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Despite the baby boomers’ liquidation of retirement assets in coming decades, the study estimates that the total size of 401(k) plans will nevertheless grow markedly. That forecast may come as a surprise to some people, the professors concede, because 401(k)’s now represent only a modest fraction of a typical retiree’s total wealth. But the professors point out that 401(k) plans have existed only since the early 1980s; by the time that today’s younger workers retire, they will have had many more years to contribute to their 401(k)’s than current retirees have had. The relative youth of 401(k)’s has worked in several ways to keep their total assets relatively small. Only in recent years have 401(k)’s become available to a majority of American workers. In 1984, for example, fewer than one in five families in the United States had any members who were eligible to participate in a 401(k), according to the professors. By 2003, however, that proportion had grown to more than half. The percentage of eligible workers who actually invest in 401(k)’s has also grown over the years. In 1984, for example, just 56% of eligible workers ages 30 to 34 who could invest in a 401(k) actually did so. By 2003, the rate had jumped to 81%. These historical patterns mean that, even among workers who invest in 401(k)’s, many have had only a few years to watch the power of compounding in their accounts. To illustrate the effect of time on these accounts, consider an investor who contributes $1,000 a year to a 401(k), which is invested in stocks that earn 10 percent a year, on average. After 10 years, the account will be worth less than $20,000, but after 40 years it will be worth nearly a half-million. The professors assumed that eligibility and participation rates for 401(k)'s would keep climbing, though at a slower pace than in recent years. They assumed that the pattern of future retirees’ withdrawals from 401(k) plans would be no different from that of past retirees. The professors assumed that the typical plan would be 60 percent allocated to stocks and 40 percent to corporate bonds, and that these two asset classes would earn the same rates over the next four decades as they have over the last eight. Using these assumptions, the professors calculated that total 401(k) assets in 2040 would be more than one and a half times the size of GDP — compared with 43% today. The professors reach broadly similar conclusions even when assuming that stocks will earn less in the future than they have in the past.
The long-term performance of actively managed small-cap mutual funds seems to support that theory. The median active small-cap stock fund beat common benchmarks by 1.7 percentage points annually, before fees, between 1984 and 2005, according to a recent study by mutual-fund giant Vanguard Group. But that strong performance is based on comparisons with popular Russell small-cap indexes. When compared against other small-cap benchmarks, the stock pickers don't fare so well. For instance, from 1992 through 2005, their performance was only on par with the returns of Morgan Stanley Capital International's small-cap indexes. The differences arise because each index firm has its own blueprints for building and maintaining benchmarks. But if small-cap active managers were truly skilled at picking stocks, they would show success against various types of small-cap benchmarks, Vanguard argues. There's more bad news for investors hoping to beat the market with an actively managed small-cap fund. Vanguard found that such a fund has only a 50-50 chance of beating the market before fees in a given year, even if it outperformed in the previous year. If small caps were really so friendly to stock pickers, then the stock pickers should have fairly good odds of beating the market year after year.
Unfortunately, many of these warnings are little more than blinding glimpses of the obvious. Greenspan helped trigger the latest flutter in share prices, particularly in emerging markets, after he said of the wild rally in Chinese stocks, "There is going to be a dramatic contraction at some point." Warnings about hot markets do serve a purpose, of course. They may keep people from becoming, well, irrationally exuberant and dumping all of their money into one asset just before it collapses. But there's a danger that investors who listen to constant fretting about how bad things might get in the economy and markets can end up paralyzed with fear and unwilling to take even minimal risks. That may cost them dearly in terms of their long-term financial health. After the S&P500 index lost nearly 50% of its value from March 2000 to October 2002, investors now know in retrospect that they should have been buying stocks with both hands. But fear reigned until the market turned up decisively in 2003. A basic truth about investing is that there's never a good time to buy — meaning, there's always something to worry about. That's life. Yet look at what the world's stock markets have overcome in recent years: record-high oil prices, rising short-term interest rates, devastating terrorist attacks in Madrid (2004) and London (2005) and, most recently, a serious U.S. housing slump. There should be a fundamental reason stock prices have forged ahead, and here it is: The global economy has continued to expand. Consumers and businesses have continued to spend, which in turn has underpinned corporate earnings. To be sure, easy money also is driving markets. Despite central-bank credit tightening, lenders around the planet remain eager to lend and borrowers remain eager to borrow. One result is plenty of capital for buyout firms, which are snapping up companies everywhere, thereby benefiting the shares of other firms on the hope that a takeover bid materializes. Some Wall Street veterans say easy money has led to rank speculation and dangerous bubbles in asset prices everywhere they look. "From Indian antiquities to modern Chinese art; from land in Panama to Mayfair; from forestry, infrastructure and the junkiest bonds to mundane blue chips; it's bubble time!" wrote Jeremy Grantham, head of Boston money manager GMO, in a letter to clients last month. We are living, he said, in "the first truly global bubble." Maybe. But some people said much the same thing two years ago, when commodities, stocks and real estate were streaking in unison. As for Grantham, whose firm manages $145 billion, he has been negative on U.S. stocks for four years, so he may have left a lot of money on the table. What a pessimistic investor calls a bubble, an optimist might say is just a fantastic, and justifiable, bull market. That's the view of Edward Yardeni, who heads his own investment and economic research firm and who, like Grantham, does a lot of big thinking on financial markets. Yardeni believes there has never been a global economic boom on the current scale, with China, India and other developing nations now full-on capitalists and with money flowing so easily and quickly into investment opportunities worldwide. "If this is the greatest global boom of all times, then why wouldn't we have the greatest global bull markets in stocks and commodities of all times?" Yardeni asks. And though experienced investors are conditioned to run the other way when someone declares a "new era" for the economy or markets, the fact is that sometimes it is a new era. Case in point: What else would you call the 20 years after 1980, when U.S. inflation and interest rates were in a sustained decline and stocks mostly marched higher? To be a buyer of stocks in general now, you pretty much have to believe we're in a new era of global growth — and that we're somewhere near the start or in the middle of it, not approaching a calamitous end. Even if Yardeni is right about an ongoing boom, there are going to be serious economic and market disruptions along the way. At the moment, the deepening trade disputes between the U.S. and China pose one significant risk. So do rising bond yields in the U.S. and Europe and decelerating corporate earnings growth. A year ago, jitters over frenzied gains in stocks and fear of inflation pressures and rising interest rates helped to trigger a five-week pullback in share prices around the globe. The declines were much worse in many foreign markets than in the U.S., exposing the soft underbelly of overseas investing: a lack of liquidity when you need it most. The next market disruption, whatever the trigger, may play out much the same. That's why many pros continue to warn clients away from emerging markets for the time being, despite their longer-term promise. If stocks scare you at these levels, then the prudent decision is to put off buying, and perhaps to start pruning. But you have to allow for the possibility, or perhaps probability, that the world as we know it isn't ending — and that the global economy will keep expanding, and stock market pullbacks will be opportunities to pick up appealing long-term investments for less.
One measure of the growth in liquidity is global central-bank reserves. These have risen to $5.8 trillion from $1.6 trillion over the past decade, more than doubling as a share of gross world product. That additional cash was produced by excessive money-supply creation in most leading economies. While these reserves don't by themselves force up share prices, their growth demonstrates the rapid increase in world liquidity. Economies depend on a stable monetary system to send appropriate price signals to producers and consumers. But with the M3 measure of money supply rising at close to 10% annually in the U.S. over the past dozen years, and world central-bank liquidity growing by 13.8% annually, the system is anything but stable. Normally, such excessive money creation would have produced inflation. But this time, it coincided with a communications revolution that lowered global production costs. Previous revolutions of this nature, like the one brought on by railroads, steamships and refrigeration in the 1880s, produced price declines. This one has merely offset the inflationary pressures caused by the increase in money supply. Consumer-price inflation has remained quiescent world-wide, but asset prices, corporate profits and the incomes of the controllers of capital have skyrocketed. Nothing suggests that these changes are permanent. They are simply a temporary distortion caused by excessive money creation. This may eventually cause a collapse in returns and a global recession. Since most of the world has shared in the explosion of liquidity and asset prices, it will share in any subsequent collapse. At that point, Mr. Greenspan, the creator of excessively loose monetary policies in the world's largest economy, will have nowhere to hide.
Taken together with data showing more workers are earning less in comparison with the incomes of top earners, the report suggests that a growing number of Americans "believe that the rules of the game are no longer fair," said John Morton, director of the Economic Mobility Project at the Pew Charitable Trusts and one of the study's lead authors. In 2004, the median income for a man in his 30s was $35,010 – 12% less than thirtysomething men in 1974, adjusted for inflation, according to the study, which was based on Census Bureau data. In contrast, men in their 30s in 1994 earned 5% more than their fathers did at the same age. Researchers focused on that age group because income in the 30s is a good predictor of lifetime income, according to the report. Outsourcing and the demise of higher-paying manufacturing jobs have contributed to the stagnation in men's incomes, Mr. Morton said. The influx of well-educated women into the workforce since the 1970s also might have weighed on men's wages, he said. A stronger push to get males to graduate college could help raise men's earnings. Among those under 50 years old, 32% of women hold a four-year degree, compared with 23% of men. That's a dramatic change from the past, when men were better educated than women.
How do longer loan terms add to the overall costs? For a $35,195 loan: a three-year loan at 5.89% rate has $3,287 in financing costs. A five-year loan at 6.05% rate has $5,679 in financing costs. A seven-year loan at 6.59% rate has $8,835 in financing costs. Cars, meanwhile, are getting more expensive. The average transaction price keeps climbing at a faster rate than inflation as people covet expensive cars and purchase more extra-cost options. In 2006, the average price paid for a vehicle was $29,316, compared with $28,942 a year earlier and $19,773 in 1996, according to CNW Marketing Research. The researcher says a rising number of people are "buying in the 90th percentile," which means they are purchasing cars with optional equipment that boosts the sticker price close to the vehicle's maximum possible price. The tendency to buy cars "loaded" with added-cost options is driven in part by the quickening pace of automotive technology. Expensive gear like satellite-navigation and video-entertainment systems once available in only the most luxurious cars are now optional on even entry-level models.
For now, there is a total of around $23 billion in 20 bond ETFs that specialize in corporate bonds of different grades of credit quality, Treasurys of varying maturities and mortgage-backed securities. That tally is still a narrow slice of the total $461 billion that State Street says sits in the coffers of 475 ETFs. But with these recent additions, it's now possible for investors to use ETFs for every facet of their portfolios. But investors must do their homework before jumping into one of these new fixed-income funds. They aren't all built the same way. There are big differences in the securities in their portfolios and in the fees they charge. And investors shouldn't assume that bond ETFs, like stock ETFs, can be more tax efficient than traditional mutual funds. In some cases, investors might be better off with a traditional bond-index mutual fund or an actively managed bond mutual fund that has a seasoned pro at the helm. One important wrinkle: While many bond ETFs aim to track identical market benchmarks, their holdings are sometimes quite different. For instance, both the Vanguard Total Bond Market ETF (BND) and the iShares Lehman Aggregate Bond ETF (AGG) are pegged to the Lehman Brothers U.S. Aggregate Bond index, a benchmark that includes 8,800 bonds. That's far more individual securities than in most stock-market benchmarks, and it's not practical for bond-index ETFs or mutual funds to hold them all. The Vanguard ETF, which is just an additional share class of a long-established index mutual fund, holds 2,581 issues. The iShares product holds just 158 bonds. Each firm says its approach is better. "Our funds are core holdings that offer a lot of diversification," says Ken Volpert, head of Vanguard's bond indexing group. Barclays notes that many individual bond issues perform similarly, which it says makes owning so many separate securities redundant -- and potentially costly to fund owners. "Many of these bonds share the same characteristics, so you don't need to hold them all," says Mr. Tucker of Barclays. The same scenario is apparent with other ETFs in the Vanguard and iShares families, like their intermediate-term bond offerings. Tax efficiency is not a big a factor with bond ETFs. The underlying structure of ETFs allows them to hold down capital-gains distributions to investors. That's important for stock investors, since most of the return from stocks may come from capital gains; when funds can delay distributing gains to investors, taxable investors get to delay paying tax. But when it comes to bond funds, most of their payments to shareholders are derived from bond interest, not capital gains. That income is taxed the same way whether you own an ETF or a bond mutual fund. In weighing the bond ETFs, the deciding factor for investors may be fees. The iShares Lehman Aggregate charges an annual expense ratio equal to 0.2% of assets, while Vanguard, which levies the same 0.2% on a share class of its similar bond fund, has chopped the fees for its ETF version to 0.11%. That might not seem like a big gap, but in the bond world, where the separation between outperforming a benchmark and lagging it is very slim, a 0.09% advantage can make all the difference. In comparing bond ETFs to bond-index mutual funds, investors need to factor in the trading commissions they'll pay to buy or sell the ETF shares, as well as any transaction costs on the traditional funds.
You'll be asked to provide your name, home telephone number, date of birth and Social Security number. There's also a form on the Web site that you can sign and mail in to opt out permanently. Removing your name from these lists, or adding it back, doesn't affect your credit score or your ability to apply for or obtain credit or insurance. Turning off these offers may limit your exposure to identity theft, says Norma Garcia, senior attorney with Consumers Union. Fraudsters can open credit accounts in your name and retrieve personal information by lifting unwanted credit-card solicitations from your mailbox or garbage can. "People just get so many of these [offers] in the mail, toss them and don't think about the consequences," Ms. Garcia says. Katherine Armstrong, an attorney with the Federal Trade Commission's Bureau of Consumer Protection, notes that "opting out won't shut off every piece of junk mail, just the 'preapproved' ones." You may still receive offers from creditors and insurers you already have relationships with and from companies that didn't obtain your information via prescreening. Where to Get Free Credit Reports David Colker, LA Times 5-13 You are entitled, by law, to three personal credit reports a year, one from each of the national credit bureaus, at no charge. The freecreditreport.com site, however, is not part of that program, despite its name and the fact that it's owned by one of the nationwide bureaus. The site where you get your no-cost, no-strings reports is http://www.annualcreditreport.com. The site is relatively plain in appearance, and at the bottom are the logos for the nationwide credit bureaus that were forced to establish it: Equifax Inc., Experian and TransUnion. The logos look innocent. But they are online trapdoors: If you happen to click on one of them, you'll be whisked away to the land of pay. Consumers can also apply for their free reports telephone at 877-322-8228.
The current bull, which was born on Oct. 10, 2002, started with a P/E ratio of 27.1, according to S&P. Four years later, the ratio was actually much lower, at 16.3. (All of these figures are based on trailing 12-month earnings, using generally accepted accounting principles, or GAAP.) Why are investors stingier with their investment dollars this time around? Part of the explanation may simply be the hangover from the bear market of 2000 to 2002, said Tobias Levkovich, chief United States equity strategist at Citigroup Investment Research. He argues that investors may be hesitant to push P/E ratios higher after getting burned so badly for doing so at the start of the decade. The lack of a P/E expansion could also be tied to the surprising strength in corporate earnings growth. When the “E” in the P/E ratio grows at a faster-than-expected rate, it’s not so surprising when the “P” doesn’t keep pace. Of course, “as earnings slow from here, the markets will need an extra boost,” Mr. Kleintop said. And there are some early indications that investors may be willing to pay slightly higher prices for stocks in coming months. Sam Stovall, S&P’s chief market strategist, noted that at the end of March, the P/E ratio of the S&P500 was 16.8 (based on trailing 12-month GAAP earnings). The multiple grew to more than 17 by mid-May. And if the S&P500 breaks its all-time high of 1,527.46 within the next few days, the market’s P/E will rise to around 18. Yet this is only a short-term move. And few are expecting the type of P/E expansion that the market enjoyed in the mid-1980s and the mid-1990s. From 1984 to 1986, the P/E of the S&P grew to about 14 from around 8. The move was even bigger from 1996 to 1998. Investors started that period paying 14 times trailing 12-month earnings. But by the end of it, the multiple had grown to 24. Market strategists note, however, that those periods were marked by significant declines in long-term interest rates and inflation — both of which have an inverse relationship with market P/E ratios. Given that 10-year Treasury notes are already yielding less than 5 percent — and given that core consumer inflation is running about 2.3 percent, according to the Labor Department — it’s hard to imagine a huge kicker from similar trends this time around. As a result, Jim Dunnigan, chief investment officer at PNC Wealth Management, argues that while P/E ratios are likely to expand, “it should be more muted than it was in the past.” Mr. Kleintop agrees. Instead of a 6- to 10-point surge in P/E ratios, we’re more likely to see a bump-up of about 3 or 4 points. Still, based on trailing 12-month earnings of nearly $90 a share for the S&P500, a climb to a P/E of 19 — about 3 points above the level of last October — would bring the index to a record level of about 1,700. That, of course, is based on a lot of ifs. Whether market P/E’s will climb this high in this bull market will depend on several factors, including these: The Inflation Outlook Liz Ann Sonders, the chief investment strategist at Charles Schwab, says that there is “a perfect inverse correlation of inflation and P/E ratios.” Since 1960, whenever the annual inflation rate (as measured by core personal consumption expenditures) has been 2 to 3 percent — as it is today — the average P/E for the S.& P. has been 19.7. But when inflation edges just above 3 percent, that average P/E has dropped to 17.6, close to the current number. The Buyout Binge Though P/E expansion isn’t likely to be aided by big drops in bond yields, the recent flurry of mergers and acquisitions could spur the market to bid stock prices higher — at least to better reflect recent earnings growth, Mr. Dunnigan said. According to Thomson Financial, global merger-and-acquisition activity is on pace to shatter last year’s record of $3.6 trillion of deals. If that holds true, there could be an uptick in P/E multiples. The Path of Tech and Health Care Stocks Historically, these stocks have had high P/E’s, but both of these sectors have generally been out of favor since the start of the decade. That is one reason the P/E ratio of the S.& P. hasn’t greatly expanded, Mr. Kleintop says. But now that tech and health care companies are again among the market’s earnings leaders, the ratio could be driven higher. Of course, the multiple could surge for another reason: if earnings fall off a cliff, as they did at the start of this decade. That would be about the worst type of P/E expansion imaginable, but, fortunately, few are predicting it. In fact, though earnings are slowing, the consensus is that earnings for the S.& P. will still grow 7.1 percent this year.
But since the price tags on the biggest companies being taken private are far higher than the market values of any of the companies that might get added to the index, much of the cash will be divvied up by all the companies in the index. (The S&P 500 is market-cap weighted, so if a company that made up 1% of the index was replaced by one that accounted for 0.5%, the remainder of the cash would be distributed to the other companies in the index.) That could help send the market higher. Of course all the cash "coming" into the stock market was really the stock market's to begin with. The reality is that, with so many companies going private, there are fewer stocks to buy, and that's sending the ones that remain higher.
While the number of companies providing financial guidance increased sharply over the last 12 years, these numbers are now leveling off and appear to be pulling back. Since beverage giant Coca-Cola stopped giving quarterly and annual earnings guidance in 2003, other big names have followed suit, including AT&T, Mattel, and McDonald's. On Apr. 26, Beazer Homes USA and Pulte Homes, two homebuilders battered by the housing downturn, said they would provide no guidance for the rest of the year because the weak market made it too difficult to predict earnings. On May 1, Blackstone Group, the private equity firm that plans to go public later this year, said it would not provide earnings guidance. Robert Pozen, chairman of MFS Investment Management, Pozen and other members of a commission assembled by the U.S. Chamber of Commerce recently put out a study that argues the U.S. is in danger of losing its leadership in capital markets, in part because of guidance. The emphasis in the U.S. on quarterly projections and results, the group says, results in wasted time and effort, and is a distraction to the company and investors. The chamber now is trying to create a groundswell among U.S. companies to stop issuing quarterly earnings goals, and instead provide annual ranges and more information about long-term goals. If they succeed, Pozen says, he hopes "markets believe this is a larger positive trend rather than masking a problem at a company." Guidance is a relatively new phenomenon. Only 92 companies gave guidance before Congress passed the Private Securities Litigation Reform Act of 1995 to give companies a safe harbor for disclosing forward-looking information, according to a McKinsey study. That number rose to 1,200 in 2001, and stayed fairly steady through 2004, the last year for which McKinsey has data. One academic study suggests that nearly 100 companies have dropped quarterly guidance in recent years, but definitive figures are not available.
Private equity firms pool money from wealthy individuals and institutions, and sometimes borrow money, for the purpose of acquiring companies, in hopes of managing them better for a couple of years and then selling for a profit. Some of the largest private equity firms produced returns last year in the high double digits. Such performance has not surprisingly attracted huge sums of additional cash, which the private equity firms have quickly put to work. This year private equity firms have announced acquisitions whose total value represents nearly a third of the $684 billion in domestic mergers and acquisitions, according to Thomson Financial. The authors of this new study analyzed cash-only acquisitions of publicly traded domestic companies completed from 1990 through 2005. In total, they focused on 1,292 deals, 32% of which involved a private bidder and 68% involved a public bidder. The professors were unable to account for the 55% price disparity in terms of any observable differences in the kind of companies that were acquired. It was not the case, for example, that private equity firms tended to purchase less profitable companies than public bidders did. Nor did private equity firms tend to acquire companies that were growing more slowly, or ones whose recent stock performance was poorer. The professors found that the highest prices tended to be paid by publicly traded acquirers whose managers owned the least amount of their companies’ stock. Indeed, upon eliminating from their database those publicly traded acquirers whose managers had ownership stakes amounting to less than 20%, the professors found no difference in the average price paid by private and public acquirers. The professors say that when corporate managers have only a small ownership stake, they are more likely to pursue acquisitions that do not enhance shareholders’ long-term value. In such cases, Professor Stulz said in an interview, their motivations may simply be to satisfy their egos by building a corporate empire. How should you react if you own stock in a company that receives an acquisition bid from a publicly traded company whose management has a small ownership stake? You may want to sell your stock immediately upon the announcement of that bid, Professor Stulz said, since chances are high that the bid will have inflated the price of your stock to overvalued levels. By selling immediately, you lock in much of that higher price and protect yourself from the possibility of the deal’s falling through. A more general investment implication, according to Professor Stulz, is that investors should pay close attention to the incentives under which corporate managers operate. “You should favor companies whose managers are working on behalf of long-term shareholder value and not personal aggrandizement,” he said. One clue that managers’ interests are aligned with shareholders’ is that they have a large ownership stake.
The American Association of Individual Investors’ survey last week found that 54.3% of members were bearish, the most skeptical positioning since last July. Online trading hasn’t spiked, and mutual fund flows still favor global funds. To some, this suggests the market has further to go; Ryan Detrick of Schaeffer’s Investment Research notes that odd-lot short interest is near a three-year high, suggesting disbelief among retail investors. Even if those investors do find their way into the market by investing more in U.S. mutual funds, Mr. Doll says the expectation that their involvement will act as a signal to get out is perhaps wishful thinking. “From the time they start [buying] to the time they end can be a several-year period — [the moment] the public starts to do more buying [it] may be premature to blow the whistle,” he says. Jeffrey Cooper of Minyanville.com says the cynicism of regular investors may result from having long memories of getting burned in 2000; the recent decline in real estate and income from home equity may also be a factor. “Maybe they will come in big time, maybe they won’t,” he says. “But I think betting on them to come in to power this thing higher immediately from here is the short straw. Maybe after a substantial correction they come in. Maybe. But the guys with the credit are behind this move.”
So, beyond a series of lucky guesses, how does anyone regularly find the best stocks on the market? Warren Buffett, Carl Icahn, Jim Simons, and David Nierenberg and the rest of the outperformers are different types of investors, there is one skill that unites them -- a skill that you can hone over time. What's the skill? Pattern recognition. In terms of picking outperforming stocks, pattern recognition means being able to frame buying opportunities within past market models. Here's an example. When Motley Fool Hidden Gems small-cap analysts Tom Gardner recommended Buffalo Wild Wings back in June 2004, here's what he saw: [1] A committed management team that owned more than 10% of shares. [2] A rock-solid balance sheet. [3] Rapidly growing owner's earnings. [4] Dominant positioning in a niche market. [5] Serious growth potential from a small market capitalization. Since that recommendation, Buffalo Wild Wings is up 200% -- and Tom expects an even brighter future.
In the United States, the Federal Reserve has held rates steady since last June, and its next move will most likely be a rate reduction to stimulate growth. The European Central Bank and the Bank of Japan, meanwhile, have been raising rates — lest their once-suffering economies overheat and spawn inflation. “The U.S. slump in the first quarter didn’t pull down growth in Europe or Asia,” said Brad Setser, senior economist at Roubini Global Economics. The seemingly countervailing trends — deceleration in America, full speed ahead abroad — have led some economists to wonder whether the United States and the rest of the global economy are going their separate ways. Some even suggest — shudder — that changes in the global economy have made the United States a less-central player. “Four or five years ago, there was an important switch in the global economy,” said Stephen King, an economist based in London for HSBC. “Since then, other parts of the world have really grabbed the growth baton from the U.S.” Until relatively recently, when the United States sneezed, the world caught a nasty cold. Today, Mr. King says, the United States has sneezed, but the world has gone shopping. Mr. King notes that emerging markets like China, India, Central and Eastern Europe and the Middle East are injecting life into the European and Japanese economies through their enormous purchases of capital goods — all those construction cranes in Dubai, bullet trains in China, oil rigs in Russia. “Emerging markets’ share of global capital spending has risen from 20 percent in the late 1990s to about 37 percent today,” he said. Western Europe is benefiting from rising trade with Eastern Europe, Russia, Asia and the Middle East. As a result, the euro zone, America’s largest trading partner, is simply not as reliant on the United States as it used to be, Mr. Setser said. “Europe is clearly no longer growing on the back of U.S. domestic demand growth,” he said. As other economies increasingly trade with one another, the United States plays a diminished role. But the consensus for decoupling is hardly complete. The United States is still setting the pace, Mr. Achuthan said: “We led the world up, and the rest of the world revved up after us. And areas like Europe in particular will be slowing in the wake of our slowdown last year.” The cars of the global economic train are still tethered tightly together, in his view. “It’s less of a decoupling“ he said, “and more like the jerking you get in a train when the first car stops, and then the other ones stop after a bit of a lag.” David Rosenberg, an economist at Merrill Lynch, said he believes that the apparent divergence in the world’s big economies has more to do with the nature of the growth slowdown in the United States, which has stemmed not from a decline in consumption, but from a decline in investment — specifically in housing. “Almost 100 percent of the U.S. slowdown has been due to the housing industry,” Mr. Rosenberg said. And housing is an intensely local and national industry — from the real estate broker to the mortgage lender, from Home Depot to interior decorators. “Unless you run a sawmill in Canada, international trade isn’t directly affected by the decline in U.S. housing,” Mr. Rosenberg said. Martin N. Baily, a senior fellow at the Peterson Institute for International Economics in Washington, says he thinks that it’s a good thing for the United States if it’s no longer the leader. “We have a huge imbalance in our trade, and we need to be a little less of an engine of growth for the rest of the world, and let Europe and Japan, and hopefully China, eventually, pick up the slack,” he said. “And right now it seems like they’re doing so.” But Mr. Baily added that we shouldn’t be so quick to believe that the world economy is significantly more independent of the United States than it was in the past. “I don’t think there’s been a complete decoupling,” he said. “A U.S. recession would dramatically slow growth in China and India.” The real test of the decoupling thesis, Mr. Rosenberg said, will come if consumer spending starts slowing down. Consumer spending in the United States, which is still on the rise, accounts for an astonishing 20 percent of the global economy, he said. “I find it hard to believe,” he said, “that the rest of the world is going to be immune to a consumer sector that’s primarily responsible for pulling in nearly $2 trillion of the world’s output.” Consumer spending hasn’t fallen for a single quarter since the fourth quarter of 1991. And while there are factors affecting domestic consumer spending — higher interest rates, lower housing prices, higher gas prices — the indefatigable American spenders show few signs of letting up. “Before we can say there’s a decoupling, we have to wait for a sneeze,” Mr. Rosenberg said. “All we’ve had is a runny nose.”
The relationship seemed to go out of whack a few years ago when Treasury yields stayed low even though the economy rebounded and the Federal Reserve raised short-term interest rates. Some economists think foreign investment in Treasury bonds might have played a role. Countries such as China and Japan were taking the dollars they made selling consumer goods to the U.S. and, rather than converting them into their own currencies, recycling them into Treasurys and other dollar assets. That helped to keep yields low as the economy grew. If U.S. consumer spending now slows, the flow of dollars overseas should slow as well, potentially stanching foreign demand for Treasurys. What's more, many countries may have concluded that they have enough Treasurys to tap into in times of trouble. That means they may invest with more of an eye toward generating returns than before. China, which has $1.2 trillion in foreign-currency reserves, said earlier this year it plans to "expand" how it uses its reserves. Maybe that's a reason why yields on 10-year Treasurys, at 4.64%, haven't fallen much even though economic growth has slowed in the past year.
But it is not just housing that is slowing. The rate of growth in retail sales has slowed in the past year, High Frequency's Shepherdson says. He uses a measure of core sales, which strips out building materials (the GDP ex- housing crowd can relate to that), price-driven food and gas, and autos, and is growing at a 4.7% pace now compared with 8.6% in March 2006. Companies that haul the stuff consumers buy are reporting weakness in their domestic operations. UPS, the world's largest package-delivery company, said U.S. volume showed no change in the first quarter from a year ago. One year ago, capital spending was growing at a 9% year-over-year rate, points out Ian Shepherdson, chief U.S. economist at High Frequency Economics. Now it's zero. In only one quarter of this entire expansion did capital spending add 1 percentage point or more to growth compared with an average contribution of 1 percentage point from the end of 1992 through the middle of 2000. The first-quarter contribution was 0.1 percentage point. Business fixed investment has underperformed its ``fundamental drivers'' for several years, the economists say. Strong profit growth, healthy balance sheets, easy financial conditions, historically low tax rates and a brisk pace of mergers and private equity deals all suggested stronger capital spending. So did solid cash flow. Last year, capital spending as a share of GDP was close to its all-time bubble highs in 2000. Economists at UBS wonder if businesses didn't decide enough was enough with economic growth downshifting to 2-plus percent in the last year. Companies have cash, but they aren't spending it in the way historical evidence would dictate. Corporations are buying back their own stock at a record pace. Instead of investing their internally generated funds, U.S. corporations retired a record $547.6 billion in equity last year. ``What if the expected return on capital isn't high?'' asks Paul Kasriel, chief economist at the Northern Trust. People will pay a high real rate to borrow when they expect a high real rate of return. If they anticipate the opposite, companies ``get a higher payoff by buying back their stock,'' he says. When the U.S. economy stumbles, the world usually does, as well. But in Q1-07 the US economy grew at an annual rate of 1.3% while Japan's economy grew 2.8% and the "euro zone" grew by 2%, according to J.P. Morgan Chase. Latin America expanded by 3.6% and Asia excluding Japan expanded by 9.8%, led by double-digit growth in China and India. Why the "decoupling"? The US slowdown is rooted mostly in housing. Houses are almost entirely built in the U.S. by U.S. workers, so the housing slump has had very little impact among our trading partners. By contrast, the collapse in technology and telecom investment in 2000 and 2001 fell hard on companies in Canada, Asia and Europe that exported high-tech products to the U.S. And some countries have also become less dependent on the U.S. In 1986, Japan sent 39% of its exports to the U.S.; by last year, that had fallen to 23%, according to Stephen Jen, currency strategist at Morgan Stanley. In the same period, Japan's exports to the rest of Asia rose from 25% to 49% of the total. Even the stock market has decoupled. Why? Foreign sales represent 49% of the total sales of companies in the S&P 500-stock index that report the data, up from 29% in 2001. (Greg Ip, WSJ 5-13) Monthly Employment Stats
Here’s the background: Each month the BLS surveys workplaces that employ about third of all nonfarm workers, and it estimates the rest, making revisions over the next two months as more complete information comes in. But it has no good way of measuring jobs created by new firms, since its monthly surveys have no record of their existence. Instead, it fills in the gap with a “birth/death” model that uses historic patterns to predict how many jobs were created by new firms or destroyed by firms going out of business. Once a year, those estimates are replaced with hard data from unemployment insurance records. Hatzius notes that by the BLS’s own admission, the birth/death model has trouble catching turning points. He notes that because it is based on history, it tends to adjust to the most recent trend. In the initial years of the expansion, the model underestimated job growth, most spectacularly in the year through March 2006, for which there was a very large upward revision later on. That pattern has now been incorporated into the model. So far this year, it has added an average of 113,000 jobs per month, compared with 88,000 throughout 2006 and 68,000 in 2005. Hatzius suspects it may have gone too far and is now overestimating job growth, but we won’t know it until preliminary benchmark revisions are announced this fall.
Health care employment continued to grow in April (+37,000), with gains throughout the component industries. Over the year, health care has added 362,000 jobs. Employment in social assistance was up by 10,000 in April and has grown by 63,000 over the year. Food services and drinking places continued to expand in April, gaining 25,000 jobs. Employment in this industry has increased by 336,000 over the year. A sizeable job loss (-41,000) in general merchandise stores followed a large gain (30,000) in March. Within finance and insurance, employment fell by 14,000 in credit intermediation and related activities in April; commercial banking accounted for over half of the loss. Within professional and business services, employment rose in April in computer systems design (+11,000) and in management and technical consulting services (+12,000). Wholesale trade employment edged up by 13,000 over the month. Government employment continued to trend up in April and has grown by 297,000 over the year. Local government accounted for three-quarters of the over-the-year growth. Employment in construction was little changed in April, with no significant movements among the component industries. Thus far in 2007, there has been es- sentially no net change in construction employment. Manufacturing employment continued to decline in April (-19,000). Small job losses were widespread across manufacturing industries, with notable declines in machinery (-5,000), motor vehicles (-5,000), and textile mills (-3,000). The return of 6,500 shipbuilding workers from a strike partly offset losses elsewhere in manufacturing. Employment declined by 26,000 in retail trade in April. In April, the average workweek for production and nonsupervisory workers on private nonfarm payrolls declined by 0.1 hour to 33.8 hours, seasonally adjusted. The manufacturing workweek and factory overtime each fell by 0.1 hour to 41.1 and 4.2 hours, respectively. Average hourly earnings of production and nonsupervisory workers on private nonfarm payrolls rose by 4 cents, or 0.2 percent, in April to $17.25, seasonally adjusted. Average weekly earnings edged down by 0.1 percent over the month to $583.05. Over the year, average hourly and weekly earnings grew by 3.7 and 3.4 percent, respectively.
Quick Facts, Stats & Opinions How to Sell High James Stewart, WSJ 5-30 It isn't easy selling into a bull market, even though that's often what's required to sell higher and buy lower. If it were easy, more people would do it, and bull markets wouldn't run as far or as long -- or provide as many opportunities to profit. But there is a way to have your cake and eat it, which is to say, take some profits and continue to ride the bull. You can sell some out-of-the-money covered calls. This is an options strategy I've addressed before, and one I often use to raise cash when the market reaches one of my selling thresholds, as it did this spring. I've employed the tactic when I thought the market was overvalued and likely to fall. When that happens, the value of the calls I sold drops, and eventually they expire worthless, with the stock trading below the strike price. I've always been rather proud that over the years I've been selling covered calls, almost every one has expired worthless. How the Chinese Invest? James Areddy, WSJ 5-23 In Chinese society, the homonyms of numbers hold deep meaning. In particular, the pronunciation of number eight -- ba in both Mandarin and Cantonese -- sounds similar to words for "wealth" or "fortune." Consider the kickoff time for next year's Beijing Olympic Games: 8 p.m. on 8-8-2008. Bank of China Ltd. puts its trading rooms on the eighth floor of its buildings. China's tallest skyscraper, the Jin Mao Tower, is 88 floors high. The appearance of an "8" is considered auspicious, whether it is a digit in the share price or a part of the six-number identity code exchanges assign to each stock. numerology is a basic trading strategy in China and it is a little noticed force adding fuel to a roaring market. The benchmark Shanghai Composite Index is up 56% this year and quadruple its level at mid-2005. To professional observers, the Chinese investing public's trust in the predictive power of numbers -- rather than fundamentals like business prospects or profit -- is one of many reminders of how buying on the Shanghai and Shenzhen stock exchanges looks like gambling. Brokerages are set up like casinos. Investors drink tea, smoke and chat as they make trades on computers lined up like slot machines. Instead of dropping in coins, they swipe bank cards to pay for shares. What Cattle & Hogs are Eating Now Lauren Etter, WSJ 5-21 Historically, the livestock industry has consumed 60% of the nation's corn crop. Thanks to the ethanol rush, the price of a bushel of corn for months has hovered around $4 - nearly double the price of a few years ago. In Pennsylvania, farmers are turning to candy bars and snack foods because of the many food manufacturers nearby. Hershey sells farmers waste cocoa and the trimmings from wafers that go into its Kit Kat bars. At Nissin Foods, maker of Top Ramen and Cup Noodles, farmers drive to a Lancaster, Pa., factory and load up on scraps of the squiggly dried noodles, which pile up in bins beneath the assembly line. California farmers are feeding farm animals grape-skins from vineyards and lemon-pulp from citrus groves. Cattle ranchers in spud-rich Idaho are buying truckloads of uncooked french fries, Tater Tots and hash browns. Alfred Smith of Garland North Carolina says he's paying about $63 to feed a single pig for five or six months before it goes to market - up 13% from last year. Dwight Hess, a cattle feedlot operator in Marietta, Pa., says that it costs him about 65 cents to put a pound on a steer, up from 42 cents last year. Number Working with Disabilities Rise M.P. McQueen, WSJ 5-01 Disabilities among American workers are growing at an accelerating pace, prompting employers to accommodate more maladies in the workplace, according to new government and industry studies. The problem is increasingly related to unhealthy lifestyles, including poor eating habits and lack of exercise, insurers and researchers say. Also, an aging work force and rising rates of obesity lead to ailments such as back pain, knee and hip injuries and diabetes. Recipients of Social Security Disability Income grew 4.4% to 6.8 million last year, and was up 51% over the past decade, with women filing claims at nearly twice the rate as men, according to an analysis of federal data by the insurance industry group. The warning: When checking out of a hotel, never return the room key card! The myth: Computerized hotel key cards are routinely imprinted with guests' personal information, including names, addresses and credit card numbers. The truth: Hotel companies and law enforcement agencies have said repeatedly that such information isn't put on the cards. How it started: In 2003, a Pasadena police detective spread the warning without checking its veracity. (David Colker, LA Times 5-27) The jump in U.S. gasoline prices this year has drained consumers of an extra $20 billion, or about $146 for each passenger car in the country, the Government Accountability Office has found. The national price for regular unleaded gasoline hit a record $3.22 a gallon last week, up $1.05 since the beginning of February, Energy Department surveys show. (LA Times 5-27) Alan F. Skrainka, chief market strategist at Edward Jones, says he expects inflation for all of 2007 to total 2.4%. Historically, he said, when inflation runs at less than 3%, stocks sell at an average price-to-earnings multiple of 17.6. Currently, stocks in the S&P500 index trade at a multiple just below that, one reason that Mr. Skrainka says stocks, despite a sustained rally, are still not overvalued.(Norm Alster, NY Times 5-27) In the 12 months ended April 30, the stocks of companies in the S.& P. 500 that had above-average international exposure advanced by 16 percent, noted Jeremy A. Zirin, senior equity strategist at UBS Wealth Management Research. Those of companies with below-average international business gained just 8 percent. “That’s a sustainable trend for the next one to two years,” Mr. Zirin said. (Norm Alster, NY Times 5-27) With 89% of S&P500 reports in hand, Thomson Financial calculated that earnings in the first quarter were running 10% higher than in the same period a year earlier. As recently as April 1st, Wall Street’s consensus prediction for first-quarter earnings growth was 3.7%. (Jeff Sommer, NY Times 5-13) Manpower tapped more than 2,400 U.S. employers and nearly 37,000 organizations worldwide for its second annual look at talent supply. And for the second year in a row, sales representatives ranked toughest to hire. Teachers, managers/executives, truck drivers, delivery drivers and accountants also repeated from the 2006 U.S. list. Manpower also learned that 41% of the employers — both domestically and globally — report difficulty filling jobs because of a lack of available talent. A separate survey released recently by Monster Worldwide and Development Dimensions International found 51% of 1,250 hiring managers globally reported finding fewer qualified candidates than two years ago. (Joel Dresang, Milwaukee Journal Sentinel 5-13) According to Morningstar, energy-focused funds have returned an average annual 26% and 21%, respectively, over the trailing three- and five-year periods. Only real-estate funds have topped those numbers. (Rob Wherry, WSJ 5-01) To appreciate just how friendly the dollar has been to U.S. investors with money overseas, consider the performance of a Bloomberg index of 500 European blue-chip stocks. That index rose 90% from the end of 2002 through last week, compared with a 71% price gain for the U.S. Standard & Poor's 500 index. But add in the effect of the euro's surge against the dollar in that period, and the rise in the European blue-chip index was 147% when translated into dollars — twice the S&P 500 return. (Tom Petruno, LA Times 5-06) A child cost calculator at http://www.babycenter.com figures that food, clothing and other items set parents back more than $6,000 a year. For two-income families, day care can be a huge cost, the experts agree. Facilities can charge $200 to $400 a week. Baby-sitting costs about $10 an hour, and more if you have more than one child. One needs to add that to the cost of every dinner and a movie weekend night. (Kathy Kristof, LA Times 5-06) At the peak of the Dow in 2000 the US equity yield was 3.2% (based on a trailing price earnings ratio of 31.3 times) and the US 10-year bond yield was 6.5%. Shares were obviously expensive, bonds were cheap; and so it turned out. Now the average P/E ratio in the US is 18 times, producing an earnings yield of 5.5%. The 10-year US bond yield has fallen to 4.7%. Shares are now cheap, despite the dramatic new record on the Dow, and bonds are expensive. (Alan Kohler, theage.com 4-28) Hedge Fund / Private Equity News Briefs In what is believed to be the first study ever to compare performance of multistrategy hedge funds with funds of hedge funds, two Georgia State University professors conclude that multistrategies’ consistently better performance can be boiled down to this: self-selection. Their study, to be published in the Journal of Investment Management, found that between 1994 and 2004, MS funds outperformed FoHFs on a risk-adjusted basis by 2.6% to 4.8% per year net-of-fees, and 3% to 4.1% per year on a gross-of-fee basis. MS funds’ "superior performance," write Professors Vikas Agarwal and Jayant Kale, "continues to hold even when we control for fund characteristic such as size, management and incentives fees, and other conventional control variables." The key difference may be in the quality of the HF managers, as they note that "self-selection" –meaning hedgies decide on their own to become MS managers – is "the driving force behind superior performance." This suggests, write Agarwal and Kale, that "MS fund managers may possess superior abilities compared" to funds of hedge funds. (Hegde Fund Daily 5-10) In the past two-and-a-half years, performance of hedge fund replicators have lagged behind funds of hedge funds, net of fees, according to an internal report by an executive at Liability Solutions. The specialist hedge fund consultant, Global Pensions reports, found that since October 2004, the Partners Group Alternative Strategies trailed Hedge Fund Research’s HFR FoHF Index, and the S&P500, though it did perform better than the HFR Investable Hedge Fund Index. "The argument for hedge fund replicating strategies is that they are able to access much of the average hedge fund return in a safe, transparent, liquid, regulatory friendly, capacity unconstrained, cheap manner," Phil Irvine, director of advisory solutions at LS, told Global Pensions. "The statistics so far do not prove whether this is possible. Irvine pointed out that the replicators underperformed on both a risk-adjusted basis (Sharpe ratio) and on an absolute basis "if the HFR FoHF returns are adjusted for the lower than headline fees available for an institutional investor." (Hegde Fund Daily 5-08) Ed Easterling, president of Dallas-based Crestmont Research, and also a professor at Cox School of Business at SMU, has compiled data for a paper titled Hedge Funds: Myths & Facts. Among the myths he attempts to debunk: that hedge funds don’t outperform equity benchmarks (he says comparisons should be not only with stocks but also bonds, as investor portfolios include both); that 10% to 20% of hedge funds fail every year (he says the figure includes attrition, not just failures); and that hedge fund performance is artificially high because of survivor bias, whereby hedge funds stop reporting funds that perform poorly (he says best performers don’t’ report returns at all). (Hegde Fund Daily 4-23) Home Page Previous Factoid Top Sites
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