Social Security losing ground to healthcare costs

I recently found an interesting article about the double whammy facing some retirees next year with no COLA adjustment to their monthly Social Security benefit and a potential 52 percent increase in Medicare premiums.  This will only affect those who are not protected by the “hold-harmless” rules, which currently is about 30% of beneficiaries.  Specifically, wealthy beneficiaries whose earnings are $85,000 for an individual or $170,000 for a married couple.

Why is this important to you?  Healthcare costs are rising and strains are already being put on the Social Security system.  This may only be the beginning of this erosion of benefits.  Retirement strategist, Sharon Carson, says “When you combine it all, it’s looking pretty ugly” and “Congress will probably go back to that well again.”  Her opinion is that the income thresholds could very well be lowered in the future which would cause many more retirees to bear the burden of increased insurance costs.  Whether it impacts you now or could in the future, this is an important variable to consider in retirement planning.

How do you protect your retirement future from these changing variables?  You start planning now with a financial planner you trust and will take a conservative approach to Social Security projections.  If you are ready to start down the path to planning your financial future, give us a call.


Living in the High Rent District

When a house sells in your neighborhood, many often look to see what the selling price was.  Depending upon the price per square foot, you might be relieved or a bit unnerved, especially if your house is also on the market.  In real estate the price per square foot is a standard measure of how expensive (or cheap) a house is relative to those that have recently sold.  The higher the price you pay per square foot, the more capital you have to come up with. Conversely, if the price per square foot drops in your neighborhood, it’s great news for the buyer but not for the seller.

In today’s equity markets, the P/E Ratio (a measure of the company’s price relative to their earnings) is at 22 times.   As a reference point, the historical P/E on stocks is 15.6.  Using the same analogy as you do on buying real estate, stocks are more expensive on per square foot basis than they historically have been.  If you have stock exposure in a 401k account or an investment account with your advisor, you’ve seen your assets appreciate over the past 6 years, and you’re now living in the high rent district. 

The challenge is this:  the more expensive the stocks become, the harder it is to project positive forward returns.  If you overpay for something and it declines (and it can decline rapidly), you spend much of your time making that money back rather than earning more on your money.

If someone knocked on your door and offered to pay you 40% more than your house was worth, you probably would consider taking it. Why not consider the same in your investment portfolio?  The equity market is full of buyers if you’d like to sell some of those appreciated assets.  Stock values can decline rapidly without warning and often without reason.   It may be a good time to put some of those assets on the market while prices are still high.


What will it cost the economy to raise rates?

As the Federal Reserve contemplates following through on their year-long promise to raise rates next month, let's analyze the potential effects on three key segments of the US economy - Consumers, Business and the Government.

Public discourse so far has focused primarily on the effect of higher rates on borrowing activity. A few years ago as rates fell to near zero, we compared this Fed growth technique to a broken transmission. The Fed was revving the economic engine but mortgage foreclosures, higher lending standards and high unemployment kept economic activity for Main Street Americans at a standstill. Corporate America garnered the majority of the benefit from the Fed's zero interest rate policy (ZIRP). Big companies have been on a borrowing binge to refinance their debt at lower rates (reducing their interest costs) and use additional cheap money to buy back their stock (which increases "per share" earnings and artificially boosts prices). 

Most corporate treasurers realized the rare opportunity that ZIRP provided them so they extended both the amount and the average maturity of their debt effectively locking a very low cost of capital for a decade or more. These same corporations won't necessarily be forced into borrowing more money if rates go higher. They could for example, simply reissue treasury stock and use the proceeds for growth. Higher rates won't have an immediate impact on their bottom line for a year or more unless they run a consumer driven business. 

Consumers that were hindered by the recession from realizing the benefits of ZIRP have recently seen the tide shift. As QE effectively replenished bank reserves, bankers have again relaxed lending standards and ramped up offers of cheap credit to consumers. This is quite apparent in new car sales. More than a quarter of all new car loan maturities are now longer than 6 years! Even 16% of USED CAR loans are longer than six years. The average car payment is now $485 per month and a 5 year obligation. ZIRP has effectively pulled demand from new car buyers for the next several years into the last 18 months.

It shouldn't be surprising that higher rates would eventually have an impact on automotive sales. Unfortunately this sector is showing signs of fatigue even before the Fed raises rates. With an average selling price of $44,000 Ford's retooled, aluminum bodied F-150 pick-up was expected to be a big money maker. Ford announced incentives of $10,000 in some regions to keep sales moving. Imagine what happens after the Fed starts raising the interest rates and your new car loan costs more. You will have to either extend the length of the loan for even longer, pay more down or pay a higher monthly payment. With that you will have to drive that car for almost a decade to get out of it at a reasonable cost. 

We saved the most interesting and least discussed segment for last. It will cost the United Sates Government the most if the Fed raises rates. Much has been written about our ballooning Federal debt:

We rarely read discussions regarding when this debt will mature and how higher rates might affect the cost when it rolls over. The average maturity of our 18 trillion dollar pile of debt is less than 72 months. Statistically this means that over the next 5 years we will have about 9 trillion dollars worth of debt repriced.

If the Fed raises rates it will force the US Government to pay more as these obligations are refinanced. Last September the Congressional Budget Office published a forecast on debt and interest payments by the Federal Government. They project that higher average interest rates on our debt will more than triple our interest payments from 231 billion last year to 799 billion by 2024. To make matters worse guess who gets the biggest piece of those debt payments? Foreign countries own 47% of our debt so if the CBO is accurate, we will be paying out 375 billion dollars to these foreign debt owners by 2024. You know what we would do if we had to send that many dollars overseas? Devalue it before that day comes. 

We would be foolish to ignore two years of warnings about rate increases from the Fed and not expect action. Yellen and company will likely act if just to salvage the Feds credibility (even if it doesn't make much economic sense). Now that you have a picture of the costs to the economy, you can adjust your portfolio accordingly. Increasing foreign equity and bond exposure sure makes a tremendous amount of sense especially while the dollar is still strong.

Commentary should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Content is derived from sources deemed to be reliable. Information presented does not involve the rendering of personalized investment advice and should not be construed as an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. Past performance may not be indicative of future results. All investment strategies have the potential for profit or loss. There are no assurances that a client’s portfolio will match or exceed any particular benchmark.
LeConte Wealth Management is registered as an adviser with the SEC and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability.

Why the NASDAQ's solo ascent this year is a problem

Through August 18th. The NASDAQ is up 7 1/4% while the other three major domestic indexes (DJI, S&P 500 and Russell 2000 small cap) are stuck in a range of -1.6% to +2%.

This comparison illustrates that after a 6 year long rally, the list of winners is beginning to shorten. The implications are important to understand especially since our domestic market hasn't seen a 10% correction since 2011. Bulls prefer stock market moves that are all inclusive. A rising tide should lift all boats. When that isn't happening it's an indication that investors are becoming more selective in what positions they hold, sell or add to. The margin for error shrinks and corporate mistakes (poor earnings, high valuations product or service issues) are punished more severely. 

When a broad rally begins to narrow the fundamental empirical business statistics become more important than price trends and momentum. We've seen this play out in real time as quarterly earnings were released. This renewed focus on fundamentals also leads corporate leaders to resort to any (legal) measures possible to reproduce good numbers. Despite their efforts reported earnings for the second quarter are down 1% and more telling (because it cant be fudged as easily) revenue dropped more than 3% (factset).

The narrowing breadth of winners comes at a time when overseas, the Chinese market can't find it's footing. Domestically the Fed has promised to raise rates at their September meeting at the same time that politicians will be reconvening to once again take up the debate over raising the debt ceiling (US Treasury Secretary Jack Lew sent a letter to congress last month begging for help on the matter).

The next few months will be filled with enough drama to agitate bulls and bears which will be a good environment to have some cash on hand for bargain hunting.

What is your plan for a correction, over-correction or crash?

Earnings are suspect, wages, consumer spending and new home sales are problematic, the Fed is talking about raising interest rates and the US market hasn’t seen a 10% correction since 2011 (Yardeni).

With both the Dow and S&P negative for 2015 it’s an appropriate time to ask some questions. Let’s start by taking a look at the Chinese stock market which is being driven primarily by individual investors who have recently discovered how to invest on margin (borrowed money). 

The rapid rise and fall of the Chinese stock market this year is useful example of the powerful effect of human emotions on investing success. As the market peaked in May investors not only piled in but doubled down by borrowing money on margin. This was after a 150% move up when rational investors should have been contemplating taking profits. In less than a month the market dropped 35% as fear took over. 

Back home second quarter earnings are coming in and the results are not what one would expect in the middle of an economic expansion. 187 of the 500 companies in the S&P 500 have reported and earnings are 2.2% less than a year ago (factset). This is before Exxon Mobil and Chevron report at the end of July. 

A correction at this point shouldn’t surprise anyone. Since the market as gone 4 years without one, the chances of the market correcting more than 10% are elevated. Some investors will be facing the first correction of their investing career. What will they do? Will they let fear take over? Will they engage or disengage? Will the robo-advisors survive? What will you do when it arrives?

The single most important question that you need to answer is this: Will you have the cash to buy in when prices drop? A correction (or worse) is an entry point not an exit point. This is counter intuitive to most investors because it goes against their emotions. If prices drop you have to have some buying power to take advantage of it. 

The second question to answer is this- Where can I raise cash now so I’ll have some buying power then? If you are contributing regularly to a company sponsored plan (401k, etc…) your next paycheck will give you buying power. If you are fully invested now consider building up some cash by rebalancing some of the riskier asset classes in your portfolio back to where they were two years ago. 

Once you have a cash stash, consider where you might deploy it when a correction arrives. What asset classes are underweight in your portfolio? Many investors could use more exposure to foreign stocks and bonds. 

This isn’t market timing. It’s prudent, proactive asset management designed to take control of the greed and fear that makes other investors reactive. 



Staying Clear of the Blast Radius

“The more you sweat in times of peace, the less you bleed in war.” General Chiang Kai Shek of China

China is having a tough time right now. The Shanghai Composite has dropped 35% in less than a month. When 80% of a market’s participants are retail investors speculating with borrowed money, this sort of volatility shouldn't be surprising.

The decline has erased more than 3 trillion dollars of gains. Compared that to the Greeks attempting to renegotiate payments on a paltry 60 billion Euros of debt that mature in the next 5 years. After this decline, the Shanghai market is still up for the year (as the S&P 500 turns negative for the year).

As second quarter earnings season gets underway this week, we learn if US companies took appropriate measures to minimize the effects of these global problems. By comparing the European and Chinese economies to the US, it’s unlikely that they are outside the blast radius of these events.

The time to enact safety measures to protect against this sort of volatility was a last fall when the European Central Bank, concurrent with the end of Quantitative Easing in the US, initiated their own stimulus program.

The Peoples Bank of China (PBOC) is sweating out their market decline by announcing several rushed solutions that are destined to exacerbate problems. Short term selling restrictions offer temporary relief but real price discover will occur when (and if) they lift them. Time will tell.

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