KFS Keeling Financial Strategies, Inc.

December 11, 2014

Fortress America


 

"But money cost more when you were a kid"

                    -Jade, my nine year old daughter.


 
 

Before I get into the meat of this article, I want to discuss the quote above. My kids say adorable things all the time of course - at least I find them adorable - but it's seldom the topic blends so wonderfully into the financial world that I write about in this newsletter. The incident that led to this quote revolved around my daughter losing a tooth and our discussion of how much (or little) money their dear old Dad used to get under this pillow from the tooth fairy. When I told my daughter, who is used to getting a couple of bucks, that I used to get 25 cents it sparked this quote. Of course I remember losing a tooth at my Grandparents' house and getting a Kennedy half-dollar - I guess they had a better tooth fairy in their neighborhood. So you probably assume by this opening that I'm going to be talking about inflation in this article, but I'm not. What I am going to talk about is relativity, of which the change in prices over time is just one example. The example I want to discuss however is the relative economy of the United States vs. the rest of the developed and in some cases less developed world. So no inflation talk and for those who were worried no Albert Einstein talk either.


 

The U.S. economy is recovering substantially more quickly and at greater volume than the economies of every other developed nation. The European Union's growth the last two and a half years is practically non-existent. In 2012 the economic growth was actually negative at -0.4%, in 2013 it barely eked out a positive rate of 0.1% and through the first two quarters of 2014 grew at the astonishingly low rate of 0.25%. Compare that to the U.S. which grew at 1.6%, 3.1% and 2.5% over the same time periods. Japan fared even worse "growing" at -0.1%, 0.6% and 0.15% once again over those same periods. Unemployment shows a similar story - while the rate in Japan is still very low and will probably always be lower than the U.S. due to cultural factors that in many ways trump economics and probably hold back the country's growth - unemployment in the EU is at 10.1% vs. 5.8% in the U.S. You can argue that the 5.8% U.S. figure is misleading as it doesn't count part-time workers who want to be full time or people who have seen partial furloughs where they are working four days a week at the job that used to employ them for five - but the calculations are consistent as they are figured out the same way overseas. Even the debt situation is getting better relatively speaking. In the fiscal year 2014, which ended June 30th the U.S. ran the lowest budget deficit in more than six years at only 2.8% of GDP. Contrast that to the EU and Japan that ran deficits of 3.7% and 7.09% respectively.


 

But you'll say (don't you love being spoken for) what about Germany and the other Northern European countries that are doing better than the U.S.? Well I'm glad you asked, because other than Germany itself those Northern European countries that are doing so well don't exist. Sure it's better to live in France with its 10.4% unemployment rate or the Netherlands with their 7.3% unemployment rate than it is to live in Spain or Greece suffering through rates in excess of 25%, but the unemployment, growth and deficit rates in in Northern Europe are still negative compared to the United States. Denmark has officially entered a recession and France may not be far behind. At the end of the day the countries using the Euro currency have decided to sink or swim together economically and that includes poor Germany. Germany can't isolate itself from the economic troubles of its neighbors any more than Massachusetts can separate itself from the economic troubles of Rhode Island.   There is a degree of isolation but the rate of inflation, the value of money, the performance of equity markets and all the other national or in the EU's case transnational systems that are interconnected can't isolate them completely. Unfortunately for Germany the variation in economic conditions between the various EU countries is far greater than even the best performing vs. worst performing U.S. state. At worst there are a couple U.S. states with unemployment rates in the 7% range at best there are a few states around 4%. Compare that with Germany's 5.1% unemployment rate and the 25.9% rate in Greece and it's a whole different story.


 

So this is great news right? The U.S. is back, we're stronger than all the other developed countries, thanks to oil prices many of the underdeveloped countries that give us fits are going into recession, and even China is having internal economic problems that are probably worse than what they are reporting - because they can pretty much make up whatever they want to tell us. This rise in the dollar is putting real money into everybody's pocket; we can pay less for gas but also pay less for imported goods as the value of the dollar rises against the Yen, the Euro and many of the emerging markets currencies like Indonesia, Malaysia and Argentina. Over 300,000 new people went to work in November alone so there's nothing to worry about? First let me say that these are all very good things and I hope they continue. Since the world economy uses dollars as its base currency the United States can isolate itself from the economic problems in the rest of the world better than almost every other country. But we can't isolate ourselves completely - especially when it comes to equity markets. It's just possible that our economy could grow in 2015, unemployment could continue to drop, our budget might even come close to balancing and we still run into a dip in the stock markets because of the race to the bottom going on in the rest of the world.


 

As has been pointed out already the rest of the world isn't recovering from the financial crisis as well as the United States has been. As mentioned last month, the recent reaction to the slowing and in some cases declining growth in both Europe and especially Japan has been to duplicate the quantitative easing (basically money printing) that the U.S. Fed was doing up until this October. The difference is that these countries don't command the reserve currency of the world and the extent of the easing going on, especially in Japan, dwarfs anything the Fed did. These two enormous and important entities are in some respects doing this for different reasons. Europe wants to increase the money supply in hopes of avoiding a recession and picking up employment, secondarily the lowering of the Euro vs. the dollar also makes the debts of the European nations go down when priced in dollars which helps them manage that debt more easily. In Japan its basically the opposite, they have a national debt close to 250% of their GDP, a debt that not only can't be paid off no matter how much they raise taxes but also a debt that is so large, just paying the interest should rates rise back to their long term averages, will eat up the entire national budget. So they are almost exclusively doing this to lower the price of their debt in dollars, they can then use the dollars that come in from their large export base and U.S. bond holdings to lower the debt load. This action could also lead to higher economic growth as their exports become less expensive and possibly then more desirable in the U.S. but that's a secondary consideration.


 

But if Europe lowers the value of its currency, and Japan also lowers the value of its currency and other nations who compete with Europe and Japan in the export markets have to lower the value of their currencies to remain competitive in the world markets - what happens? How does it help Japan's export led growth experiment if most of the other countries in the world cut their currencies so Japanese goods are still no more attractive than they were before? What happens if Europe's stimulus lowers the value of the Euro but because their trading partners do the same thing there is no advantage to buying European made products? Finally what happens to the economies of the world that are mainly commodity based when the prices of those commodities are drastically lower for a long period of time? As I mentioned last month this might seem like good news since we all think of Russia and Iran as countries that rely on oil and gas exports for revenue - and they do - but there are other countries that have very heavy commodity exporting economies that can have a more negative impact such as Canada, Norway, Chile, Australia, Nigeria and Mexico. Take Canada for instance, over 9% of their GDP is in commodity exports. Sure oil and gas and gold have always moved around in price, but a 30%+ downward price in just a few months can be devastating if the prices don't quickly bounce back up. 30% of 9% is about a 3% decrease in overall GDP - in a country that had economic growth of less than 1% going into 2014. A 3% drop means negative growth and two consecutive quarters of negative growth means a recession. Can the U.S. stock markets continue to surge if Canada, Russia and half the European Union officially go into recession in 2015?


 

I don't want to make it sound like I'm rooting for the markets to correct, or that I'm rooting against a continued U.S. recovery - I am really not. It very well could be that the U.S. economy and the U.S. based stock markets continue to rise even as the rest of the world deals with ever more troubling problems. I'm just concerned that the run up in U.S. equity markets over the last three years was in anticipation of the current good economic news - not a reaction to it. Meaning the markets could start to level off or drop based on an anticipation of slowing caused by the rest of the world impacting our economy even before it begins to happen. I still believe it is healthy to have a real correction every once in a while, and while there was a drop in late September / early October, it never reached the level of a full correction. It's quite possible that several economic entities outside of our shores enter a recession in 2015 (or maybe already have.) If we're lucky they'll enter those recessions in sequence, if we're unlucky they'll enter them all at the same time. I don't really know how that will impact our economy or our markets (both stock and bond) but I know we'll be watching and helping you make the best decisions for your financial future based on whatever the impacts may be.


 

All of us at Keeling Financial want to wish you all a very Happy Holidays. Look for our next newsletter in January 2015!

 


 

 


 

401K rules

 

Recently the PBGC (Pension Benefit Guarantee Corporation) which insures private retirement pensions in the United States announced that it would insure the value of any 401K assets that are transferred into a pension plan. Before I address that let me tell you what this actually means. The PBGC is one of those quasi-governmental / self-regulating agencies that is not funded by Federal dollars but everyone assumes the government will bail out if there's a crisis. The PBGC makes sure that if a companies' pension plan goes belly up (or the company itself does or both) that the retirees from that company will still get some pension benefits. Historically when the PBGC has had to bail out a pension fund the pensioners have received far less than they were supposed to. First of all the PBGC has a monthly cap of $4,500 so if you work at a company making $120K a year and you're supposed to get an 75% pension payout of $7,500 per month the most the PBGC will pay you is 60% of that. In the real world many people have gotten pension benefits far less than that $4,500 a month supposed cap. The pilots of U.S. Airways are still fighting with the PBGC over this issue, with many pilots who were supposed to get pension benefits in the $90,000 per year range instead receiving less than $2,500 per month. Traditionally if you added 401K money from another employer into your pension benefit to qualify for a higher pension payout or to buy back years lost to maternity leave or sick time, that portion of your pension benefit would not be covered by the PBGC insurance, now it will.

 

The reality is that the PBGC is not doing this to help those who have pensions they insure - they are doing it to help keep America's pensions viable. The 401K money you put into a pension plan gives that pension plan immediate assets while only adding to very long term liabilities. The way pensions are calculated to figure out if they have adequate funding is to look at the current values and extrapolate them out vis-à-vis the future liabilities using expected retirement dates, life expectancies and earnings growth. Because of this, that $100,000 you add to the pension today might be worth far more under these calculations than it will pay you as a pension benefit - meaning that same $100,000 helps the current value of the pension meet a higher percentage of its long-term liabilities making it less likely to fall apart and have the PBGC need to step in. Essentially your assets are helping to support the whole pension not just give you a slightly higher payout.

 

So should you put 401K money into your pension? As always this is a case by case decision. If you can add a small amount of your qualified money to a pension plan and buy back service time or some such thing resulting in a payout that is more than the assets you deposited were likely to generate then of course you should do that. But don't let this new rule change be anything more than a minor factor in that decision. The deposit of 401K money into a pension plan may very well do far more to help the pension and the PBGC than it will do to help you.

 

 

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Matthew H. Keeling, CFP®
Keeling Financial Strategies

759 Falmouth Road, Unit 2
Mashpee, MA  02649
508-539-0900

 

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