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Personal Finance Blog By MoneyRates - March 2012

Market 'milestone' more hype than substance

February 29, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Media outlets love nice, round numbers. So when the Dow Jones Industrial Average recently closed above 13,000 for the first time since 2008, there was quite a bit of fanfare in the press. The truth is, though, this type of landmark number is usually more hype than a significant measure of market conditions.

Un-curbed enthusiasm

After the Dow closed above 13,000, the Associated Press quoted one institutional investor as gushing that it was "a momentous day for investor confidence," and that the Dow regaining its 2008 level implied "that the financial crisis that we were all losing sleep over, it never happened, because now we're back."

Really? It's as if the financial crisis never happened?

Tell that to the people who are still out of work. Tell that to people whose retirement programs are way behind schedule because of all those years without net gains in the stock market. Tell that to people whose incomes have been crushed by low interest rates on savings accounts.

Three truths about 13,000

The Dow reaching 13,000 really doesn't qualify as "a momentous day." Here are three truths to put this landmark in perspective.

  1. Prices mean less than valuations. The level of the Dow Jones Industrial Average is determined by a collection of prices, and prices alone tell you very little about the condition of stocks. You need to know the valuation of stocks, which is how those prices compare to underlying fundamentals such as earnings, earnings growth rate, net asset value, cash flow, etc. All things considered, it is better for fundamentals to be improving than for prices to simply be higher.
  2. Nearly four years of dead money is nothing to celebrate. Most retirement savings plans are based on assumptions about stock market growth and interest rates. After the stock market has take years to simply retrace its steps, and with interest rates on savings accounts down near zero, those assumptions have been severely disappointed. This means retirement savings still need to dig out of a hole.
  3. Psychological barriers are all in the mind. Fundamentally, professional investors know that crossing 13,000 is no more significant than crossing 12,631 or 13,029, but they justify the hype by calling the round numbers a psychological barrier. That little game is all in the mind. The reality is, prices have no problem at all crashing through those supposed barriers on the way up during a rally, or on the way down during a panic.

So pop a champagne cork if you want, but only if you're in the mood for champagne. If you are looking to celebrate true progress, look for another sign of good news on the employment front, or any sign of good news from Europe, or perhaps an ease back in oil prices. Those things will tell you more about where the market is going than where it has already been.

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The Greek debt deal is not the end of the crisis

February 24, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Agreement on a $172 billion aid package for Greece bought only a mixed reaction from the financial markets. While it might seem that this was the resolution of a threat that has been hanging over the financial world, the markets recognize that this is just the end of a chapter, not the conclusion of the whole story.

One of the challenges of following the economy is that negative shocks can develop quickly, but resolutions tend to play out slowly. So, the European debt saga still has more twists and turns ahead of it, and could have an effect on a number of aspects of U.S. finances:

  1. The US economy. Rising employment numbers are probably the best indicator that the U.S. economy is building momentum, but that economy does not operate in a vacuum. Financial system shocks in Europe could start to freeze up capital here in the U.S. -- an important setback after the Federal Reserve has made increasing liquidity such an area of emphasis in recent years. More fundamentally, slower growth in Europe could affect U.S. exports. At the very least, it doesn't appear Europe as a whole can be counted on as a source of demand growth in the near future. In terms of economic recovery then, the U.S. may have to go it alone -- perhaps with help from Asia.
  2. The U.S. stock market. The U.S. stock market has had a strong rally in recent months, and in many cases prices seem to be responding to improving fundamentals. However, the potential for Europe to be an economic drag could slow that improvement in general. In particular, companies that are heavy exporters (especially to Europe) and large financial companies could be vulnerable to earnings disappointments.
  3. U.S. interest rates. One of two things -- and preferably both -- has to happen in order for rates on savings accounts, money market accounts, and other deposits to start to climb back up from near zero. One is that the U.S. economy has to improve enough for the Federal Reserve to have sufficient confidence to start to raise short-term interest rates, though based on the Fed's extraordinary commitment to low rates, it appears they will err overwhelmingly on the side of caution before letting rates rise. Therefore, the more likely possibility in the near term is that economic activity in the U.S. could pick up enough to raise loan demand. This will make banks hungry for more working capital, and raising savings and money market rates would represent a mild form of bidding war for that capital. As noted above, though, the situation in Europe still could weigh on the U.S. economy, and thus hold back savings and money market rates a little longer.

The European debt crisis is a complicated situation that took years to develop. It is going to take more than one agreement to set it right.

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Payroll tax deal sets tone for election-year finances

February 21, 2012

| MoneyRates.com Senior Financial Analyst, CFA

With the payroll tax deal, Democrats and Republicans finally found some common ground -- namely, that they are both willing to pander in an election year.

A joint committee of the Senate and House of Representatives last week reached an agreement in principle on a measure that would extend both a payroll tax break and unemployment benefits. This agreement still needs to be voted on by the full House and Senate, but if passed it should be popular because it will keep money flowing to tens of millions of Americans. The price will be paid in the future -- and the future is a constituency which has little voice in the immediacy of an election year.

Feel-good measures

The proposed agreement would keep unemployment benefits extended far beyond their normal 26 weeks, and continue a $100 billion partial suspension of payroll taxes that pay for Social Security benefits. There is generally a tendency to pass feel-good measures in an election year, and politicians would be very reluctant to do anything that might impede a fragile economic recovery. While preserving that recovery is a legitimate concern, neither extending unemployment benefits or continuing the payroll tax break should be viewed as an untarnished victory:

  • The move to extend unemployment benefit comes at a time when job growth is improving. It targets special relief for high unemployment states, but given the disparity of unemployment rates among states, shouldn't people be encouraged to move to where the jobs are?
  • While people may love the payroll tax break, they shouldn't forget that the tax was there for a reason. They may find out what that reason was when their Social Security checks come up short somewhere down the line.

Feel-good measures may be inevitable in an election year, but in this case they raise the question of when the economy will be deemed healthy enough to be weaned off its stimulus dependency.

Stimulus dependency

The payroll tax break and extension of unemployment benefits were originally positioned as temporary measures to get the economy through a rough patch. Now, a series of rolling extensions have demonstrated that even temporary measures can be difficult to discontinue.

The same is true of low interest rates. Though the argument can be made that low interest rates on savings accounts and other income-generating vehicles has taken money out of the economy, the Federal Reserve has not only stuck to its low interest rate stance, but has made a multi-year commitment to it.

It's difficult to foresee when politicians and policy makers will have enough confidence to unwind the artificial stimuli that have been built into this economy. Again, those who will pay the price someday -- such as future Social Security recipients -- will generally have their voices drowned out in the present. It may be up to a constituency of those hurt by artificially-low interest rates - people with savings accounts, money market accounts and CDs -- to start to put some pressure on Washington.

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New proposal may give money market accounts an edge

February 15, 2012

| MoneyRates.com Senior Financial Analyst, CFA

A new proposal by the Securities and Exchange Commission (SEC) regarding money market funds makes bank money market accounts look more attractive by contrast -- and underscores the importance of the distinction between money market funds and money market accounts.

Though the similarity of their names makes it easy to confuse money market funds and money market accounts, they have a fundamental difference. The similarity comes from the fact that both generate interest through investment in the money markets, which consist of short-term, income-generating instruments. However, money market funds do this by acting as a mutual fund, with the value of the fund riding on a specific set of investments. Money market accounts are general obligations of banks, and in turn are backed by FDIC insurance.

If the SEC proposal moves forward, this difference will be more important than ever.

The SEC proposal

In 2008, the financial crisis jeopardized the value of some money market funds, triggering a run on those funds that exacerbated the problem. Money market funds have traditionally been held at a stable value of $1 per share, and when the value of some funds threaten to fall below that mark, the federal government stepped in with temporary guarantees to stabilize the markets.

To avoid a repeat of this situation, the SEC now proposes that the price of money market funds be required to fluctuate according to the value of the underlying securities. This would make changes in value clear on a continuous basis, so that the funds would be less subject to sudden shocks if they could no longer maintain a $1 per share value. The SEC would also limit investors to redeeming 95 percent of their holdings at any one time, with the remaining 5 percent not available for another 30 days.

The reality of money market funds

Though money market funds have lost some popularity since 2008, they still represent a $2.7 trillion business. They are widely used by institutional investors as a predictable and liquid source of capital for trading purposes. The proposals to let their values fluctuate and to limit liquidity would significantly reduce the usefulness of money market funds in this capacity.

The reality, though, is that something has to give. Money market funds have tried to do too much in the past -- providing stable values and liquidity while investing aggressively enough to earn returns strong enough to justify fund company fees. This has led to some risky investments that are not consistent with stability and liquidity.

The value of money market accounts

As the mutual fund industry argues bitterly against the SEC's proposal, bank customers should be comfortable in the knowledge that money market accounts are not affected by it. While not suitable as frequent trading vehicles like their fund counterparts, money market accounts remain a source of ready liquidity and stable values. Now if only their interest rates would rise ...

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Now available from Amazon: Economic disappointment?

February 3, 2012

| MoneyRates.com Senior Financial Analyst, CFA

It's a symptom of a mixed economic environment that if a piece of information indicates a trend in one direction, it won't be long before something comes along to contradict it.

Late last month, the Bureau of Economic Analysis released its advance estimate of fourth-quarter 2011 U.S. GDP. This initial look at last quarter's economic strength indicated a real growth rate of 2.8 percent, the strongest reading in a year-and-a-half.

The glow from this encouraging news hadn't subsided before an unpleasant surprise threw a damper on it. Just a few days later, Amazon released a fourth-quarter earnings report that fell well short of analyst expectations. This micro-economic snapshot conflicted with the improving economic environment indicated by the macro-economic GDP report.

Amazon earnings report raises four questions

Of course, individual stocks frequently miss earnings expectations without it signaling a broader economic trend. However, Amazon isn't just any stock. As a retail giant, it is an especially significant bellwether at a time when consumer spending seemed to be enjoying a revival. As an online company, it should be a beneficiary of the accelerating transition of retail sales to the Internet. And yet, with these two winds supposedly at the company's back, its fourth quarter earnings disappointed.

Amazon's revenues, which measure sales volume, fell a billion dollars short of analyst expectations. Further, the company warned that its earnings, which measure profitability, might actually be negative in the first quarter of 2012. This combination of top-line and bottom-line trouble raises some questions:

  1. Is the economy not really recovering as well as hoped?
  2. Is the transition to online sales happening more slowly than expected?
  3. Is Amazon facing renewed competition for market share?
  4. Does Amazon's business model fail to leave room for profits?

Only the first two of these questions -- and especially the first -- raise the prospect of slackening economic growth. The last two questions deal with company-specific issues, which could affect Amazon without hurting the broader economy.

To put this all in perspective, Amazon's revenue did grow by 35 percent. In the world of the stock market, everything is relative and it was only the expectation of even more robust revenue growth that made Amazon's announcement so disappointing. However, if the reason for that disappointment is that consumer spending is weaker than experts expected, the concern about the broader economy could be valid.

Stocks and bonds take separate cues

Recently, the stock and bond markets have been taking different cues from the economy. The stock market has been rallying, which is generally associated with strong growth. Yet bonds also rallied for a time, which is generally a sign of economic weakness, before falling again.

Ultimately, savings accounts will take their cue from the bond market. With interest rates on savings accounts needing sustained growth before they are likely to mount a recovery, trying to make progress in this mixed economic environment is like trying to gain traction on uneven ground.

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