Being employed in the securities industry has its fair share of unique and challenging situations. One situation that I always find comical is when a client calls me and wants to buy some obscure penny stock that they claim is the next “sure thing”. Each time this occurs, it never fails that the stock is some random recommendation from the client’s brother’s barber’s son-in-law who guarantees the stock is getting ready to take off. Every time this occurs I always sigh to myself and think, “Sure it is”. Before you go out and try to strike gold let’s find out what a penny stock really is and what risks they have.

Pennies on the Dollars

One would think that a penny stock would cost only pennies, right?  Well, not quite.   Actually, to qualify as a “penny stock”, the stock price will be less than $5.00.  Here are a few other characteristics of a penny stock:

• They are not traded on any exchange or the Nasdaq
• Priced less than $5.00
• Company has not met financial standards of listed equity companies.

Why Are Penny Stocks Risky?

Many investors are attracted to penny stocks because of the buying power (you can buy lots of shares without a lot of money)  and “potential” payoff.  Keyword is “potential” or better translated as “not likely“.   What makes penny stocks so risky is there lack of liquidity.   Penny stocks are not traded on the major exchanges (NYSE or Nasdaq) and are traded on Over the Counter Bulletin Board (OTCBB) or the Pink Sheets.  The listing requirements of these  are far less stringent than the major exchanges,  so many of these companies do not have to have as detailed reporting as their publicly traded counterparts.

All these factors combined are what make penny stocks that much more risky.

Liquidity is an Issue

Penny Stocks are Risky

Since these stock are more thinly traded, it can be hard to find a buyer if you hold the stock.  And just because the stock may list for a certain price, doesn’t mean that there is a buyer out there.  Think trying to sell a Barry Bonds rookie card for what the pricing guide lists it for.  Chances are you are not going to find a buyer.

Beware of Penny Stock Scams

Many of us have been exposed to some sort of scam promoting penny stocks. According to a study conducted at Oxford, 15% of all e-mail spam was related to penny stock fraud. According to the study,

“People who responded to the ‘pump and dump’ scam lost 8% of their investment in two days. Conversely, the spammers who buy low-priced stock before sending the e-mails, typically see a return of between 4.9% and 6% when they sell.”

The most common penny stock fraud is the “Pump and Dump“. A small group of speculators will accumulate a large number of shares in a penny stock. Once their positions are in place, they will release positive financial propaganda, news so unexpected and titillating it can drastically affect people’s perception of the stock. The intent is to get small-time investors to start trading irrationally. The news is almost always false, but before this is discovered, the price of the stock often skyrockets and the original speculators exit with large profits.

Beware of Penny Stock Scams

Over the years, I have received countless solicitations at work from cold calling Boiler Room types trying to get me to take a look at a hot stock so that I would call my clients about it.  It never failed that this next supposed gold mine was some thinly traded penny stock that was going anywhere but up.

Another example of a scam that I and another blogger Mrs. Micah both experienced was receiving a fax at work involving penny stocks.  The fax is made to somebody else’s attention and you are led to believe by the scammers that you have been on the receiving end of inside information by mistake.  They are hoping that you will go out and buy the stock and tell all your friends to buy it, too.  If you get a similar fax at work, don’t call your stock broker about buying it.  Head to the shredder and save yourself the trouble and money.

photo credit: killerturnip

Securities offered through LPL Financial, Member FINRA/SIPC

Jeff Rose is a Certified Financial Planner and co-founder of Alliance Investment Planning Group.

Welcome JoeTaxpayer to Good Financial Cents

I’m excited to share that a new staff writer will be contributing to Good Financial Cents. JoeTaxpayer, who authors the self titled blog, will be sharing his expertise here from time to time.  I’ve been wanting to add more quality tax posts, but my schedule has prevented me from doing so.  Joe will be able to offer some good insight on these and other related topics.  Just in cased you missed out, Joe had already authored a post on Maximizing your wealth through Roth IRA’s.  His next post is due up soon, so stay tuned!

Securities offered through LPL Financial, Member FINRA/SIPC

Choose your plan wisely.

Tis the season of open enrollment and if you are like me, you’re trying to figure what you’re going to do about your health insurance for the coming year. On top of choosing the right coverage, you also have to decide what additional health savings plan works best for your situation. Health Savings Accounts (HSAs), Health Reimbursement Accounts (HRAs) and Flexible Spending Accounts (FSAs) are gaining popularity with employers (especially employers with younger and healthier workforces). Many companies are offering their workers the option of enrolling in an HSA or similar account instead of the usual HMO or PPO. Here’s how these new consumer-driven health savings accounts work.

The HSA- Health Savings Account.

An HSA gives you a tax-exempt savings account to pay for your own health care expenses. Money you don’t spend in one health plan year rolls over to the next. You are also enrolled in an HDHP (High Deductible Health Plan), in which your insurance company will only pick up the tab for major health care expenses (including types of preventive care, maternity care, and pediatric primary care). In 2007, the minimum deductible on an HDHP is $1,100 for individuals and $2,200 for families.

The rising popularity of HSAs can be summed up in two words: low premiums. In the traditional insurance plan, you pay high premiums up front; in the HDHP, you pay lower premiums and essentially assign the savings to your own health care expense account.

Individuals can currently put up to $2,850 per year in an HSA, families $5,650 per year. The money grows tax-deferred and distributions are tax-free (if they are used to pay for qualified medical expenses). You can even invest HSA assets. If you’re 65 or older, you may withdraw money from an HSA for any reason without tax penalty.

The HRA- Health Reimbursement Account.

While an HRA is a tax-advantaged account like an HSA – the account savings grow with time – the assets in an HRA don’t belong to you. They belong to your employer, and they revert back to your employer when you leave your job. The HRA is essentially a favor your employer does for you – a reimbursement account rather than a true “asset” in your possession.

The FSA- Flexible Spending Account.

With an FSA, you deduct pre-tax dollars out of your salary to pay qualified medical expenses. You can designate an FSA for your own health care expenses or for those of a dependent. But most FSAs are “use it or lose it” – at the end of the plan year, the money left in the account doesn’t roll over into the next year. Employees tend to minimally fund FSAs as a result, although they can be used in conjunction with HRAs.

If you have questions about HSAs, HRAs or FSAs, why not speak with a financial or insurance professional as well as your human resource officer? It’s wise to get as much information as you can before making the switch from an HMO or PPO.

This was prepared by Peter Montoya, Inc., Securities offered through LPL Financial, Member FINRA/SIPC.

Do you need life insurance when you are wrong?

I‘m constantly amazed at the fact of how many young people I come across that don’t have any life insurance.  While they all have there different reasons, the most common reason I hear is that it’s too early to think about life insurance.  I couldn’t disagree more.

Most Important Question:

Are you supporting individuals whose livelihood depends on your income? If the answer is yes, it’s time to look at life insurance.

Now, you may be saying: shouldn’t I wait to get a policy? Why should I pay premiums when I have so many other checks to write? Well, the reluctance is understandable: the perception is that life insurance is for old people, and when you’re 30 or 35, chances are you’ve got a long, great life ahead of you. But in financial terms, here is why this can be advantageous.

Healthy is Good

Typically, Americans shop for a life insurance policy in the middle of their life spans – when they are in their forties or fifties. At that time, they may have already fallen into the grip of bad habits (smoking, obesity, heavy drinking) and diabetes, heart disease, cancer or HIV may have entered their health picture. All these conditions can jack up premiums or make it harder to get a policy.

Term Life Insurance is Cheap

Okay, maybe you won’t have to contend with any of the above health risks at 45 or 50 – but who knows? Buying a term insurance or permanent cash value life policy early in life, before you have to encounter any of these problems, should allow you to pay less expensive premiums. (Presuming you don’t face recurring risks to your health and safety today.)

Did you know that premiums for standard-risk term life insurance fell 50% between 1994 and 2008?

Premiums have been getting cheaper and cheaper for new term life policyholders, partly because the mortality rate has dropped over the decades. In fact, the non-profit Insurance Information Institute says term insurance premiums have fallen by more than 4% per year since 2000, and the premiums on cash value policies are averaging roughly 5% lower today compared to a decade ago.

Do young singles need life insurance?

Good question. Some financial consultants will tell you there is no pressing reason for it. Yet if you are single, buying a term life insurance policy (or even a permanent life policy) early on could bring you a better deal and potentially guarantee your insurability.  I have to admit that I did not do this.  But I was fortunate  to take out a term life policy early enough that the premiums were still very affordable.

Maybe it’s time. Time passes, things change, and so does your need for insurance. Even if you are insured, it’s important to keep up with change – as an example, the Insurance Information Institute estimates that about a third of families don’t update their life insurance coverage after a new baby comes home.  I’m an exception to this stat.  Not only did I increase my insurance after having our first child, but I’m now increasing it again with the soon arrival of our second.  I increased the amount dramatically so that I won’t have to worry about increasing premiums if we have another child.

If you’re young and you haven’t yet talked to a qualified insurance advisor, think about doing so today – you may be pleasantly surprised how affordable life insurance can be.

This post is featured in the Best of Money Carnival at Gen Y Wealth.

This was prepared by Peter Montoya Inc. Securities offered through LPL Financial, Member FINRA/SIPC.

Jeff Rose is a Certified Financial Planner and co-founder of Alliance Investment Planning Group.

Investment Time Horizon

This guest post was written by ABCs of Investing – a new site for novice investors which offers a weekly short and simple investing posts.

One of the most valuable pieces of money management information I‘ve learned is the concept of investment time horizon.  The basic idea behind investment time horizon is that if you are investing for the long term (ie retirement and you are young) then you can consider having part or all of your investment in riskier securities such as equities or stocks.  If you are investing for the short term (ie a house down payment) then you need to reduce your risk as much as possible and put the money into CDs or a high interest savings account.

All equities (stocks) are risky

While it is true that some stocks are safer than others – don’t get the wrong idea that certain stocks (ie blue chip stocks) are safe investments.  Yes, they are less risky than the junior mining stock the guy at the coffee shop told you about, but there is still a lot of risk in all kind of stocks – especially in the short term (think 2008 for example).  This doesn’t mean that you should avoid stocks because of risk – only that if you need the money in the near future – then stocks probably aren’t the safest bet.

Stock Investments

If the investment is composed mostly or entirely in equities then they are potentially more risky.  Diversifying among more stocks reduces risk compared to a single stock but it’s still a risky investment for the short term.

Balanced or Target Date Investments

These types of investments can be misleading – there are no rules regarding what percentage of equities are in these , regardless of the name of the investment.  It is up to the investor to do the research to find out what the mandate of the investment is (how they plan to invest your money) and hope that the portfolio managers stay on course.  If you have your house down payment in a target date retirement investment that is coming due in the next few years i.e. target date 2015 – don’t assume the equity component is small.  The best thing is to put your money into an investment where you can be 100% confident of what you are investing in.  CDs and high interest savings account are the best choice.

Summary

If you are investing for the short term then you need safety.  If you are buying a house next year then go as safe as possible.  The investment return doesn’t matter – you need your money to be there when you need it.

If your time line is a bit longer – up to 5 years then I would still go very safe.  If you know for sure it’s 5 years then you have some options for locking in the money and getting a higher interest rate.  No equities!!!  this might be a situation where you are saving for something that you know you can’t afford for a while….maybe a world travel trip or a cottage.

Keep it in a cash account – don’t put it in any kind of retirement account such as 401k etc since you’ll be looking at penalties if you withdraw while still young.

If you are investing for the long term then you should have part of your portfolio in equities.  It doesn’t have to be all or none – you can have 80% equities/20% bonds or 20% equities/80% bonds or any other combination you are comfortable with.

If you enjoyed this post from ABC’s of investing, please feel free to subscribe to the feed.

* Please note: I had to change some of the text in the post to accommodate my compliance department.  Just in case you thought some of the terms of the guest writer sound funny.

IMPORTANT DISCLOSURES

• The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
• Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
• Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
• Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise and are subject to availability and change in price.

Securities offered through LPL Financial, Member FINRA/SIPC.

Jeff Rose is a Certified Financial Planner and co-founder of Alliance Investment Planning Group.

Stocks to high again?

Back in the summer months of May, June, and July, the stock market, measured by the S&P 500, remained in a range around 900 after investors moved from pricing in another great depression to a typical recession. Now, this fall, the S&P 500 has been in a range around 1050 as investors have moved from pricing in a typical recession to a recovery. The recent pattern of performance of the S&P 500 is remarkably similar to what took place during the early summer months.

The nearby chart of the S&P 500 compares this summer’s performance (from April 22 through July 31) and the pattern this fall (from September 1 to now) [Chart 1]. They are nearly a perfect match, with the fall being exactly 150 points higher on the index than during the summer. What this suggests is that the recent slide may not be the end of the bull market, but it may also not be the end of the pullback either. An eventual move down of a few more percentage points in the next few weeks may unfold if the S&P 500 tracks this summer’s pattern. The slide may end as we start to get confirmation of the sustainability of the recovery in the form of better labor and spending numbers. The confirmation that the recovery was underway came in the later part of the summer in the form of consistently better than expected economic data.

Chart 1

But could this pullback go a lot further?

Has the 60% rally since March 9 pushed stocks too far? Are stocks overvalued? Our answer to all of these questions is no. In fact, there is room for a potential rise in valuations in the coming months. When we discuss valuations we use the forward price-to-earnings ratio (P/E), defined as the price of the S&P 500 divided by the expected earnings of the companies in the index over the next year. This industry standard definition is used in favor of a trailing P/E that uses the earnings of companies over the prior year since it is the outlook for earnings that best measures market participants expectations and drives their decisions rather than what happened in the past.

There are three time periods over the past 30 years of data tracking analysts’ earnings expectations that we can study to determine the extent of the rebound in stock market valuation associated with the end of a recession. These are the periods that followed the S&P 500 low point in 1982, 1990, and 2002. The amount of the rise varied, but, on average, P/Es rose 37% over the 14 months following the low in the stock market. P/Es are currently tracking the average of the three prior scenarios very tightly which suggests further room for improvement [Chart 2].

Chart 2

While in 2002 P/Es were at record highs and had no where to go but down, in 1982 P/Es bottomed at record lows and had nowhere to go but up. Also, there are concerns that this recovery may be a jobless recovery and somewhat weak. However, it is worth keeping in mind that looking back to the periods following the 1990 and 2001 recessions that were called “jobless” recoveries at the time, there were questions about the sustainability of those recoveries. So, on balance, the scenarios are comparable and reflect the range of potential outcomes.

Our analysis of the monthly data suggests P/Es may rise 37% from the low of 11.3 in March of 2009. The P/E has already achieved most of that rise. A continued rise in the P/E to the historical average expansion of 37% would produce a P/E of 15.25 as the peak at the end of April 2010, 14 months after the market bottom.

Some may recall that the P/E at the low point for the S&P 500 was actually 10.5. If we use the actual day the market bottomed in each scenario—rather than the month end—the low point was a little lower and the typical rebound in valuations was a bit greater, about 45% over 14 months. The closing daily low in the S&P 500 in early March 2009 put the P/E at 10.5. A 45% gain would lift this daily P/E to 15, not materially different from our monthly approach.

The S&P 500 is tracking the average very closely since the February 2009 low, with room for improvement. A P/E of 15.25 on the 12 month forward estimates 14 months from the start of the rise at the end of April 2010 (we expect to be about $82) suggests a level of 1250 on the S&P 500 at the valuation peak in 2010. This supports our overweight position to stocks, in general.

Of course, valuation is depended upon earnings—if earnings were to fail to recover stocks would be overvalued. Fortunately, 80% of companies have exceeded analysts’ estimates so far during the third quarter earnings season and many companies are raising their earnings outlook for the next year bolstering our confidence in the recovery into 2010. We expect earnings to rise to about $75 to 76 in 2010, by year end we expect them to recover back where they were in 2005, about 20% below the peak in mid-2007.

While volatility around the 1050 level on the S&P 500 may continue, we do not believe that stocks are overvalued or that stocks are on at the beginning of another major decline. While our favorite asset classes such as small cap and emerging market stocks are trading at a premium to large cap US stocks represented by the S&P 500, we find the greater outlook for earnings growth justifying their premium valuations.

IMPORTANT DISCLOSURES

• This report was prepared by LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
• Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
• Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
• Small-cap stocks may be subject to higher degree of risk than more established companies’ securities. The illiquidity of the small-cap market may adversely affect the value of these investments.
• Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise and are subject to availability and change in price.

photo credit: Truthout.org

2010 401k Contribution Limits

2010 is coming and many have been wondering if 401k contribution limits would increase, decrease or stay the same. For those that have taken steep losses in their retirement accounts, maxing out their 401k, either traditional or Roth, is one of the only ways to try and get their portfolio back to respectable levels.

Many still my perceive the 4o1k purely as a money trap, but there is no other retirement vehicle that allows you to defer as much as the 401k. (You can obviously take advantage of the 401k counterparts 403b and 457 plan)

2010 401k Limits Unchanged

For the 2010 the 401k limits remain at the 2009 levels of $16,500.  While many might be upset that the levels didn’t increase like they did last year, one must consider that the potential for the limits to have been reduced was almost a reality.  This is in part because 401k limits are based on the increase of cost of living from one year to the next and 2009 saw these levels decrease.

Catch Up Contributions Remain Same, Too.

Catch Up Contributions

For those that got a late start saving for their retirement, the 2009 401k contribution limits have increased the “catch up” provision as well.  For those over the age of 50, you are allowed the $16,500 plus a “catch up” of $5,500 for a total contribution of $22,000.  For all the procrastinators out there, this gives them an excellent opportunity to grow their retirement nest egg to a respectable level.

Recap of 401k Limits

How Do You Change Your Contribution Amounts?

For those that are already maxing out your 401k contributions, you may want to double check with your benefits department to ensure that it continues. You may have to manually increase it to make sure that it happens. If that’s your plan, go ahead and change it immediately to make sure that don’t put it off too long into the new year.

There are no doubts the rules for qualified retirement plans such as 401k plans are complex. Your plan administrator should have documentation outlining the rules that apply to your particular employer’s plan. That document should explain these limitations as well as other rules or regulations that might apply.

photo taken by Jason York Photography

Securities offered through LPL Financial, Member FINRA/SIPC

Is Your Nest Egg Ready for Retirement?

64% of Americans have no financial strategy at all. That’s right – no plan whatsoever to build wealth or keep it. That finding comes from the 2009 National Consumer Survey on Personal Finance conducted by the Certified Financial Planner Board of Standards, Inc. (The survey collected data from 1,700+ U.S. residents.)
Only 17% of us have a written financial plan that is updated regularly. So congratulate yourself if you are in that group. The CFP Board found that just 17% of the 36% polled who did have a written financial plan had reviewed it in light of changing times. Notably, 48% said they had benefited from having a written plan.

Just 38% of the 36% having written financial plans retain a financial advisor. The really troubling part: 37% of those with written plans are doing their financial planning on their own. Another 12% of respondents with written plans have consulted a friend or family member who isn’t a financial services professional for advice.

Why don’t more people have a financial plan?

After all, Americans of all incomes and savings levels certainly are free to set financial goals. In the survey, the reasons varied. Some cited the expense of engaging a financial advisor; some said they get along just fine without a financial plan, and others felt their finances weren’t complicated enough to warrant one. Others were hazy about financial services industry qualifications – 40% of respondents had no idea that there were professional credentials or designations for financial advisors.

Syndicated financial columnist Humberto Cruz recently noted that when he told some fellow vacationers in Orlando that he wrote about financial planning, they all asked him if he gave stock tips. He had to explain that he was simply a journalist, not a financial planner.

Defined goals lead to definite plans.

If you set financial objectives and plan for them, you vault ahead of most Americans – at least according to the CFP Board’s findings. A written financial plan does not imply or guarantee wealth, of course; nor does it ensure that you will reach your goals. Yet that financial plan does give you an understanding of the distance between your current financial situation (where you are) and where you want to be. Too many Americans, it seems, have little comprehension of their financial situation or their financial potential.

How much planning have you done?

Retiring without a financial plan is an enormous risk; retiring with a financial plan that hasn’t been reviewed in several years is also chancy. A relationship with a financial advisor can help to bring you up to date about what you need to do, and provide you with more clarity and confidence when it comes to the financial future.

This was prepared by Peter Montoya Inc. Securities offered through LPL Financial, Member FINRA/SIPC.

Jeff Rose is a Certified Financial Planner and co-founder of Alliance Investment Planning Group.

Passing the baton.

This White Paper report was prepared by Burt White, LPL Financial’s Chief Investment Officer.

In 1996, I was fortunate enough to attend the Summer Olympic Games when they visited Atlanta, Georgia. Of all of the events that I attended, the evening of track and field was the most memorable. Throughout the stadium, track and field icons were setting and breaking world records. That evening Carl Lewis won his fourth gold medal in the long jump. Dan O’Brien held off the field in a hotly contested decathlon. And the golden shoe-clad Michael Johnson set a new world record winning the 200 meters.

But perhaps the most memorable was the men’s 4×400m relay race. The drama in the standing-room only stadium was thick that evening given the results from the night before when the heavily favored American team lost in the 4×100m relay to the Canadian team, anchored by the “world’s fastest man”: Donovan Bailey. The upset by the Canadian squad was shocking given that the U.S. team had never finished without a gold medal in the 4×100m relay event in any Olympic Games that the U.S. had ever participated in—to have lost on home soil took the air right out of the crowd. The next night, the American team fielded a dominant line-up of elite runners to try to redeem itself in the 4×400m. What made the task even more daunting was that the team tried to do it without the services of the golden shoes of world-record holder Michael Johnson, who sat out the race due to his lack of practice working with the team in baton handoffs.

For the casual viewer of relay races, it is hard to understand why the Americans would not want to have the fastest 400m runner in the world participate. While running is usually viewed as an individual sport, in a relay race, teamwork is the real key to winning or losing. Although much of the time is spent with a single runner carrying the baton over his leg of the track, it is the pass-off of the batons that usually determines the outcome. A lot can go wrong in a relay. The baton can be dropped. If you pass the baton too late (outside of the handoff zone), the team is disqualified. But if you pass the baton too early, the team loses the momentum of the current runner.

Thus, it is often not the strength of the individual runners that decides the outcome of a relay race, rather the execution of the handoffs. The U.S. team went on to win the 4×400m relay that night. But that race forever memorialized the concept that the execution of a team is more important than the speed or strength of individuals.

The Initial Runners in the Road to Recovery Relay

photo credit: Will Palmer

Currently, the market’s Road to Recovery is in its own relay race. In any economic recovery, there is a required “teamwork” of factors that contribute to the healing and ultimately the return to growth. No element of the economy—whether it is the consumer, business, or government—can move an economy from recession to recovery alone. It requires a coordinated effort by market forces to “take turns” providing recovery leadership. The first runners in the market’s Road to Recovery have been the strength of government stimulus and the powerful demand of China. These two “runners” have been the catalyst to start the move of the market from recession to recovery.

With both consumer and business spending at multi-year lows, global central banks provided quick stimulus to ailing economies in late 2008 and throughout 2009. Government stimulus serves as the jolt that jump starts an economy in contraction to one that has the backdrop to expand. The first part of the government action was through monetary policy as central banks swiftly moved to lower interest rates and flooded the economy with easy access to capital. Within the U.S., the monetary base exploded as the Federal Reserve (the Fed) made more reserves for banks readily available. In addition, interest rates were slashed to record low levels, in an attempt to spur a stabilization of the housing market and coerce demand for business and consumer loans. The effects of easing monetary policy is dramatic, as lower rates often serve as the most effective catalyst to reverse the recession’s economic contraction.

China’s tremendous growth also served as an early runner in the market’s Road to Recovery relay race. China has adopted capitalism over the last few decades and has seen its place among the world’s spending and manufacturing ranks rise. In fact, the tremendous growth and favorable demographics has China on pace to pass the U.S. as the world’s largest economy in the next 10 years. It has been this growth in China that has taken some of the sting off of the recent recession as Chinese consumption has remained strong.

The Next Runner in the Relay

While government stimulus and robust consumption by China has served as the catalyst for growth, neither is strong enough to move the global economy from contraction to expansion alone. China’s demand, while impressive, cannot pull the sluggish economies of the rest of the world for long and government stimulus is limited, especially for debt-ridden countries like the U.S. and U.K.

So, the baton needs to be passed off soon to the next runner in the market’s relay race. The next runner appears to be corporations through increased business spending, creation of jobs (or at least mitigate job losses), and expanded worker compensation. In the end, there is no runner that has a bigger multiplier effect than business spending—as it benefits the economy in two ways. First, it generates demand for new goods and services through increased consumption (technology spending, materials, etc.) and a shift from decreasing to re-stocking inventories. Secondly, as business spending picks up, workers feel more secure, the average work week and overtime hours expand, temporary workers are engaged and ultimately jobs are created. So, what is the evidence that businesses are ready to grab the “baton” and start running? In two well-respected business surveys, conducted by the Federal Reserve Bank of New York and the Institute of Supply Management (ISM), respectively, data shows that production and general business conditions have improved dramatically over the last few months. The ISM Production Index is above the 50 level for the first time in almost two years, reflecting expansion in factory and manufacturer production driven by increased orders. In the Fed’s Empire State survey, companies indicated that general conditions have rebounded to the highest levels in more than five years.

In addition, data has begun to show that factories and manufacturers are beginning to expand their payrolls in order to meet increased production demands. While job growth continues to be muted, businesses are increasing hours worked by employees and offering more overtime opportunities. In general, businesses are slow to add to their permanent labor forces following a recession and favor more hours for current employees and the use of temporary workers until conditions are stable enough to warrant bringing in full-time staff. This is the beginning phase of healing in the labor market and it is driven by the emerging growth of business spending.

Our Final and Star Runner: The Consumer

photo credit: Ani Od Chai

The final runner in a relay is called the anchor, which is usually the fastest and most important of the runners. The key is to get the baton in the hands of the anchor runner as quickly as possible and then watch the gold-medal sprint to the finish line. In the market’s Road to Recovery relay, the anchor is the consumer. Representing almost 70% of the GDP of the U.S. economy, no recovery can take hold until the consumer joins the race.

Perhaps the biggest headwind facing the consumer is the dire, but rapidly improving, employment situation. With the unemployment rate hovering just below 10%, which is the highest level over the last 60 years outside of the 1981-82 recession’s 10.4% peak, the concern holding back the pocketbooks of consumers is: just how high will unemployment go? In the last two mild recessions (1991 and 2001-2002), the unemployment rate continued to rise an average of 0.9% higher during the 15 to 18 months after the recession ended. However, we feel that the unemployment rate in this latest recession will follow the path of the more severe 1973-75 and 1981-82 contractions. In both cases, the unemployment rate topped out within six months of the end of the recession. As such, we look for the employment rate to begin to moderate around year-end 2009.

That said, we believe that the unemployment rate and even the number of unemployed is the wrong way to look at the healing of the labor market and the subsequent potential re-engagement of the consumer back to spending. While the number of job losses is an issue, it is which jobs are being lost that has the greatest impact on consumer spending. Make no doubt about it, losing any jobs is a bad result and is a social issue that needs to be resolved. However, economically, not all job losses have the same impact on consumer spending and thus GDP growth.

In fact, more than 60% of consumer spending is conducted by the 20% highest earners. While any job losses are an important social issue, from an economic perspective, having healing at the top end of the labor market delivers the biggest consumer spending “bang for the buck”. As shown nearby, the number of unemployed with a college degree (proxy for the highest earners) peaked early in this recession and well before the job losses among less than high school degree recipients (proxy for lower earners). This was due to the extraordinary elimination of top paying jobs within auto manufacturing, corporate middle management, and financial services at the outset of this current crisis. However, what is important to note is how retail sales began to improve as soon as the unemployment for higher earners began to moderate even though lower wage earners continued to see the rate of job losses rise. In the end, for robust consumer spending to return, we have to get the entire labor market healed. However, as long as the upper end of the labor market continues to improve, retail sales and overall consumer spending are likely to continue to surpass expectations and allow for the consumer to run through the “finish line” with surprising strength.

How to Invest in the Next Two Runners

The question remains: what is the best way to benefit from the sprinting of the final two runners? Classic early cycle opportunities continue to be the most attractive investments. Asset classes that are most tied to the initial stages of economic growth should provide the greatest leadership, including Commodities, Small and Mid Cap Stocks, and Emerging Markets—debt and equity.

As business spending returns, perhaps the biggest beneficiary will be the Information Technology sector, as corporate America upgrades software, hardware, and devices to gain productivity. On the consumer side, Consumer Discretionary names, such as Retailers, appear to benefit most from rebounding consumer spending. In addition, as business and consumer spending takes hold, increasing demand for products will lend a tailwind to the Materials and Energy sectors.

The Finish Line

photo credit: the_amanda

When it comes to relays, it is not only the strength and speed of the individual runners, but also the execution of the baton handoffs that ultimately determine the winner. The market’s Road to Recovery relay is also at an important transition as it looks to handoff the baton from the government stimulus and Chinese demand driven growth to our next runners, which require organic expansion in productivity and spending increases from both corporations and consumers. While the race is far from over, this recovery is well ahead of schedule. And, who would have thought at the beginning of the year, that words like “recovery”, “growth”, and even “Dow 10,000” would be the market headlines? This just proves that a strong start out of the gates, smooth sprints around the corners, and well executed handoffs can turn a race lost into a gold medal performance at the finish line.

Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

• Stock investing involves risk including loss of principal.
• The fast price swings of commodities will result in significant volatility in an investor’s holdings.
• International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.
• Small-cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the smallcap market may adversely affect the value of these investments.
• Mid-capitalization companies are subject to higher volatility than those of large-capitalized companies.

Open that safe deposit box. See if your bond has matured.

Did you buy U.S. Savings Bonds decades ago?  Or like me, received them as gifts from your grandparents? If you do, take a look at them before April 15 rolls around. Your bonds may have matured. That means they are no longer earning interest, and it also means you need to cash them in.  I was fortunate enough to catch this before it was too late.  Don’t lose out on earning some interest on your bonds.

Check those maturity dates.

Sometimes people hold U.S. Savings Bonds past the date of final maturity. That’s a problem. In fact, it’s a violation of IRS statutes. If you hold these bonds after the date of final maturity, it opens the door to a possible tax penalty and/or fine for you. IRS Publication 550 states that once that savings bond passes its final maturity date, the interest accumulated over the life of the bond must be reported on that year’s federal tax return.

What should happen.

You are supposed to pay tax on a U.S. Savings Bond in one of two ways. Most bondholders choose to defer the tax until the bond matures. They redeem the bond and then report the interest through a 1099-INT form. Some choose to pay the tax annually prior to cashing the bond in, by reporting the increase in the value of the bond as interest each year.

What happens instead.

People hold the bonds too long and have to pay a lump sum and sometimes penalties in light of what the IRS considers under reported unearned income.

What if You held a U.S. Savings Bond too long?

Well, if it has been less than three years since your bond stopped earning interest, you may be able to file an amended federal tax return without being penalized.2 What if more than three years have passed since your bond earned interest? The sooner you cash it in and report the interest, the better. The longer you wait to cash in the bond, the longer it is not earning interest and the larger the penalty you could face.

Plan ahead and keep track.

Savings bonds can prove quite useful to a retiree looking to improve cash flow. When you cash in a bond, or even multiple bonds, the “cash infusion” may help you put off withdrawing assets from another retirement account. Also, these bonds are exempt from state and local taxes.

You want to keep track of the maturity dates, the yields and the interest rates on your bonds, as that will help you to figure out what bond to redeem when.
A useful website. Do you own a Series E U.S. Savings Bond? You might want to check on its maturity date. Treasury Direct, which provides records of most registered U.S. Treasury notes and bonds issued since 1974.

This report was prepared by Peter Montoya, Inc.  Securities offered through LPL Financial, Member FINRA/SIPC.