Did Greenspan really warn of a recession by the end of the year?

Did Greenspan really warn of a recession by the end of the year? The simple answer: No, he did not. Read the AP press report yourself. Clearly the AP reporter was more than a little sloppy with their wordsmithing and their own choice of language, but here are the key quotes from Greenspan (at least as they were reported):

When you get this far away from a recession invariably forces build up for the next recession, and indeed we are beginning to see that sign... For example in the U.S., profit margins ... have begun to stabilize, which is an early sign we are in the later stages of a cycle... While, yes, it is possible we can get a recession in the latter months of 2007, most forecasters are not making that judgment and indeed are projecting forward into 2008 ... with some slowdown.

To emphasize, Greenspan himself did not forecast a recession in late 2007 and didn't even "warn" of such a prospect. In fact, he didn't warn of or forecast a recession in 2008 either. Also note that "slowdown" is not the same as "recession". Q3 and Q4 of 2006 were a "slowdown", but not a recession.

Granted, we do not have the full text of Greenspan's remarks, but you can be sure that reporters will latch on to anything remotely resembling a juicy soundbite, so if Greenspan had warned of an imminent recession, it would have gotten reported with the relevant quotations.

I would simply add that Greenspan would be the first to admit the economic forecasts many months out tend not to be reliable indicators of the actual economic activity that will transpire. In fact, as the AP story reports:

Greenspan said that while it would be "very precarious" to try to forecast that far into the future, he could not rule out the possibility of a recession late this year.

Not "ruling" something out is never the same as forecasting it or warning of it. Usually, in common usage, the phrase "could not rule out the possibility" is a caveat, not a primary statement of belief or forecast. In fact, all he is really saying there is that the end of the year is too far away to reliably forecast what will be going on out that far. Greenspan's own phrasing of "very precarious" clearly indicates that he is cautioning people to be more than a little wary of attaching too much of a sense of certainty to longer-range economic forecasts.

-- Jack Krupansky

Revised Q4 GDP

The revised number for annualized real GDP growth in Q4 came in very slightly below the bottom end of my previous forecast range. Back in January I had forecast:

Annualized real GDP growth for Q4 will be in the range 2.25% to 3.25% with a midpoint of 2.75%.

Although the advance estimate had come in very high at 3.5%, the preliminary estimate was knocked down to 2.2%.

All I can really say is that my midpoint forecast (2.75%) was closer to the revised number (2.2%) than the original number (3.5%.)

There will be yet another, "final" revised estimate of Q4 GDP at the end of March, which may actually be higher than this first revision.

Personally, I don't see or get much value from the GDP number, but it is the "big" number and does represent the overall aggregate of the economy and economic activity.

FWIW, the actual (nominal) growth in Q4 was $127.3 billion or 0.955% for the quarter or 3.82% annualized, to a level of $13,449.9 billion or $13.45 trillion. Adjusted for inflation the growth was $63 billion or 0.55% for the quarter or 2.2% annualized (that is the so-called "headline" number), to a "chained dollar" (2000) level of $11,506.5 billion.

Maybe the single most important fact of this report is that growth was in fact stronger than in Q3, not by a lot, but we did not see a "weakening" economy. Q1 is probably not going to be great, but it won't be a disaster either. Q2 will probably be at least somewhat stronger.

-- Jack Krupansky

Where is the price of crude oil headed?

The price of crude oil has risen above $60 again, and even popped above $61. Traders and short-term speculators may try to push it a bit higher, but there may be significant technical resistance around $62.50.

Oil is once again being driven primarily by massive speculation, far out of line with actual physical demand or supplies. This simply illustrates the extent to which there is a massive excess of money sloshing around in the financial system, unable to find a productive home.

I continue to believe that crude will eventually retreat and fall back under $50, but trying to predict the short-term behavior of speculators when such massive liquidity is in play is an exercise in futility.

Even though energy price changes are not considered to be a component of "core" inflation, the reason for this is that normally non-core price volatility tends to dissipate fairly quickly after it accumulates, usually within a few months or a year at worst. But in the current episode, a massive speculative commodities bubble, core inflation is probably a full percent higher than where it would probably be ex the commodities bubble. The big ise from the $20's to the $50's and beyond that occurred over the past three years is gradually spilling over into the rest of the economy. Normally, the Fed pays little attention to that non-core volatility, but you have to believe that the Fed is more than a little concerned about the persistance of high commodities prices.

While it is true that energy is a smaller component of economic activity that a few decades ago, you also have to take note of the fact that energy prices are probably more than double what they would be ex the speculative bubble. Normal economic signals become quite distorted in the presence of such abnormal stimulus.

Part of the persistence of high energy prices is due to no shortage of investors who have been mislead to believe that energy commodities are a long-term investment rather than simply what they are: commodities. Not only are speculators trading in energy futurs contracts, but over the past two years they have been taking physical delivery of the commodities themselves (not delivery to their offices, but electronically they are now the owners of commodities in storage.) Ultimately, this amounts to raw, naked market manipulation, the process of artificially taking supplies off the market by financial players rather than true end users of the commodities. There is nothing illegal there, per se, but it does cause prices to stay artificially higher than true supply and real demand would suggest, and does mean that energy commodities will come tumbling down as these so-called investors begin to lose patience with the fact that they are not getting the kind of dramatic returns that they secured over the past two or three years.

Near term, expect a lot of volatility. And expect a lot of "stories" that are used to promote higher energy prices, or more specifically to promote more speculation.

It will be interesting to see if short-term players can manage to push oil above $62.50 this week. If not, these same short-term players will likely reverse and start playing oil on the short side.

In summary, crude oil continues to be a speculation and trading game, quite divorced from economic fundamentals.

-- Jack Krupansky

Your life expenctancy must be less than 100 years?

I was checking out the retirement planning calculator on the AARP web site, and entered 105 as my life expectancy, which seems reasonable to me, but the tools popped up a stern error message informing me that my left expectancy "must be" less than 100 years. Well. Who determines that?! So, I used 99 years instead. I'll probably just drop back to using my own custom spreadsheet model, where I have complete control of the model.

The good news is that at my current income, current savings rate, and reasonably conservatve rates of return (7% until retirement and 5% during retirement), and what the Social Security Administration tells me to expect for my monthly SS income, I will be able to pull in 51% of my current income. That's not great at all, but rather decent considering that I'm starting over with my savings so late in the game.

-- Jack Krupansky

Where is the euro headed now?

This past week the euro has rallied a bit and it now up to $1.3178. It did poke above $1.32, but it is running into "technical resistance" at that level. In other words, the movement of the euro versus the dollar is at this time driven mostly by "technical" trading rather than fundamental considerations. I suspect that traders and short-term speculators could take a couple more shots at pushing above $1.32 and even $1.33, but they could simply give up and try to make more money by chasing the euro back down in its trading range.

Given that there is no serious expectation that the Fed will cut interest rates in the next six months, there is little fundamental reason for the dollar to "plunge" further from current levels.

I wouldn't be completely surprised if short-term players managed to push the euro up to $1.34 or even $1.35, but I do expect that the euro will more likely trade down below $1.30 again within a few weeks.

In short, the dollar is not "plunging."

-- Jack Krupansky

Fed to hold a steady course at 5.25% for all of 2007 and probably into 2008

For now, my overall assessment of Fed monetary policy remains unchanged:

My view is that the Fed will keep the Fed funds target rate paused at 5.25% for all of 2007, and probably into 2008.

There will not be a recession this year, nor even enough of a growth slump to trigger a Fed rate cut.

I tentatively say "for now" because I am half-convinced that the Fed may in fact feel the need to make another hike in the spring (March or May) to 5.50%. To my way of thinking, it all depends on what happens with energy commodities. Prices of oil and gasoline futures are still quite elevated, albeit off their Summer peaks, and this constitutes an ongoing source of inflationary pressure that continues to propagate throughout the economy. If prices of energy commodities resume their decline, the Fed will be able to remain paused for all of 2007. But if energy commodities prices do not continue to fall, the Fed may have little choice but to hike to 5.50% in March or May. If we don't see crude oil consistently below $50 and retail unleaded gasoline consistently under $2.00 by April, expect a Fed hike to 5.50% at the May FOMC meeting. Based on economic fundamentals, we should see the prices of energy commodities come back down to Earth, but unfortunately there is simply so much free cash sloshing around seeking "some action" and a lot of speculators are simply unable to resist the urge to try to run commodities prices back up since "it worked before." My view is that there is a fairly good chance that prices of energy commodities will recede in the coming months, but it may be too soon to bet too heavily against the speculators. My finger is on the trigger, but for now I'll retain my belief that the Fed will remain paused for at least another year.

I am not suggesting that the Fed will "target" commodities prices such as crude oil and gasoline, but that the Fed will be noticing the degree to which elevated commodities prices are influencing the rest of the economy and pushing up even core prices. We did have good news on the inflation front in the past couple of months, but that was primarily the result of the decline of crude oil and gasoline prices off the summer spike, but crude oil and gasoline prices have risen since November.

My latest thinking is that $60 may be the magic number for crude oil for the Fed in May even though $50 is what they would really like to see. If crude is $60 or higher in May, the Fed will have a high probability of a hike to 5.50%. If crude is below $50, the probability of a hike is very low. If crude is at $55, it will be a 50/50 coin flip. At $58, the Fed would seriously consider a hike. At $53, the Fed would likely hike only if there were some other significant factors, such as a strong resurgence in housing demand.

The point here is not $58 crude oil per se, but the fact that $58 crude oil means that either real demand is overly strong, or there is too much monetary liquidity in the financial system that inspires speculators to throw too much money around because it is relatively too cheap and the Fed will feel some pressure to "mop up" such excess liquidity.

Although the moderation of the housing boom will indeed hold back the economy over the next couple of quarters, the Fed seems to agree with me that this is to be expected and not an indicator of a coming recession. A lot of people are desperately funneling money into bond funds in response to an expectation of well below-par economic growth, and this is depressing Treasury yields and causing an inverted yield curve, but this is ultimately indicating only below-par growth (e.g., 2% to 2.75% rather than 3+%) for the coming six months. Yes, there is a lot of anxiety, but anxiety itself is not a reliable indicator of a particular outcome.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive. All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer. The odds of such a hike causing a recession are negligible.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• March: 0% chance of a cut
• May: 2% chance of a cut
• June: 14% chance of a cut
• August: 30% chance of a cut
• September: 48% chance of a cut
• October: 74% chance of a cut
• December: 100% chance of a cut and 10% chace of a second cut
• January 2008: 100% chance a cut and 36% chance of a second cut
• February 2008: 100% chance a cut and 42% chance of a second cut

I personally don't concur with these odds after June, but that is how a lot of people are actually "betting." I would simply note that such betting can change on a moment's notice as economic and financial data, not to mention commentary and sentiment, unfolds and evolves. Like it or not, the economy proceeds more through Darwinian evolution than "intelligent design." The Fed (and Wall Street) can influence the evolution, of the economy, but not control it as if it were a clockwork machine. Predicting the precise or even general impact of any Fed action or inaction is quite literally a fool's errand. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet". Finally, studies have shown that Fed funds futures are not a very reliable indicator more than 45 days into the future.

What the Fed funds futures market tells us clearly is that the Fed is most likely to leave rates unchanged at least through September. The market is predicting a cut at the September FOMC meeting, but that is too far in the future for the market to give a reliable forecast.

My feeling is that since the housing retrenchment didn't cause a Fed cut at the January FOMC meeting, it is unlikely that housing will be enough of a problem to cause a Fed cut for the rest of the year either.

I note that as of the January 25, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research now forecasts a Fed funds rate of 4.25% by the end of 2007. That would be four quarter-point cuts. They continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective.
The bottom line here is that the Fed won't move through September, and any speculation about Fed moves further down the road are simply wild guesses based on contrived stories about a hypothetical future economy that happens to have a mind of its own.

Why are so many smart people so confused about the future? It is simply the fact that the conservative thing for them to do is to assume that economic events such as housing booms always play out in the same pattern every single time. For a bureaucrat, that is always the safe approach. Alas, every economic episode has its own idiosyncratic pattern and the real issue is how to forecast the interactions between the many sectors and regions of the economy, and that is a really hard problem that is absolutely not amenable to the cookie-cutter application of historical patterns.

The current "herd mentality" on Wall Street is basically sending so many speculators and even investors off on a truly wild goose chase, after which Wall Street will quietly acknowledge its error ("the data changed in an unexpected manner") and then chase those same speculators and investors back in the opposite direction, making sure to collect transaction fees and spreads on both legs of the roundtrip "chase."

Note that the Weekly Leading Index of the Economic Cycle Research Institute is telling us that the economy will be holding together reasonably well for at least the next few months.

-- Jack Krupansky

Test

Test.

 

-- Jack Krupansky

Test

Test.

 

-- Jack Krupansky

Multiple asset allocation models

My latest thought on asset allocation models is that I need to have at least two, one for my retirement assets, and one for my non-retirement assets. Oddly, my retirement asset decisions can afford to be significantly more risky since I won't need those assets for another 20 years or more, but the bulk of my non-retirement assets are currently dedicated to my rainy-day contingency fund, which is by definition cash-equivalent.

That suggests that I need to consider my rainy-day contingency fund as simply a third asset allocation model and that my non-retirement focus should be on my investment asset allocation model. That seems to make sense. Unfortunately, my current net worth spreadsheet doesn't separate out my rain-day contingency cash from the remainder of my cash. I'll have to do that paper separation and then work on an asset allocation model for it. 

-- Jack Krupansky

PayPal money market fund yield holds steady at 5.02% as of 2/24/2007

Here are some recent money market mutual fund yields as of Saturday, February 24, 2007:

• iMoneyNet average taxable money market fund 7-day yield rose from 4.73% to 4.75%
• PayPal Money Market Fund 7-day yield remains at 5.02%
• ShareBuilder money market fund (BDMXX) 7-day yield fell from 4.49% to 4.48%
• Fidelity Money Market Fund (SPRXX) 7-day yield rose from 4.95% to 4.96% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield remains at 4.93%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield rose from 4.44% to 4.45%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield rose from 3.19% to 3.25% or tax equivalent yield of 5.00% (up from 4.91%) for the 35% marginal tax bracket and 4.51% (up from 4.43%) for the 28% marginal tax bracket
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield rose from 3.21% to 3.27% or tax equivalent yield of 5.03% (up from 4.94%) for the 35% marginal tax bracket and 4.54% (up from 4.46%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate rose from 5.23% to 5.27%
• 13-week (3-month) T-bill investment rate rose from 5.16% to 5.17%
• 26-week (6-month) T-bill investment rate fell from 5.16% to 5.15%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 4.52%, with a fixed rate of 1.40% and a semiannual inflation rate of 1.55% (updated November 1, 2006, next semiannual update on May 1, 2007)
• Charles Schwab 3-month CD APY remains at 5.04%
• Charles Schwab 6-month CD APY rose from 5.16% to 5.21%
• Charles Schwab 1-year CD APY remains at 5.20%
• NetBank 6-month CD APY fell from 5.45% to 5.40%
• NetBank 1-year CD APY fell from 5.50% to 5.45%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

PayPal continues to be a fairly interesting place to store cash for both relatively quick access and a well above average yield. There is no minimum for a PayPal account, no fee for a basic account, and it can be linked to your bank checking account or even your brokerage checking account for easy access. Right now I am using PayPal as a savings account, putting a little more money in whenever I get a chance and feel that my budget has some "spare change." I did that this past week. The PayPal 7-day yield of 5.02% is equivalent to a bank APY of 5.14%.

4-week T-bills were once again very attractive for cash that you won't need for a month, since the new issue yield was well above the yield of PayPal and Fidelity Cash Reserves. But, this rate fluctuates significantly from week to week. The rate is locked in for four weeks once you buy the T-bill at the weekly auction, but you can't predict what rate you will get at the next auction since it is based on supply and demand. Simply letting the T-bills automatically roll every four weeks will average out a lot of this volatility.

Check Bankrate.com for the availability of high-rate CDs (5.00% APY to 5.45% APY for 6-month). Alas, there are frequently quite a few caveats, strings, restrictions, requirements, minimums, "introductory specials", and other gotchas, so read the fine print carefully. CDs work great for some people, but horribly for others. I have no CDs since I do not have any free cash that I can afford to lock up with restrictions. But, that said, I am considering putting at least a little free cash in short-term CDs (three-month, six-month, or maybe even one-year), around the middle of 2007, especially if the Fed raises interest rates by a quarter-point in the spring.

Please note the disclaimer on Fidelity's web site for mutual funds:

Past performance is no guarantee of future results. Yield will vary.

As always, please note that cash placed in money market mutual funds is subject to the disclaimer that:

An investment in the Fund is not insured or guaranteed by the Federal Insurance Deposit Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

In practice, that is not a problem at all, but it does incline me to spread my money around a bit.

T-bills and the cash in your bank checking and savings accounts or bank CDs are of course "protected", either by "the full faith and credit of the U.S. Treasury" or the FDIC. Please realize that you may not get your full principle back if you attempt to cash out early for Treasury securities since you'll get the price on the open market, which is not guaranteed by the U.S. Treasury. You are only assured of getting your full principle if your Treasury security is held until maturity. (or Treasury "calls" the security or issues an offer to repurchase).

-- Jack Krupansky

Two key months for the economy

The two coming months, March and April, will be a critical juncture for the economy. Best case, March and then April will show nice up-ticks in economic activity as the housing market moves past a bottom. Worst case, March and April both show dispiriting down-ticks as lingering weakness in housing drags down the rest of the economy a bit more. My conservative best guess as to the most likely trajectory for the economy is that March is a volatile month, giving mixed signals of growth and weakness, but then April shows a more clear "hint" that the economy really is on a steady, but modest upwards path, the culmination of the soft landing.

One big wildcard is commodities prices and the activity of speculators in those commodities, such as the hedge funds. If the prices of commodities such as oil and gasoline remain persistantly high, as they are right now, that will be an indication that there is still way too much cash sloshing around in the financial system, and this fact, inflationary pressure, could cause the Fed to raise rates again, to 5.50%. That rate is still in the so-called "neutral" range, so any risk of "causing" a recession is negligible. But, such a rate hike would not come until May when we have hindsight to tell as the state of the econmy coming out of this critical March and April period.

Watching and listening to the commentary on the economic reports of this period will not be an activity for the faint of heart. For most investors, it would be best to close your eyes, sit tight for the ride, and then open your eyes in early May and then decide what state the economy seems to be in. Much of the "advice" that you will be hearing from the so-called "professionals" of Wall Street will be designed not to enhance your well-being, but to strip as much of your assets as (legally as) possible. DO NOT listen to any of the "sky is falling" stories that the pundits and bears and cynics will be vigorously promoting at even the hint of a raindrop.

-- Jack Krupansky

Regulating hedge funds

I have mixed feelings on the matter of regulating hedge funds. There are plenty of pros and plenty of cons. I think the question should be re-framed from whether to how, and whether regulation should be direct or indirect.

I was inspired to write these words after reading the article in The New York Times by Stephen Labaton entitled "Current Hedge Fund Rules Work, Regulators Say" which basically tells us that the Bush administration is not going to crack down on hedge funds, despite their clear excesses and potential risks.

Since big banks, insurance companies, and pension funds seem to be the primary investors in hedge funds, I strongly suspect we should  look at how those entities are financially regulated, which I would call indirect regulation of hedge funds.

For example, the Fed other other banking regulators can set rules as to how the big banks treat hedge fund investments in terms of risk and capital requirements. A direct requirement that banks report an accurate characterization of risk and refrain from investments with open-ended risk might either limit their investment in hedge funds or indirectly cause hedge funds to morph into a more transparent investment process.

One potential downside there is that venture capital is an inherently risky business and big banks, insurance companies, and hedge funds play an important role in investment into venture capital limited partnerships. We certainly do not want to throw out the venture capital baby with the hedge fund bath water. One difference is that with a venture capital investment, everybody knows that you could easily lose 100% of the investment, while with hedge funds, the assumption is that the fund will yield dazzling returns and only very rarely might the investment principal be at risk. So, there is reasonable clarity of risk with venture capital that simply isn't there with opaque hedge funds.

That brings us back to a core question of what risk of hedge funds are we most worried about? Granted, we do want to assure that all investors get clear and accurate characterizations of risks for all investments, whether they be individual stocks, bonds, mutual funds, commodities, venture capital, and even hedge funds, and hedge funds do need more clarity of risks, but the huge question plaguing policy makers is the issue of systemic risk, ala the LTCM meltdown. If there were only a relatively small number of hedge funds, each managing a relatively small amount of investments, there would be no issue at all. The problem is that there are a large number of large funds with large investments, not to mention that many of them are making the same large bets.

The essential problem is that we don't actually know what the systemic risks are today. The lack of transparency of hedge funds coupled with their number and size is an almost certain recipe for eventual disaster. Not a certainty, but a near certainty. My own belief is that LTCM was a true fluke and with just a few slight deviations in their trading patterns there would have been no disaster. To be sure, they were definitely skating on thin ice, but they still could have skated around the weak points. Alternatively, regulations requiring transparency of such funds would have reined in their excesses since a poorly hedged notional exposure or liability of a trillion dollars would frighten away even the largest bank, insurance company, or hedge fund.

One other area of regulatory concern that gets zero attention by the media is the degree to which speculative activity impacts consumer markets. Hedge funds have made huge speculative investments in commodities, thus driving up the price of oil, the retail price of gasoline, heating oil, natural gas, building materials, etc. I would not suggest that such speculation be prohibited, but that the regulators of those markets simply place limits on the total amount of speculation, so that, for example, speculative positions not be permitted to move the price of any commodity up (or down) by more than a few percent. Sure, by all means, let us still permit and encourage speculators to arbitrage small nickel and dime pricing discrepencies between markets, but outright market manipulation as has occurred with commodities over the past two years should be strictly banned.

The key here is not to regulate the hedge funds directly, but to prevent the hedge funds, or any other large investor, from causing harm to our economic and financial systems. After all, if you make hedge funds unattractive, managers (and their eager investors) will simply move on and form investment vehicles which skate around the technical and legal definitions of "hedge fund."

As the old saying goes, be careful what you ask for, because you might get it.

-- Jack Krupansky

Tax prep

My lingering, unfinished task at this time of year is tax prep. I, unlike everyone else in the world, find that doing my taxes is a less than desirable process. My solution is to have an accountant do my taxes. I've been doing this for about 24 years now. Even so, I still have to prepare all of the raw data. I try to get as much of it as possible in spreadsheet form, mostly to stay organzed, and then I can email the files to my accountant.

The main complexity for me is my business expenses while I was self-employed. After this year, I won't have that overhead to deal with, but this tax year (2006) I was self-employed for three months, out of work for six weeks, and fully employed for the rest of the year.

I also have the complexity of splitting my year between states. The state of Washington doesn't have a state income tax, but I worked my three months of self-employment in Colorado. I simply fill in my spreadsheet with dates and amounts and show where the income was earned, and my accountant handles the rest.

Actually, I just sent an email to my accountant "warning" her that my tax prep info was "coming soon."

I should really do the work this weekend to get it over with, but I find it too depressing to think about. I suspect I'll do a little, just to feel I made some progress.

What I usually find is that I keep putting it off until one day I wake up and simply feel inspired (really) to just get it all done in one sitting. Frequently it has taken four to eight hours to do it all, mostly sifting through receipts, looking for as many deductible expenses as I can find. Sure I could keep my info more organized with some fancy software, but over the course of a year that could cost me much more than those eight hours. I have enough data to be a annoying, but not enough to be worth a premium software solution.

-- Jack Krupansky

ECRI Weekly Leading Index indicator up modestly and continues to point to a relatively healthy economy in the months ahead

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose modestly (+0.28% vs. -0.90% last week) while the six-month smoothed growth rate fell slightly (from +3.5% to +3.4%), but continues to be modestly above the flat line, suggesting that the economy continues to retain much of the steam that it had picked up. The smoothed growth rate has been positive for 19 consecutive weeks. We haven't finished the soft landing yet, but we are in great shape, despite the weakness in the housing sector and the feverish hand-wringing of the pundits.

The WLI is now 29 weeks past its summer low and the six-month smoothed growth rate is now 26 weeks past its summer low. Although not signalling an outright boom, this is a fairly dramatic recovery from the somewhat dark times of last summer.

A WLI growth rate of zero (0.0) would indicate an economy that is running at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to be a relatively stable "Goldilocks" economy. We're actually doing somewhat better than that now.

Although the WLI smoothed growth rate remains relatively modest and will likely remain so for the next few months, it isn't showing any signs of the kind of persistent and growing weakness (values more negative than -1.5% over a period of time) that would be seen in an economy that was slowing on its way into recession, but does look a lot like an economy moderating on its way to a relatively stable growth rate.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate. Goldilocks might not be completely happy with the current state of the economy, but she should be. Ditto for NYU Professor Nouriel Roubini. Sorry Nouriel, but Professor Ben Bernanke has it right this time. Anyone expecting a recession or very weak economy this year will be disappointed.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates "clear weather" for the next few months.

-- Jack Krupansky

Need to set a new financial goal

Now that my finances are in substantially better order than even six months ago, it is time to set yet another new financial goal rather than to succumb to the euphoria of complacent drifting, as enticing as that may be.

A number of questions, issues, and opportunities arise:

1. Should I be saving more for retirement or am I right on track?
2. Should I be increasing my non-retirement savings and investments?
3. Can I loosen my budget and spend a little more money or do I need to tighten it to get used to living even more frugally, with the possibility of early retirement?
4. Can I begin to travel a bit more?
5. Should I consider buying a house or condo in a few months, six months, or a year? Should I save more towards that as a possible goal?
6. Should I get some more formal training in finance?
7. Should I be considering other educational and training opportunities?
8. What aspects of my finances can and should I put on auto-pilot, which should I monitor like a hawk, and which need to be re-evaluated only on an annual, semi-annual, or quarterly basis?
9. Should I try to significantly accelerate paydown of my remaining back taxes?
10. Can I fund a small stock market account where I can take some significant risks for much higher returns?
11. Do I have the spare time to do the research needed to properly assess risk for individual stock investments?
12. What asset allocation models should I be considering?
13. Can I find a significantly higher yield for my rainy day contingency fund?

By default, I monitor my budget and net worth on a weekly basis, with hawk-like intensity. Whenever I see some extra money accumulate in my main checking account, I either transfer it to my higher-yielding PayPal money market fund (currently a 7-day yield of 5.02%) or less frequently make an additional payment on my IRS installment plan. I'm already regularly paying extra on that installment plan, so PayPal is my main focus.

All of this is well and good, but the simple fact is that I don't have a clear financial goal other than simply "keep on track, more of the same." That actually seems okay at this moment, but I would like to have a more specific goal that I can actually track and monitor and have a sense of progress.

More deep thinking is required. Or maybe a few friendly suggestions.

Maybe I should consider myself fortunate to have this as my main financial problem.

-- Jack Krupansky

Credit record and free credit report

Everybody should check their credit record at least once a year, and I am no exception. Even if you have no big debt problems, it is always possible that mistakes might be made and it can take time to clear them up. Even though my non-tax debts were discharged in bankruptcy back in 2005, I've been a little hesitant to even look at my credit record. I had a "warrant" on my record due to my back New York state (and city) taxes, and had been waiting for that to clear. It was a simple technicality and no sheriff was out looking to arrest me, but it was in fact a formal record. I did pay off New York back in August, but since they said it could take 90 days for the credit record to update, I had another convenient excuse.

It has been six months since that August tax payoff, so I should go ahead and see that my record has been properly updated. The good news is that my record is clean enough that I was able to get three new credit cards. I have no near-term interest in buying a house, so I really have no credit needs that would cause me to worry about my credit record. Still, it is one of those housekeeping details that I need to attend to soon. Maybe after I finish getting all of my income and expense records together for my accountant to do my income taxes.

My understanding is that we are each entitled to one free annual credit report from each of the major credit bureaus, but I have never requested my reports. I think it can be done easily online via AnnualCreditReport.com, but I need to check into it some more. The FTC has a web page that describes the program. When they announced the full rollout of the program they had this warning:

The only authorized Web site for the program is www.annualcreditreport.com. Some Web sites offer a supposedly "free" service that converts to one that requires a fee after a trial period ends. Some bogus Web sites have "free" in their name; others misspell the name of the official Web site, hoping consumers' typing errors will lead them to Web sites that try to sell things or collect personal information. To avoid mistyping the name, click on the annual credit report link on the FTC's website (www.ftc.gov).

So, watch out for the scam artists.

-- Jack Krupansky

My credit card debt is...

I just read an article in The New York Times by John Leland entitled "Debtors Search for Discipline via Blogs" about some debtors who have blogged the specific amounts of their debts and efforts to get out of debt, but you can be sure that I will never (or almost never) divulge specific details such as amounts even though I may discuss my own financial situation and past problems in general terms, or that when I do get fairly specific, I won't give specific dollar amounts for my financial situation. I'm a little skeptical about some of the blogging efforts referenced in the Times article.

If you go to some of these blogs you find references to a "people-to-people lending" site called Prosper.com. I suspect that some of these bloggers are just trying to make a few extra bucks from Google AdSense ads by associating their blogging efforts with Prosper. Kind of a Web 2.0 variant of Amway. Sure, I have Google ads on my blogs as well, but I'm not teasing you into reading my words by suggesting that I will offer intimate, gossipy details of my finances.

I do track my budget and net worth on a weekly basis, but no numbers. Yes, I told you when I finally got into the black and back to a positive net worth, but I won't be telling what my net worth really is. Crossing over zero was the closest I'll come to giving an actual number. I won't even be telling you my weekly meal budget or how much I spent on dinner last night.

Sure, I'll blog about my budget for a trip to NYC, but that doesn't reflect on my overall financial situation.

Now, back to the important stuff.

I will continue blogging about abstracted details of my financial situation, but I will stay away from anything resembling a direct look at my spreadsheets.

So, what is my credit card debt? It is a grand total of... sorry, I simply am not going to divulge that information, but it is a rather small number.

I pay off my credit card debt every month in full, paying the statement balance, which means that there are additional charges against my account after the statement date that aren't due until the following month. My net worth spreadsheet does have a "credit card debt" line which simply lists the total amount of credit card expenses that I have outstanding, irregardless of the fact that it will be paid off (the statement balances) each month and those payoffs are already in my budget for the coming month. The only reason I have this line on my net worth is that if for some reason my income was immediately disrupted, that debt would in fact come due, and it is strictly speaking a liability that counts against next worth.

-- Jack Krupansky

Asset allocation clock: asset allocation for market timing

Many years ago my full-service broker's firm would send out a monthly newsletter that contained a continuously updated view of the firm's recommended client asset allocation model, namely, how to proportion your financial assets between the three main asset classes of cash, bonds, and stocks. How the model was updated was always a mystery. And, it was never clear if following the model ever worked for anything other than to increase trading and cause you to pay more commissions.

Not too many years ago (maybe back in 1999 or 2000), I was leafing through a zillion finance books at Barnes & Noble and stumbled across something called the asset allocation clock which purported to show you how to expand and shrink your asset class allocations at different stages of the traditional business cycle. It wasn't a precise mathematical model for asset class allocation, but did show which asset classes would be in favor and which would be falling from favor at each stage. In essence, it was a grand attempt at a unified approach to market timing. Again, I do not know how well it works, if at all. But, at least it resolves the mystery about the basis for those mysterious monthly updates from my old brokerage firm.

Each firm has their own proprietary asset allocation models and proprietary processes for updating them and not all firms agree on even the time of day for their asset allocation clocks (i.e., precisely where we are in the business cycle). Further, these models seem less in favor in recent years. A few years ago I recall frequent news items about various firms raising or lowering their equity and cash allocations. These days, the term asset allocation model is not used as frequently and tends to refer simply to your current proportion of various asset classes, without regard to what principles guided the selection of the model. And even the term asset class is more loosely used to refer to domestic versus international and regional stocks and bonds, and even individual countries.

The real catch with these asset allocation clocks and their implied asset allocation models is that it is very difficult, if not impossible to judge what "time" it is on the clock. There is no shortage of people who claim that they "know" what time it is, but there is very little agreement between many of them, other than in various "camps" or "factions", and even then there is some degree of disagreement. Further, some people may attempt to jump the gun and pre-position themselves in anticipation that others will in fact jump in and out of asset positions precisely as dictated by the clock.

I wish I could remember which book I saw it in. In fact, I saw it in two different books.

Later when I search the Web, I could find very few references to asset allocation clock. One of them being my own description. Here the main diagram that I found that seemed to convey the essence of what I had seen in those books years ago:

As you can see, the original source was Merrill Lynch. My source on the Web no longer exists. Luckily, I saved a copy of the clock image. Here is another variation of the asset allocation clock which I found on the Web:

A more traditional and simpler asset allocation "clock" is that which Ben Graham proposed in The Intelligent Investor, which simply had a rough 60/40 split between stocks and bonds. When stocks appeared to be relatively overvalued, you would go an overweight 60% stocks and underweight 40% stocks, and when bonds appeared to be relatively overvalued, you would go an overweight 60% stocks and underweight 40% bonds, and then slide between those two extremes as relative values shifted over time.

In summary, I am not advocating outright market timing, but it would be instructive to contrast the principles that you currently use to drive your asset allocation models with these traditional approaches. Just because an approach is newer doesn't mean that it is better.

-- Jack Krupansky

Fed to hold a steady course at 5.25% for all of 2007 and probably into 2008

Despite the "shocking" housing data on Friday, the overall fed rate expectation picture hasn't changed too dramatically. Sure, the data "moved the needle", but only modestly. The market still believes the Fed will be on hold through June.

For now, my overall assessment of Fed monetary policy remains unchanged:

My view is that the Fed will keep the Fed funds target rate paused at 5.25% for all of 2007, and probably into 2008.

There will not be a recession this year, nor even enough of a growth slump to trigger a Fed rate cut.

I tentatively say "for now" because I am half-convinced that the Fed may in fact feel the need to make another hike in the spring (March or May) to 5.50%. To my way of thinking, it all depends on what happens with energy commodities. Prices of oil and gasoline futures are still quite elevated, albeit off their Summer peaks, and this constitutes an ongoing source of inflationary pressure that continues to propagate throughout the economy. If prices of energy commodities resume their decline, the Fed will be able to remain paused for all of 2007. But if energy commodities prices do not continue to fall, the Fed may have little choice but to hike to 5.50% in March or May. If we don't see crude oil consistently below $50 and retail unleaded gasoline consistently under $2.00 by April, expect a Fed hike to 5.50% at the May FOMC meeting. Based on economic fundamentals, we should see the prices of energy commodities come back down to Earth, but unfortunately there is simply so much free cash sloshing around seeking "some action" and a lot of speculators are simply unable to resist the urge to try to run commodities prices back up since "it worked before." My view is that there is a fairly good chance that prices of energy commodities will recede in the coming months, but it may be too soon to bet too heavily against the speculators. My finger is on the trigger, but for now I'll retain my belief that the Fed will remain paused for at least another year.

Note: I am not suggesting that the Fed will "target" commodities prices such as crude oil and gasoline, but that the Fed will be noticing the degree to which elevated commodities prices are influencing the rest of the economy and pushing up even core prices. We did have good news on the inflation front in the past couple of months, but that was primarily the result of the decline of crude oil and gasoline prices off the summer spike, but crude oil and gasoline prices have risen since November.

Update: Both crude oil and gasoline bounced around quite a bit, but lost their upwards momentum, with crude still hanging back from the $60 "resistance" level. Expect more volatility in the weeks ahead, but if oil is still where it is in six weeks (near or above $60), expect the Fed to seriously consider a rate hike at the May meeting.

My latest thinking is that $60 may be the magic number for crude oil for the Fed in May even though $50 is what they would really like to see. If crude is $60 or higher in May, the Fed will have a high probability of a hike to 5.50%. If crude is below $50, the probability of a hike is very low. If crude is at $55, it will be a 50/50 coin flip. At $58, the Fed would seriously consider a hike. At $53, the Fed would likely hike only if there were some other significant factors, such as a strong resurgence in housing demand.

The point here is not $58 crude oil per se, but the fact that $58 crude oil means that either real demand is overly strong, or there is too much monetary liquidity in the financial system that inspires speculators to throw too much money around because it is relatively too cheap and the Fed will feel some pressure to "mop up" such excess liquidity.

Although the moderation of the housing boom will indeed hold back the economy over the next couple of quarters, the Fed seems to agree with me that this is to be expected and not an indicator of a coming recession. A lot of people are desperately funneling money into bond funds in response to an expectation of well below-par economic growth, and this is depressing Treasury yields and causing an inverted yield curve, but this is ultimately indicating only below-par growth (e.g., 2% to 2.75% rather than 3+%) for the coming six months. Yes, there is a lot of anxiety, but anxiety itself is not a reliable indicator of a particular outcome.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive. All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• March: 0% chance of a cut
• May: 2% chance of a cut
• June: 16% chance of a cut
• August: 40% chance of a cut
• September: 52% chance of a cut
• October: 82% chance of a cut
• December: 100% chance of a cut and 20% chace of a second cut
• January 2008: 100% chance a cut and 52% chance of a second cut
• February 2008: 100% chance a cut and 56% chance of a second cut

I personally don't concur with these odds after June, but that is how a lot of people are actually "betting." I would simply note that such betting can change on a moment's notice as economic and financial data, not to mention commentary and sentiment, unfolds and evolves. Like it or not, the economy proceeds more through Darwinian evolution than "intelligent design." The Fed (and Wall Street) can influence the evolution, of the economy, but not control it as if it were a clockwork machine. Predicting the precise or even general impact of any Fed action or inaction is quite literally a fool's errand. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet". Finally, studies have shown that Fed funds futures are not a very reliable indicator more than 45 days into the future.

What the Fed funds futures market tells us clearly is that the Fed is most likely to leave rates unchanged at least through August. The market is predicting a cut at the September FOMC meeting, but that is too far in the future for the market to give a reliable forecast.

My feeling is that since the housing retrenchment didn't cause a Fed cut at the January FOMC meeting, it is unlikely that housing will be enough of a problem to cause a Fed cut for the rest of the year either.

I note that as of the January 25, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research now forecasts a Fed funds rate of 4.25% by the end of 2007. That would be four quarter-point cuts. They continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective.

The bottom line here is that the Fed won't move through August, and any speculation about Fed moves further down the road are simply wild guesses based on contrived stories about a hypothetical future economy that happens to have a mind of its own.

Why are so many smart people so confused about the future? It is simply the fact that the conservative thing for them to do is to assume that economic events such as housing booms always play out in the same pattern every single time. For a bureaucrat, that is always the safe approach. Alas, every economic episode has its own idiosyncratic pattern and the real issue is how to forecast the interactions between the many sectors and regions of the economy, and that is a really hard problem that is absolutely not amenable to the cookie-cutter application of historical patterns.

The current "herd mentality" on Wall Street is basically sending so many speculators and even investors off on a truly wild goose chase, after which Wall Street will quietly acknowledge its error ("the data changed in an unexpected manner") and then chase those same speculators and investors back in the opposite direction, making sure to collect transaction fees and spreads on both legs of the roundtrip "chase."

Note that the Weekly Leading Index of the Economic Cycle Research Institute is telling us that the economy will be holding together reasonably well for at least the next few months.

-- Jack Krupansky

Housing construction limping along

People were chattering on Friday about the "shocking" housing data. New residential "starts" were down -14.3%. Yeah, that's a really bad number, but is it always nest not to take one data point in a series and take it out of context and draw strong conclusions from it. Here's a little more context from the official New Residential Construction report:

1. Permits declined only -2.8% in January compared to December and were still well above the level of October and November.
2. Housing units that had previously been given permits but not yet started were actually up by +2.9%.
3. Starts declined by a whopping -14.3% (or an even more eye-popping -37.8% from a year ago), but were only -4.7% below the pace in October.
4. Housing units under construction declined by -2.4%.

You need to look at the full picture, with all four data items, and you need to track them for more than a month or two. We all have the separate data on new housing sales and existing home sales, as well as pricing for new and existing homes. We also get weekly data on mortage applications, both to purchase a home and to refrinance an existing mortgage. You need to look at all of this data to get a more accurate picture of the economic impact of the housing market.

My expectations from a few months ago remain unchanged: the housing pullback is likely to take a few more months to wind down, somewhere between February and May, before beginning a slow rebound.

Wall Street and so many of today's commentators and pundits and journalists are extremely prone to knee-jerk reactions. Be careful to make your own assessments rather than get sucked up in their hyperbole (positive or negative).

-- Jack Krupansky

Asset allocation and cash

As I gradually recover from my financial difficulties and bankruptcy of 2005, I am slowly accumulating cash and stock and in the not too distant future will have enough net worth that I will seriously need to have a formal asset allocation model. Other than my rainy day fund which is by definition 100% cash or near cash, I simply don't yet have a large enough pool of assets for it to be worth a formal asset allocation model and re-allocation process.

You could argue that with even $1,000 you should be at least considering the asset allocation issues, if only in anticipation of the future so that you will smoothly transition into the formal process when you do finally have enough, and I may in fact do so, but the sense of urgency simply isn't here right now.

The traditional asset allocation model has only three components: cash, bonds, and stock.

As you become more sophisticated (i.e., richer) you can add real estate and commodities.

As you become even more sophisticated (i.e., even richer), hedge funds, angel and venture capital, and all manner of "alternative investments" come into play. One difficulty is that some of these are so vague in terms of their precise risk profiles, that it can become near impossible to compare relative risks the way it is done with cash, bonds, and stocks.

Even with stocks and bonds, there are many sub-categories of assets that each has a dramatically different risk profile and different "days in the sun". We have growth and value stocks, small caps, mid caps, large caps, cyclicals, counter-cyclicals, staples, utilities, etc. We have junk or high-yield bonds, distressed debt, different grades.

Personally, I don't like bonds, simply because they are not as liquid, not as fairly priced, and how they trade is simply beyond the comprehension of typical investors. Even with a "good" bond fund, you are acting on "faith" in the reputation of the manager and it is virtually impossible to really know what is in there and its true risk profile.

Treasuries are a different matter, and in fact many of them can be treated more like cash than a corporate bond. Even so, you have spreads, inflation expectations, economic growth expectations, etc. to muddy the waters.

My immediate issue is that I need to decide whether that big pile of cash in my rainy day contingency fund counts as cash in my eventual asset allocation model, or doesn't since I won't reduce that cash if the model shifts out of cash. My inclination is that it is outside of the model. Which means that my current, default "model" is essentially 100% stock, albeit a small absolute amount, which is far from ideal. That's my starting point in my thinking. But, I need to consider a few alternative models before coming up with my initial model goal.

-- Jack Krupansky

How GM could buy Chrysler

For GM to buy Chrysler, the deal would have to be very attractive to both GM and the Daimler management faction within DaimlerChrysler. Chrysler has enough liabilities, especially plant and labor-related, to make a simple purchase at this time rather unattractive to GM. I have an idea, the kind that would appeal to greedy Wall Street investment banks. Simply spin off Chrysler and issue bonds in lieu of shares to DaimlerChrysler shareholders. Those bonds would trade as an alternative to stock, but guarantee that shareholders will get at least a semi-decent "deal" if if an independent Chrysler falls into bankruptcy or otherwise deteriorates before GM finally decides to acquire the bonds on the open market. In a stock deal, bankruptcy would wipe out the shareholders, rendering such a spin-off a very unattractive deal. A multi-step deal such as my bond idea is necessary because the liabilities, primarily labor-related, cannot be easily put in a box and written off at low cost. Labor would extract a price much higher than GM would rationally be willing to pay.

The key here is that Chrysler with its liabilities is a drag on Daimler. Better for DaimlerChrysler to fully finance the bonds at 100% of par, with the expectation that the bonds on the open market will rapidly fall to a price level where GM could make a financially justifiable argument for buying the bonds at such a fire sale price.

Any such fire sale would presumably occur only after the independent Chrysler either renegotiated its most onorous liabilities away or simply went into bankruptcy and defaulted on the bonds which then puts the bondholders (i.e., GM or whoever wanted to buy the bonds on the open market at the fire sale price) into control and leads to bankruptcy court approval to force labor to make the needed concessions before the bondholders (led by GM or whoever it wanted to partner with) decide how to best dismember Chrysler and integrate the viable pieces of business into GM's business. Some pieces might be sold off to other firms or even leveraged buyout firms who have other ideas for pursuing any hidden value of the pieces.

DaimlerChrysler shareholders who get stuck with these bonds could in fact go along for the ride and eventually become GM shareholders, or simply dump the bonds and get a gain from the tax loss. The real point is that the liabilities of Chrysler are a hidden drag on DaimlerChrysler's stock price, so taking a loss on the bonds could well significantly reward those shareholders who then have shares in a firm with a better balance sheet and streamlined operations.

Wall Street could of course collect boatloads of cash, both in fees to structure such a complex "deal", and profit on the side by trading the bonds as their price fluctuates wildly while the terms of the final deal slowly wend their way to a conclusion.

I'm sure there are lots of details that I have glossed over, but at a minimum this is an interesting thought experiment to evaluate the prospect of any deal for GM to acquire the Chrysler business from DaimlerChrysler.

-- Jack Krupansky

How much cash reserve should you keep in your bank account?

 Liz Pulliam Weston over on MSN Money has an article entitled "Why you need $500 in the bank - Having a few hundred bucks at the right times in your life can make all the difference. Here's how to tuck away money for emergencies, even if you don't have much" which recommends that we all try to maintain a $500 "cushion" in our bank accounts.

Nobody is immune from occasionally forgetting about a recent check or charge or an upcoming expense (particularly those that are not recurring monthly expenses) and either being lucky enough to find themselves short or being unlucky and being hit with an overdraft.

Sure, some of us have the credit history to merit overdraft protection (a credit line) on our checking accounts, but even then the purpose of the credit line (a convenience for the bank) is that you will use it and start paying interest on the balance. Keep the so-called "cushion" and you won't have to worry about the potential interest or pain of coming up with the extra cash to avoid the interest when an unexpected expense does hit.

Even with a balanced monthly budget, there tend to be one or two times during the month when a rush of expenses hit a week or even days before you have income that will easily cover those expenses in the overall monthly budget. The cushion eliminates the need to worry about such times.

The only downside to a "cushion" is the interest income you lose in a bank account compared to a higher-yield money market mutual fund or even a bank CD. That was a primary motivator for me moving most of my banking away from traditional banks and into a brokerage account. Not that the monthly interest on $500 is that much ($1.85 at Fidelity or $3.69 for a $1,000 cushion), but the thought that the bank is effectively charging me an extra service fee when they are not offering an additional service is rather annoying.

My intention had been to keep a $1,000 cushion in my main Fidelity brokerage account which I use as a combination checking and savings bank account as well as the destination for my employee stock purchase plan. I have a lot more than $1,000 in the savings portion of the account as my rainy day contingency fund (a year of expenses), but I mentally do not count that as part of my "cushion."

Fidelity has this concept of "core cash" which is the default money market mutual fund that incoming cash goes into and expenses (checks, debit card expenses, stock or mutual fund transactions, and electronic money transfers) come out of. Unfortunately, the fund choices for core cash are very limited and yield a lot less than the full offerings in the "savings" side of the account. So, I ended up putting $500 of that $1,000 in my PayPal account which yields more than any money market mutual fund Fidelity offers me (5.02% vs. 4.93% on FDRXX or the taxable equivalent yield of 4.43% for the tax-free FTEXX fund that is the best I can do with core cash).

Incidentally, I derived the $1,000 number from the fact that my second paycheck of every months comes on the last business day of the month and if there was any reason why it wasn't credited promptly (yeah, I don't trust computers to always "do the right thing"), I would be almost $1,000 short on the 1st of the month for my rent and utilities. I may never hit such a problem, but having a $1,000 "cushion" would guarantee it and give me rock-solid piece of mind.

Since I can quickly "sell" $500 from my rainy day fund on the savings side of the account, I'm not totally exposed. I may yet go to maintaining the full $1,000 cushion, but having that extra $500 earning less interest annoys me a little. The financial "loss" is minimal, a whole 30 cents in lost interest compared to PayPal, but its the principle of the thing and the fact that Fidelity has me over a barrel and is using my money at a discount.

I still have an old-fashioned, traditional bank account with Wells Fargo (their stage coach is a great symbol for my attitude towards traditional banks) and actually direct deposit a small portion of my paycheck there simply for the convenience and lack of fees of the ATM machines. I still use that bank account for my TreasuryDirect T-bill transactions as well, so it gets a small amount of additional monthly deposit from that source as well. I don't want to accumulate too much cash in an account that pays less than peanuts in interest, but the piece of mind of being able to get a few bucks no matter what is going on in my Fidelity account is worth the 36 cents of interest that I am foregoing. Every other month I transfer the "excess" cash from the bank account to Fidelity.

I try to be strict with my budget and have enough slack built into my budget that I frequently accumulate a modest excess "cushion" in my Fidelity core cash, which I then transfer either to PayPal or the higher-yielding "savings" side of my account. The key advantage of the PayPal account besides its higher yield is the simple principle of "out of sight, out of mind." After all, with financial matters, comfort and complacency are the roots of all evil. We all need tools and tricks to extend our skills beyond our limited raw abilities.

-- Jack Krupansky

ECRI Weekly Leading Index indicator down moderately sharply but continues to point to a relatively healthy economy in the months ahead

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell moderately sharply (-0.87% vs. -0.16% last week) and the six-month smoothed growth rate fell moderately (from +4.3% to +3.5%), but continues to be modestly above the flat line, suggesting that the economy continues to retain much of the steam that it had picked up. The smoothed growth rate has been positive for 18 consecutive weeks. We haven't finished the soft landing yet, but we are in great shape, despite the weakness in the housing sector and the feverish hand-wringing of the pundits.

The WLI is now 28 weeks past its summer low and the six-month smoothed growth rate is now 25 weeks past its summer low. Although not signalling an outright boom, this is a fairly dramatic recovery from the somewhat dark times of last summer.

A WLI growth rate of zero (0.0) would indicate an economy that is running at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to be a relatively stable "Goldilocks" economy. We're actually doing somewhat better than that now.

Although the WLI smoothed growth rate remains relatively modest and will likely remain so for the next few months, it isn't showing any signs of the kind of persistent and growing weakness (values more negative than -1.5% over a period of time) that would be seen in an economy that was slowing on its way into recession, but does look a lot like an economy moderating on its way to a relatively stable growth rate.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate. Goldilocks might not be completely happy with the current state of the economy, but she should be. Ditto for NYU Professor Nouriel Roubini. Sorry Nouriel, but Professor Ben Bernanke has it right this time. Anyone expecting a recession or very weak economy this year will be disappointed.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates "clearing weather" for the next few months.

-- Jack Krupansky

4-week T-bill up to 5.23%

I have a standing order with TreasuryDirect to roll over my maturing 4-week T-bills every four weeks. Yesterday was the weekly T-bill auction that happened to be on my 4-week cycle. A month ago the investment yield was 4.98%. This week it was 5.23%, which is probably the best return you could get for cash that is tied up for only four weeks. Alas, in four weeks my rate will reset to whatever the auction results are that particular week.

Note: A 4-week T-bill investment rate of 5.23% is equivalent to a CD with an APY of 5.36%, but try finding a 1-month CD, let alone at that rate.

Incidentally, the investment rate this week for the 3-month T-bill was 5.16% and for the 6-month T-bill was also 5.16%.

You can view the recent history of T-bill auction results on the TreasuryDirect web site.

-- Jack Krupansky

Dollar continues to duke it out with euro

Despite all of the incessant chatter about the "plunging" dollar (I just saw a reference to "the dollar's value sliding" in The New York Times), the dollar is present fairly stable against the euro. It is currently hovering near $1.30 to the euro, plus or minus a penny. I call such a narrow range stable, not "plunging" or "sliding", but I'm not trying to sell newspapers or advertising.

I continue to expect the dollar to trade in the range $1.25 to $1.33 to the euro for the next few months. Traders and short-term speculators may attempt to push the dollar outside of this range, but any such movement in the near-term would likely be only temporary.

-- Jack Krupansky

I'm getting out of the oil and natural gas business

As I noted back in November, I have a tiny bit of old IRA money in some Geodyne oil and natural gas production limited partnerships dating from back in the late 1980's and early 1990's. The limited partnerships were due to terminate years ago, but have been extended at management's option several times now. Back in November they finally started selling off some properties for their oil and natural gas. Now, I've just received a letter (actually a separate letter for each limited partnership) informing me that all of the limited partnerships would be terminating and liquidating by the end of this year. We'll get some or most of the proceeds this year, and the remainder next year. The potential proceeds are unclear.

These Geodyne limited partnerships that I'm in have returned in the form of income the full original investment plus over another 68% return over these many years.

Currently, you can sell the limited partnership units back to Geodyne, but for only about 20 cents on the dollar, depending on the specific limited partnership. Some are as low as 9 cents, some at 20, 21, 33, and the highest at 41 cents on the dollar. There is no ready and liquid market for such limited partnership units.

We might get twice as much as those stingy buyback numbers, or we could do significantly better, or we could do much worse. What a crap shoot. I'll be glad when this stuff is gone. I'll also miss them since they've been such a quirky investment.

The good news is that oil prices are still relatively high and there are still plenty of people who think commodities are "hot."

Lucky for me, these limited partnerships are in an IRA, otherwise I'm sure there would be quite a mess of tax forms to deal with.

My total investment in these limited partnerships is actually quite small. Even so, now I need too start thinking about what to do with the proceeds, as minimal as they will be. I'm also thinking of converting that IRA to a Roth since all my other retirement accounts are Roth now.

-- Jack Krupansky

Fed to hold a steady course at 5.25% for all of 2007 and probably into 2008

Although there was actually a bit of chatter this past week about the possibility that the Fed could raise interest rates this year, that was mostly due to quite a number of people being behind the curve and not previously being willing to acknowledge the posture that the Fed has held all along. The Fed may have been a little more vocal about its position, not because there was any change in that position, but if I were the Fed I would be getting awfully tired of the way so many people pretend that they know more than the Fed. Nonetheless, nothing really changed this past week, and nothing occurred to lead me to change my own position.

For now, my overall assessment of Fed monetary policy remains unchanged:

My view is that the Fed will keep the Fed funds target rate paused at 5.25% for all of 2007, and probably into 2008.

There will not be a recession this year, nor even enough of a growth slump to trigger a Fed rate cut.

I tentatively say "for now" because I am half-convinced that the Fed may in fact feel the need to make another hike in the spring (March or May) to 5.50%. To my way of thinking, it all depends on what happens with energy commodities. Prices of oil and gasoline futures are still quite elevated, albeit off their Summer peaks, and this constitutes an ongoing source of inflationary pressure that continues to propagate throughout the economy. If prices of energy commodities resume their decline, the Fed will be able to remain paused for all of 2007. But if energy commodities prices do not continue to fall, the Fed may have little choice but to hike to 5.50% in March or May. If we don't see crude oil consistently below $50 and retail unleaded gasoline consistently under $2.00 by April, expect a Fed hike to 5.50% at the May FOMC meeting. Based on economic fundamentals, we should see the prices of energy commodities come back down to Earth, but unfortunately there is simply so much free cash sloshing around seeking "some action" and a lot of speculators are simply unable to resist the urge to try to run commodities prices back up since "it worked before." My view is that there is a fairly good chance that prices of energy commodities will recede in the coming months, but it may be too soon to bet too heavily against the speculators. My finger is on the trigger, but for now I'll retain my belief that the Fed will remain paused for at least another year.

Note: I am not suggesting that the Fed will "target" commodities prices such as crude oil and gasoline, but that the Fed will be noticing the degree to which elevated commodities prices are influencing the rest of the economy and pushing up even core prices. We did have good news on the inflation front in the past couple of months, but that was primarily the result of the decline of crude oil and gasoline prices off the summer spike, but crude oil and gasoline prices have risen since November.

Update: Both crude oil and gasoline have bounced up quite a bit, but this was likely a technical or speculative move rather than based on fundamentals. Crude is likely simply trading up within its trading range. As I had suspected, it did in fact poke a little above $60 before retreating. It could take a couple of more pokes at $61 or $62 before trading back down in that $45 to $60 range.

My latest thinking is that $60 may be the magic number for crude oil for the Fed in May even though $50 is what they would really like to see. If crude is $60 or higher in May, the Fed will have a high probability of a hike to 5.50%. If crude is below $50, the probability of a hike is very low. If crude is at $55, it will be a 50/50 coin flip. At $58, the Fed would seriously consider a hike. At $53, the Fed would likely hike only if there were some other significant factors, such as a strong resurgence in housing demand.

The point here is not $58 crude oil per se, but the fact that $58 crude oil means that either real demand is overly strong, or there is too much monetary liquidity in the financial system that inspires speculators to throw too much money around because it is relatively too cheap and the Fed will feel some pressure to "mop up" such excess liquidity.

Although the moderation of the housing boom will indeed hold back the economy over the next couple of quarters, the Fed seems to agree with me that this is to be expected and not an indicator of a coming recession. A lot of people are desperately funneling money into bond funds in response to an expectation of well below-par economic growth, and this is depressing Treasury yields and causing an inverted yield curve, but this is ultimately indicating only below-par growth (e.g., 2% to 2.75% rather than 3+%) for the coming six months. Yes, there is a lot of anxiety, but anxiety itself is not a reliable indicator of a particular outcome.

Please note that current Fed policy at 5.25%, or even a hike to 5.50%, is not restrictive, but within the neutral range which is neither accommodative nor restrictive. All "normal" economic activities can be easily financed with Fed policy at this level. This does eliminate a lot of excessive speculative behavior, but won't crimp the average business or consumer.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• March: 0% chance of a cut
• May: 2% chance of a hike
• June: 4% chance of a cut
• August: 18% chance of a cut
• September: 30% chance of a cut
• October: 52% chance of a cut
• December: 84% chance of a cut
• January 2008: 100% chance a cut and 4% chance of a second cut
• February 2008: 100% chance a cut and 8% chance of a second cut

I personally don't concur with these odds after August, but that is how a lot of people are actually "betting." I would simply note that such betting can change on a moment's notice as economic and financial data, not to mention commentary and sentiment, unfolds and evolves. Like it or not, the economy proceeds more through Darwinian evolution than "intelligent design." The Fed (and Wall Street) can influence the evolution, of the economy, but not control it as if it were a clockwork machine. Predicting the precise or even general impact of any Fed action or inaction is quite literally a fool's errand. Further, the "betting" on any last Fed move is usually more of an insurance hedge than an outright bet, more of a "just in case I'm wrong" kind of "bet". Finally, studies have shown that Fed funds futures are not a very reliable indicator more than 45 days into the future.

What the Fed funds futures market tells us clearly is that the Fed is most likely to leave rates unchanged at least through September. The market is predicting a cut at the October FOMC meeting, but that is too far in the future for the market to give a reliable forecast.

My feeling is that since the housing retrenchment didn't cause a Fed cut at the January FOMC meeting, it is unlikely that housing will be enough of a problem to cause a Fed cut for the rest of the year either.

Last week: I note that as of the January 11, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research continues to forecast a Fed funds rate of 4.00% by the end of 2007. That would be five quarter-point cuts. They also continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective.

Update: I note that as of the January 25, 2007 edition of the UBS As We See It - Market Viewpoint report, UBS Wealth Management Research now forecasts a Fed funds rate of 4.25% by the end of 2007. That would be four quarter-point cuts. They continue to forecast 2% GDP growth for 2007. Obviously I do not concur, although I welcome their alternative perspective.

The bottom line here is that the Fed won't move through September, and any speculation about Fed moves further down the road are simply wild guesses based on contrived stories about a hypothetical future economy that happens to have a mind of its own.

Why are so many smart people so confused about the future? It is simply the fact that the conservative thing for them to do is to assume that economic events such as housing booms always play out in the same pattern every single time. For a bureaucrat, that is always the safe approach. Alas, every economic episode has its own idiosyncratic pattern and the real issue is how to forecast the interactions between the many sectors and regions of the economy, and that is a really hard problem that is absolutely not amenable to the cookie-cutter application of historical patterns.

The current "herd mentality" on Wall Street is basically sending so many speculators and even investors off on a truly wild goose chase, after which Wall Street will quietly acknowledge its error ("the data changed in an unexpected manner") and then chase those same speculators and investors back in the opposite direction, making sure to collect transaction fees and spreads on both legs of the roundtrip "chase."

Note that the Weekly Leading Index of the Economic Cycle Research Institute is telling us that the economy will be holding together nicely for at least the next few months.

-- Jack Krupansky

PayPal money market fund yield holds steady at 5.02% as of 2/10/2007

Here are some recent money market mutual fund yields as of Saturday, February 10, 2007:

• iMoneyNet average taxable money market fund 7-day yield fell from 4.74% to 4.73%
• PayPal Money Market Fund 7-day yield remains at 5.02%
• ShareBuilder money market fund (BDMXX) 7-day yield rose from 4.47% to 4.48%
• Fidelity Money Market Fund (SPRXX) 7-day yield fell from 5.02% to 4.95% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield fell from 4.95% to 4.93%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield remains at 4.45%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield fell from 3.22% to 3.14% or tax equivalent yield of 4.83% (down from 4.95%) for the 35% marginal tax bracket and 4.36% (down from 4.47%) for the 28% marginal tax bracket
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield fell from 3.19% to 3.13% or tax equivalent yield of 4.82% (down from 4.91%) for the 35% marginal tax bracket and 4.35% (down from 4.43%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate rose from 4.99% to 5.14%
• 13-week (3-month) T-bill investment rate remains at 5.15%
• 26-week (6-month) T-bill investment rate fell from 5.18% to 5.15%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 4.52%, with a fixed rate of 1.40% and a semiannual inflation rate of 1.55% (updated November 1, 2006, next semiannual update on May 1, 2007)
• Charles Schwab 3-month CD APY rose from 5.04% to 5.09%
• Charles Schwab 6-month CD APY remains at 5.16%
• Charles Schwab 1-year CD APY remains at 5.20%
• NetBank 6-month CD APY sremains at 5.40%
• NetBank 1-year CD APY remain at 5.45%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

PayPal continues to be a fairly interesting place to store cash for both relatively quick access and a well above average yield. There is no minimum for a PayPal account, no fee for a basic account, and it can be linked to your bank checking account or even your brokerage checking account for easy access. Right now I am using PayPal as a savings account, putting a little more money in whenever I get a chance and feel that my budget has some "spare change." The PayPal 7-day yield of 5.02% is equivalent to a bank APY of 5.14%.

4-week T-bills were once again very attractive for cash that you won't need for a month, since the new issue yield was well above the yield of PayPal and Fidelity Cash Reserves. But, this rate fluctuates significantly from week to week. The rate is locked in for four weeks once you buy the T-bill at the weekly auction, but you can't predict what rate you will get at the next auction since it is based on supply and demand. Simply letting the T-bills automatically roll every four weeks will average out a lot of this volatility. My 4-week T-bills will be rolling over this week (2/15).

I would note that T-bill yields have been rising, implying that their prices are declining, as people find more interesting places to invest, including the stock market or commodities. The implication is that as people become more confident that the economy is stronger than they thought, more money will flow out of Treasuries and into stocks or commodities, causing Treasury yields to rise. In theory.

Check Bankrate.com for the availability of high-rate CDs (5.00% APY to 5.45% APY for 6-month). Alas, there are frequently quite a few caveats, strings, restrictions, requirements, minimums, "introductory specials", and other gotchas, so read the fine print carefully. CDs work great for some people, but horribly for others. I have no CDs since I do not have any free cash that I can afford to lock up with restrictions. But, that said, I am considering putting at least a little free cash in short-term CDs (three-month, six-month, or maybe even one-year), around the middle of 2007, especially if the Fed raises interest rates by a quarter-point in the spring.

Please note the disclaimer on Fidelity's web site for mutual funds:

Past performance is no guarantee of future results. Yield will vary.

As always, please note that cash placed in money market mutual funds is subject to the disclaimer that:

An investment in the Fund is not insured or guaranteed by the Federal Insurance Deposit Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.

In practice, that is not a problem at all, but it does incline me to spread my money around a bit.

T-bills and the cash in your bank checking and savings accounts or bank CDs are of course "protected", either by "the full faith and credit of the U.S. Treasury" or the FDIC. Please realize that you may not get your full principle back if you attempt to cash out early for Treasury securities since you'll get the price on the open market, which is not guaranteed by the U.S. Treasury. You are only assured of getting your full principle if your Treasury security is held until maturity. (or Treasury "calls" the security or issues an offer to repurchase).

-- Jack Krupansky