About 25 years ago one of my clients gave me some advice that has produced one of my biggest treasures.  At the time, my two daughters were very young.  My client suggested that I buy one of the technology marvels of the early 80’s – a video recorder and use it frequently to record family events.  In those days, the recorders weighed about 50 times more than present day recorders and carried a battery charge for only a couple of hours.  The tapes were those big ones too.  Well, both of my daughters happened to come home this weekend, and we watched some of those old tapes.  We relived some great family times.  Not all treasure is measured in dollars and cents. 

An excerpt from a Barrons On line interview with Scott Minerd, chief investment officer of Guggenheim Partners. Asset inflation—and then what?

THESE ARE TURBULENT TIMES, as evidenced by the huge gains forged by the Republicans in last week’s mid-term elections. For some perspective on a host of economic and investing matters—including suggestions on tax policy and asset allocation—Barron’s spoke with Scott Minerd, chief investment officer at Guggenheim Partners. The firm, based in New York and Chicago, has about $84 billion under management, the majority of it in fixed income for institutional and wealthy clients. Minerd, 51, a CPA who graduated from the University of Pennsylvania’s Wharton School, has a deep understanding of the fixed-income world, having been an early player in areas like structured-credit products. He’s overseen fixed-income credit trading in the U.S., Europe and Asia at Credit Suisse; he was also a managing director at Morgan Stanley. Among his related interests: financial history and macro economics.

Minerd: Mark Twain said that history doesn’t repeat itself, it just rhymes. And the events we are experiencing today look a lot like the same experiences that we had in the 1930s. There are lessons to be taken away from the 1930s that are useful in evaluating both policy and markets today. The lesson that we learned in the 1930s was not to run a restrictive monetary policy and not to allow protective barriers to go up against trade. Those have been the two things that I have kept my eye on throughout the ongoing financial crisis.

And what are you seeing?

There is no doubt that the chairman of the Federal Reserve, Ben Bernanke, is a student of history himself and is very aware of the monetary accidents of the 1930s. And as the chairman of the Federal Reserve during this period, his worst nightmare would be for the United States to fall into a debt-deflation spiral. Therefore, he is engaging in a series of policies that are creating excess liquidity in the system, relative to the mistake that was made in the 1930s. That will probably be sufficient to keep the United States from falling back into a recession. However, he is also setting the stage for events, both in the near term and the long term, that will have a dramatic impact, ultimately, on a lot of things in the United States, including asset prices and interest rates.

That sounds very ominous.

Well, in the near term, with so much liquidity available, asset prices will rise for a number of categories, particularly financial assets like stocks and bonds and commodities. That’s a bull market, which most people enjoy. But in the long run, after an extended period with low interest rates, which I believe the Fed will be able to engineer, the question becomes: How do you reverse this aggressive monetary policy without having a financial accident? And I don’t believe that the Fed will be able to pull that off successfully without some sort of a massive problem down the road. It is the problem that will occur in the next decade. And, in all likelihood, the ultimate outcome will be a paradigm shift in the way we view money. There have been five paradigm shifts in the last century on the definition of money. And it is not unusual for central banks and governments to make a shift when the problems become so big that they can’t resolve them within the financial system they created.

So you see a very tough decade ahead?

I actually think this decade is a great opportunity for investing—that is, for people who buy high-quality stocks and investments in select categories of fixed income, especially areas like high yield, and in commodities. The bull market in gold, as George Soros has said, is the mother of all bubbles, and we are still in the early stages of a bull market that will probably go on for another decade. So there are lots of opportunities for people to make money. But in most of the asset classes where people could make money, investors are afraid to get involved. That includes equities.

So while you see trouble longer term, in the meantime there are some good opportunities to make money for now?

Right. I ultimately call this the anti-currency trade. What you really don’t want to do is, at the end of the day, get stuck holding a lot of financial assets. But in the near term, because the rising tide of liquidity from the Federal Reserve is lifting all the boats—except for the boats with the holes in them, which I refer to as real estate—you can take advantage of this liquidity shift to make a lot of money over the next five to 10 years.

What is your assessment of the Federal Reserve’s decision last week to purchase $600 billion of U.S. government bonds, otherwise known as Quantitative Easing 2?

QE2 is a very blunt instrument. It is an attempt on the part of the Fed to raise asset prices in the categories where it can re-inflate. The wealth effect of increasing asset prices should help stimulate consumer demand. There’s also the incremental disposable income which can come from mortgage refinancings, if rates remain low. So in some ways the Fed essentially is handing out a subsidy or a tax cut.

Presumably financial assets worry you over the long term?

If you believe that we could ultimately end up in an inflationary spiral, any financial asset becomes a concern to me.

Where should the rest of the portfolio be?

The balance should be split between equities and certain categories of fixed income. In equities, we like U.S. large-cap, dividend-paying companies, with maybe about 10% of your equity holdings allocated to emerging markets.

Why the emphasis on U.S. equities, as opposed to emerging markets?

From a value standpoint, equities are very attractive. When you look at the earnings yield on equities relative to bonds, U.S. equities are exceptionally cheap. There is also a pretty solid uptrend in earnings growth in the United States. And given that the dollar is so cheap, this is probably not the pivotal moment to be diversifying away from the dollar. But it would be imprudent not to have an allocation to the emerging markets, because within the next 20 to 30 years China, India and Brazil are likely to account for a much larger percentage of the world market-cap.

STOCKS CLIMBED TO THEIR highest levels in 26 months, with the Dow Jones Industrial Average reaching its highest peak since Lehman Brothers’ collapse set off a world-wide financial crisis. Now what could possibly Sherpa stocks higher?

Last week’s 3.6% gain was delivered on the backs of two long-anticipated events: Republicans seized control of Congress in the midterm elections, and the Federal Reserve said it will pump $600 billion into our economy, by buying roughly $75 billion worth of Treasury securities per month through next June. It also helped that manufacturing activity expanded in October and the U.S. economy added 151,000 new jobs, the best showing since April.

Several catalysts are needed to extend that high, the first of which involves tax policy. “With 36 different tax programs set to expire on Jan. 1, some clarity is needed on any potential extensions of part or all of the tax cuts,” notes a well known Wall Street strategist. Traders are already counting on an extension, and this strategist’s call for 2.2% economic growth next year, for example, could be slashed by half if the Bush tax cuts were allowed to expire.

Also, “confidence remains more subdued than it could be, especially as way too many Americans believe that the country is headed in the wrong direction,” he adds. A persuasive plan to cut our deficit and chip away at the government’s ballooning debt burden might surprise skeptics and could help restore economic confidence in the long run. The president’s commission for deficit reduction will report on Dec. 1.

Meanwhile, corporate America must squeeze greater earning power from today’s hospitable interest rates. Standard & Poor’s 500 companies are on track to earn a weighted average of $85 a share in 2010, according to Thomson Reuters. While analysts’ projections for earnings to grow 13% next year to $96 seem rather optimistic, it will take a mere 4% improvement to surpass the previous peak in profitability, when companies earned $88.18 in 2006.

If today’s leaner, meaner companies merely matched their 2006 prowess and earn $88 a share next year, the stock market would be valued at 13.9 times future profits. Only once in the past two decades has the S&P ended a year with a price-to-earnings multiple of less than 14, notes BofA Merrill Lynch strategist David Bianco. That was in 1994, when the Fed was hiking rates and the 10-year Treasury yield was pushing 8%. Today, the Fed is hell-bent on keeping rates low, and the 10-year yield is slumping at 2.5%. Bianco sees S&P profits topping $90 next year and thinks “there’s room for stocks to rally on the earnings outlook alone.”

Of course, valuation multiples and public confidence are so low because our government is burdened with debt, and investors are rightly concerned that much-needed austerity measures will crimp profits in future. That’s why this uncomfortable rally was populated largely by performance-chasing professionals, and even as stocks rose 17% over the past 10 weeks, individual investors yanked more than $39 billion from U.S. stock funds and plowed $83 billion toward bond funds.

The S&P 500 is now 21.7% below its 2007 peak. To close that gap, more investors must believe that stocks offer a viable–or at least cheap—hedge against the inflation that must eventually follow the Fed’s frenzied money printing. As the dollar slid further last week, crude oil and copper rose to 2010 highs, and gold closed in on $1,400 a troy ounce, a record.

The Dow ended the week up 326, or 2.9%, at 11,444. The S&P 500 rallied for a fifth straight week and snagged its ninth gain in 10 weeks. That’s its highest finish since Sept. 19, 2008, and the benchmark is up 9.9% this year. The Nasdaq Composite Index added 72, or 2.9%, to 2579, while the Russell 2000 jumped 33, or 4.7%, to 737 (Source: Barrons Online).

In an unusual week, U.S. Stocks, Foreign Stocks, and Bonds all advanced.  During the last 12 months, U.S. STOCKS outperformed BONDS. 

Source: Morningstar Workstation. Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  Three, five and ten year returns are annualized.  Assumes dividends are not reinvested.

Question:   

My wife and I are trying to do estate planning, but we don’t know how Congress is going to change the law.  My wife and I jointly own a small farm, some investments and a life insurance policy – the grand total value equals $1,400,000.  Do you have any idea of what they are going to do?

Answer: 

Unfortunately, the estate tax picture, as well as the general tax picture in Congress, is about as clear as mud right now. As you may know, the federal estate tax expired Dec. 31, 2009, after Congress was unable to reach an agreement on either a permanent or short-term extension. There is no federal tax on estates if you die this year, but then the death tax comes back with a vengeance on Jan. 1, 2011, with only a $1 million exemption and a 55-percent tax on amounts over that level–unless Congress takes action to change the law. As a result, many individuals, even smaller farms and businesses, could end up paying a bucketful of taxes if the person survives until 2010 and beyond.

Several lawmakers have introduced bills to raise the exemption and change the tax rates. But changing the law won’t be easy. The Statutory Pay-As-You-Go Act of 2010, enacted in February 2010, requires that any changes to the estate tax beyond a two-year extension of 2009 law must be fully offset by cuts in programs or revenue raisers.

I recommend that you act now to update your will and estate plan AS IF the estate tax comes back with vengeance on January 1.  In your case, updating your estate plan could save your heirs over $120,000 of Federal Estate Taxes. 

Feel free to contact me if you or someone you know has this type of situation.  Financial Planning advice presented here is general in nature, and individual circumstances make applying these general rules tricky; thus, the above answer cannot be applied to all circumstances because the slightest variation could cause a different outcome.

“Genius is 1% inspiration and 99% perspiration. Accordingly a genius is often merely a talented person who has done all of his or her homework.”

Thomas Edison

1. Detecting Risk of Heart Attacks – Celera Announces Issuance of United States Patent Relating to LPA Gene Variant Associated with Increased Risk for myocardial Infarction. Celera Corporation (ticker: CRA) today announced that the United States Patent and Trademark Office has issued United States Patent 7,781,168 relating to methods of determining heart attack risk by detecting the Ile4399Met genetic polymorphism in the protease-like domain of LPA. Studies have shown this variant of the LPA gene is associated with a two-fold higher risk of major cardiovascular events (myocardial infarction, ischemic stroke and cardiovascular death). The increased risk of cardiovascular events observed in LPA carriers was independent of other well known risk factors associated with cardiovascular events (hypertension, LDL-cholesterol, HDL-Cholesterol, and age) which further supports the conclusion that a LPA gene variant as an independent predictor of risk for myocardial infarction. LPA encodes apolipoprotein (a) which is a protein component of Lp(a) plasma lipoprotein particles and the gene variant results in an amino acid substitution (methionine for isoleucine) in the protease-like domain of apolipoprotein(a). Carriers of the LPA gene variant also had higher plasma Lp(a) levels.
Source: TechnologyReview

2. Scientists Find a Link in Humans Between Nerve Cell Production, Memory – Production of new nerve cells in the human brain is linked to learning and memory, according to a new study from the University of Florida (UF). The research is the first to show such a link in humans. The findings, published online and in an upcoming print issue of the journal Brain, provide clues about processes involved in age- and health-related memory loss and reveal potential cellular targets for drug therapy. The researchers studied how stem cells in the hippocampus (a memory-related region of the brain) proliferate and change into different types of nerve cells. “The findings suggest that if we can increase the regeneration of nerve cells in the hippocampus we can alleviate or prevent memory loss in humans,” said Florian Siebzehnrubl, Ph.D., a postdoctoral researcher in neuroscience in the UF College of Medicine, and co-first author of the study. “This process gives us what pharmacologists call a ‘druggable target.’”
Source: EurerkAlert

The show airs on WDIY Wednesday evenings, from 6-7 p.m. The show is hosted by Valley National’s Laurie Siebert CPA, CFP®. This week, Host Laurie Siebert, CPA, CFP® and her guest Thomas Riddle CPA, CFP will discuss “Market Volatility and How to Handle It.” Laurie will take your calls on this subject and other financial planning topics at 610-758-8810. WDIY is broadcast on FM 88.1 for reception in most of the Lehigh Valley; and, it is broadcast on FM 93.9 in the Easton/Phillipsburg area; and, it is broadcast on FM 93.7 in the Fogelsville/Macungie area – or listen to it online from anywhere on the internet. For more information, including how to listen to the show online, check the show’s website www.yourfinancialchoices.com and visit www.wdiy.org.

I enjoy appearing as a guest on Your Financial Choices with Laurie Siebert.  She keeps the radio studio set very casual and informal.  I sense she enjoys the experience, too.  This Wednesday, I am appearing as a guest again and discussing the tough subject of market volatility.  I think I can make the broadcast flow smoothly by simply printing several recent issues of The Weekly Commentary and going over their content.  Please tune-in if you are not busy Wednesday at 6PM.

The headwinds blowing against the economic recovery are getting stronger.

The latest batch of economic data to come down the pike point to an economy that is not merely heading for a double-dip — it suggests that we are already there.  Jobless claims jumped to a nine-month high, the leading indicators flattened and the Philly Fed’s index of regional manufacturing took a header.  The second quarter’s gross domestic product showed a growth rate of 1.6%, compared with a 3.7% clip in the first quarter. This was weaker than it looked, since a lot of it was due to goods that were produced but not sold.  Since this is an annual rate, the actual percentage change was less than 0.4%.  The current quarter does not look much better. Indeed, it might well be even worse, and if just a little worse, then negative growth (the start of the double dip??).

It is not hard to see why the economy is struggling. As anticipated, the push from inventories appears to have faded. So has the stimulus from the housing tax credit and the government’s “cash for clunkers” program.  Washington has laid-off temporary census workers, while many states and local governments are furloughing people as well. For its part, the private sector is creating few new jobs while terminating many.  The U.S. economy appears to be caught in a vicious circle.   People are not spending because they lack home equity and have no jobs or are afraid they will lose the one they have. Business is not hiring because demand is weak, and at the risk of being repetitious, many firms are unwilling to hire because they face more than the usual uncertainties. They may be making good money (and many are sitting on mountains of cash), but they are concerned about the anti-business environment that appears to be developing in Washington.  Talk to business people from all walks of life and they will tell you that there is too much government, too many new rules and regulations — not to mention the higher cost of providing health care for their employees. To top it off, many are expecting their taxes to go up next year — which tilts the cost-benefit equation even further against hiring.  If business does not hire, consumers won’t spend.

And, real estate, the keystone of the vast number of past recoveries is going nowhere (but down). 

Washington could surprise me and take some aggressive steps to right the economic ship through intelligent moves; but, like I said, I would be surprised (Data Source: Irwin Kellner, MarketWatch).