Spring Cleanup

March 11, 2018

by Steve Stofka

Today time springs forward. Tufts of grass turned green, and some trees are beginning to bud. It was still light after 6 P.M. even before the time change. Great flocks of cranes fly north. In the springtime evening we can hear the siren call of the booby headed tax deadline.  2017 IRA contributions are due by April 15th.

This is a good time to check our game plans. Are we saving enough? In the accumulation, or pre-retirement, phase, 10% or more of our income is a good savings goal. 5% is an absolute minimum. Savings should be used to pay down any debt that has an interest rate more than 5%. High interest rate loans are a weight we must drag around with us. Consider working part time for a while and using that money to pay down high interest rate debt.

New car loans now average over $30K with an average maturity (length of payment period) of 67 months. The average interest rate is 4.21% but anyone with less than a FICO score of 690 is paying 5% or more. This article has breakdowns by credit score, lending institution, length of loan, and other factors.

Of the money we have saved – any annual portfolio realignments to be done? This is a good time to not only think about it but to do it.

In the distribution phase of a portfolio, we begin to withdraw funds from the portfolio that we have accumulated through a lifetime of saving.  Using Portfolio Visualizer, I’ve compared two portfolios with a 60/40 mix – 60% stocks, 40% bonds and cash.  These backtests include an annual rebalancing that may be more difficult for funds in a taxable account because buying and selling may generate taxable capital gains.

Let’s pretend a person retired in May of 1998 at the age of 68 and just died last year. During this twenty years, there were two times when the stock market fell 50%. The beginning year 1998 is near a high point in the stock market. The ending year 2017 was the 8th year of the current bull market. The test begins and ends at strong points in the market cycle, a key feature of a test like this.  Beginning a backtest with a trough in the market cycle and ending with a peak only distorts the results.

Portfolio

At the time of retirement, our retiree had a $1 million portfolio, although the amount could have been $100,000 or $10 million.

Portfolio6040

Although the stock allocation is the same for both portfolios, Portfolio 2 is totally simple. Put all the money in Vanguard’s Total Stock Market fund and forget about it. Portfolio 1 manually diversifies the 60% stock portion of the portfolio among four classes: Large capitalization, mid cap, small cap value stocks in the U.S., and European large cap stocks. Think of Goldilocks sitting down to a table with four bowls of soup – big, medium, small and European.  If that person retired today, a diverse stock portfolio would include an emerging markets index fund like Vanguard’s VEIEX.  In 1998,  emerging markets were not part of a core portfolio as they are today.  For this test, I left out emerging markets.

The bond portion of the portfolio is an index fund of the total bond market. Both portfolios hold 10% in cash for emergencies and living expenses.

Income

A portfolio is like snow in the Rocky Mountains that melts and flows toward the Pacific Ocean. Will the water make it to the ocean? Each year this retiree withdrew 4% of their portfolio balance for expenses. That percentage is considered safe during most twenty-year retirement periods. Note that some advisors are using a thirty-year retirement period to test a portfolio mix. As the years go by and the purchasing power of a $1 erodes, will 4% be enough to meet a retiree’s income needs? The more diverse portfolio allowed the retiree to withdraw a larger amount every year, and the annual withdrawal did keep up with inflation.  Secondly, the ending balance was about the same as the beginning balance after adjusting for inflation.

PortfolioWithdrawal6040

Return

The more diverse Portfolio 1 (marked complex in graphic below) has a better return over this twenty-year period. See the Internal Rate of Return (IRR) column, which adjusts for the withdrawal amounts each year.

PortfolioReturns6040
The drawdown, or greatest decline in value, in the time series is a critical test of a portfolio mix. The retiree needs that portfolio to generate a certain amount of income every year. If the portfolio falls to zero, the income stream has dried up. In the chart below, look at the dip in the portfolio value during the 2008 Financial Crisis. The more diverse Portfolio 1 (blue line) dipped below the starting $1 million figure, but not by much. The investor who was 100% invested in the stock market, the 500 Index portfolio (yellow line), fared the worst during most of the twenty-year period.  In a sign that the bull market has matured, the 500 Index has overtaken the simple 60/40 mix (red line) and is about to overtake the diversified 60/40 mix (blue line).

PortfolioGrowth6040
The diverse portfolio is not complex. There are no gold or commodity assets, no energy or natural resource funds, and no real estate REITs to manage.  If emerging markets were added to the Goldilocks mix, there would now be five equal bowls of soup, each of them taking 12% of the portfolio. This portfolio would have earned 4/10% better each year.

PortfolioEM6040

We could add a Pacific stock index like Vanguard’s VPACX to the mix, but when do we stop adding indexes? In this time period, that index had a slight negative effect on returns. As the number of indexes grow, we are less likely to adjust our allocation.

Our portfolios can get cluttered and too complicated to be effective and easily managed.  Can we simplify?  It’s worth a look see. In taxable accounts, de-cluttering and re-balancing can generate taxable capital gains, so it might not be advisable to make any changes.

Labor Languishes

March 4, 2018

by Steve Stofka

Next week, the White House intends to impose tariffs on imported steel and aluminum. China subsidizes their core building industries. When global demand for China’s products wanes and inventories build, Chinese industries can sell at reduced costs, a practice known as “dumping.” Although the Commerce Dept. has warned China about dumping, the lower prices do benefit a range of U.S. industries but hurt U.S. steel manufacturers, who have endured both lower demand and unfair pricing competition from China.

Following the announcement, the Dow fell back 3%, wiping out Thursday morning’s gains. The prospect of tariff wars sent global stocks down later that night and the following morning. China’s stock index fell 6.5% for the week and Japan was down more than 4%. On Friday, the U.S. market experienced wide swings but settled nearly flat for the day and down 3% for the week.  Opinions vary on the long term consequences.

Let’s turn to a trend that has developed since China was admitted to the World Trade Organization (WTO) in 2001. A year ago two BLS economists presented a historical estimate of labor’s share of yearly GDP since World War 2. If GDP is $100, how much went to the people who produced that output?

The authors describe it: “The labor share is the percentage of economic output that accrues to workers in the form of compensation. It is calculated by dividing the compensation earned during a certain period by the economic output produced over the same period.” The paper is intended for an academic audience, but I will extract some disturbing highlights. First of all, the graph.

LaborShareOfGDP

Note the sharp decline after China was admitted into the World Trade Organization (WTO) in 2001. Some economists have concluded that half of the decline can be attributed to the mobility of computerized capital. Firms can produce a $100 of output with less labor and more of this mobile capital.

Labor in the U.S. is gradually being converted into capital. A business owner may be able to cut his labor costs by buying a machine. A rule of thumb in some industries is a two-year payback period for an investment of this type. Let’s say an owner can save $50,000 per year in labor costs with a machine. Using the two-year rule of thumb, they would not want to pay more than $100K for that machine.

During the past two decades, Asian factories have greatly improved their manufacture of such production machinery and the lower labor costs in Asian makes the machines cheaper. Quality up, costs down. It makes economic sense for more American business owners to replace some of their workers with machines. Before replacement: $100 output by the firm took $65 of labor and $20 of capital and included a profit of $15. After buying the machine, the figures might look like this initially: $100 of output by the firm costs $60 of labor, $25 capital, $15 profit. The $5 that used to go to an American worker now goes to a company in Japan and a bank in America that financed the purchase of the machine.

That laid off American worker bought stuff in their local community. Their sales and property taxes supported the services provided by the community. Although the machine may need maintenance and repairs, it doesn’t spend money regularly in the community, nor require community services like schools, police and medical care.

Donald Trump was elected President based on his claim that his administration would reverse this two decade trend.  The tariffs announced this week will have a small beneficial effect on workers in those industries because steel and aluminum manufacturing have become much more automated in the past twenty years.  The aluminum tariff will add about 1 penny to the cost of a can of beer. The tariffs are a symbolic nod to a campaign pledge that Trump made to those in the rust belt.

I applaud Trump for remembering his campaign pledges.  Professional politicians have long understood that campaign pledges are rhetoric that must fall to conflicting political alliances. Six months after taking office, most pledges have been broken or quietly slipped to the rear of an administration’s porfolio.  Trump has not forgotten the voters who put him in office, but he does have trouble maintaining a consistent stance on gun policy or immigration.  Keep those seat belts buckled.

The Puff

February 25, 2018

by Steve Stofka

Each week I’m hunting scat, the data droppings that a society of human beings leaves behind. This week I’m looking for a ghost ship called the Phillips Curve, a relationship between employment an inflation that has had some influence on the Federal Reserve’s monetary policy. The ideas and policies of others, some long dead, have a daily impact on our lives. I’ll finish up with a disturbing chart that may be the result of that policy.

A word on the word “cause” before I continue. As school kids we learned a simplistic version of cause and effect. Gravity caused my ball to fall to the ground. As kids, we like simple. As adults, we long for simple. As we grow up, we learn that cause-effect is a very complex machine indeed. The complexity of cause-effect relationships in our lives are the chief source of our disagreements.

So, “cause” is nothing more than shorthand for “has an important influence on.” The dose-response mechanism is a key component of a causal model in biology. If A causes B, I should be able to give more of A, the dose, and get more of B, the response, or a more frequent response.

Let’s turn to the Phillips Curve, an idea that has influenced the Federal Reserve’s monetary policy since it was proposed sixty years ago by economist A.W. Phillips. Simply stated, the lower the unemployment rate, the higher the inflation rate. There is an inverse relationship between unemployment and inflation.

Inverse relationships are everywhere in our lives. Here’s one. The lower the air temperature, the more clothes I wear. I don’t say that air temperature is the only cause for how many clothes I wear. There is wind, humidity, sex, age and fitness, my activity level, social protocols, etc. While there is a complex mechanism at work, I can say that air temperature has an important effect on how many clothes I wear. If I measure the varying air temperatures throughout the year and weigh the amount of clothes that people have on, I will get a strong correlation. High temps, low clothes.

Now what if the temperature got colder and people still wore the same amount of clothes? I would need to come up with an explanation for this discrepancy. Perhaps there never was much of a relationship between air temperature and clothes? That seems unlikely. Perhaps clothes fabrics have been improved? I would need to look at all the other factors that I mentioned above. If I could find no difference, then I would have to conclude that air temperature had little to do with clothes wearing. Headlines would herald this new discovery. Important areas of our economy would be upended. Retail stores would stop stocking coats or bathing suits a few months in advance of the season. Businesses around the country who depend on warm weather clothing would go out of business.

Unlike air temperature and clothes, the relationship between inflation and employment is two-way. The change in one presumably has some influence on the other. During the 1970s, inflation and unemployment both rose. The hypothesis behind the Phillips curve posits that one should go up when the other goes down. Some economists threw the Phillips curve in the trashcan of ideas. Milton Friedman, an economist popular for his lectures and his work on monetary policy, proposed a concept we now call NAIRU. This is a “natural” level of unemployment. If unemployment goes below this level, then inflation rises.

Some economists complained that NAIRU was a statistical figment designed to fit the Phillips curve to existing data. Economic predictions based on the Phillips curve have been consistently wrong. Still, the Congress has mandated that the Federal Reserve maintain “maximum employment, stable prices, and moderate long-term interest rates” (Federal Reserve FAQs). Economists at the Fed must consider both employment and inflation when setting interest rates. The models may not accurately describe the relationship, but many will instinctively feel that the relationship, in some form or another, is valid.

For the past several years, the economy has been at or near maximum employment. In January 2018, the unemployment reading was 4.1%. Whenever that rate has been this low, the country has either been at war or within a year of being in recession. The puzzlement: only lately have there been signs of an awakening inflation.

Because inflation was below the Fed’s 2% benchmark while unemployment declined, the Fed kept its key interest rate near zero for seven years. For its 105 year history, the Fed has never kept interest rates this low for as long as it did. Low interest rates fuel asset bubbles. Such low rates cause people and institutions who depend on income to take inappropriate risks to earn more income. The financial industry develops and markets new products that hide risk and provide that extra measure of income. We can guess that these products are out in the marketplace, waiting to blow up the financial system if a set of circumstances occurs. What set of circumstances? We will only know that in the rear view mirror.

Here’s a chart that tracks price movement of the SP500 ETF SPY for the past twenty years. I’ve shown the tripling in price that has occurred during the past five years.  Notice the long stalk of rising prices. That growth has been nurtured by the Fed’s policy.  Well, maybe this time is different.  Maybe not.

SPYPF20180223

The Un-Crash

February 18, 2018

by Steve Stofka

The stock market did not go down 4% this past Wednesday.  It could have. The annual inflation reading for January was above expectations and confirmed fears that inflation forces are heating up. January’s retail sales report was also released Wednesday. It showed the second weakest annual increase in the past two years. If consumers are moderating their spending a bit, that would counteract inflation pressures.  Instead of dropping 2 – 4% on Valentine’s day, the SP500 went up 2.7%.

The labor report and the retail sales report each month have a significant sway on the market’s mood because they measure how much people are working and getting paid, and how much they are spending.

On a long-term basis, I think (and hope) that consumers will remain relatively cautious in their use of credit. Families today carry a higher debt burden relative to their income. By 2004, household debt levels had surpassed their annual level of income. As housing prices continued to rise, many families overextended themselves further and paid a horrible price when jobs and housing prices declined during the recession.

Families during the 1960s and 1970s carried far less debt relative to their income. People saved their income and bought many items when they could afford it. High inflation in the late 1970s and more relaxed lending standards in the 1980s helped cause a shift in thinking. Why wait? Charge it. Businesses learned that consumers are more likely to spend plastic money than real money. Consumers were encouraged to take another credit card. Buy that new car. Your family deserves it. We have a good interest rate for you.

Following the recession, families have kept the ratio of debt to income at a steady level, so that their debt is slightly below the level of their annual income. Prudent consumers will help keep inflation in check.  Here’s a chart of the debt to income ratio.  See how low it was during the decades after World War 2.

BuyingPower

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Housing

In the past year, tenant groups in California have been lobbying to loosen rent control laws in that state. You can read about it here (Sacramento Bee). To illustrate the economic pressures on many middle-class California residents, I’ll show you a few graphs. The first one is per capita income in six cities. All of them are above the national average. San Francisco and New York top the income list, followed by Denver, Chicago, Los Angeles and Dallas.

PerCapIncomeMSA

Now I’ll divide these income figures by an index of housing costs, the largest expense in most household budgets. In the past few years Chicago has edged into the top spot.  San Francisco is still in the top 3, but has shifted downward as housing costs have climbed.  The housing adjusted income of Los Angeles has dropped even further below the national average.

PerCapitaIncomeHousingMSA

Feeling the fatigue of keeping up with escalating costs, some Angelenos are reaching out to their local politicians for help. Some have thrown up their hands and left the state.

Stress Test

February 11, 2018

by Steve Stofka

The recent market correction, defined as a 10% decline, has been a real time stress test for our portfolios. There hasn’t been a stock market correction since the 11% drop in December 2015 to January 2016. Because the end of January was near the height of the stock market, you can more easily find out how much your portfolio declined relative to the market. As of the close Friday, the SP500 had fallen 7.2% since the end of January. That is your benchmark. Later in this blog, I’ll review a few reasons for the decline.

You can now compare the decline in your portfolio to that of the market.  If you use a personal finance program like Quicken, this is an easy task. If you don’t, then follow these steps:
1) Write down your January ending balances at your financial institutions, including any savings accounts or CDs that you own.
2) Write down the current balances and calculate the difference in value since the end of January.
3) Divide that difference by the balance at the end of January to get a percentage decline.

For instance, let’s say your balances at the end of January added up to $100K and your current balance is $95K (Step 1). The difference is $5K (Step 2). Your portfolio has declined 5% (Step 3) compared to the market’s 7.2%, or about 70% of the market. If the market were to fall 50% as it did from 2000-2002 and 2007-2009, you could expect that your portfolio would fall about 35%. Are you emotionally and financially comfortable with that? A safety rule of investing is that any money you might need for the next five years should not be invested in the stock market.

The next step is to compare the gains of your portfolio in 2017 to the market’s gain, about 24%. The gain should be approximately the same as the loss percentage you calculated above. If the gain is slightly more than the losses, you have a good mix.

The chart below compares two portfolios over the past ten years: 1) 100% U.S. stock market and 2) 60% stocks/ 40% bonds (60/40 allocation). Notice that the best and worst years of the 60/40 portfolio are nearly the same while the best year of the 100% stocks is 10% less than the worst year.

StressTest2008-2017
The 60/40 portfolio captured 80% of the profits of the 100% stock portfolio ($101,532 / $128,105) but had only 60% of the drawdown, or decline in the portfolio. Compare that with the chart below, which spans only nine years and leaves out most of the meltdown of value during the Financial Crisis. There is no worst year! La-di-da! Investors who are relatively new to the stock market may underestimate the degree of risk.

StressTest2009-2017
The 60/40 portfolio captured 58% of the profits of the 100% stock portfolio ($152,551 / $262,289) but the drawdown was 63% (11.15% / 17.84%).  If the drawdown is more than the profits, that doesn’t look like a very good deal for the 60/40 portfolio, does it?  That is how bull markets entice investors to take more risk than might be appropriate for their circumstances.  Come on in, the water’s fine!  An investor might not see the crocodiles. Markets can be volatile. This has been a good reminder to check our portfolio allocation.

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Why?

So, why did the market sell off? Let me count the ways. It began on Friday, February 2nd, when the monthly labor report showed an annual gain of 2.9% in hourly wages. For much of this recovery, economists have been asking why wage growth was sluggish as unemployment fell. Economists who like their idealized mathematical models don’t like it when reality disagrees with those models. Finally, wage growth showed some healthy gains and the market got spooked. Why?

As wages take more of the economic pie, profits decline. Companies respond by raising prices, i.e. higher inflation. As interest rates rise, there are several negative consequences. Companies must pay more to borrow money. Fewer consumers can afford mortgages.  Homebuilders and home improvement centers like Home Depot and Lowe’s may see a decline in sales. Car loans become more expensive which can cause a decline in auto sales. There is one caveat: even though hourly wages increased, weekly earnings remained stable because weekly hours declined slightly.  Next month’s reports may show that inflation concerns were overestimated.

This past Monday, ISM released their monthly survey of  Non-Manufacturing businesses and it was a whopper. 8% growth in new orders in one month. Over 5% growth in employment. These are two key indicators of strong economic growth, and confirmed  the fears stirred up the previous day’s labor report. Inflation was a go and traders began to sell, sell, sell.

For the past year, market volatility was near historic lows. Volatility is a measure of the predictability of the pricing of SP500 options. A profitable tactic of traders was to “short” volatility, i.e. to bet that it would go lower. There were two exchange traded funds devoted to this: XIV and SVXY. Traders who bought XIV at the beginning of 2017 had almost tripled their money by the end of the year. When volatility tripled this past week, the whole trade blew up. People who had borrowed to make these bets found that their brokers were selling assets to meet margin calls.  Within days, XIV was closed and investors were given 4 cents on the dollar. SVXY may soon follow. Investors had been warned that these products could blow up. Here’s one from 2014.

The stock market is both a prediction of future profits and a prediction of other investor’s predictions of future profits! The prospect of stronger interest rate growth caused traders to reprice risks and returns. Much of the impact of the selling this past week was in the last hour on Monday and Thursday, when machine algorithms traded furiously with each other. The last hour of trading on Monday saw an 800 point, or 3% , price swing in just a few minutes. In the closing ten minutes of that hour, Vanguard’s servers had difficulty keeping up with the flow of orders.

Contributing to the decline were worries over the government’s debt.  The new budget deal signed into law this week will likely increase the yearly deficit to more than $1  trillion.  There was soft demand for government debt at this week’s Treasury bill auction.  Even without a recession in the next ten years, the accumulation of deficits will increase the total debt level to about $33 trillion.

This correction is an opportunity for the casual investor to make some 2017 or 2018 contributions to their IRA. Profit growth is projected to be strong for the coming year. The correction in prices this week has probably brought the forward P/E ratio of the SP500 to just below 20, a more affordable level that we haven’t seen in few years.

 

Smackdown

February 4, 2018

by Steve Stofka

We tell ourselves stories. Here’s one. The stock market fell over 2% on Friday so I sold everything. Here’s another story. After the stock market fell 2+% on Friday, the SP500 is up only 21% since 2/2/2017. Wait a second. 21%! What was the yearly gain just a few days earlier? 24%! Yikes! How did the market go up that much? Magic beans.

Here’s another story. Did you know that there has been a rout in the bond market? Yep, that’s how one pundit described it. A rout. Let’s look at a broad bond composite like the Vanguard ETF BND, which is down 4% since early September, five months ago.  The stock market can go down that much in a few days. Bonds stabilize a portfolio.

Two stories. Story #1. The Recession in 2008-2009 produced a gap between actual GDP and potential GDP that persists to this day. To try to close that gap, the Federal Reserve had to keep interest rates near zero for almost eight years and is only gradually raising interest rates in small increments.

Story #2. The Great Recession was an overcorrection in a return to normal. The GDP gap was closed by 2014. Here’s a chart to tell that story. It’s GDP since 1981. I have marked the linear trends. The first one is from 1981 through 1994. The second trend is an uptick in growth from 1995 to the present.

GDP1981-2018

What do these competing narratives mean? For two years the economy has been growing at trend. Should the Federal Reserve have started withdrawing stimulus sometime in 2015, instead of waiting till 2017? Perhaps chair Janet Yellen and other members were worried that the economy might not sustain the growth trend. A do-nothing incompetent Congress could not agree on fiscal policy to stimulate the economy.  The extraordinary monetary tools of the Federal Reserve were the only resort for a limping economy during the post-Recession period.

Ms. Yellen’s last day as Fed chair was Friday. She served four years as vice-Chair, then four years as chair. During her tenure, she was the most powerful woman in the history of this country. She was even-tempered in a politically contentious environment. She kept her cool when  testifying before the Senate Finance Committee.  A tip of the hat to Ms. Yellen.

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Performance

Vanguard recently released a comparison of their funds to the performance of all funds.

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Good Times

January 28, 2018

by Steve Stofka

Since the passage of the tax bill about a month ago, the stock market has risen 8%. Some people are convinced that only those at the top own stocks. Any market gains go only to the rich, they say. In the most recent of an annual Gallup survey, 54% of households reported that they directly owned stocks and stock mutual funds (Gallup).  Before the financial crisis, 65% reported direct ownership of stocks.

Private and public pension plans, as well as variable annuity life insurance plans, invest a great deal in stocks. When indirect ownership is added to the mix, a whopping 80% of the stock market is owned by households (Business Insider ). The fortunes of the stock market affect most people, even those on the margins of our economy.

A quarter of companies in the SP500 have reported earnings this month. Annual earnings growth is 12% (FactSet ). In response to the new tax law, companies are bringing home their overseas cash profits and paying Federal taxes on the repatriated profits. Most are predicting strong profit growth for the coming year. Home Depot announced that they are paying bonuses to all their employees.

Since the tax law was signed, the dollar has dropped 5% against the euro. This will make U.S. exports cheaper and more attractive to overseas markets. A euro of profit earned in the Eurozone market was worth $1.07 a year ago when Donald Trump took the oath of office. That same euro is now worth $1.24. Half of the profits of SP500 companies come from overseas, and investors are betting that the dollar will not strengthen substantially in the coming year, despite Trump’s insistence that he likes a strong dollar.

The first estimate of GDP growth, announced Friday, was 2.6%, down from the above 3% performance of the 2nd and 3rd quarters but much better than the 2% and lower rate of growth during 2015 and 2016. The growth of business investment has accelerated over the past four quarters and is nearing 7%.

NonResInvest

Consumer spending grew by 3.8% in the final quarter of 2017, and confidence is near twenty-year highs. Accelerating business investment and a rising stock market help those on the margins of the economy. Unemployment is low. As companies struggle to find employees, they turn to those that they might have turned away a few years ago.

My checker at Target last week had a slight speech defect.  A few years earlier, Target management might have put this person on some duty that did not have such frequent contact with the public, if they hired such a person at all.  Unless there is a specific outreach program, many companies are reluctant to hire those with impediments when there are many able-bodied candidates to choose from.  I was glad to see this twenty-something man employed.

At my local Home Depot a few weeks ago, a guy in a motorized wheelchair helped me locate an item. I got my question answered. Good for him, good for me, good for Home Depot.

A rising tide lifts all boats.  Every day the ever-upward stock market convinces scores of people that they are really smart investors. Many who buy “on the dip” are rewarded as they take advantage of a short term price decline. Some who timidly stayed in cash become convinced that they were too conservative.  They may listen to the market gains enjoyed by their co-workers, family and friends, and feel left out.  How to catch up?  They could take out a home equity loan and use the cash to buy stocks, some leveraged ETFs, or maybe some bitcoin.  Some of those have been on a tear lately.  Hmmmm…

Here’s the thing about a rising tide. A lot of ideas make sense while riding a good tide.

 

Free Stuff

January 21, 2018

by Steve Stofka

I like the 21st century. I get a lot of free stuff. Opinions, news and information, and directions to anywhere on the planet. Free apps and games for my phone. Free porno and free sermons.

I get so much free stuff that I can afford to pay for fancy coffee and smart phones, television and internet access. I can now afford a personal guru to align my chakras. My personal assistant, Alexa, listens to me and answers my questions.

Goodbye and good riddance to the 20th century with its clunky records, cassettes and DVDs. I say “Alexa, play me blankety-blank song,” and millions of tiny electrons do my bidding, and out comes my song!

My real personal income has doubled since 1973 (Average per capita income ) so I got all this extra free money. I’m getting paid more at work than 45 years ago. My total compensation has gone up 44% (Total real compensation per employee ). My employer provided benefits have doubled (Real employee benefits ). My employer kicks in more free money into my retirement program, and into my health care insurance. That’s real dollars, after inflation.

I got so much extra free money coming in that I’m living like royalty. My income has gone up 100% in 45 years, but my spending has increased 137% because I’m a first class 21st century person that banks want to loan money to.

Outlays1973-2017

Since 2000, I eat out a lot more – like 75% more (Real restaurant sales ). I deserve it cause I’m making all this extra money and I’m too busy to cook. In 2000, I was spending $11.50 a day for shelter but I needed more personal room and modern conveniences. Now I got more room but I’m spending $16 a day.

HousingCostRealPerCap2000-2017

Living first class means that I’m saving a lot less of my free extra money.  45 years ago, I was saving 12% of my income.  Now it’s 3%. But there’s an easy fix to that. More free stuff!
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Farming Communities

This past summer, my wife and I joined the many thousands of solar eclipse watchers who visited western Nebraska, where the totality and length of the eclipse was near its peak.  At hotels, shops and restaurants we were greeted with a cordiality that is typical of Nebraskans.  They worked extra hours to accommodate the influx of visitors. At one restaurant, our waitress remarked that the extra business would make up for the slack earlier in the year.  The reason?  Not the food and service, which were both excellent. The locals weren’t eating out as much. And why was that?

Last week, I wrote about the seven-year downturn in commodity prices that has affected many rural communities.  Although agriculture contributes about 6% to GDP (USDA) the changing fortunes of the people who produce our food gets little attention in urban areas.

A few hundred miles away, Denver is booming.  Gentrification and rising housing costs have stressed the pocketbooks of some families.  In Nebraska, it is declining prices that have caused stress fractures in the community (Denver Post ). Land values declined 4% in 2015, and another 9% in 2016 (U. of Nebraska-Lincoln report).

Despite a strong export market for corn, soybeans and other agricultural products, Iowa has had falling land prices for three years. In a recent survey, 40% of responding Iowa farmers reported lower sales in 2017.  However, there was a slight uptick in land values this past year and the hope is that the Iowa agricultural community may be turning a corner.

As land values decline, banks lower lending limits, refinancing terms become more strict.  Families sit at the kitchen table and try to pay higher bills with less money.  Property taxes decline so that there is less money for schools and other public infrastructure.  Seeing the stress that their parents face, younger folks are attracted to urban areas where there is more economic opportunity.  Farms that have been in the family for several generations get sold to large farm management companies.

The governors of western states must understand that they serve all the people of their state.  As people concentrate in the urban centers, they demand more resources from the state.  Those in rural areas feel as though they are being left out.  They will form elective coalitions within state legislatures to offset the growing urban power.

To those in the dense population centers of the coastal states, the shifting political and economic alliances in the fly-over states might earn a shrug.  Our federalist system of voting was a grand bargain to offset the dominance of high population states.  The 2016 election was a good lesson in the power of electoral federalism.  State and federal politicians must build a bridge that crosses the divide between the fortunes of those in urban and rural areas.

Ten Year Review

January 14, 2018

by Steve Stofka

To ward off any illusions that I am an investing genius, I keep a spreadsheet summarizing the investments and cash flows of all my accounts, including savings and checking. Each year I compare my ten year returns to a simple allocation model using the free tool at Portfolio Visualizer. Below is a screen capture showing the ten-year returns for various balanced allocations during the past several years.

10YrReturn20180112
The two asset baskets are the total U.S. stock market and the total U.S. bond market. A person could closely replicate these index results with two ETFs from Vanguard: VTI and BND. Note that there is no exposure to global stocks because Portfolio Visualizer does not offer a Total World Stock Asset choice in this free tool. An investor who had invested in a world stock index (Vanguard’s VT, for example) could have increased their annual return about 1.3% using the 60/40 stock/bond mix.

I include my cash accounts to get a realistic baseline for later in life when my income needs will require that I keep a more conservative asset allocation. An asset allocation that includes 10% cash looks like this.

10YrReturnStkBondCash20180112
In the trade-off between return and risk, a balanced portfolio including cash earns a bit less. In 2017, the twenty-year return was not that different from the ten-year return. From 2009 through 2011, ten-year returns were impacted by two severe downturns in the stock market.

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The Hurt

Falling agricultural prices for seven years have put the hurt on many farmers. This decade may turn out to be as bad as the 1980s when many smaller farms went belly up because of declining prices. Remember the Farm Aid concerts?

The Bloomberg Agriculture Index has fallen about 40% over the past five years. While farmers get paid less for their produce, the companies who supply farmers with the tools and products to grow that produce are doing reasonably well. A comparison of two ETFs shows the divergence.

DBA is a basket of agricultural commodity contracts. It is down 33% over the past five years.
MOO is a basket of the stocks of leading agricultural suppliers. The five-year total return is 31%.

The large growers can afford to hedge falling prices. For family farmers, the decline in agricultural prices is a cut in pay. Imagine you were making $25 per hour at the beginning of 2017 and your employer started cutting your pay bit by bit as the year progressed? That’s what its like for many smaller farmers. They work just as hard and get paid less each year.

Long-Term Trends

January 7th, 2018

by Steve Stofka

This week I’ll look at a few long-term trends in the marketplace for goods and labor.  Millennials born between approximately 1982 – 2002 are now the largest generation alive. Their tastes will dominate the marketplace for the next twenty years at least.  In the first eighteen years of the new century, change has been a dominant theme.

Some businesses drowned in the rush of change. A former member of the Dow Jones Industrial Average, the film giant Eastman Kodak is a shadow of its former self after it emerged from bankruptcy in 2013.

Some in the music business complain that the younger generations don’t want to pay for music. Much of YouTube music is pirated material and yes, Google, the site’s owner, does remove content in response to complaints. There’s just so much of it. Album sales revenue in the U.S., both digital and physical, fell 40% in the five years from 2011 to 2016. Globally, the entire music business has lost 40% in revenues since the millennium and is just now starting to grow again (More).

Some in the porn industry make the same complaint as those in the music business. As online demand for porn grew, the industry helped pioneer digital payment security. Now there is too much free porn on the internet. Producers and distributors pirate each other’s content. Who wants to invest in good production values only to see their work ripped off? (Atlantic article/interview on the porn industry) Will the lack of quality reduce demand? ROFL!

An ever-diminishing number of city newspapers struggle to survive. Some complain that people don’t want to pay for local news. Local reporters have long been the bloodhounds who sniff out the corruption in city halls and state capitols around the country. There are fewer of them now.  Think that corruption has been reduced?  ROFL!

Surviving bookstores glance over their shoulders at Amazon’s growing physical presence in the marketplace. This year Amazon became the 4th largest chain of physical bookstores. The large book publishing houses try to preserve their hegemony as readers turn to a greater variety of alternatively published books.

As online sales grow, brick and mortar stores struggle to produce enough revenue growth to sustain the costs of a physical store.  During the past three years, an ETF basket of retail sector stocks (XRT) is down almost 10%.

Hip-hop music was a fad of the ‘80s and ’90 until It wasn’t. Rock ‘n Roll was a fad that has lasted sixty years. In the early 60s, the Beatles were told to make it rich while they could, and they worked hard to capitalize on their success before it fizzled. Never happened.

How are we going to predict the future if it is so unpredictable? Some standards fade while some fads become standards. We face the past, not the future, as the future sneaks up on us from behind.

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Employment

A few notes on what was the weakest employment report of the past year. Job gains were only 150K as reported to government surveyors but the percentage of businesses responding to the survey was particularly low. Expect the BLS to revise those job gains higher next month when more of the survey forms come in. I have long used an average of the BLS numbers and ADP’s estimate of private job gains. That average was 200K – a healthy number indicative of a growing economy.

The long-term trend remains positive. The annual growth of total employment should be at 1.5% or above. We are currently holding that threshold despite the loss of jobs to automation and the growing number of Boomers retiring.  Growth in construction jobs  remains at or above the growth in total employment – another healthy sign.

ConVsPayemsGrowth

The employment market faces a long-term challenge as the largest generation of workers in history is retiring. In January 2000, 69 million adults were out of the labor force. That figure now stands at 95 million. As a ratio, there were 53 adults not in the labor force for every 100 adults with a job. Now there are 65 adults for each 100 workers.

NotInLabForceVsPayems

Although growth in hourly wages is at 2.5%, weekly paychecks have grown 3% as part-time workers get more hours or find full-time jobs. Look for inflation to approach that growth in paychecks.

WeeklyEarnVsInflation

When inflation rises above paycheck growth, workers struggle more than usual to balance their income with spending.  I’ll use that same chart to highlight some stress points during the past decade.

WeeklyEarnStressPoints

As the economy continues to improve, the Fed is expected to continue increasing interest rates either two or three times in the coming year.  After a decade of zero interest rates (ZIRP), those with savings accounts may have noticed that their bank is paying 1% or more in interest.  It is still a far cry from the 4% to 5% rates paid on CDs in the ’90s and 2000s.  This past decade has been particularly worrisome for older folks trying to live off their savings.