Ups and Downs, Again

Consumer spending was actually higher in July, figures from the Commerce Department showed yesterday, despite the fact that most of the other economic signals we've gotten lately have been down. The rise in consumer purchases of 0.4 percent was the biggest increase since March. At the same time, though, real disposable incomes dropped for the month.

How is that possible? Well, the inflation rate was up slightly, at 1.5 percent. So even though overall incomes were up by 0.2 percent, real disposable income was still off some.

In another sense, what's going on here is that these numbers are all so close to zero that it doesn't take much to push one into the negative while a related one remains positive. If the figures for consumer spending and real disposable income had each come in 0.5 percentage points higher - putting the rise in consumer spending at 0.9 percent and putting income up for the month by 0.3 percent - it wouldn't seem so incongruous. But since they landed on either side of zero, things seem a little off.

Revising the Second-Quarter GDP

The second-quarter GDP figures were revised on Friday, and as expected, they moved sharply lower. Where second-quarter growth had originally been pegged at 2.4 percent, the figure has now been downgraded to 1.6 percent.

Leaving aside for the moment the question of what this means to the economy, you may be wondering: Why did the number fall so far? There are two basic answers:

(1) There wasn't a good measure of the dollar value of imports coming in to the U.S. until July 30. For the second quarter, as we know now, imports rose a whopping 32.4 percent (exports rose a more modest 9.1 percent). The purchase of all those imports doesn't add very much to the American economy.

(2) Much of the economic growth in recent quarters has been the result of businesses ramping up inventories that had gotten depleted, but we didn't see as much of that in the second quarter as originally anticipated. The Commerce Department now estimates inventories as adding 0.6 percentage points to GDP in the quarter, after an initial estimate of 1.1 percentage points.

Changes in Retirement Age

There's been some talk lately that Washington will deal with the upcoming shortfall in Social Security by raising the age which you can retire with full benefits from 65 to 70. But for many people, a later retirement age is already the reality.

Over the past 15 years, Gallup's polling has shown that the number of workers intending to retire at age 65 or older has risen from 44 percent to 61 percent. The number who intend to retire before they reach 65 has dropped from 50 percent to 29 percent. A big reason for these changes is the 401(k), which was designed primarily to give people more control over their retirement savings. But the market declines in recent years have reduced many people's assets to the point that they have no choice but to continue working.

That doesn't have to be the case, of course. With careful planning, most people can retain a certain measure of control over their retirement, including the age at which they'll cease working. If, like most Americans, you're concerned that you'll need to work longer than you'd like to, I'd be happy to talk to you about your options.

Bond Funds on a Roll

The ups and downs of the stock markets in recent years have kept a lot of people from putting their money into equities. But there's still plenty of money to be invested. Where has it been going? The answer is pretty clear: the bond market.

The amount of money put into bond funds exceeded that put into stock funds in June. This was the 30th consecutive month in which bond funds garnered more assets than stock funds. The last month in which equity funds took in more money than bond funds was December 2007 - a month after the recession started.

On the other hand, bond funds still have a ways to go before they catch up with stock funds. There is now $2 trillion held in taxable bond funds and $489 billion in municipal bond funds. But there is still $4.6 trillion invested in stock mutual funds - almost twice as much as in bond funds.

A Housing Relapse

The housing market seems to have fallen through the floor on Tuesday, with single-family home sales slipping to their lowest level in 15 years. Existing home sales fell to their lowest level since the National Association of Realtors began keeping those numbers in 1999, meaning nobody really knows when they were last this low.

In part, this is because of the distortions provided by the homebuying tax credit, which expired on April 30. Home sales were up when people could take advantage of the tax break, and have dropped ever since. Overall, they're projected to be right where they ought to be: The chief economist of the NAR projects that we'll see total home sales of around 5 million in 2010, slightly up from the average of 4.9 million annual sales over the past 20 years.

The larger question at this point is whether the ups and downs of the housing market will be enough to tip the economy back into recession. While that still seems unlikely, the economy won't be back at full strength until at least one of the twin scourges of unemployment and housing concerns reaches the recovery stage.

The New Landscape for Credit Cards

The new credit card regulations, which limited the ways in which credit cards could raise their interest rates, have resulted in an overall increase in rates, as issuers have sought new ways to make money. For instance, your interest rate can't be raised on an existing balance any more. But according to a study from the market-research firm Synovate, the average credit card rate has soared in the past year, to 14.7 percent from 13.1 percent twelve months earlier.

On the other hand, solicitations for credit cards have also been soaring. There were 640 million credit card offers sent to American households in the second quarter of this year. That's up a staggering 83 percent from the same period last year, when there were just 349 million offers.

So even as rates are rising, credit card issuers are still desperate for your business. If you're unhappy with the rates your current card is offering you, just remember, you always have other options.

Can CFOs Pick Stocks?

Many of the means we have for taking the temperature of the economy involve asking people where they think our financial situation is headed. This can take the form of asking run-of-the-mill consumers to answer a consumer confidence survey, or talking to business executives about whether they'll be bring more people in the future.

Strangely enough, a recent survey indicates that the top exec may not have a better handle on certain things. Ever since 2001, Duke University has asked CFOs at major American corporations to predict where the S&P 500 would land over the next 12 months. They were even allowed to give an interval, where there was a 10 percent likelihood the S&P would exceed their upper limit and a 10 percent likelihood it would come in below their lower limit. Even within those parameters, the CFOs could place the S&P 500 within the 80 percent confidence interval only a third of the time.

The point isn't that CFOs are worse than anyone else at predicting the direction of the market. The point is that it's very hard to predict the direction of the market - which is why the best investors tend to be long-term, buy-and-hold proponents like Warren Buffett.

A Simpler Way to Pick Mutual Funds?

There's been a lot of talk in investing circles lately about a recent study showing that the best predictor of performance for mutual funds was the funds' expense ratios, which did the job even better than the famous Morningstar mutual-fund star rating. What's most remarkable about the study is that it was conducted by Morningstar itself.

The fund-rating firm took funds' star ratings and expense ratios from 2005 to 2008 and compared those to its returns as of March 2010. The star ratings did their job - higher-rated funds outperformed lower-rated ones 84 percent of the time. But they weren't as effective as looking simply at the expenses.

In a way, this study fits in with many of the time-tested principles of investing, in particular the idea that you can't beat the collective wisdom of the stock market. And there's no reason to pay high fees to a fund manager if he or she can't outsmart the market with your stock picks.

New Jersey vs. the SEC

The state of New Jersey has settled a case with the SEC, which had charged the state with misleading investors over the nature of how it intended to repay its bonds. At issue was the state's claim that its pension funds for public employees and New Jersey teachers were both adequately funded between 2001 and 2007, which shouldn't have hindered its ability to pay off its bonds.

But the SEC claims that the two pension funds were only well-funded if one presumed that there would eventually be either tax increases or some kind of service cuts to the programs. In other words, it was a problem that the politicians kicked down the road to their successors, who would then be responsible enough to make the pension funds whole in order to meet the state's obligations to its bondholders.

The good news for New Jersey is that there's no penalty or fine to be paid. We just have to comply with the SEC's cease and desist order. But in the future, states are on notice that if they want to sell bonds, they can't just assume that future generations of politicians will come along and clean up whatever mess they left.

The Manufacturing Upswing

There was much made yesterday of the fact that the producer price index showed an increase in July, tamping down fears of deflation. But it may be even more significant that the Federal Reserve' estimated industrial production rose by 1.0 percent in July, after having slipped by 0.1 percent in June. Manufacturing output was up 1.1 percent for July, after falling 0.5 percent in June.

The production of motor vehicles and parts was up a robust 10 percent on the month - the Fed credited the production of light trucks for most of the increase - but even excluding that, manufacturing production was up for the month. Every manufacturing segment was up, except for consumer nondurables, which were unchanged. Total industrial production was up 7.7 percent from July of 2009.

There are still many trouble spots in the economy: new housing permits fell in July, and the number of new housing starts missed the analysts' expectations, though it was still up slightly from June. But a turnaround in manufacturing, if it holds, could be strong news for this recovery.

Life Insurance Controversy

It may sound like a highly technical, nitpicky issue, but there's some real substance behind the National Association of Insurance Commissioners' warning to consumers about how their life insurance is invested. The controversy is over retained-asset accounts, in which beneficiaries receive their payout from a checkbook-like account, with the funds held at the insurer.

That sort of account allows the life insurance company to invest the money for itself while waiting for the beneficiary to eventually draw down the entire sum. On the other hand, with a lump-sum payout, the beneficiary gets both the money to live on and the ability to invest his or her own assets.

The NAIC says the issue is one of disclosure: Life insurance policy holders deserve to know exactly how their payouts will be structured. This is of course true, but you should be fully informed on all your investment products. If you have any questions about the nature of your life insurance, or anything else you're invested in, feel free to give me a call.

The Turbulence of August

Last week in the stock market may have seemed unusually turbulent to investors: The Dow lost 100 points early Tuesday then quickly gained it all back, only to drop by 265 points on Wednesday. While it wasn't a good week for the equity markets, and it's dangerous to read too much into the Dow's short-term movements, it's even more dangerous to try to do so in August.

Why? Because far fewer people, both Wall Street professionals and individual investors, are making stock trades during the vacation-heavy month of August. The Dow's volume peaked last week at 4.5 billion shares traded on Wednesday, and at other times during the week it was almost down to 3 billion. But in a really busy time, there can be more than 10 billion shares traded in a day, as there were at one point last May.

What happens when there aren't very many shares being traded? Smaller moves in the market get magnified. Most stocks don't move a whole lot during each trading day, so the more trades are made, the more likely the Dow's movement will regress to the mean, and be damped down. When there are comparatively fewer trades, swings in just a few stocks can cause the entire market to move. That's part of what we saw last week.

Real Estate Fraud in Lakewood

There are some key lessons to take away from the story of the Lakewood man who bilked investors out of tens of millions of dollars in a real estate scheme, things we should already know but are very helpful to be reminded of:

* If something seems too good to be true, it probably is. The alleged crook, Eliyahu Weinstein, promised his investors huge, immediate payoffs from real estate investments. Do you know of very many people who are making a fortune in real estate right now?

* If something happens for no good reason, it probably happened for a bad reason. One of Weinstein's investors, after pestering Weinstein for a promised payoff, received a wire transfer worth $320,000 from a Lakewood charity called Kars 4 Kids. Why would a real estate investor get his money from a children's charity? There's no good reason.

* Be careful who you trust. Weinstein preyed on the close-knit Orthodox Jewish community, depending on their trust for one another to bring more victims into his schemes. Sadly enough, when it comes to investing, you really can't be too careful, even with friends and extended family.

The Impact of Quantitative Easing

As expected, the Fed announced that it was going to buy Treasury bonds on Tuesday, engaging in the kind of quantitative easing we discussed earlier this week. And still, the Dow fell by more than 250 points on Wednesday. Does that mean the Fed's decision was a bad move? Not necessarily. There are several competing explanations:

* Investors saw the Fed's move as not significant enough to strongly affect the overall economy.

* Investors, anticipating the Fed's quantitative easing, had already factored that into their pricing decisions before Wednesday's drop.

* Bad economic news out of China and Japan, which caused a drop in the Asian markets, affected prices here as well.

All of these certainly had some impact on the Dow over the past couple of days. As is the case most of the time that the Dow has an eventful day, it's hard to pinpoint an exact cause. It's possible the markets didn't like the Fed's move, but there's no way of knowing for sure.

Sales Up, Hiring Flat

A group called the Young Presidents' Organization recently polled business executives on the trends they see developing in their companies over the next 12 months. Their answers help us see how the recovery can continue - albeit at its very slow pace - while unemployment is hardly moving at all.

Nearly 60 percent of the executives expect their sales to be up in the next year, while 34.5 percent think they'll remain the same. Less than 10 percent thought sales would be down. But only 30 percent expect their employee count to go up over the next 12 months; more than 60 percent expect it to remain the same. So many of those executives think sales will increase, but don't foresee extra hiring as a result.

It's interesting to note that this phenomenon isn't limited to the United States. The above figures are solely for the American executives surveyed, but in the YPO global survey, the results were similar. Globally, more than 61 percent of executives expect sales to be up in the next year, but only just over 30 percent expect to be adding to their employee count.

The Fed's Stimulus

Yesterday's hot rumor was that the Fed, which is scheduled to conclude a policy-setting meeting this afternoon, would decide that recent disappointing economic reports warranted some additional fiscal stimulus on its part. With interest rates still at near-zero levels, the question is, what else can the Fed do?

What some investors expect is that the Fed will buy Treasury notes or other securities, in a strategy known as quantitative easing. The purpose is to expand the money supply and, by increasing the number of investors in Treasury debt, lowering the cost of borrowing for the Treasury department. It also provides more money for banks, who then can extend more credit and eventually fund more business activity.

The downside to this strategy - which is sometimes called "printing money" - is that it can lead to inflation. If the Fed does decide to employ quantitative easing, that would be a signal that it has decided that rampant inflation is not such a threat to this economy anymore, or at least not as big a threat to our prosperity as this incredibly slow recovery.

Private Sector Job Creation

Friday's unemployment report was indicative of the glacial pace this economic recovery has been taking. There were only 71,000 private sector jobs created in the month of July, which wasn't enough to change the national unemployment rate of 9.5 percent. It would take roughly 200,000 jobs to affect the unemployment rate; it takes somewhere between 100,000 and 125,000 jobs created per month just to keep pace with population growth.

So 71,000 jobs created per month isn't going to cut it. On the other hand, if you look solely at private-sector job creation, that's the highest number we've had in three months. We've had some screwy things going on with the employment numbers because of census jobs, but in the private sector, recent months look like this:

July: 71,000

June: 31,000

May: 51,000

April: 241,000

March: 158,000

February: 62,000

So the pattern appears to be a lack of a pattern. One step up, and one step back.

Due for a Rebound?

Does the stock market's poor performance in the second quarter of this year portend bigger things ahead? Morgan Stanley has compiled a look back at the quarters since the Great Depression in which the equity markets have lost more than 10 percent overall - as they did in the quarter we just finished - and found that there's almost always a nice bounceback.

Of the ten quarters showing the biggest loss, nine of them showed positive returns over the following year. The one that didn't was the third quarter of 2001, which was followed by a loss of 20 percent over the next four quarters. All ten of those quarters, though, were followed by positive returns over the course of the following five years, as well as over the following ten years - not counting those where ten years haven't passed yet. That's an important qualification, since some of those quarters were from the early 2000s and have suffered through the recent recession. So the history might not be as rosy as Morgan Stanley perceives.

And as we've seen, this market doesn't have much respect for history. It's nice that down quarters have tended to turn into long bull markets, but it's not at all a sure thing.

Keeping Lenders Honest

A followup on an earlier discussion: You may recall that one of the provisions of the new financial reform legislation was intended to hold lenders' feet to the fire by making them hang on to 5 percent of the subprime mortgages they had issued. In the past, these lenders had been able to securitize and sell off all of the mortgages they issued, leaving them with little incentive to worry about whether the loans would ever be paid back.

Now, forcing these people to keep 5 percent of their loans doesn't sound like an awful lot. But in his new book The Big Short, Michael Lewis explains why this small step could make a big difference. In the first wave of subprime lending, in the mid-1990s, Lewis notes that the lenders didn't bother to sell off every last mortgage they issued. These lenders almost all failed, Lewis says, because even keeping a small fraction of their loans proved to be toxic.

So perhaps the new law has a good chance of keeping lenders honest, and prevailing upon them to issue mortgages only to people who are likely to repay them.

Derivatives in Mutual Funds

Is the mutual fund industry too dependent on derivatives? It's a little hard to tell, according to a new letter from the SEC, which says that many funds aren't providing adequate disclosure about their uses of derivatives. As a result of this, the SEC thinks that investors may not be fully aware of the risks inherent in their funds.

The action was triggered by several ETFs coming onto the market that the SEC delayed approval for because they dealt heavily in derivatives. While looking into the ETF situation, the SEC also found that mutual funds either described their derivatives holdings in terms that were "generic" or "abbreviated," or else the information wasn't "consistent with the intent" of the required registration forms. In other words, the mutual funds were trying to get around telling investors what the SEC felt investors had the right to know.

The bottom line here is simple: Don't invest in anything you don't understand. If the mutual fund company can't explain what's in their products, don't assume that they understand them, either.

And Now for the Good News

As we've noted here many times, the customary pattern for this economy has been one step up and one step back. After the GDP numbers took a step back on Friday, we got the upward step on Monday:

* The Institute for Supply Management said its index of manufacturing industries increased in July for the 12th consecutive month. The rate of increase was slightly lower than in June, but slightly ahead of the analysts' estimates. Drilling down into the details, the ISM's manufacturing employment index was up in July for the eighth consecutive month, and that number was also an improvement over June.

* Manufacturing in Europe was also reported improved in July, and several European banks reported strong earnings. All told, the European recovery is proceeding faster than expected, and may quell fears of a double-dip recession over there.

* And while it's very dangerous to read too much into a single day's stock trading, the market seemed to like all this news. The Dow gained more than 200 points - its best showing for the first trading day of August since 1934.

Second Quarter GDP

Friday's report on the nation's second quarter GDP was disappointing: The growth figure came in at 2.4 percent, slightly below the consensus estimate of 2.5 percent. The good news was that the first-quarter figure was revised upward to a solid 3.7 percent, but that also meant that GDP declined by 35 percent in the second quarter from the first.

So were there any positive aspects to Friday's report? There are a couple:

* Much of the previous quarters' growth had been fueled by businesses rebuilding their inventories, which has largely dropped off by now. This was the first quarter in a while where we haven't had that extra boost. So in that sense, Obama Administration economic advisor Christina Romer contends, business growth has been roughly keeping pace.

* Business investment has continued to grow. Investment in equipment and software has grown by at least 20 percent for two straight quarters now.

* The savings rate is at a lofty 6.2 percent, above earlier estimates. So as soon as people start to feel comfortable spending again, they will have a decent amount of money to spend.