SWR, terminal values, TIPS, I-bnds & comm paper

[Michael]

I agree Ronin, although the demographic trends in the US have not yet turned unfavorable. Overseas stocks may indeed become more important in future portfolio construction than they are now.

[cute fuzzy bunny]

Another play on the aging of our population that I think is appropriate is the health care sector.

Unless we end up with the guvvinmint cracking down on prescription drug costs, or perhaps state or nationalized health care.

That would bring THAT parade to a screeching halt.

Half of my IRA was in the vanguard healthcare fund, a solid historic performer. I downed that to about 15% recently.

[Michael]

This doesn't seem very likely to me in the next 5 years or so. President Bush is firmly against it, and he is very popular in the current polls.

[Hiss]

President Bush is firmly against it, and he is very popular in the current polls.

Maybe not so much now. The most recent poll I saw this week showed his approval rating below 50% (@ 48 or 49%, I forget exactly). Also showed Kerry beating Bush if the election were held today with a poll that was outside the margin of error. I realize the Democrats are riding somewhat a high with all the publicity from the primaries. Hopefully things will get back to normal in a month or so once the Iraq WMD stuff cools down.

My politics are "off the chart", partly why I no longer vote. When I was in defense contracting, I used to
have to fill out forms for security clearance. Whenever
they asked "Do you advocate the overthrow of the
government by force or violence?" I always circled
"violence". Anyway, all of the presidential possibles
for 2004 look pretty nutty to me. I guess if we all have to
go up in a mushroom cloud, I would prefer Bush in The
White House. He may be wrong but he's never in doubt.
On a visceral level, that appeals to me. I like Cheney,
Rice and Rumsfeld also. (Yes, I recognize this has nothing to do with the topic

John Galt

[cute fuzzy bunny]

Yeah I saw the same polls. Unfortunately I know Kerry to a degree since I come from MA. Used to run into him at nightclubs all the time, surrounded by a small circle of the long blonde haired in little black dresses awash in chanel no 5. Kind of an empty suit, although politics as usual and special interests seem to get plenty of attention.

I'm unimpressed with most of the candidates, and dont have anything in particular against Bush. I'm not sure if our civil rights can take four more years of Ashcroft though.

About the only one i've seen speak that seems to have a well rounded head on his shoulders is Edwards.

Hello TH. No shortage of "empty suits" is there?
I agree with you about Ashcroft. Interesting that
I usually think of myself as an arch conservative
and yet the ACLU frequently makes a lot of sense to me.

John Galt

[Ted]

*
Less overall spending may result in lower corporate profits, which may in turn result in lower total return from the stock market. *

This is 180 degrees off. *The fundamental economic problem in the future will not be a lack of spending -- by retirees or anyone else -- but rather too much demand for consumer goods by people who are no longer producing anything of economic value. *In real terms, this will necessarily reduce both the consumption of workers, and capital investment. *

Probable efforts by the federal government to "weasel out" of this dilemma by a combination of "printing money" and deficit spending will lead to some combination of inflation and soaring interest rates that will reduce the purchasing power of the financial assets *that retirees have accumulated (except, hopefully, TIPS). *And retirees won't be able to get much by liquidating stock because there will be relatively more sellers than buyers, compared to the past couple of decades when the "baby boomers" were loading up on stocks, causing their price to rise to an unsustainably high level relative to earnings.

[charlie]

Hi all,

Sorry to butt in, but I am trying to learn how to value
TIPS. I am a little concerned that the price of TIPS
may take a real hit if the cupon "regresses" to the
long term mean of 2.8% . After all, the cupon started
at about 4% in 1997 and has since dropped to around
2%. If you study Vanguard's Inflation Protected Fund
you will see that the average cupon is 3+% yet the
quoted interest rate is about 1.5%. This means, I
think, that there is substantial capital gain in the fund's
holdings.

I found an interesting article on the internet that analizes the sensitivity of TIPS to changes in real
interest rates. The bottm line, as claimed by the author,
is that real rates tend to go up with increasing GDP.
To some extent, real rates will increase as inflation
increases due to GDP growth. This means that TIPS
are not a perfect hedge against inflation. The article
is found at:

http://rondvari.com/Business%20Journal_200206_D.pdf

Please let me hear what you think.

Thanks and Cheers!!

Charlie

[Hiss]

The fundamental economic problem in the future will not be a lack of spending -- by retirees or anyone else -- but rather too much demand for consumer goods by people who are no longer producing anything of economic value.

Ted,
Do you think that we will be a nation "no longer producing anything of economic value" because of the shortage of workers due to retiring baby boomers in the future, or because of the shift we have seen away from manufacturing in this country, leaving the production of "goods of value" to the labor cheap countries?

If the reason is the former, I believe we will continue to make up for the future labor shortage to a large degree by productivity gains. We have seen a sustainable level of increased productivity in this country for a decade (?) or more now. I think even Greenspan has been confounded by it. No one even knew the power of things as simple as e-mail and the impact it would have on business efficiency when it started to be popular 10+ years ago.
I believe, as a nation, we will continue to find technological advances to compensate for the diminishing workforce, as we always have. I know I am not an economist, but as one of the many engineers in this forum, I know that most anything can be engineered once it is conceived, and these implemented ideas lead to further productivity gains. I see so much waste in the chemical plants in which I am associated to know we still have a lot of slack that can be taken up.
I appreciate your point of view, as it is apparant to me you are very well learned in your field. Perhaps I am overly optimistic or naive in my point of view.

[charlie]

Hi all,

I am new to the ethics of posting on this forum so
if I offended anyone by butting in with my previous
post on TIPS valuation, please accept my humble
apology. Perhaps this is an old subject that has
been exhausted. Or, perhaps I was stating the
obvious and you are all too polite to tell me to
MYOB. In any case, I think this is not a good time
to be buying a TIPS fund because of the potintial
likelyhood of real interest rates to rise toward the
mean in the near future.

I am also wondering if the TIPS model used in
FIREcalc accounts for the effect of variation in
real rates on the value of a TIPS portfolio. Dory??

Thanks and Regards,

Charlie

[haha]

I am new to the ethics of posting on this forum so
if I offended anyone by butting in with my previous
post on TIPS valuation, please accept my humble
apology. *Perhaps this is an old subject that has
been exhausted.

Charlie,

I doubt that valuation as a topic can be exhausted. Probably you haven't heard from anyone because it might take a while to formulate a meaningful opinion.

I owned tips a few years ago, I think they were 3 3/8 which I bought a bit below par. Like a nut I sold them when they jumped up. I think they may have sold cheaper (at a higher base interest rate) than they will again, because they were new to this country. There really isn't any good way to know what the boundaries of the base interest rate will be going forward.

The UK form of inflation protected securities didn't look so good in the 90's, because real rates were rising, and inflation was low. Personally, I am not attracted to TIPs at current rates, but they could turn out to be the best of a bad lot of current choices.

Mikey

[Michael]

Ted wrote:

And retirees won't be able to get much by liquidating stock because there will be relatively more sellers than buyers, compared to the past couple of decades when the "baby boomers" were loading up on stocks...

Mike replies:

This is a valid point. I expect P/E ratios to contract. When the demographic trends start to turn, TIPS may be safer than the S&P for a while.

Ted:

...too much demand for consumer goods by people who are no longer producing anything of economic value. In real terms, this will necessarily reduce both the consumption of workers, and capital investment.

Mike:

Yes, in the future workers will probably get less reward for their efforts, and less capital investment will further reduce the potential supply of goods. I expect to see more 2 earner couples as a result. Also more elderly working.

Ted:

...inflation and soaring interest rates ...

Mike:

Considering our nation's long history of debasing the currency in times of stress, this is a real possibility. Those depending heavily upon fixed defined benefit pensions could have what they worked their whole lives to earn taken away.

[Michael]

Charlie wrote:

To some extent, real rates will increase as inflation
increases due to GDP growth. This means that TIPS
are not a perfect hedge against inflation.

Mike replies:

I will give you my opinion, but I am not an expert. TIPS are really too new in the US to have enough of a track record to accurately predict their future performance. Real interest rates were high initially partly because people were unfamiliar with them, and thus a bit wary. Added to this was the pre Y2K stock craze which made a lot of people invest in "hot" stocks rather than "stodgy" bonds. When the market crashed, people fled tech and ran to TIPS for safety, which lowered their real interest rates (the greater the demand, the lower the real rate). Real rates are likely to rise and fall over time, and mutual funds that hold TIPS will rise and fall in price accordingly. Over long periods of time, TIPS held in an IRA will probably keep up with the CPI, but in the short term you can lose money in a TIPS fund as real rates change.

[Hyperborea]

Ted:

...too much demand for consumer goods by people who are no longer producing anything of economic value. *In real terms, this will necessarily reduce both the consumption of workers, and capital investment.

Mike:

Yes, in the future workers will probably get less reward for their efforts, and less capital investment will further reduce the potential supply of goods. *I expect to see more 2 earner couples as a result. *Also more elderly working.

I would think that with more dollars chasing fewer workers that the future workers will get more for their efforts. Which area those workers are in will likely be different than now though. The dollars will go towards medical care, home maintenance, personal services, etc. The actual goods required by the US will come from places like China and will be paid for by the spending down of retirees life savings - either directly or indirectly through the medial and service workers.

Hyperborea

[Michael]

I would think that with more dollars chasing fewer workers that the future workers will get more for their efforts

Before taxes perhaps, but what will their take home pay be?

The actual goods required by the US will come from places like China and will be paid for by the spending down of retirees life savings

What savings? The average 401k balance is hopelessly inadequate to support a boomer. The balances will look even worse if P/E multiples contract.

[Ted]

1. Do you think that we will be a nation "no longer producing anything of economic value" because of the shortage of workers due to retiring baby boomers in the future, or because of the shift we have seen away from manufacturing in this country, leaving the production of "goods of value" to the labor cheap countries?

If the reason is the former, I believe we will continue to make up for the future labor shortage to a large degree by productivity gains. We have seen a sustainable level of increased productivity in this country for a decade (?) or more now. ...I believe, as a nation, we will continue to find technological advances to compensate for the diminishing workforce, as we always have. * *

Perhaps I am overly optimistic or naive in my point of view.

I said that the problem is that the ratio of retirees (who are no longer producing anything of economic value) to workers, is increasing. *I did not say, and do not believe, that the productivity of workers is likely to decline. *In fact, the economic advantage of sending some manufacturing jobs overseas is that it creates new, more productive jobs in exporting industries. *Some of theses jobs may be "service" jobs such as in finance or engineering, but there's nothing wrong with that!

I do think, however, that it is Pollyanish to assume that the rate of productivity gain that the U.S. has experienced throughout most of its history will necessarily continue indefinitely. *In fact, that's physically impossible. *The U.S. has been a relativley "young" nation that has reaped the benefits *of huge technological advances in transportation, communications, health maintainance, etc. *The fact that it had a lot of readily available natural resources certainly helped. *But the supply of some critical resources is dwindling, and there is no guarantee that some presently-unforeseeable technological breakthrough will once again occur to prolong the increase in productivity. *

Incidentally, productivity is measured on the basis of the working population, not the total population. *So productivity per worker could continue to increase, while real output per capita (which is based on the total population) could decrease. *Time will tell, but I'm preparing for a future with rising prices and declining real returns on most financial assets.

Speaking of which -- if the real return on TIPS declines (which is likely) it won't affect people who currently own TIPS and hold them to maturity. *The problem will arise when they go to "roll them over" into TIPS paying a lower real return.

And I'm also doing what I can to oppose the equally irrational responses of (a) admitting a flood of immigrant workers to the U.S. or (b) trying to "save American jobs" by restrictions on trade.

Hey Ted! Re. "equally irrational responses", you have
regained some esteem here. I agree completely.

John Galt

[Michael]

From a previous post by Ted:

The idea of increasing the size of the working population through increased immigration will simply defer the problem farther into the future and make it worse then, because even more workers will be required to support the immigrants when they retire. It is physically impossible for the population to keep exponentially increasing forever...

I can see your point, but Congress has a tendency to postpone problems whenever it can. When the crunch comes, Congressmen of the time may very well decide to postpone the problem for someone else's future term in office. (Hoping that some technological breakthrough will occur to solve it by then. After all, they may reason, Malthus has been proved wrong so far. Improved tech has kept the industrialized world fed in greater numbers than Malthusians predicted possible.) Postponing the problem is exactly what the current Congress is doing, rather than taking politically painful measures to prepare for the boomer retirement. The average boomer retiree will probably much prefer more immigration to going back to work themselves into their 70s. The elderly tend to vote in large numbers, and politicians like to be reelected. Politicians who tell the elderly that they are restricting immigration, and making them work into their 70s, to solve a potential problem 50 years away may have a hard time at to polls.

Due to the nature of American politics, I can see a significant possibility of increased immigration in the future, although possibly not enough to make boomers comfortable. There will likely also be much longer working lives for many, and a reduced standard of living for most.

[Hiss]

The fact that it had a lot of readily available natural resources certainly helped. But the supply of some critical resources is dwindling, and there is no guarantee that some presently-unforeseeable technological breakthrough will once again occur to prolong the increase in productivity.

Thanks Ted. Just two points and I will be quiet with my Polyanish view:
1) Natural resources are helpful but not at all critical in economic growth. Look at Japan (overlooking current fiscal issues). Energy can come from alot of sources, which leads to point two:
2) All technological breakthroughs were unforseen, so I certainly wouldn't count them out.

Thanks again, I appreciate your opinion.