Thursday, November 6, 2014

What We Think The Elections Are Telling Us

Well, the elections are over and we can now watch attorney ads instead of nasty political ads. In general, the election went as we predicted. The Republicans have taken the largest house majority since WWII and now have the Senate. The question is what does this mean? 

There are two options: the GOP assumes a leadership role and tries to pass legislation (that the president will sign); or continues obstructionist roles. If the obstructionist strategy continues, we will have more brinksmanship and battles. On the other hand, if we get cooperation, a variety of things could happen. A possible outcome is that Paul Ryan will push for tax reform.

The low hanging fruit is corporate reform and repatriation, which would bring billions back into the US for capital expenditures and buybacks. Right now, it is beneficial for corporations to leave their profits abroad rather than bring them home, due to our corporate tax law. Burger King just changed its headquarters to Canada. As my friend Greg Valliere says, "When I say the words 'tax haven' and 'Canada' in the same breath, our tax system is broken." 

The tax extenders, like the qualified charitable distributions from IRAs are likely to pass before year-end. It is unlikely anyone will touch Medicare or Social Security before 2017. Obamacare will still be here, but they may remove the medical device tax and the employer mandate (that depends on Obama's pen). It is unlikely we will see individual tax reform. It sounds good, but everyone will start cobbling on their favorite things: "What about charitable contributions? Mortgage interest? Small businesses?"

Spending is unlikely to increase by any significant measure. Defense spending needs to be maintained, so something will likely happen there. We think Keystone will re-appear, and possibly pass. I am sure out of 535 people, someone in that group will have something to say about Obamacare.

In Michigan, Rick Snyder won re-election and Gary Peters was elected to the Senate. That outcome is interesting because of the party shift. Obviously, a portion of the electorate crossed party lines and voted for the candidates, not necessarily the party. Our prediction is Governor Snyder will continue his current policies of fiscal responsibility, and hopefully address roads, education and jobs. Senator Peters was formerly on the House Financial Services Committee. Both were supporters of the Detroit Grand Bargain. We think the outcome is a 'stay the course' vote in Michigan.

History shows us the very best market situation is a unified congress and lame duck opposition president. In fact, the Republican Senate/House and Democratic president has historically been best for the markets (maybe we remember that one of the only surpluses ever was in the Clinton-Gingrich days). So we are slightly more optimistic. Of course, Congress could just stay obstructionist, which we think enhances Hillary Clinton's position for 2016. One last word: if you have an old car, you might be able to keep your bumper stickers for 2016; you could have Jeb Bush run against Hillary Clinton.


Monday, October 20, 2014

Why we are rebalancing now

Unless you’ve been on a beach without cell phone service (in which case, I envy you), the market is exhibiting a vast amount of volatility and uncertainty.  In today’s world, we can find explanations for everything.  Amongst those is how the drop in oil prices and strong dollar are hurting the market, or that Europe is slowing (I hate to tell Europe, but they have been slow).  We see the glass half-full, and not half-empty.  Here’s why:

 Oil.  Oil prices have “tanked” (down over 20%), which is bad for oil companies and good for everyone else (OK, it’s bad for ISIS, Iran, Iraq and most of the Middle East, but I’m not overly concerned with their financial well-being).  Low crude is a stimulant for the consumer and for profits.  My family spends about $10,000 a year on gas; so a 20% drop in oil prices is like $2,000 in my pocket, tax-free.  Low oil prices are good for consumers and corporate profits.

·         Europe.  Most of the volatility centers around the inaction of Mario Draghi and the European Central Bank (ECB).  The ECB has been too tame in monetary policy, despite many verbal pledges to do whatever it takes.  This may be sending Germany into a recession, and Germany is the strongest EU member.  Greece suffered under the assumption that they may default on their debt.  Not a big surprise since Greece was the first sovereign nation to ever default on their debt in 377 BC and has five debt defaults modern times.  Spain has defaulted 13 times.

·         Talk is cheap. The ECB has been talking but not doing.  This leaves two options:  they can keep doing nothing (which lets the economic march continue), or they can do something (like Quantitative Easing).  A QE type move would probably be good for stocks in Europe.  I’d predict the pressure is on the ECB (and the Chinese Central Bank) to do something, and rather quick.

·         Our economy.  The budget is being cut, unemployment is down, and sentiment is up.  Profits are not terrible, and consumer spending is up along with industrial production.

·         Strong dollar.  The dollar is strong against other currencies.  Why?  Because we are improving our account deficit, booming energy production (hence low crude prices), and reduced unemployment.  Because we are growing, we look good, and it shows.  It also makes imports cheaper, and hurts foreign companies who sell in dollars, but build in other currencies (like Airbus or Swatch).  

·         So why the volatility? I think a bunch of this is the market looking for an excuse.  A few days ago, I joked that the S&P 500 was about to break its 200 day moving average and that it would tank when the program trades kicked in.  It did.

·         Ebola.  Scary stuff.  It’s a horrible disease.  Right now one person has died and two have it in the United States.  So that’s 3 out of 330 million.  In 2010, 53,826 people died of influenza and pneumonia, 576,691 died of cancer and 1 in 700,000 people were struck by lightning.  I offer this as perspective.

·         Factoid on elections.  Interesting fact on mid-terms:  since 1950, there have been 6 calendar years when a Democrat was in the White House and the Republicans controlled the House and the Senate.  The average gain on the S&P 500 during those 6 years was 21.3%. 

What’s our prognosis?  Low oil is good.  Strong dollar is good.  Fundamentals for the US look good.  We believe in capitalism and free enterprise.  If you think owning businesses (stocks) is way to increase wealth, you are right.  So volatility like this requires us to look at the big picture and see if equities are actually vastly worse than they were a month ago, or whether they are merely on sale.  It’s like a big rain storm.  Eventually the sun comes back out.  We choosing to rebalance and take advantage of the opportunity.

If you’d like my commentary on the economy, markets and the elections, I’ll be giving a talk on October 28th at Walsh College at 1:00 and 6:00.  I’ll cover oil, the dollar, gold, stocks, taxes, and whatever else crosses my mind, and will predict that political advertising will decrease abruptly by November 4th (this one I’m sticking by).  If you’d like to join us, RSVP at or 248-641-7400.  Space is limited.


Friday, October 10, 2014

What Goes Up

What goes up…must come down…and up…and down

October of 2014 has been an interesting month so far, just in the first seven trading days.  In seven days, the Dow Jones 30 industrials have moved (up and down) over 1,300 points.  That is significant volatility, especially since the movement tends to oscillate, in an ugly fashion reminiscent of early 2009.  I can’t help but wonder why.  Market movements are of course related to human behavior:  Mr. Market (as Warren Buffet calls the market), can’t make up his mind if he’s bullish or bearish.  Lately, it’s almost an even bounce:  down 270, up 270.  What’s the cause, and what do we do?  We could attribute this to a variety of causes: 

·         Ebola.  Ebola is a significant problem, both from a pandemic standpoint and economic standpoint.  Western African nations stand to lose possibly more than $32 billion of economic growth, just when they were getting out of the woods.  On the other hand, the S&P 500 lost about the same amount on October 9th.  So far, one person has died in the US (out of 330 million people) and three in the EU.  From a global standpoint, the death rate is bad, but it stands at 0.000001% of the world population.  The Ebola outbreak started earlier this year, and the market seemed to shrug it off.  I’ll suggest Ebola is sinister, but maybe not the major fear driver.

·         ISIS.  ISIS is a significant problem, actually more deadly than Ebola.  ISIS has killed, by reports in July, over 5,600 civilians in Iraq alone.  And, like Ebola, ISIS seems to be spreading (and possibly treatable), with a couple of billion dollars, tens of thousands of fighters and some very good (our) military hardware.  However, ISIS has been around for a while, is sinister, but we’ve had bigger and badder opponents. ISIS is a fear driver.

·         North Korea.  Huh?  North Korea?  Haven’t heard anything from them.  That’s exactly the problem.  We haven’t even seen little Kim Jong-un since September 3.  Is he around?

·         Mario Dragi.  Now we may have something.  The head of the European Central Bank (ECB) promised he would take all steps to get the EU out of recession.  However, all steps appear to involve only talking.  The ECB has not engaged in any serious monetary policy (at least compared to the US Fed).  As a result, we’re now seeing signs of weakness in the German manufacturing economy.  Maybe we can remember when the Grecians didn’t have a formula.  Right now, it’s possible the ECB doesn’t have one.  Definite headwind.

·         US Economy.  Back to good news.  The US economy saw a drop in unemployment (down to 5.9%), and the dollar is rising (don’t get too excited: a strong dollar is a double edged sword).  Exports are up, bankruptcies are down.  Business optimism is up, but business confidence is down.  The bellwether consumer confidence is up, as are retail sales and consumer spending. The US economy is providing a nice tailwind.

·         Interest Rates (US).  I only say US because the bond market is kind of silly right now.  The 10-year Spanish bond is at an all-time low yield (a hair over 2%), lower than the US 10-year, which is at a 15-month low.  By way of reference, Spain’s GDP is shrinking at a rate of 1.2%, compared to the US’s growing rate (2.9-4.65%, depending on how you measure it).  Spain’s unemployment rate is 24.5% (versus our 5.9%).  Yet those Spanish bonds are considered lower risk?  The simpler reason is that our Fed is ahead of the European’s, already tapering their bond buying, and trying to get our rates higher, which is good for everybody. (As long as they are not too high).  I’ll say the threat of inflation is modest, compared to the benefits of somewhat higher interest rates.  This is a tailwind.  And think about it:  what sounds better, a Spanish bond paying 2% in euros or a nice global stock paying 3.6% in a dividend in dollars?

·         Elections.  I could say that TV advertising will be off significantly after November 4.  I’ll use the mute button less, but the outcome will probably be rather anticlimactic.  As long as there is rancor in Washington, the sequester forces the deficit to be reduced.  So the infighting is actually good at cutting the budget, albeit not in the way anyone really wants it to be cut.  But, as a wise man once said, “gridlock is good.”  I predict continued gridlock, which means no tax cuts or increases, and less spending. Election results are probably a non-factor.

·         The ‘Orange Car’ syndrome.   There’s a psychological exercise that we find what we look for.  Try it:  for 48 hours, count how many orange cars you see.  You probably never noticed them before (unless you drive an orange car), but now you start looking for them and they appear everywhere.  The last time we had a 10% decline in the S&P 500 was the third quarter of 2011, over 1,100 days ago.  This is on a market that is up 189% off its 2009 lows.  Many investors are waiting for the correction to buy.  And maybe, if you look hard enough for a correction (or an orange car), you’ll find one.  (I saw 38 orange cars in a 48 hour period).

See why the market is getting volatile?  World jitters, behavior, economic data.  But when this happens, recognize that volatility provides the opportunity to rebalance, the opportunity to re-price and more importantly, the opportunity to let markets regroup.  My take is that global GDP is still growing at about 3.3%.  Inaction by the ECB can (and probably will) turn into action.  The US is still continuing to slowly grow, but grow it will.  ISIS and Ebola are sinister, but solvable threats.  The glass is half-full.  Maybe tomorrow it will be half empty.  But note that in my research, all downturns are followed by upturns.  So far, that’s been running at a 100% observation rate.


Tuesday, July 29, 2014

My Buy Michigan Week Contribution

It’s Buy Michigan Week (July 28th through August 3rd), so I’m making my contribution. I’m a Michigan homeboy: I was born in Detroit, grew up in Hazel Park, went to college and law school in Detroit; spend summers in Eastport, hunt in West Branch and kayak any stretch of open water I can find without too many lake freighters. I’ve viewed Michigan as a state of opportunity, and a state where businesses large and small can thrive. Michiganders are survivors: we survive fierce winters, and fierce recessions.

In 2009, I viewed Michigan as an emerging market. We had two of the big three car companies emerging from bankruptcy, plus a plethora of other horrible news. Our unemployment was way over the national average; our real estate markets were devastated. I started tracking Michigan-based companies just by their market capitalization. And guess what? Michigan not only emerged from the ashes, they outperformed the S&P 500 from March 2009 through December 2013 by 25%.

At the end of 2013, I met with the faculty at Walsh College to discuss the finance lab I’m proud to support. Our discussion led to the concept of an emerging market in Michigan and we agreed it would be very cool for the students to have a portfolio of Michigan stocks. I suggested that real money is better than virtual money, so I put up $100,000 of my funds for the students to invest, and the Michigan Alpha Project (MAP) was born.

A student-run team won the request for proposal process to manage the funds. They created an investment policy statement for my account and I gave them access to invest it. How are they doing? Right now, kind of flat. They picked some nice winners, which were offset by some losers. I own a wide spectrum of stock in Michigan businesses, in everything from cars to furniture to high tech and biotech. But I think the students are winning as well, with real-life examples and real money. Hopefully, some of this talent will stay here in Michigan and help our state continue to grow.

So we can ‘Buy Michigan’ in a lot of ways. You can buy a La-Z-Boy chair or La-Z-Boy stock. You can buy a box of Corn Flakes or Kellogg stock (some of the stocks the MAP team picked in my portfolio). In any event, I celebrate our state. We have good companies, great people and bright students. Seems like a good combination.

Si quaeris peninsulam amoenam circumspice


Wednesday, June 25, 2014

Breakfast Indicator

In the information age of today, there are myriad indicators for the economy ranging from the employment numbers to the men’s underwear indicator. They wouldn’t exist if they didn’t have some merit but none tell the full story. So, why not add one more? I propose the “Breakfast Indicator”, which is currently anecdotal, though testing will commence soon. If fast-food restaurants have lines waiting for breakfast, the economy is improving or doing well. Fast-food companies expanding to offer menus including breakfast clearly see opportunities, implying people are buying more breakfast, furthering the claim.

Why does this indicate a strengthening (strong) economy you may ask? If money is tight, grabbing something on the way to work, while much easier than making something at home, is much more of a luxury. In a weak economy, a commuter wakes up a couple minutes earlier, grabs a bowl of cereal and cup of coffee before heading to work. In a stronger economy, an employee feels more confident with her current level of income and wakes up a bit later, stops for a quick eat-in-the-car breakfast before continuing to work.

Let me pause to address the issues that have arisen in brief conversations about my intuition. First, being awake, and in line, for fast-food breakfast on my way to work is a little early for someone unemployed (and not actively looking for work). In addition to being awake, the cost (relatively small, but still) is greater than someone without income will usually feel comfortable spending. Second, if the population feels better about work, they are more likely to feel comfortable showing up to work less early. Finally, one may ask why breakfast and not lunch? For a couple reasons: most everyone is awake by lunch time; grabbing something quick to head back to the office implies a rush (less comfort in the job); and most importantly, fast-food lunch is cheaper than sit down places.

What does this say about today? Every morning, I see drive thru lines full at Taco Bell, Tim Hortons, Dunkin Donuts, McDonalds and Starbucks in that order on my way to work. To take it one step further, Taco Bell just recently expanded to serving breakfast, citing potential for great growth. From everything I am seeing, the economy looks to be growing. Not all is growing though; I have found the drive-thru lines, coupled with my complete lack of patience has shrunk my waistline.

As always, stay invested.
Michael Baldwin
Research Analyst

Wednesday, April 16, 2014

Fire in the Hole: Lesson Learned

Fire in the Hole: 
Lesson Learned

I dodged a potential big loss last month.  Anne, my wife, and I have a nice house and a very nice kitchen.  Anne is a gourmet chef, so we have really good (and expensive) appliances.  One fateful morning one of our appliances went rogue.  The control panel in the stove shorted out and the stove burst into flames.  Once a month we have cleaning ladies come in and, luckily for us, they were at the house and they're tough.  One hit the circuit breaker and the other called 911 and ran across the street to get my neighbor, who is a firefighter.  The fire was extinguished leaving behind one ruined, expensive stove and some burn marks on the floor.  We just finished the clean up this weekend.

We dodged the bullet, but it got me thinking about a lot of things, such as what if the cleaning ladies hadn't been there, or if we had been sleeping, or so many other possibilities.  Then I realized that I'm a personal finance whiz with some missing ingredients.  Had my house burned down, I did have replacement insurance on the contents, but didn't really have a record of the contents.  I have a whole bunch of pin numbers on my account, but not a way to get those to my wife.  I have insurance, but I haven't shopped it for quite a while.

This was annoying, so I sat down with the programs I wrote years ago and built some useful checklists; simple lists, but things we all should be doing.  We refined it and sampled it with some clients, and got a shocking 100% positive response.  It seems that most of us, no matter how organized we are, want to get our affairs in order and have some peace of mind.  I noticed something else:  I have a scarcity of time, so getting these things done liberates some time and brain space.

What kinds of things are on the checklists?  Well, the first and foremost is to make a visual inventory of the contents of your home.  Use one of your snazzy electronic devices, a camera or video recorder, and make a timely picture record.  Put something in the photos (e.g. Time magazine) that dates the picture.  Store the picture in a safe place.  What about your wallet?  Make a copy of the contents of your wallet (not the money, that's illegal), and have that in a safe place.  Do the same with your pin numbers and account numbers in your digital legacy.

There's more, a lot more.  Have you told your agent on your power of attorney about the POA?  Have you talked to the guardian in your will?  Did you put a guardian in your power of attorney?  Are you using auto-bill pay to speed up your cash flow?  Can you benefit from some kind of account aggregation?  This is where you can look at all of your accounts in one place at one time, like a dashboard.

All in all, we came up with almost 60 ideas of some simple, but important things that you can do.  Of course, not all apply to everyone, but the basic principle is simple:  a good financial life has a lot of pieces that are just common sense things that we should do.

Living without a stove for a couple of months was troublesome:  I can't wait to make some omelets.  On the other hand, I think about what might have happened and respect the wake-up call.  If you want a copy of our checklists, drop me an e-mail ( and I'll send you the pdf version.  I think it's the right thing to do and it will make you and your family's life better.  Oh, and be sure to check the batteries in your smoke alarms as well.


Monday, February 24, 2014

Detroit Bankruptcy Plan: A Lose-Lose for Retirees and a Math Problem

Detroit Bankruptcy Plan:  

A Lose-Lose for Retirees and a Math Problem

On February 21st, the city of Detroit emergency manager, Kevin Orr, presented a plan to U.S. District Court Judge Steven Rhodes to bring Detroit out of bankruptcy. One salient point of the plan is a reduction to the pensions of Detroit retirees. Police and fire retirees are poised for a 10% cut (4% if they accept right away), and general retirees are set to take a 34% reduction. This is on top of a giant increase in retiree health care costs, where the retirees will get a fraction of the amount necessary to keep health care.

It's unfair, and aggravating that retirees take a hit for a situation they didn't cause and a decision they didn't take part in. Bondholders and creditors made conscious decisions to lend money to Detroit, but a pensioner had the presumption that they were to receive a pension that was protected by the state constitution. But that's not all. I don't like the precedent; if you think about it, now the most distressed cities are having their risk increased, and that affects hiring to bonds. I also think that the private sector has at least a safety net of insurance, which apparently a state constitution cannot provide.

But beyond my moral and social objections, there's a potential problem with the math.

You see, pension math and bond math are different. A bond has a specific legal obligation that is written and enforceable. So if I lend the city of Detroit $1,000, they agree to pay me back my money at a maturity date and pay interest in the meantime. The liability is known, and measurable: the city owes me $1,000. In a pension, the city owes an annual obligation to fund the liabilities of the plan. The liabilities of the plan are calculated using a complicated formula. Basically, the liability of a pension plan is calculated based on:
a.       The amount promised the retirees (their monthly pension);
b.       An estimate of how long the plan has to pay it (the mortality 
          assumption), and
c.       The rate of return the plan will make to fund it (the interest rate 
Sound like a lot of moving parts? It is. Now, here's more of the problem. According to the EM, the unfunded liabilities of the pension system total $3.5 billion. In February, when the state of Michigan's team came in, the unfunded liabilities were $650 million. The city's actuary, which represents literally hundreds of municipal pension systems and applies a rigorous set of established actuarial standards, reported Detroit's general fund as 82.8% funded, and the police and fire pension as 99.9% funded.

The EM hired a different actuary, and that actuary recalculated the pension obligation using a different set of assumptions, which they called a, "very rough preliminary guestimate," and then recharacterized the pension obligations bonds (secured bonds to fund the pension) as unsecured bonds outside of the pension (not the normal practice). That new calculation adjusted the assets way down to 32% for the general fund and 50% for the police and fire fund. This put the pensions below the 80% threshold to allow them to be under EM control.

In other words, the liability might be $3.5 billion, or might be $650 million, or might be some other number, or nothing. In addition, the plans pay this liability over the lifetimes of the pensioners, not all at once, or even on a schedule like bonds. During that time frame, the plan's assets make money and retirees pass away. Depending on those factors, we can determine where the liability goes. If the plan makes more on its investments than the assumptions, the liability reduces, or even vanishes.

It reminds me of the quote attributed to Mark Twain: "Figures don't lie, but liars do figure."

Pension math is tricky, and I don't think people's financial lives should be at the stake of a single calculation. The average Detroit general retiree gets a pension of $19,000, which by my standard is very modest, and to cut that by $6,460, plus make them pay all but $125 of their retiree health care is devastating. I guess I can liken this to an appraisal on a house. We get one appraisal, then another one comes in way lower. Do you automatically accept the lower number (in the case of liabilities, the higher number?) To me, I'd like to see a real version of what the unfunded liabilities really are before the people who worked hard for the city get a haircut. Not only that, if the plan's assets are invested right, there may end up being no liability.

Let's prove the figures. The retirees deserve it.