Plan To Live Longer Than You Think

Aurum Weekly Access - 2/27/2015

By Michael McKeown, CFA, CPA - Director of Research

In the 1800s, old age was considered making it to 40.  At the beginning of the 20th century, life expectancy was 47 years old.  A baby born today will live to 79 years old on average, and perhaps much longer, as biotechnology and medical research funds pour into anti-aging treatments.

There are researchers all over the country seeking the holy grail.  The Buck Institute in San Francisco has quintutupled the life span of laboratory worms. Google even is in the mix with its California Life along with Craig Venter, the first person to sequence the human genome.  These groups are not just seeking to extend life spans, but improve the ‘health span’ of individuals.    “Drugs that lengthen health span are becoming to medical researchers what vaccines and antibiotics were to preivous generations in the lab: their grail.  If health span research is successful, pharmaceuticals as remarkable as those earlier generation drugs may result.”

There is a lack of retirement readiness endemic in the United States today.  Most people are not prepared to fund retirement given current life expectancies, let alone if these increase.  Economist Barry Bosworth looked at data from the Brookings Institute that showed how life expectancy changes based on wealth.  In fact, it can be much longer than average for those with above average income and assets.  The charts below lay this out in detail.

 
What the above charts show is the average 55-year old in the top income decile will live another 35 years to age 90 for both men and women.  This compares to the median income decile projection of 85 and the bottom decile at 80-81 (for men and women, respectively).

We consistently see clients underestimating how far in the distance their own mortality actually is.  The scenario analysis our firm goes through projects life expectancy out to ages 90 to 100, as even a couple with both spouses at the age of 65 have a one in five chance of at least one living to age 95.   All of this has consequences for savings, spending, estate planning, and more.

What can people do to stay on track for retirement and ensure they do not have to drastically scale back lifestyle or be concerned about running out of money in retirement?  In two words: Save More.   Applying a consistent process to saving makes this habitual.  The table below lays out a checkpoint based on income, age, and baseline assumptions on income replacement during retirement. 
 
 

Source: JPMorgan Guide to Retirement

The table provides a decent starting point for benchmarking whether someone is on the right path toward retirement or needs to make adjustments.  The earlier the better for modifications to savings and planning, as even Albert Einstein noted that “compound interest is the eighth wonder of the world.”


If you would like to see more interesting information on savings, longevity, or retirement data, please contact us.

 

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

[1] “What Happens When We All Live to 100?” by George Easterbrook, The Atlantic http://www.theatlantic.com/features/archive/2014/09/what-happens-when-we-all-live-to-100/379338/

[2] JPMorgan Guide to Retirement 2015, page 6. Social Security Administration.

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Tea Leaf Reading with the Fed

Aurum Weekly Access - 2/19/2015

By Michael McKeown, CFA, CPA - Director of Research

According to the ever powerful Wikipedia, tasseography (aka tea-leaf reading) traces back to medieval European fortune tellers who developed readings from splatters of wax, lead, and other molten substances.   Over the years, economists, analysts, and the media often feel like tea leaf readers when decoding the language used in memos and speeches from Federal Reserve members, searching for hints of the next policy move.  Yet this Fed has been quite transparent about its plans, though not everyone believes them this time.

Last week, John Williams of the San Francisco Federal Reserve Bank was interviewed by the Financial Times.  It is a great interview I recommend to all readers. This quote stuck out to me:

“Say the Fed were to raise interest rates later this year, a few times and over the next year or so, interest rates would be above zero, and say the economy slows relative to our expectations and progress on our inflation mandate slows. Well obviously we can slow down the process of raising interest rates. We can even pause for a while, not raise interest rates further. We have a lot of degrees of freedom to adjust our policy dependent on how circumstances develop. It is really important to remember though that monetary policy does work with a lag. Typically our models, our analysis, tells us it takes us a year or two to have a full effect on the economy and inflation.

So let me randomly pick a date out of my head. Say middle of 2015 you started just removing accommodation, well the effects of that on inflation really wouldn’t be felt until mostly until the middle of 2016 or maybe 2017 given the lags in monetary policy.”

Source: CME Group FedWatch, as of 2/19/15

Many large investment firms whose research we still follow have been notoriously wrong at predicting interest rates the last several years.  Why bother read it you may ask?  Well, to get a feel for what the majority of folks may be thinking.  Writing an opinion is easy, it's best to look at where traders placed bets in the Fed funds futures market (chart above).  Investors believe there is an 82% chance that the Fed hikes rates by the end of the year, with the slight majority believing at the last meeting rates will be at 0.75% (from a 0 to 0.25% range today).

In anticipation of the move, the change in interest rates followed similar patterns to previous hiking cycles.  While short-term interest rates increased (the 1-5 year maturity area), longer term maturities (of the 10 and 30-year variety) actually decreased in yield.

 

Source: NBER.org/cycles.html

The expansion of the business cycle reached its 68th month as the previous recession ended in June 2009, making it the fifth largest all-time since 1857.  The chart above demonstrates that cycles are living longer than previous expansions, as each of the previous three made it over 6 years.  We would attribute this to the growth and availability of credit.  While many cite the lack of credit expansion in this cycle as holding it back, banks are in the midst of loosening standards while demand for credit is increasing at the margin.  Still, we should keep this chart handy as the signaling of interest rate hikes marks a key line of demarcation from accommodative monetary policy to tightening policy.

Many of the bond fund managers we use within portfolios forecasted the Federal Reserve’s intention of interest rate hikes in 2015, including Doubleline’s Jeff Gundlach and Guggenheim’s Scott Minerd.  In his note last week, Minerd keyed on St. Louis Fed President James Bullard’s outspokenness on policy over the past few years, including lately.  He wrote, “Whenever ‘lift off’ actually occurs, we’ve been long anticipating this day would come…. The good news is there is still time [for investors] to prepare for when the Fed finally runs out of patience.”

Interest rates seem to be reacting to this rhetoric, and so far closely following  an analog to the “Taper Tantrum” in 2013 (when then Fed Chairman Ben Bernanke uttered the word ‘taper’ in regards to the quantitative easing program).

No central bank has been able to get off the 0% floor, that is, raise rates once the policy rate has been at the lower bound like it has been in the U.S. for the past six years.  Investors will be reading the tea leaves from the Fed closely, as removing accommodation will likely bring volatility to capital markets.

 

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

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Can the U.S. Run a Budget Surplus?

Aurum Weekly Access - 1/30/2015

By Michael McKeown, CFA, CPA - Director of Research

The question may be not as far-fetched as it sounds.  The Congressional Budget Office (CBO) just released its 10-year projections on government spending, revenue, and debt. As Matthew Levine points out, there are major conflicts in its assumptions.  The main one being that “more than all of the projected increase in the US federal budget deficit between now and 2025 is expected to come from higher interest payments on the existing debt.”

This does not jive with nominal growth rates of just 4.2% over the next decade, as the CBO projects, especially if interest rates stay “lower for longer,” as markets believe.  Given the low demand for credit at today’s current price (i.e., interest rates), the scenario of lower rates for longer means that interest expenses could stay low in the future.  This would result in the persistent deficit projection turning into a surplus, perhaps as soon as the 2016 election season.

The new Chief Economist to the Senate Budget Committee may have something to say about that. Stephanie Kelton, Ph.D. is a professor of Economics at the University of Missouri-Kansas City and a thought leader for Modern Monetary Theory (MMT).

The chart below lays out a key component of MMT by a leading founder of this heterodox school of economics, Wayne Godley.  It represents the sectorial balances for three sectors of the economy: the domestic private sector, government sector, and foreign sector.  By definition, these three sectors much sum to zero, since one (or two) sector’s surplus, is another’s deficit.

Source: Stephanie Kelton

According to MMT, we can see that the U.S. government running a deficit was the norm over the last 65 years.  It is a by-product of the system if the private sector and foreign sector are going to acquire assets. Why does any of this matter?  Historically, budget surpluses served as a good signal of an impending rough patch for the economy.  According to MMT economist Randy Wray:

Since 1776 there have been exactly seven periods of substantial budget surpluses and significant reduction of the debt. From 1817 to 1821 the national debt fell by 29 percent; from 1823 to 1836 it was eliminated (Jackson’s efforts); from 1852 to 1857 it fell by 59 percent, from 1867 to 1873 by 27 percent, from 1880 to 1893 by more than 50 percent, and from 1920 to 1930 by about a third. Of course, the last time we ran a budget surplus was during the Clinton years. I do not know any household that has been able to run budget deficits for approximately 190 out of the past 230-odd years, and to accumulate debt virtually nonstop since 1837.

The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929. (Do you see any pattern? Take a look at the dates listed above.) With the exception of the Clinton surpluses, every significant reduction of the outstanding debt has been followed by a depression, and every depression has been preceded by significant debt reduction.  The Clinton surplus was followed by a recession, a speculative euphoria, and then the collapse in which we now find ourselves.

While a surplus may be a few years away, with Kelton on the Budget Committee, she would surely steer away from this policy.  The trend towards a surplus means other sectors (the domestic private and foreign) would have to run a deficit.  With public debt at such a high level relative to GDP and a Republican led Congress preferring a contraction in the deficit, something has to give.

 

Given the shakiness of European and Asian economies, this would be untenable, since many countries and companies with debt denominated in U.S. dollars require a surplus for the foreign sector to meet interest obligations.  That is, unless these countries were able to rebalance their economies to more domestically-based consumption.  In the near term, the strength in the dollar should help those companies and countries with large export exposure to the U.S., such as Germany, Japan, and China.  As for the U.S., it will be interesting to see if a deficit is maintained given the increasing tax receipts from households and corporations.

 

This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

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Quick Emerging Markets View

Aurum Weekly Access - 12/19/14

By Michael McKeown, CFA, CPA - Director of Research

We just came across this great chart from The Economist.  The data is from this past January and shows how the market value of major U.S. companies is comparable to the total market value of a country’s stock market (based on the Morgan Stanley Capital Index (MSCI) local shares, which typically tracks 85% of local stock market listings).

For example, Google is about the size of Brazil’s total stock market value and Nestle the size of India’s. First, these countries have a long runway of opportunity as the winners in the local markets go on to become well recognized multi-nationals and more companies become public.  According to the International Monetary Fund, emerging market economies make up 40% of world economic output, yet the MSCI Emerging Markets Index is less than 15% of the world’s stock market value.  In the short-term, studies show economic growth and stock market performance have zero correlation.  Eventually though, value created through economies tends to intersect with capital seeking growth.

Most recently, the MSCI Emerging Markets Index tested the bottom level of a 5-year range between 900 and 1,100.  The strength in the U.S. dollar against emerging markets currencies is having the biggest effect on performance rather than country specific stock market price moves.

Emerging markets get lumped together for convenience sake, but the countries have many idiosyncratic drivers.  Monetary policy, demographics, natural resources, and more vary greatly as you look at each country.  The fundamentals driving stock price movements may correlate from time to time, such as now.

Previously we wrote about the relative cheapness of emerging markets.  It is important to remember that cheapness, by itself, is not a strong catalyst for near term returns.  It does, however, provide a basis for long-term expectations.  According to the Credit Suisse Global Investment Returns Yearbook, which looks at data over the past 90 years, emerging markets provided a 2% annual excess return premium over developed markets, so patient investors should be rewarded.

 

Important Disclosures
This material is based on public information as of the specified date, and may be stale thereafter. We make no representation or warranty with respect to the accuracy or completeness of this material. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Aurum Wealth Management Group and/or Aurum Advisory Services does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. This material should not be viewed as advice or recommendations with respect to asset allocation, any particular investment, or any tax advice.

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Don’t Be Crude

Aurum Weekly Access - 12/12/14

By Michael McKeown, CFA, CPA - Director of Research

Just a few years ago the theory of “Peak Oil” was making the rounds, that the world would reach a point in the not so distant future that oil reserves would deplete rapidly, sending crude oil prices to the moon.  Fast forward a few years and the shale revolution in the U.S. brought a glut of supply onto the market, combining this with a secular decline in demand (along with several other factors we can only speculate) caused an oil price crash.

 

Food and energy are relatively inelastic purchases by households.  Regardless of price, households must consume these items.  Since energy and food comprise a higher share of income for lower income households,  a lower price at the pump will increase the marginal propensity to consume other goods and services.  Note the jump in sentiment in the bottom third household income tercile (red line) the last few months coinciding with the decrease in gas prices.

 

University of Michigan Consumer Sentiment Survey

Gas prices are the lowest since 2010, a welcome development.  It will be a net positive to gross domestic product with economists estimating a contribution 0.2% to 0.5% to growth in the fourth quarter.

This turns into analysis on inflation, or the lack there of, and the assumption that measures of inflation will fall.  However, it simply is not true, at least for the measure that matters for the Federal Reserve.  The Fed takes a long-term view with its monetary policy and will be looking at the “Core CPI (Consumer Price Index) excluding food and energy.”  The below scatterplot shows no linear relationship between the change in oil prices and the change in core CPI the following year. It does not impact the current year either.

The lower prices are affecting the big exporters negatively.  Many countries will be forced to run a deficit if oil prices stay below the breakeven levels and especially if the decline continues.

Source: UBS, Credit Suisse, Bloomberg, Reuters, IMF, J.P. Morgan Asset Management.

Expectations for earnings growth for the energy sector over the next twelve months are now -8.4% and were only lower in 2008, 2004, and 2002.  In contrast, the sector grew earnings at a positive rate in over 90% of rolling 5-year periods in the last 20 years.  There will definitely be companies that need restructured if the price of oil persists at these levels, yet there will also be winners who weather the storm.

 

Important Disclosures
This material is based on public information as of the specified date, and may be stale thereafter. We make no representation or warranty with respect to the accuracy or completeness of this material. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Aurum Wealth Management Group and/or Aurum Advisory Services does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. This material should not be viewed as advice or recommendations with respect to asset allocation, any particular investment, or any tax advice.

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15 Years of Market Returns

Aurum Weekly Access - 11/28/14

By Michael McKeown, CFA, CPA - Director of Research

It was 1999, the topic of conversation was how the Y2K bug would affect companies, the NASDAQ hitting new highs, and the West Nile Virus first appearing in the U.S. Today we still have computer bugs that more frighteningly look to steal our identity.  The NASDAQ is yet to reach its all-time highs, but is at the highest level since 2000.  And the Ebola virus talk in the media seems to have slowed, as the news cycle moves on to its next headline focus for the next 3 to 6 weeks.

Over the years we have seen ups and downs in markets both domestically and abroad. Rather than look at them year by year, the below sheet breaks down 3 separate 5-year calendar periods, all ending in October (2004, 2009, and 2014 respectively) since it is the latest full month of data we have.

In 1999, not many people expected the next five years to bring -2.22% annual returns to the S&P 500, let alone -7.85% returns for large cap growth stocks (as measured by the Russell 1000 Growth). Likewise few would believe REITs would lead the way from 1999 – 2004, more than doubling with 20.83% annual returns.

Beginning in 2004, institutions really became interested in commodities and index like products.  Since 2004 though, the two sets of 5-year returns for the Dow AIG Commodity Index average out to -1.28% annually.

Shifting forward to October 2009, U.S. equity indices were barely positive over the trailing 5-year period due to the 2008-09 bear market.  International markets held up well and emerging markets crushed returns as China and others stimulated their economies.  Few would predict that the following five years, U.S. markets would take the lead followed by international and lastly, emerging markets.

Fixed Income returns were a little better than starting yields as interest rates fell in each of the five-year periods.  For example, municipal bonds returned 7.19%, 4.15%, and 5.26% annualized in the five-year periods ending in 2004, 2009, and 2014.

Why take a look at data this way?  As we discussed back in January, many allocation decisions are made looking backward at returns rather than forward, using valuations as a starting point.  This often leads to performance chasing and avoidance of opportunities.  Of course, 1999 was a peak in the domestic stock market and a trough in 2009, with many areas of the globe offering opportunity in between.  It will be interesting to see how the asset class hues shake out for the 2019 column.

 

Important Disclosures
This material is based on public information as of the specified date, and may be stale thereafter. We make no representation or warranty with respect to the accuracy or completeness of this material. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Aurum Wealth Management Group and/or Aurum Advisory Services does not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. This material should not be viewed as advice or recommendations with respect to asset allocation, any particular investment, or any tax advice.

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Aurum Access: King Dollar

By Michael McKeown, CFA, CPA – Director of Research

Over the last four months, the U.S. dollar increased against foreign currencies and put downward pressure on precious metals. While oil also fell, its correlation to the U.S. dollar index was actually positive, indicating the oversupply and capacity issues were the driver of its fall.

Gold, Gold Stocks, Oil vs. US Dollar

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Midterms & Stock Market Performance

Aurum Weekly Access - 11/3/14

By Michael McKeown, CFA, CPA - Director of Research

The midterm elections do not seem to be generating a lot of buzz. Perhaps it is me though, not watching the nauseating cable news channels or the general apathy of the nation towards politics, except for watching House of Cards.

The S&P 500 price index is up an average of 17% from Nov 1st to October 31st following midterm election years since 1966. Over the last twelve midterms, there have been zero subsequent down years for the equity market.

Midterms & Stock Market

 

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The Fund (Almost) Everyone Owns - PIMCO Total Return

Aurum Weekly Access - 10/3/14

By Michael McKeown, CFA, CPA - Director of Research

It is the most widely held bond fund in the world and likely shows up in your 401(k) plan, your brokerage account, or in the endowment of the investment committee you advise. At its peak, the fund held nearly $300 billion in assets and with separate account vehicles, the total strategy assets were reportedly over $500 billion. On Friday, September 26th, PIMCO's founder and Co-Chief Investment Officer Bill Gross resigned. He was the lead portfolio manager on the PIMCO Total Return fund since its inception in 1987 and often nicknamed the "Bond King".

Due to his departure, $23.2 billion of net assets left the fund in September. While the media loves the gossipy details of the story inside PIMCO, the consultants and advisors that recommended the fund are scrambling to save face. How could steady underperformance and an embarrassing discontent within the organization go unnoticed by the very people compensated to know these things?

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Must Watch Bond Charts

Okay, love may be a strong word to describe these colorful data points plotted below. But I do not think investors are paying these enough mind. Everyone has said interest rates will rise, usually generically referring to the 10-year bond. Investors crowded into short duration bonds to avoid a rise in interest rates. Interestingly from a year ago, what area actually had a tougher time? The short duration bonds (blue line, orange dots). Note that the 2-7 year area of the curve all rose relative to 1 year ago. The 10-year and 30-year yields are both lower. 092414yield curve This is a chart of bond prices for CCC-rated companies. These are companies having a tough time making payroll with 50% defaulting within five-years of issuance. Investors are so starved for yield that they are paying above par for the privilege of lending to these junk rated companies!  Since 1986 according to Standard & Poor's, the cumulative default rate over a 5-year period for this group is 50%, making this area of the corporate bond market a very risky proposition at today's prices.

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