Wind Stocks
Wind Stocks
Where’s the Wind?
Before he takes off, every good aircraft pilot asks, “Where’s the wind?” Knowing the direction and strength of the wind is essential to safe flight, as the wind has a huge affect on your takeoff. The speed of the air over your wings determines whether or not you will fly.
Pilots want the wind right down the runway and blowing in the opposite direction of their take off. The more wind the greater the air over your wings and the sooner your aircraft will lift-off and fly. If the wind is blowing from the side, it may make takeoff unsafe. And if it is blowing behind you, you taxi to the other end of the runway and reverse your takeoff direction.
Investors, like pilots, need to ask the same question. But in the case of investors, we want the wind at our back, pushing us along. Investors need to frequently figure out from which direction and how hard is the wind blowing.
“Wind” for investors is the general background conditions in the markets. Monetary policy, tax policy, and other government actions, regulations, and policies all create wind. So, do inflation and inflation expectations. And of course, all these things influence interest rates which is the discount rate applied in determining the prices of both stocks and bonds. Economic activity and the environment in which risk takers must function also creates wind.
So, where’s the wind blowing from now? It is blowing steadily in our face, slowing us down.
Short term US treasury interest rates are near zero and long term (10 year) treasury rates are about 4%. Long term real interest rates average about 2%. At 4%, long term Treasuries are anticipating inflation of 2%, which is right where it is. This interest rate structure provides a nice steady breeze on our backs, pushing us along.
If current interest rates and inflation expectations are positive, then why is the wind blowing in our face? What’s the problem? Different factors each provide wind. In this case the burdens on our productive workers and unearned payments to non-workers are creating a stiff headwind that more than offsets the positive breezes from the Federal Reserve’s accommodative monetary policy. In short, one more than offsets the other. And that is why all the actions of the Fed to date are not working and will not work.
Headed For Disaster
The composition of our economy is slowly changing and is headed for disaster. The overwhelming burden put on risk takers and the steady reallocation of wealth to non productive beneficiaries is creating huge headwinds.
This did not happen overnight. In fact, it started in the 1930′s with the massive expansion of the role of government in our lives. It took another massive leap toward the abyss with the Great Society, and another step with the passage of Medicare Part D. So, it is not a single event we can point to, but a continual step by step process of allowing the government to control more and more of our economy.
What it all boils down to is growing disincentives to take business risk and massive transfers of wealth to non-productive beneficiaries.
Here are just two examples before we get into how this all happened.
Example one: Twenty six separate governmental approvals are required to open a paint shop in Los Angeles. It should not surprise us there are no new paint shops opening in L.A.
Example two: Recently 9 NYC policemen retired with full pensions in excess of $100,000 a year. They were all less than 40 years old. Adding the cost of their pension to their annual salary means the NYC taxpayers paid these policemen about $300,000 for each year of service. This does not include the cost of medical benefits.
Unfortunately, early retirement with lush benefits in excess of $100,000 a year is now commonplace in cities from Miami to Seattle. With the average American family earning about $70,000, these kinds of wealth transfers are unsustainable and poor public policy.
How did we get to this ridiculous state?
The answer is little by little over many, many years. And we are now at the point of no return. We must take action. As this is a political issue, we have an opportunity, as voters, to register a strong vote for less government in November.
Three Actions Take Nobody’s Rice Bowl
As it took us almost 100 years to get in this mess, it will take a few years to get this straightened out. But here are three actions we can take today that would make a massive contribution toward rebalancing our economy. These three cut no one’s current entitlements, so no one should object. It just cuts future pay that was not earned and is not deserved.
- Outlaw all COLAS (Cost of Living Allowances)
- Require voter approval of any unfunded government worker benefit
- Put the assets and liabilities of all benefits into the annual government budget.
What is required is nothing less than a massive rebalancing of our economy back to strong incentives for producers, and modest, contributory and limited benefits to those that do not produce. The three actions above would simply stop some of the bleeding and fully disclose all the facts to the voters. The real answer is to abolish all defined benefit plans, and replace them with defined contribution plans.
- Outlaw COLAs- In 1991, a Rhode Island fireman retired with a pension of $54,616. Today, because of COLAs he is now paid $165,247, and with already scheduled COLAs he will receive $221,139 in five years; FOUR times his original pension! This is just a blatant plundering of the taxpayer, and it needs to stop. Outlawing all COLAs will stop this madness.
- Voter Approval – You can bet if the New York City taxpayers knew each beat cop they saw cost them $300,000 a year, this would get stopped.
- Consolidated Financials- Part of the problem is the taxpayers who must ultimately pay for benefits don’t know and were not asked to approve the benefits paid to government workers. Consolidated statements would tell them exactly.
Two Sides of the Same Coin
The central issue is who gets the benefit of our production? How much does America produce each year and who gets it? Almost every year we produce more goods and services, which is measured by our Gross Domestic Product or GDP. This is one side of the coin.
In 2009, America’s GDP was $14,259 billion. The following schedule details the main items.
America‘s 2009 Product (GDP)
($Billions)
As you can see, most of our economy is made up of consumption, 71%. You will also note our investments are much less than the cost of government. This is a very bad sign.
Now let’s look at the other side of the coin which tells us who gets the income from all our production. I have listed it in four categories. The largest and most important is Income from Working. This includes wages and benefits of both private industry and government.
The next is Income from Assets. This is rents, dividends, interest income, and corporation savings, or profits. The next is Income from Other’s Work. This is government entitlements such as welfare, social security, and Medicare. The final category is long term investments which include contributions to pension plans and individuals contributions to social security.
America’s 2009 Income
($ Billions)
As we would expect, the largest portion goes to workers, 48%. After all, they do all the work. The problem is entitlements have grown relative to wages and are now 29% of all wages.
In 1960 entitlements were just 7% of wages. If we take out wages to government workers because government activity produces no profit and therefore no growth, the burden on private workers increases to 34%.
Private sector workers support non-workers equal to more than one third of their pay. This is sheer madness, and is unsustainable. You can not grow an economy by paying non-workers one third of what you pay workers.
We now have strong evidence of the long term failure of wealth transfers. You can see it clearly in growth rates over the past 20 years, and especially in the last ten years. The next schedule compares the rate of growth of the economy and private sector with the non-productive sectors of our economy, government entitlements.
Long Term Nominal Rates of Growth
Source: Economic Report of the President – 2010
These are alarming figures! The rate of economic growth is slowing. The rate of private sector growth has fallen to half of the rate of growth of the economy. This is an absolute disaster. And finally the rate of growth of entitlements is more than twice the rate of growth of the economy.
If these trends continue the economy will stagnate and will no longer support massive wealth transfers. For at least the past 40 years, our elected officials (Congress) have been unwilling to deal with this imbalance as it gets worse year after year. Their answer is to borrow more to pay entitlements. This solves nothing. In fact, makes the situation worse.
The source of all growth is savings. No savings; no growth. For you and me, we call money we don’t spend our savings. For corporations, we call it profits. It’s all the same, and is the only source of long term growth.
We have already reached the point where the top 50% of taxpayers pay all (97%) income tax. What is the incentive for these wage earners and potential risk takers to take more risk? The answer is none.
The result is the private sector is shrinking. The non-productive entitlement sector is growing. This is a sure recipe to kill an economy. Our standard of living has been slowly declining for several decades and continuing on our current path will probably result in great upheaval and social unrest.
This is not necessary. The answers are simple and right in front of us. I am a voter; you are voters. We must demand this nonsense be stopped. If you think you are not affected by this as an investor, you are dead wrong. The success of our investments depends on the strength and growth of our economy.
This is the first part of a two part series. This first part is about the out-of-control government entitlement programs and its disastrous impact on the productive sector of our economy. This is producing a steady wind in our face and is negatively affecting our investments.
The second part of this series is about the mischief and evil created by defined benefit pension plans.
May you live long and prosper,
Mike Williams, CFA
Earth, Wind, and Fire Stocks
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