Market movements are often not based on fact.
Robert J. Shiller’s October 18th New York Times article, “When a Stock Market Theory Is Contagious” discusses the recent stock market fluctuation. In addition to being a professor of economics at Yale University, he has authored many books, writes columns, co-created the “S&P/Case-Shiller Home Price Indices” and was 1 of 3 recipients of the 2013 Nobel Prize in Economic Sciences.
The topic of the article ties into my comments about risk and volatility in my October newsletter.
“The problem is that short-term market movements are extremely hard to forecast. But we live in the present and must try to understand what’s driving the market now, even if it’s much easier to predict their behavior in the long run.” That is to say we do not know the future, but we can explain what happened in the past.
“…stock markets are driven by popular narratives, which don’t need basis in solid fact.” The article compares the narratives with the “Ebola virus: they spread by contagion.” The narratives causes investors “…to take action that propels prices…in the same direction.” That is, we do not know why the market fell but people and companies may respond by cutting spending resulting in the market falling further.
Recent stories attribute the current drop in the stock market to a “global slowdown”. The narrative can cause people and companies to spend less continuing the fall in the stock market. He concludes with the following. “The question may be whether the virus mutates into a more psychologically powerful version, one with enough narrative force to create a major bear market.”
Financial markets fluctuate
Discussions in articles, books, studies and commentaries from different sources have some common elements about investing. Investing is discussed in different contexts. Examples of the different discussions include: performance, risk, retirement, budgeting, goals and government policies.
An example is an August 15th New York Times article:”Fears of Renewed Instability as Fed Ends Stimulus”. The article reflects a conversation with Jeremy Stein, who left the Fed’s Board of Governors at the end of May to return to Harvard’s economics department.
Many investors are getting nervous because of the length of good stock and bond performance. Recent fluctuations are a reminder that markets go down as well as up. Maybe the recent gyrations are signs of impending instability.
Referring to the Federal Reserve (Fed) actions the article discusses the possible unintended consequences of the Fed policies that have guided us through the recent financial crisis. The low rates have resulted in investors reaching for yield. The consequence of reaching for higher yield is increased risk. Some investors may not realize the increased chance of losses. The result could be further strain on our economy.
The author of the article, James B. Stewart, included the following:
The Princeton economist Markus K. Brunnermeier, an expert on asset bubbles and crashes, has identified what he calls “synchronization risk,” a phenomenon in which investors ride a wave of price increases even if they realize the assets are overpriced. “It’s what economists call a lack of common knowledge,” he said. “We may all know an asset price is too high, but we don’t know the others know it, too. Timing is everything. The danger is if you move too early and the market doesn’t follow up. So everyone waits on the sidelines watching and listening,” as long as asset prices keep rising. The danger comes when they all try to get out at the same time.”
“No one wants another crash, but a garden-variety correction may be just what’s needed to avoid one in the future.”
The discussion recognizes that the market fluctuates. Frequent and/or large fluctuations indicate concern about the future direction of the markets. No one thinks they know what direction the market will go when it fluctuates. Investors are cautious when the market gyrate. They become optimistic when the market continues to rally. This is when investors become confident and make mistakes.
Economists, journalists, regulators and politicians are all poor forecasters of the future movement of the markets.
Reaching Your Goals
Gregory Karp, in his “Spending Smart” column “Money maxims: What dads can tell grads”, June 1, 2014 Chicago Tribune is the incentive for this blog.
Money can be saved or spent. How you handle money will have a significant impact on happiness and future financial well being. Studies relating to finances have increased in the last 15 years. Each year there seem to be more studies. Studies on happiness conclude that people are happier when they spend money on experiences rather than things. Other studies find that most people’s happiness increase as their income increases, up to about $70,000. Studies about retirement have found that the most important thing that anyone can do to reach their retirement living expenses is to save.
Saving is hard to do. Spending must be limited to available income. For most people, living within their income does not mean complete denial. It does require selectivity in the timing and amount of splurges.
Good daily spending habits are important. We have more control over daily spending habits than large items. Minimizing unnecessary and/or unwise expenditures will reduce many items that reduce the amount that can be saved on a regular basis. Most people give larger expenditures, such as homes and cars, significant thought and deliberation. They should also do the same for daily expenditures.
There are also studies that show that we should imagine ourselves in retirement. Aging Booth is an app that will show what you might look like when you age. You may have more incentive to save for that person. Contributing to a 401(k) plans and capturing any employer match may seem more important. Having part of your pay direct deposited to an investment account may also seem like a good way to be kind to the older you.
Necessities and a reserve fund come first. The reserve fund provides a cushion for the frequent unexpected expenditures. Preretirement six months of living expenses is generally recommended. After retirement, a minimum of living expenses after reoccurring income (like social security) for a year is recommended.
The sooner a saving program is started the less required on a periodic basis. To determine how much to save, you need to set financial goals. Your progress should be monitored, at least monthly; more frequently is better. Without knowing the future, your circumstance will change from what you originally projected.
Last-Minute Agreement Ends Government Shutdown, Suspends Debt Ceiling
After a 16-day federal government shutdown and gridlock over whether to raise the nation’s debt ceiling, a last-minute agreement brought a temporary end to the impasse. The measure, formally known as the “Continuing Appropriations Act, 2014,” was passed by both houses of Congress and signed by President Obama shortly after midnight on October 17–the day on which the Treasury had said it would begin running out of cash to pay the nation’s bills.
What does the agreement do?
The legislation suspends the debt ceiling until February 7 and provides sufficient funding to reopen the government for the next three months (through January 15). It applies retroactively through October 1, the day on which the federal government was forced to begin furloughing roughly 800,000 employees.
To try to address longer-term issues, the agreement also establishes a congressional budget conference that would issue a report no later than December 13. That will be run by Sen. Patty Murray (D-Washington) and Rep. Paul Ryan (R-Wisconsin), who head their respective chambers’ budget committees. The across-the-board budget cuts known as the sequester, which were adopted as part of the agreement that ended the 2011 debt ceiling and were implemented earlier this year, remain in effect. The new agreement also requires income verification for people receiving subsidies under the Affordable Care Act, and if the debt ceiling is reached again in February, the Treasury will not be prohibited from using measures like those it has been using since May to cope with the current debt ceiling.
What exactly is the debt ceiling?
The debt ceiling represents a limit on the amount the Treasury is allowed to borrow to manage the national debt (the total amount currently owed by the U.S. government). An increase in the debt limit does not authorize additional government spending, which only Congress can approve; it enables the Treasury to help manage its cash flow and pay bills that have already been incurred.
Technically, hitting the debt ceiling is not the same as defaulting on payments. In fact, the Treasury actually hit the debt ceiling in May, and has been using various accounting measures since then to temporarily extend its ability to borrow. That created greater uncertainty about whether hitting the debt ceiling on October 17 would have prevented the country from meeting its financial obligations. That was a special concern not only for recipients of Social Security and Medicare benefits but also for investors. Because Treasuries have traditionally been seen as the safest sovereign debt in the world, overseas investors hold a substantial amount of it. The uncertainty helped underscore fears not only of a default, but that some countries might increase calls for alternatives to the U.S. dollar as the global reserve currency.
How will the agreement affect financial markets?
Investors’ immediate reaction to the news was extremely positive. Word on Thursday that a deal had been reached sent the S&P 500 up 1.4% and added 206 points to the Dow Jones Industrial Average in a single day. Even if that enthusiasm fades as equities once again start to respond to other influences, it was a far cry from the reaction to the 2011 extension of the debt ceiling, which was followed by a 10.6% decline in the S&P over the week following the August 2 signing. But investors now must turn their attention once again to corporate earnings season and the question of whether the shutdown’s economic impact will affect when the Federal Reserve starts to taper its economic support.
The new agreement also helps protect the nation’s credit rating from a threatened downgrade that would have affected borrowing costs. Yields on 1-month Treasury bills, which had soared in October when several institutional investors began unloading them as the debt ceiling deadline neared, were cut in half overnight after the announcement.*
When will government agencies return to fully functional status?
The roughly 800,000 federal employees furloughed during the shutdown were instructed by the Office of Management and Budget to be ready to return to work the day after the agreement was signed. However, individual agencies may vary depending on the method each uses to notify employees, who will be entitled to receive back pay for the shutdown period.
What was the economic impact of the shutdown?
Standard & Poor’s estimated that as of the day before the agreement, the shutdown had cost the U.S. economy $24 billion, cutting roughly 0.6% from inflation-adjusted Q4 gross domestic product.** (S&P also estimated that had there been a default, the result would have put the economy into recession.)
*Source: U.S. Treasury Resource Center (www.treasury.gov) Daily Treasury Yield Curve Rates as of 10/17/2013.
**Source: Standard & Poor’s press release, October 16, 2013.
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U.S. Government Shutdown Explained
Congress failed to agree on a spending bill for the fiscal year starting October 1, 2013, resulting in the first government shutdown since 1995. According to the Congressional Research Service, this is the 18th time the federal government has shut down as a result of a failure to agree on an annual appropriations bill. Most shutdowns have lasted only a few hours or a few days. The most recent shutdown, in 1995, lasted three weeks.
What happens when the federal government shuts down?
When the government shuts down, federal agencies must generally suspend operations and furlough their employees. However, there are significant exceptions for government functions that promote national security, or protect human life and property. As a result, a shutdown doesn’t impact certain essential functions like the military, law enforcement, TSA, air traffic control, border patrol, emergency and disaster assistance, food safety, foreign embassies, prisons, and federal medical care (among others).
A shutdown also doesn’t impact federal entitlement programs (like Social Security and Medicare) that aren’t funded by discretionary annual appropriations. Funding for these programs is considered mandatory, because the legislation creating the benefit obligates the government to make payment. So benefits under these programs continue uninterrupted, and the employees who administer those benefits are generally exempt from furlough.
Finally, some agencies are funded by multiple year appropriations. Even though these agencies don’t yet have any funds appropriated for the new fiscal year, they may still have funds remaining from prior appropriations, which they can use to continue operations until those funds run out.
So what does a government shutdown mean to you?
What you can do during the shutdown:
Receive and send mail–the post office is an independent agency unaffected by the budget process
Buy insurance through one of the new health insurance Exchanges
Receive your Social Security and Medicare benefits, or apply for new benefits
Get a passport or visa–but only until the State Department’s available funding runs out (during the 1995 shutdown, 200,000 U.S. applications for passports went unprocessed)
Conduct business with the United States Patent and Trademark Office–but only until the USPTO’s available funding runs out
Receive unemployment benefits and food stamps
Get an FHA or VA mortgage
Receive medical care at a veterans hospital
Use the federal court system–but only for about 10 days
What you can’t do during the shutdown:
Stop paying taxes–the IRS will continue to process electronically submitted tax returns, but if you’re being audited, you’ll get a temporary reprieve
Get taxpayer assistance from the IRS
Get a small business loan
Go to a national park, zoo, or museum–if you’re already overnighting in a national park, you generally have two days to leave
Get a paycheck, if you’re a federal employee–unless you’re the president, a member of Congress, or in the military; however, in the past workers were paid retroactively after a new appropriations bill was passed
If you need more information, most government agencies have posted their shutdown contingency plans on their websites.
And there’s more to come…
The shutdown is separate and distinct from another looming crisis–the debt ceiling. According to Treasury Secretary Jacob Lew, it’s anticipated that the United States will run out of funds as soon as October 17, and will default on its debts, unless Congress acts to raise the debt ceiling before then. More on that crisis to follow…
The shutdown is separate and distinct from another looming crisis–the debt ceiling. According to Treasury Secretary Jacob Lew, it’s anticipated the United States will run out of funds as soon as October 17, and will default on its debts, unless Congress acts to raise the debt ceiling before then.
Signs of a Housing Recovery?
According to a well-known gauge of the U.S. housing market, home prices have been on an upswing. The latest S&P/Case-Shiller 20-City Composite Home Price Index, which was released in May, posted its biggest gain in seven years. This improvement has spurred renewed optimism about housing’s role in the country’s economic recovery.
What does the latest S&P/Case-Shiller home price index reveal about home prices?
The 20-city index–one of several S&P/Case-Shiller housing indices–showed a 10.9% gain between March 2012 and March 2013, the highest increase since 2006. In addition, all 20 cities tracked by the index had gains for three straight months.
While the numbers certainly give homeowners and real estate investors cause to be optimistic, it’s important to note that not all cities saw the same price increases. Both San Francisco and Phoenix saw large price jumps of more than 20%. However, New York and Boston had smaller gains of 2.6% and 6.7%, respectively.
A June 13th article in the Chicago Tribune June 13th discussed Cook county home prices. “First-quarter prices of single-family homes in Cook County increased 3.5% from 2012’s first quarter and rose 3.2% from December.” “…first-quarter condominium prices, while down 5.2% on a year-over-year basis, rose 1% from the end of 2012.”
What factors are driving the recovery, and what do rising home prices mean for the economy as a whole?
A variety of factors are driving home prices up, such as low housing inventory, low mortgage rates, and a decline in foreclosures/short sales.
As for the economy as a whole, rising home prices often serve as an indicator that the economy is performing better since it generally demonstrates increased consumer confidence. And while this latest report is good news for homeowners looking to sell, it also provides welcome news to underwater homeowners who may now see an increase in their home equity.
It is important to note, however, that other economic data–such as the large number of institutional investors buying properties to rent–suggests that there is still a ways to go in terms of a full-fledged housing recovery.
Could this all lead to another housing bubble?
Today’s economic environment is different than the one that led to the housing bubble burst in 2006. Those differences include a tighter mortgage lending environment and houses that are still undervalued at prices that are significantly lower than they were at their 2006 peak.
A financial plan is essential for you to know how to invest your money.
To over simplify, financial planning is how you manage your finances and establish a path to reaching your goals. Investment management is one part of managing your finances. It is the part that determines how your savings will be invested.
Financial planning starts with your goals. The amount and timing are critical. Prioritizing your financial goals is necessary. You can assign a priority of 1 to 10 or categorize your goals by what is needed, what is wanted and what is wished for. This will be essential as you monitor your progress. Life and unanticipated events are not controllable and may require adjustments. Adjustments may result in changes to your goals, the timing of your goals, or your spending.
A reserve fund is needed to absorb unexpected events. Reserves should be held so that they are quickly assessable, that is, liquid. Six months of reserve are generally recommended. As you approach each goal, the reserve fund should be increased. This will avoid the impact of fluctuating investment values when the funds are needed. The amount of liquid assets should be increased as you near retirement. This minimizes the need to sell investments when the market is depressed. Two years of liquid funds are generally recommended for retirees. A portion of the funds for living expenses in retirement might be held in short-term bond funds or bonds.
Investments are purchased with the amount of your savings that exceed your reserves. The amount that is used for investments must be sufficient to reach your goals. Education expenses and health care are two categories of expenses that have exceeded what people anticipated. Many people underestimate the amount they will need in retirement. Because life expectancy has increased and people have retired early, many people will not be able meet their retirement goals.
The planning process needs to consider the above events and your ability to withstand losses.
The above has touched on cash planning, investment planning, education planning, risk assessment and retirement planning. All the planning areas need to fit together. How you manage your investments is dependent on the other areas of your financial plan.
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2013 FICA Tax Increase Surprises Some Taxpayers
With all the end-of-year hype surrounding the fiscal cliff and the relief that came with New Year’s legislation permanently extending most income tax rates, one change seems to have been veiled by the settling dust: the 2 percent increase in FICA (Federal Insurance Contributions Act) tax. That increase, the result of an expiring provision that was not extended, means that the vast majority of American workers are now receiving about 2 percent less in their take-home pay, an unwelcome surprise to some people.
Background
In the midst of the last recession a little more than two years ago, Congress passed and the president signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. This new law included a 2 percent reduction in the Social Security (OASDI) portion of the FICA tax. The provision was designed to help put a little more money into the wallets of American workers during the challenging economic environment of 2011. While the employer portion of the OASDI contribution remained at 6.2 percent, the employee contribution was reduced from 6.2 percent to 4.2 percent. The provision was extended through 2012 by the Temporary Payroll Tax Cut Continuation Act of 2011 and the Middle Class Tax Relief and Job Creation Act of 2012.
The reduction was never meant to be permanent, as it put additional financial pressure on the already stressed Social Security Trust Fund. So during the 2012 fiscal cliff negotiations, both Democrats and Republicans agreed that it should expire at the end of the year.
Impact of 2 percent
Despite media reports warning of the impending payroll tax increase, many Americans were caught off guard when they received their first paychecks in 2013. How much of an impact might the additional withholding have? A family earning $60,000 a year will see their pay cut by about $1,200, or $100 per month, during 2013. Those earning $100,000 will receive about $2,000, or about $167 per month, less. (The maximum amount of an individual’s earnings that is subject to Social Security tax in 2013 is $113,700.)
While most experts believe the decrease in take-home pay won’t be enough to cause major economic damage, it may encourage families to cut back on spending enough to slightly dampen the nation’s overall growth. For example, the 2 percent decrease could represent a family’s monthly utility bill, an investment in a college savings account, or a week’s worth of groceries.
Medicare taxes for high earners
Also consider that high earners will need to pay a bit more in Medicare taxes beginning in 2013. Taxpayers will pay an additional 0.9 percent Medicare tax on wages exceeding $200,000 for single/head of household, $250,000 for married couples filing jointly, and $125,000 for married couples filing separately. Taxpayers whose modified adjusted gross income exceeds those same threshold amounts will also pay a 3.8 percent Medicare tax on some or all of their unearned income. These provisions were part of the Patient Protection and Affordable Care Act of 2010, and like the expiration of the FICA reduction, were not affected by the 2012 fiscal cliff legislation. When combined with the 2 percent Social Security increase, the total hit could mean a difference of several thousand dollars a year to some higher-earning taxpayers.
Questions?
If you have questions about your FICA withholding, your human resources department or personnel manager might be a good place to start. These representatives are typically prepared to answer such questions and can help you confirm that your withholding is correct.
