On the Economy and Investment Dos and Doníts
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
2. Unemployment Rate – Good News & Bad
3. Not-So-SmartMoney Advice
4. Results of the Financial Literacy Test
Today we will delve into several topics, including a look at the latest economic reports, which continue to be encouraging on balance. We will also focus on the most recent unemployment numbers that are confusing to many people.
Following that, I will tackle some recent advice on what to do, or not do, with your hard-earned money. Some so-called “experts” are advising people to make some financial moves today that should normally be avoided. I’ll give you my take on these issues.
There’s a lot to cover, so let’s get started.
The Economic Recovery Continues Slowly
Most (but not all) of the economic reports of late have been positive. As noted previously, the Commerce Department reported that 4Q GDP rose 3.2% (annual rate) as compared to 2.6% in the 3Q. While 3.2% was a definite improvement from the 3Q, the pre-report consensus called for a rise of 3.7%, so the report was initially considered a disappointment.
Even though 4Q growth was not as robust as expected, a number of economists continue to increase their forecasts for 2011. The Blue Chip Economic Indicators (BCEI) survey of 50 leading economists earlier this month saw a slight increase in growth forecasts for all of 2011. The consensus calls for GDP growth of 3.2% this year, up from the 3.1% estimate in January.
The same survey found that the consensus expects inflation to rise only 1.9% in 2011 and 2.0% in 2012, as compared to 1.6% in 2010. I continue to feel that these estimates may prove to be somewhat low, but that remains to be seen.
Several specific economic reports of late were quite surprising. As one example, the Conference Board reported in the last week of January that its Consumer Confidence Index jumped from 53.3 in December to 60.6% in January. That was well above the pre-report consensus of only 53.5. By comparison, the University of Michigan Consumer Sentiment Index rose only modestly in January from 72.7 to 74.2.
It remains to be seen if the Consumer Confidence Index number will be revised downward later this month when the report for February is announced, but it wouldn’t surprise me. In any case, it does appear that Americans are becoming somewhat more confident in the economic recovery.
Another surprise came with last week’s report on consumer credit from the Federal Reserve. The Fed reported that U.S. consumer borrowing rose in December (latest data available) for a third consecutive month, led by the first increase in credit-card charges in more than two years as holiday sales improved. Credit rose by $6.1 billion in December to $2.41 trillion after increasing a revised $2.02 billion in November.
The pre-report consensus called for a rise in consumer credit of only $2.4 billion in December, so the $6.1 billion number was quite surprising. However, consumer credit still remains below the peak of $2.58 trillion in July 2008. For all of 2010, consumer credit contracted by 1.6% as compared to 2009 when credit fell a record 4.4%.
A thawing of credit makes it more likely that consumer spending, which accounts for apprx. 70% of the economy, will keep increasing after climbing at the fastest pace in four years in the 4Q of last year. We can argue, of course, as to whether consumers taking on more debt is a good thing or not, but increased spending is helping the economy in the short-term.
Elsewhere, the government reported that worker productivity rose a better than expected 2.6% in the 4Q, up from 2.4% in the 3Q. The ISM manufacturing index rose to a better than expected 60.8 in January, the highest level since May 2004. New home sales came in well above expectations in December at 329,000 units versus 280,000 in November.
Of course, not all the latest reports were positive. Orders for durable goods fell 2.5% in December versus the consensus forecast for a rise of 1.5%. Construction spending also fell 2.5% in December, which was worse than expected.
Overall, the economic recovery is gaining momentum, but growth should remain in the 3.0-3.5% range for the rest of this year.
The Unemployment Rate – Good News & Bad
The government announced on February 4 that the official unemployment rate fell from 9.4% in December to 9.0% in January, while the pre-report consensus number was for a slight rise to 9.5%. The official unemployment rate has fallen from 9.8% just two months ago.
Last Thursday, the Labor Department announced that weekly “initial claims” for state unemployment benefits fell to 383,000 for the week ended February 5. It was the second monthly drop in a row and was the first time initial claims fell below 400,000 since July 2008.
That’s the good news.
The bad news is that much of the improvement in the unemployment rate came as a result of an increase in the number of Americans who gave up looking for work in the previous four weeks and are therefore no longer counted as unemployed. DOL reports that there were 2.8 million people in this “marginally attached” category in January who were not counted as being unemployed.
Using this logic, if everyone stopped looking for work, the unemployment rate would fall to zero. This is one reason why the official unemployment rate is not very reliable on a month-to-month basis. Overall, there are still 13.9 million Americans who are out of work.
Furthermore, the latest unemployment report noted that only 36,000 new jobs were created In January versus the consensus forecast for 150,000 new jobs. Keep in mind that 150,000 jobs per month are not even enough to absorb new people trying to enter the workforce for the first time, much less create jobs for the unemployed.
Next, the Labor Department report also announced that it had over-counted by 452,000 the number of jobs it previously thought had been created in 2010. President Obama loves to say in speeches that 1.3 million jobs were created last year. He can't anymore because the new figure is just 909,000 jobs in 2010, and many of those were temporary Census 2010 positions.
I have included a link to a good article that explains more fully the flaws in the Labor Department’s model that they use to calculate the official unemployment rate in SPECIAL ARTICLES below.
Finally, the consensus among the 50 economists surveyed by BCEI is that the US unemployment rate will average 9.3% for all of 2011. In fact, the lowest estimate among the 50 is for the rate to average 9.0% this year, while others see it rising back to 9.5% in the months ahead.
A recent article appeared on the SmartMoney website that I think merits comment. Long-time readers may recall that I have criticized publications like SmartMoney (among others) that offer lists of “hot” mutual funds every year. The problem with these articles is that hot performing funds are very unlikely to repeat their performance the next year, yet many investors rush like lemmings into these funds based only on the merits of the magazine article.
The most recent article was entitled, “4 Traditional Money Rules to Break Now.” The first thing that struck me about this article is that there are very few hard-and-fast “rules” in the financial/investment business. However, financial publications often like to create such rules since it makes it easier to develop listing articles such as “5 reasons to buy this or that security now,” and so on.
Another problem is that there is no way to know whether or not to follow any generalized rule or suggestion without knowing the underlying financial situation of the individual or household involved. Considering some of the Internet responses to this article, I’m not alone in my criticism. What follows is a brief summary of the four rules mentioned in the article as well as my own observations and comments:
Traditional Rule #1 – Avoid taking 401(k) loans at all costs.
The SmartMoney article argues that the general rule of not using 401(k) loans is no longer as valid because interest rates are much lower now than in the past. Thus, 401(k) money can be accessed at a much lower interest rate than is available from other sources.
While the article’s observation is true, the conclusion is faulty. Many 401(k) plans now offer loans in the 4% to 5% range, making them attractive alternatives to credit cards and banks. However, you have to remember that in a 401(k) loan, you pay the interest toyourself as part of your retirement plan earnings. Thus, if you borrow at a bargain rate of interest, your account may be earning far less than what remaining invested would produce. In other words, bargain interest rates result in lower borrowing costs at the expense of your 401(k) account.
The article’s author also forgets that times are tough and employees are still being laid off and losing jobs every day, despite hints of a recovery. Should you lose your job with an outstanding 401(k) loan, it will most likely be deemed a taxable distribution complete with a 10% penalty tax if you are under age 59 ½, unless you can immediately pay the loan off in full. Somehow, the prospect of losing your job and having to pay off a 401(k) loan with savings is not a good situation to find yourself in.
Another factor that I think should be considered is that 401(k) balances shouldn’t be seen as sources of money for discretionary spending. I have written before on how consumers used tech stock gains and then home equity as personal piggy banks for spending. The last thing we need right now is for consumers to start seeing their 401(k) plan balances as attractive sources of money for consumption.
While I have always felt that 401(k) loans can be a resource where circumstances merit, the decision must be based on the financial situation of the plan participant and not the fact that 401(k) loans are available at low interest. Considering the negatives, now may be a much worse time to take a 401(k) loan than ever before.
Traditional Rule #2 – Convert traditional IRA account balances to Roth IRAs
SmartMoney contends that it’s not always beneficial to convert a traditional IRA, where withdrawals are taxed upon receipt, to a Roth IRA where contributions are taxed but earnings grow tax free. They reason that the amount of time required to recoup taxes paid on the conversion may be too long, especially for those close to retirement.
Actually, I have to agree with SmartMoney on this one for some investors. However, I have to disagree with the idea that, before now, it was always a good idea to convert traditional IRAs to Roth IRAs. Once again, the individual situation of the IRA account holder drives the decision, not some general rule.
The age of the person converting the IRA has always been a factor in whether or not to convert, but there’s also the matter of paying the tax upon conversion. In many situations, traditional IRA account holders would have to pay taxes by pulling money out of the IRA, which often negates the advantages of converting. This is especially true for those who are near retirement. For our clients, we often discourage withdrawing money from their IRA to convert to a Roth.
On the flip side, however, a tax-free benefit from a Roth IRA may now be more attractive than ever, even for older traditional IRA account holders. That’s because future tax rates are likely going to be higher than they are now. There used to be an assumption that retirees would always be in a lower tax bracket upon retirement, but I don’t think that’s necessarily true anymore. With soaring budget deficits and mounting national debt, some fear that the only way tax rates can move is up, and I would sadly agree.
While I believe that anyone with a traditional IRA should explore conversion to a Roth IRA, it should be done with the assistance of a financial professional who can help you consider all of the facts and circumstances to see if it’s a wise financial move.
Traditional Rule #3 – Choose the mortgage with the smallest interest payments.
SmartMoney’s recommendation is based on the assumption that it generally takes a 20% down payment and a shorter repayment period in order to get the lowest mortgage interest rates, which is correct. Instead of minimizing interest, SmartMoney recommends putting only 10% down and selecting a 30-year mortgage rather than a 15-year payback period. The other 10% of the home’s cost that would have otherwise been used as down payment could then be set aside as an emergency fund, where the article said it might be safer than invested in the home which could lose value.
Of course, putting only 10% down on the home would likely require borrowers to purchase private mortgage insurance, which would add to the monthly cost until they reach the equity threshold where such insurance is no longer necessary. However, the SmartMoney article deems this to be an acceptable tradeoff.
Once again, the selection of a mortgage is dependent upon the situation of the person seeking financing. Considering that home prices have taken a beating since the peak of the housing bubble, SmartMoney’s concern about losing more money on a home purchase may be off base. In fact, if the emergency fund is invested in the stock market (not recommended!), it could have greater potential for loss there than had it been invested in the home.
Another issue I have with this idea is that emergency funds are often spent rather than saved for a rainy day. Those who do have the discipline to maintain an emergency fund often already have one over and above money saved up for a home down payment.
A final thought is that current home prices, depending upon the region of the country, are likely far lower than they were back before the credit crisis. In some cases, what would have been a 10% down payment at the peak of housing prices could now go a long way toward a 20% down payment today, again depending upon where you live.
Traditional Rule #4 – Refrain from using credit cards.
SmartMoney’s premise in regard to credit cards is that it can be important for your credit score to maintain credit lines. That’s because credit cards that aren’t used are often closed or have their credit lines reduced, resulting in a higher ratio of outstanding balances to total credit available. In some cases, this can actually affect credit scores. Thus, SmartMoney recommends that those with significant credit card balances use credit cards periodically, but pay off the balance in full when due.
This idea seemed to get the most flak from those responding to the article, and I have quite a problem with it myself. In my opinion, a better way to maintain your credit score is to pay down balances rather than build up credit lines. While individuals may fully intend to pay off balances in full, we all know that this sometimes doesn’t happen. You could actually end up with worse credit scores than before by accumulating even more debt.
While SmartMoney’s advice may be accurate for anyone who cannot pay down their debt, it is a pathway fraught with peril. It requires considerable financial discipline to charge on a credit card and faithfully pay off the balances every month. If those whose credit scores are affected by low unused lines of credit had such discipline, it’s probably that they wouldn’t be in the situation where their credit scores are at risk.
The bottom line is that publications like SmartMoney like to promote hard and fast rules to live by, but these decisions are seldom as cut-and-dried as its editors want us to think. All financial decisions are the result of comparing an array of alternatives that tend to differ with each person. That’s why it’s important to contact a financial professional and get their advice rather than basing your decision on a magazine article.
If you’d like to read the SmartMoney article for yourself, click on the following link:
As always, if you have questions, feel free to call one of our experienced, non-commissioned Investment Consultants at 800-348-3601 or via e-mail to firstname.lastname@example.org.
Results of Last Week’s Financial Literacy Test
Last week’s E-Letter on financial literacy was a huge hit, just as it was back in June when I last wrote about it. Thousands of you have taken the test, and the results are pretty exciting. My readers had an average score of 92.4%! That’s awesome!!
I would like to encourage everyone to forward last week’s E-Letter and the Financial Literacy test to as many people as possible. I am appalled at the lack of financial literacy in this country, and I’m sure you are too.
On a related note, I would also encourage you to forward my weekly E-Letters to anyone that you think might enjoy and/or benefit from the topics I cover. Emphasize that they are FREE of charge and they can subscribe at www.halbertwealth.com.
Congratulations to those who took the Financial Literacy test!
Very best regards,
Gary D. Halbert
Good and bad news in latest unemployment report
Workforce still under siege from slow economic recovery
Economic Recovery Likely to Remain Slow
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.