s website has reviews and commentary about dining and night life in New York City. For site content, he goes out and spends a lot of money on dining and night life. He wants to write-off all of these expenses on his Schedule C.

The site is actually very good – it contains detailed reviews for each restaurant and night club – and it is updated frequently. It has the prospect of making money because there are Google advertisements on the site.

Would the IRS consider this a business or a hobby?

Assuming everything is well documented, it would probably depend on whether this business has any prospect of ever turning a profit. The IRS will consider it a for-profit enterprise “if it makes a profit during at least three of the last five years, including the current year.”

I won’t venture a guess as to the likelihood this website will ever generate a profit, but the fact that he is trying really hard should be enough to allow the deductions on his Schedule C… at least for a few years. The main advice I gave my friend is that he’d better keep meticulous documentation of every single expense. Since he probably will get audited next year, the only way he stands a chance is if he can produce comprehensive books and records of his “business.”

Q1 2007 Portfolio Review

2007-05-03T17:13:00.000-07:00

At the end of Q1 2007, I performed a comprehensive review of my personal balance sheet. As part of this review, I “realized” that I have an inordinate amount of risk due to the misalignment of my assets and liabilities.

Through a combination of savings and a gift from my grandfather, I have set aside some money to be used for grad school tuition. I expect to need this money in Fall of ’08 or ’09. Up to now, I have had the entire amount invested in the stock market. This has leveraged up my networth and has been a source of excess returns for the past year or so.

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!

For Q1 ’07, my portfolio returned 1.07% compared to .64% for the S&P 500:

Q1 Portfolio Returns*

	My Return	S&P 500 Return
Jan - 07	-0.41%	1.51%
Feb - 07	-0.22%	-1.96%
Mar - 07	1.66%	1.12%
	1.01%	0.64%

* Includes retirement & non-retirement accounts. Also includes interest earned on cash balances.

Welcome to my new Blog!

2007-05-03T17:01:00.000-07:00

Welcome to my new blog! This is my third attempt at blogging. My first blog was a random mixture of my opinions, pictures, personal finance, investing, news & politics. My second blog was written anonymously and contained detailed personal financial information along with lurid details of my life. Blog #1 & Blog #2 are now history.

As I envision it, this will primarily be a personal finance blog. I will talk about details of my personal situation, but only in general terms. It is customary on many blogs of this type to display month-to-month variations in one's networth. Aside from the reality that it's interesting for readers, it's meaningless without more context (such as actually knowing the person).