Fundmastery Blog

Kurt Brouwer January 28th, 2009

Here is a chart based on data from the Congressional Budget Office. It illustrates how much of the $825 billion stimulus package that just passed the House of Representatives will be spent in 2009, assuming the bill goes through as written:

Data: Congessional Budget Office; Chart: ReadtheStimulus

I’m all for economic stimulus during this recession provided it is implemented very quickly — that is this year — when the economy could use a boost. If government spending kicks in during the recession, it stimulates demand and could certainly help reduce the downturn.

But, if spending does not kick in until well after the recession ends, then it will just contribute to inflation and will needlessly increase government debt and the budget deficits in the future.

The Congressional Budget Office report estimates the impact of the stimulus as follows:

Assuming enactment in mid-February, CBO estimates that the bill would increase outlays
by $92 billion during the remaining several months of fiscal year 2009, by $225 billion in
fiscal year 2010 (which begins on October 1), by $159 billion in 2011, and by a total of
$604 billion over the 2009-2019 period…

In addition to the $92 billion in spending there will be $77 billion in tax cuts hitting in 2009. The good news is that some of the proposed $825 billion economic stimulus package will take effect this year. Unfortunately, much of it will not. But, the report makes it clear that most of the stimulus spending does not kick in until 2010 or 2011 or even later. Unfortunately, spending in 2010 or 2011 does not help us much and it may even hurt.

The following excerpt from the Vox blog makes the point that stimulus spending has to be done during the recession if it is to be effective. It was done by Nicholas Bloom, a Stanford economics professor, and Max Floetotto, a Stanford Ph.D candidate in economics.

Bloom and Floetotto had done an earlier report in which they forecast a deeper and longer recession. Now, they are a bit more optimistic, but they warn that any stimulus spending needs to be done quickly for it to have a positive effect [emphasis added]:

The Recession Will Be Over Sooner Than You Think (Vox, January 12, 2009, Nicholas Bloom & Max Floetotto)

…Many pundits…are warning that a dire recession is in the offing. We would have agreed with them three months ago; indeed, we wrote a VoxEU column predicting a severe recession in 2009; based on the analysis of 16 previous economic shocks, we forecasted a 3% drop in GDP and a 3 million increase in unemployment in each of Europe and the US with these predictions…

We also worried about a far worse outcome – Europe and the US slipping into another Great Depression due to damaging policy responses. Luckily, using the latest data on uncertainty measures, our model predicts that the worst has been avoided.

Good news: Great Depression II avoided and growth resumes mid-2009

Much like today, the Great Depression began with a stock-market crash and a melt-down of the financial system. Banks withdrew credit lines and the inter bank lending market froze-up. What turned this from a financial crisis into an economic disaster, however, was the compounding effect of terrible policy. The infamous Smoot-Hawley Tariff Act of 1930 was introduced by desperate US policymakers as a way of blocking imports to protect domestic jobs. Instead of helping workers, this worsened the situation by freezing world trade. At the same time policymakers were encouraging firms to collude to keep prices up and encouraging workers to unionize to protect wages, exacerbating the situation by strangling free markets.

In fact economic uncertainty is now dropping so rapidly that we believe growth will resume by mid-2009…

This view that the economy will begin growing this summer makes sense in historical terms. The two previous recessions lasted only eight months and this one is already in its 13th month. Assuming growth resumes in July, the recession would have lasted 18 months or so, which is a little longer than the post-World War II average duration of a recession. If we assume growth does not resume until January 2010, the recession would have been 24 months long and would be one of the longest in history.

So, if the stimulus plan is going to go through and if it really is meant to help in this recession, the majority of the spending will be ineffective because it will almost certainly come after the recession has ended. That’s unfortunate.

• Business , Economy , Geopolitics , Investing , income taxes , inflation
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Kurt Brouwer January 27th, 2009

In the wake of the real estate crunch, mortgage-backed bonds have plummeted in price.  In fact, if you want to lay culpability for this financial crisis at the feet of any security, it would be mortgage-backed bonds, which were bought in the billions by highly-leveraged banks, brokerage firms, insurance companies and hedge funds.  When those bonds tumbled in price, so did those financial institutions that owned them.

Of course, one man’s trash is another man’s treasure.  Now, Wall Street firms, hedge funds, bank trading desks and other professionals are wading back in to the mortgage-backed bond market in hopes of earning high returns.  Recently, the Powershares unit of fund management company Invesco formed a couple of exchange traded funds to help smaller investors profit from this segment of the bond market.  This Wall Street Journal piece gives the tale, with a little bonus information at the end [emphasis added]:

Powershares Goes Bargain Hunting (Wall Street Journal, January 26, 2009, Ian Salisbury)

A lot of people think someone somewhere is going to make a killing buying cheap mortgage-backed securities. PowerShares Capital Management figures that person can be a small investor.

The Invesco Ltd. unit recently filed to launch two new actively managed exchange-traded funds that will invest in bonds backed by pools of prime and Alt-A mortgages, investments at the center of the credit crisis. Alt-A is a category of loans between prime and subprime.

The funds won’t invest in subprime mortgages — the riskiest type — and they also will steer clear of the highest-quality mortgage bonds, those backed by housing-finance companies Fannie Mae and Freddie Mac, which were taken over by the government in September.

The new PowerShares funds, run by a team of five managers from Invesco’s institutional money-management unit, will buy only the slices of mortgage-backed securities that would be paid back first in case of a default, betting that the market panic means prices are “well below fundamental values implied by conservative cash-flow projections,” according to a Securities and Exchange Commission filing…

Before the credit crisis, mortgage-backed securities could, depending on their design, rank among the safest investments available. Bonds comprising subprime or Alt-A loans, those to borrowers with poor or mediocre credit, were backed by a larger number of loans than bonds backed by prime loans, those to borrowers with the best credit.

The system unraveled when default rates rose to levels the market hadn’t anticipated. Even bonds that weren’t overwhelmed by defaults saw resale values plummet because no one trusted the models bankers used to put them together.

Some believe there are now bargains among these types of bonds. Pimco Total Return, the large bond-focused mutual fund managed by Bill Gross, has about 62% of its portfolio in mortgage-backed bonds, although Pimco has favored the safer bonds backed by firms like Fannie and Freddie. Another bond fund, TCW Total Return — run by TCW Group Inc., a unit of Société Général SA — has nearly all its assets in mortgage debt and about 45% in mortgage debt not backed by Fannie and Freddie.

…By proposing a pair of new funds amid such a difficult climate, PowerShares is asking a lot of potential investors. For one, the new funds will lack the track record of a vehicle like Pimco Total Return.

There also could be questions about the new funds’ novel legal structure. ETFs, which are open-end mutual funds that trade on an exchange like a stock, have only recently begun to incorporate active management. Until last year, all ETFs tracked market benchmarks.

In addition, fixed-income ETFs have encountered a number of problems recently, including costly trading spreads and difficult-to-gauge prices…

There are couple of reasons to be cautious about these funds.  First, actively-managed exchange traded funds are quite new and unproven, although certainly the Invesco group is a reputable organization.  Another reason for caution is just that these are brand new funds with no track record as the article points out.

The bonus I hinted at above is that the article did mention Pimco Total Return and TCW Total Return, two mutual funds with lots of experience in this area.  We have not written about the TCW fund before, but Pimco has been covered here quite a bit.  See What Are Bill Gross and Pimco Buying?.

• Hedge Funds , Investing , Money , Mutual Funds , Personal Finance
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Kurt Brouwer January 24th, 2009

Matthew Parris, a former British MP (Member of Parliament) and a current columnist for The TimesOnline [of London] gives us the quote of the day in a recent column [emphasis added]:

…This recession is not a failure of market economics. It is a reassertion of market economics after a decade in which we paid ourselves more than we were producing, and funded it precariously and temporarily by complicated credit instruments that it took a while for the market to rumble...

The last word in the quote is ‘rumble’ and my limited grasp of British vernacular suggests that he meant catch on or grasp. That is, …it took a while for the market to catch on…

In reading Parris’s column I was reminded of the pithy comment variously ascribed to George Bernard Shaw or Oscar Wilde about the language differences between the U.S. and Great Britain. The comment was that we are:

“Two countries divided by a common language.”

• Business , Economy , Geopolitics , Money , Personal Finance , income taxes , inflation
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Kurt Brouwer January 23rd, 2009

Source: Pew Research Center

This report from the Pew Research Center shows how much the current economic contraction has affected public opinion [emphasis added]:

Economy, Jobs Trump All Other Policy Priorities In 2009 (Pew Research Center for the People & the Press, January 22, 2009)

…As Barack Obama takes office, the public’s focus is overwhelmingly on domestic policy concerns – particularly the economy. Strengthening the nation’s economy and improving the job situation stand at the top of the public’s list of domestic priorities for 2009. Meanwhile, the priority placed on issues such as the environment, crime, illegal immigration and even reducing health care costs has fallen off from a year ago.

While it is not unusual for the public to prioritize domestic over foreign policy, the balance of opinion today is particularly one-sided. Roughly seven-in-ten Americans (71%) say that President Obama should focus on domestic policy, while just 11% prioritize foreign policy. By comparison, last January, 56% cited domestic policy as most important while 31% said Bush should focus on foreign policy…

I think the American people are pretty sensible in these priorities and I hope the new administration pays attention.

• Economy , Geopolitics , Personal Finance , income taxes , inflation
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Kurt Brouwer January 21st, 2009

Unlike most investments in 2009, tax-exempt municipal bond funds have had a pretty nice rally. In fact, for the first time in months, investors put more in to muni bond funds than they took out. And, cash was still pouring in as recently as last week as pointed out in this piece from the public finance paper, The Bond Buyer:

…Muni funds that post weekly numbers reported inflows of $737 million for the week ended Jan. 14, the most since the final week of May, AMG Data Services reported last week…

However, my friend Tom Petruno, financial columnist at the Los Angeles Times and blogger at the LAT Money & Co. Blog, points out that the rally may be taking a breather:

Rebound in tax-free muni bonds may be running out of gas (Los Angeles Times, January 21, 2009, Tom Petruno)

The tax-free municipal bond market has had the wind at its back for the last five weeks, driving yields down — and bond prices higher. But that may be changing.

Selling in the muni market has picked up since Friday. Some investors are balking as bond yields have dropped.

In the California muni market, “It’s certainly a lot harder to find a bargain now, that’s for sure,” said George Strickland, a muni bond fund manager at Thornburg Investment Management in Santa Fe, N.M…

The share price of the Vanguard California Long-Term Tax-Exempt Bond Fund plummeted from $11.24 on Sept. 11 to a low of $9.77 on Dec. 16, a drop of 13%. For munis, that’s a big loss in a short period.

From the December low, however, the fund’s share price rallied back to $10.74 by last Thursday, a 10% rebound. On Tuesday the fund fell 0.8% to $10.63, the biggest one-day drop since Dec. 8.

As for interest rates, the Vanguard fund’s estimated annualized dividend yield was about 5.1% at the share price low in mid-December. Now the yield is about 4.7%.

That’s still a good tax-free return, particularly compared with yields on U.S. Treasury securities. But analysts note that one of the factors that triggered selling of munis in early December — worries about the deteriorating finances of many states and municipalities as the economy worsens — hasn’t gone away, even as yields have dropped. . .

I’m not sure I would buy a long-term muni fund, such as the one mentioned above, right now, but I definitely agree that tax-exempt bond fund yields are attractive.

For example, the Vanguard California Tax-Exempt Money Market Fund has a yield that is well below 1% (the latest information on Vanguard’s web site shows its SEC yield at 0.44%). With money markets funds and other liquid investments offering skimpy returns, a tax-free yield of 3% or 4% from a bond fund is a nice alternative for any investor with a longer time horizon.

If buying a California (or New York or any other state) fund seems too risky, then a national tax-exempt bond fund such as the Vanguard Intermediate Term Tax-Exempt Fund would be a logical alternative with a yield of approximately 3.50%.

See also Are California’s Muni Bonds Golden? and Bill Gross & Pimco Like Munis Too.

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