Dealing with an Uncertain Market, US Credit under Fire, and What does $900 Gold Mean?

January 21, 2008

The Barn in the Storm by Stuck in CustomsIn today’s show I give you my thoughts on the broad sell-off that occurred in the financial markets last week. If you need proof that this broad sell-off is nothing new then read an article that I wrote back in October 2002. (click here for a copy) In the article I let readers know that diversification and not letting their emotions get the best of them is the secret to long-term investing. I think it is very interesting that I wrote this article right before the market completely turned things around and we have been reaping the benefits of that bull market (2003-2007).

If anyone ever doubts the power of historic numbers consider the fact that in my article I note that in the first month of market recovery historically the equity markets have increased by 9% and the first 12 months of a recovery have historically resulted in a 26% return. That 26% number is what is amazing to me because in 2003 the S&P 500 returned 28%… That is pretty close to the historic average. Give the article a read and remember that it was written in October of 2002 which is during a period when the market was in a dark period following the losses of 2000, 2001, and 2002.

As I already mentioned, I am not worried about this down turn… I am more worried about the state of America’s addiction to debt and spending. It seems that Washington has gone slap crazy over the last 20-25 years and we are starting to get articles and questions that just might be the wake-up call that our leaders need. As many of you know I am not a Debt-Hater. I think that debt (especially “good” debt such as mortgages and student loans) can be used as tools to bettering yourself or allowing you to capture an appreciating asset. With that said we have stretched ourselves too thin. We need leaders who understand the concern of deficits and what keeps the engine of our country running. Ok let’s get into my discussion points for today’s show:

** Moody’s (credit rating agency) warning our government about future debt concers
** Understanding what the recent run-up of Gold means

I had an individual from one of the Business TV Networks ask me to read this piece and give my thoughts. It seemed crazy to do the research for them and not share my thoughts with you.

Financial Times had an article titled US triple-A credit rating under threat (click here for link) by Francesco Guerrera, Aline van Duyn and Daniel Pimlott

I do believe that our country has some big decisions to make over the next decade. We can continue to ignore our problems or we can choose to correct course, but every day that passes we multiply our problems and make the fixes that much harder. A few key facts to consider:
Social Security

** Within the next 10 years (2017) Social Security will begin to pay more benefits then it takes in from current workers
** For those not in the know Social Security is a pay as you go system. Back in 1965 under President Lyndon Johnson as part of the Great Society program Social Security was changed to withdraw funds from the independent Trust and put into the General fund for additional congressional revenue. It should also be noted that the same act that made this change (Social Security Act of 1965 also created Medicare).
** This dramatic change in policy effectively turned Social Security into a Pyramid Scheme where current young workers pay the benefit of retired individuals. This worked great in the past but now with the graying of our country we will soon have many more retirees than workers.
Healthcare including Medicare and Medicaid
** With the change of our demographics we have also seen a dramatic change in healthcare. Consider as the FT.com article points out Medicare and Medicaid spending now accounts for 45% of total federal spending compared to 25% in 1975
** Somehow we continue to increase benefits. My administrative assistant joined me after she retired from a large company that provided health insurance coverage to retirees. What is unbelievable to me is that once the government offered a prescription drug benefit plan as part of Medicare the company stopped offering her prescription drug coverage. Somehow, the government plan is cheaper and provides additional benefits including a free monthly gym membership. I want to know who is going to pay for all of this with an aging population base and fewer workers.
**Premiums for employer-sponsored health insurance rose less in 2007 than in any other year since 1999, with a 6.1% increase but that still outpaced a 3.7% rise in workers wages and 2.6% general inflation rate (data according to the annual Employer Health Benefits Survey by the Kaiser Family Foundation

Government concern and denial (including Presidential Candidates)

These concerns are not new, but they are finally getting media attention because we are almost to the point of no return. I personally believe that if some type of significant change does not occur soon we will have Generational warfare. There was a 2005 article from the Boston Globe that hinted at this concern with a memo that was leaked to the media from President Bush to his aids stating, It is their responsibility and duty to ensure that they do not create an inter-generational conflict. This was back when President Bush proposed private investment accounts. (http://www.boston.com/news/globe/editorial_opinion/oped/articles/2005/01/14/generational_warfare/

What is unfortunate is that our 2008 Presidential Candidates are not willing to get their hands dirty by telling us what they would do to address the problems with Social Security and Medicare. It is business as usual with one party wanting to increase payroll taxes and the other wanting to adjust inflation increases and add private account options. Unfortunately, we are at the point that these suggestions are not going to be the silver bullets that fix the problem. Let’s face it: the true fix is going to be a mix of lowering benefits, increasing retirement age, and increasing payroll taxes. As everyone knows to be honest about the issue would be political suicide hence Social Security and Medicare being called the 3rd Rail and untouchable.

Article of interest concerning Social Security and Presidential Candidates http://money.cnn.com/2007/11/28/pf/taxes/campaign08_SocSec_proposals/index.htm

Long-Term outlook for the United States

As for the long-term viability of the United States I would not count us out. What has made this such an incredible country is our ability to adapt and create innovation.
** The government needs to transform Medicare into a catastrophic coverage plan by gradually raising the deductible
** Have a honest open discussion about the state of social security

Notable Quote:

“The nearest thing to eternal life we will ever see on this earth is a government program.” Ronald Reagan

The Interesting World of Gold and What does it mean to me and you?

** Now let’s talk Gold and what the recent increase means and will provide us in the future

First a few interesting facts about the timeless Element of Gold:
1) Gold Holdings are held by central banks as a store of value. At the end of 2004 central banks and official organizations held 19% of all above ground gold as a reserve asset.
2) Before the 1970s the US dollar was pegged to the value of Gold. You can thank President Nixon for that change.

Another advisor that is great about keeping me and my partner up to speed on Global Economic activity emailed me commentary that I think is very fitting to talk about today (thanks Russ):

“What Can We Infer From $900 Gold?” by Paul Hoffmeister

** Show Update **
I just bought a new piece of equipment that is going to allow me to use phone calls on the “Money Guy” show. Many of you have written personal finance questions and over the next two weeks a few of you may receive an email from me asking if you would like to talk about your issue on the our show. I would also like to ask for other listeners to write me with their issues that they are willing to share with our listening audience. You can write directly at [email protected]


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