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Dear Valued Client,
Little-by-little, things seem to be improving. We've had our own
personal version of economic "green shoots" as Jennifer recently started a job
in community outreach for Borders Books. The job is ideal, as it's part-time
and still allows us to split time between Atlanta and the coast, it's something
that she enjoys and it will help us to contribute our small part to an increase
in consumer spending.
Speaking of consumer spending, some census data was recently released
that highlights falling incomes. In the first article below I relate decreasing
incomes to rising credit and explain the implications of both for economic
recovery.
For the financial planning tip of the month, we return to health
insurance and the importance of examining whether your policy covers the
doctors and prescriptions you use.Lastly, the question of the month covers how bonds might perform
should the economy turn downwards again.
Let us know if you have any questions or suggestions regarding
the newsletter, and please feel free to forward on to family and friends.
To more green shoots for all of us,
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1955: A Financial Dividing Line?
Micah Porter, CFA
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It’s not often that I run across an article or data that
crystallizes a situation for me quite as well as census data that was recently
released. The data showed there was a stark economic divide in America, which
was summarized in a USA Today
article:
The dividing line between those getting
richer or poorer: the year 1955. If you were
born before that, you're part of a generation enjoying a four-decade run of historic income growth. Every generation after
that is now sinking economically.
The census data the article refers to is in the table to the
right. There were a number of factors cited for falling income, including
several that are likely structural in nature as opposed to transitory. In any
event, my first thought aft er seeing this data and reading the article was
“where did the money come from then?” After all, there was no shortage of high
dollar cars on the road, custom built homes and fantastic lofts in the city and
the apparent wealth wasn’t limited to those groups that saw an increase in income.
It’s purely subjective, but I suspect if you were to compare the
outward appearance of wealth to that of 20 years ago, there’d likely be no
comparison - to an outsider, we as a society would likely have appeared far
more prosperous in 2006 than in 1986.
The obvious answer to how one can enjoy a rising standard of
living without a rising income is, of course, credit. Rates were historically
low throughout much of the decade, and many lenders ensured that underwriting
standards were lowered to match rates. Most everyone was pleased for a time.
Consumers could “bring the future forward” and make purc hases that would be
impossible without credit, while lenders saw profit skyrocket as they borrowed
cheap and lent dearly. The chart to the left, from GMO, illustrates both the
explosion of debt as well as the financial profits that inevitably followed.
As we look towards recovery, this credit binge exerts a downward
pull in two ways. First, there will be those consumers that simply won’t be
able to repay their loans. As a result, financial profits will drop and in some
cases financial institutions will become insolvent.
The second issue involves
many of those that can repay their debt. In aggregate, if wages have fallen but
debt service has gone up, consumer spending will be impacted. As I’ve discussed
many times in past newsletters, consumer spending is the core of the U.S.
economy and has a disproportionate impact on the global economy - as long as it
remains at depressed levels, a robust recovery will require drivers other than
the American consumer.
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Financial Planning Tip
Choosing Among Healthcare Plans
Micah Porter, CFA
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A
reporter from Dow Jones recently contacted me for an article she was writing on
selecting health insurance coverage during what is traditionally the open
enrollment period for employees. Specifically, she wanted to know if we provide
advice to our clients on this topic. I explained that as comprehensive
planners, we do - and we then talked about what factors we consider when
looking at various coverage options.
Aside
from the advantages that HSAs provide to some, we discussed a recent experience
I've had in looking at coverage options for retired Georgia teachers. Unlike
many retirees, Georgia teachers don't directly participate in Medicare, but
rather participate in a program in which Medicare provides payment to private
insurers who administer the plan. The documentation sent out provides good
advice regarding a starting point - beyond simply comparing premiums - for
anyone considering health insurance options. They are:
* Check to see
if the healthcare providers you use participate in the program
* Confirm that
medications you take are included in the formulary, and what the costs for
those medications will be
After
comparing premiums and confirming the answers to the questions above, you should
have a good idea of which coverage is most suitable for you. At that point, you
should then delve further into policy details to ensure that you have the
coverage you need. If we can help you in doing this, don't hesitate to contact
us.
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Client Question of the Month
How Safe are Bonds in Another Downturn?
Micah Porter, CFA
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Typically, bonds are considered safer than stocks during an economic downturn. Last year was an anomaly, as concerns weren't about an economic downturn as much as they were about the entire system. Because of this, many investors opted to forego credit risk altogether and invest in U.S. Treasures. As a result, aside from Treasuries, most bond sectors saw sharp drops in value that were extremely unusual.
Equally as unusual are the rallies most bond sectors have staged this year - they have been extremely sharp, in some cases more than recovering last year's losses. If the economy does hit a rough patch again, two factors will have a large impact on how bonds behave. The first factor is the riskiness of the business issuing the bonds, and second is inflation.
As to the former, we've focused on higher credit quality businesses, such that just a small portion of portfolios are invested in high yield bonds, and of that, investments are concentrated in the higher grades of high yield. Thus, while a downturn could adversely impact bond fund values, the impact should be a good deal less than that in the stock market. Regarding the risk of inflation, in a downturn in which wealth is decreasing and credit is constrained, it's hard to see inflation gaining a foothold in the near term. Thus, it's likely that low interest rates will be with us for some time, and bond values will not be impacted by rising rates over this period.
Thus, the bottom line is that bonds are likely to follow their historical tendency and be safer than stocks. Furthermore, by ensuring that there is an adequate cash reserve and CD ladder to cover anticipated cash needs for several years, fixed income investments should have time to recover should another downturn occur and lead to falling bond values.
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