California tax free bond funds


By iwog   Follow   Mon, 7 May 2012, 9:05am   4,470 views   38 comments
In Lafayette CA 94549   Watch (0)   Share   Quote   Permalink   Like   Dislike  

With opportunities drying up in real estate, and my feeling that this recovery will be short lived, I have decided for the first time in a VERY long time to start putting money in California tax free bond funds.

Obviously this move carries risk, but at this point I'm convinced that there will be no fundamental changes in federal tax policy over the next 4-8 years, and therefore no changes in the direction of wealth disparity.

I agree with Warren Buffett that state obligations will never be allowed to go bankrupt. (most munis are insured anyway) If anything, both Romney and Obama will be MORE likely to authorize bailouts than Bush.

I'm going with NCO (6% return) and NUC. (6.3% return) I welcome arguments why this is a stupid thing to do.

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  1. freak80


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    1   9:16am Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    Hard to say. Republicans will probably "play politics" with any potential California bailout like they did during the whole debt ceiling fiasco. I suppose the end result is anyone's guess.

  2. Vicente


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    2   9:26am Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    Because California is soon going to GET WHAT IT DESERVES and shake, then bake, then slide into the ocean. Then it'll go bankrupt. Somewhere in there is Mad Max. Or maybe I mixed up the order on that.

    That's what all my East Coast relatives relate to me with a twinkle in their eye at least.

    I've been long California tax-free bonds for a while through Fidelity fund FCSTX.

  3. FortWayne


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    3   9:55am Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    Seems like a huge gamble, they are really expensive now at their peak. Is the 6% return guaranteed?

  4. msilenus


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    4   9:59am Mon 7 May 2012   Share   Quote   Permalink   Like (3)   Dislike  

    California doesn't have to go bankrupt for investors to be force-fed a writedown.

  5. iwog


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    5   10:09am Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    FortWayne says

    Seems like a huge gamble, they are really expensive now at their peak. Is the 6% return guaranteed?

    Quality Auto Repair Since 1979

    Nope, returns on California municiples is currently around 5%, which is a guaranteed rate barring default or redemption. The discrepancy is either lag time in the fund catching up to yields, higher risk investments which the fund states are limited to 20%, or something else which I'm not aware of.

    Here's a quick historical. The 1-year spike is due to appreciation of the fund and NOT related to yield:

  6. Vicente


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    6   10:10am Mon 7 May 2012   Share   Quote   Permalink   Like (1)   Dislike  

    Kramer : Municipal bonds Ted, I'm talking double A rating. . .
    the best investment in America.

  7. iwog


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    7   10:19am Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    FortWayne says

    Seems like a huge gamble, they are really expensive now at their peak.

    Not really. The recent dip is courtesy of the "THE DOLLAR IS CRASHING AND CALIFORNIA IS GOING BANKRUPT!" crowd.

    A fund like this is only about yields. Volatility on principle is simply something that smooths out over long periods of time. Keep in mind that if Munis were considered as safe as treasuries, prices would double.

  8. freak80


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    8   10:35am Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    Vicente says

    Kramer : Municipal bonds Ted, I'm talking double A rating. . .
    the best investment in America.

    Striker...Striker...Striker... *punch*

    ...Ted Striker?

  9. Patrick


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    9   10:54am Mon 7 May 2012   Share   Quote   Permalink   Like (1)   Dislike  

    Why not buy the CA bonds directly, instead of in some mutual fund that can screw you with churn, fees, and large unwanted taxable distributions (which has happened to me)?

    If the underlying bonds don't pay the same rate as the mutual fund, I'd be suspicious that they're doing something too funky to get that 6%.

  10. iwog


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    10   11:02am Mon 7 May 2012   Share   Quote   Permalink   Like (1)   Dislike  

    Patrick says

    If the underlying bonds don't pay the same rate as the mutual fund, I'd be suspicious that they're doing something too funky to get that 6%.

    They are putting 20% in non-insured, non-rated bonds. It's a common practice to boost yield with the assumption that most if not all will remain solvent, and even if one or two go bankrupt it isn't going to affect overall profits that much.

    Buying bonds directly has risks too. What if you bought Stockton? A managed fund reduces overall risk.

    http://www.reuters.com/article/2012/02/29/stockton-default-idUSL2E8DT0KL20120229

  11. rdm


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    11   11:02am Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    iwog says

    A fund like this is only about yields. Volatility on principle is simply something that smooths out over long periods of time. Keep in mind that if Munis were considered as safe as treasuries, prices would double.

    Yes, I think that is right if you are in it for the long term and dont need to cash out. I have had a large position in CTEZX ( long term muni fund not restricted to CA.) for many years it is around a 4% yield. It is currently at or near a 5 year high. I suppose this is driven by low interest rates and relative safety. Not sure I would buy more at this level. I saw it drop like a rock in 2008 but less % wise than the stock market. None the less the bottom was still about 20% below where I bought it, so there is principle risk and I think more so in CA Munis.

  12. clambo


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    12   1:06pm Mon 7 May 2012   Share   Quote   Permalink   Like   Dislike  

    Vanguard tax free high yield.

  13. freak80


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    13   5:57am Tue 8 May 2012   Share   Quote   Permalink   Like   Dislike  

    "They're not junk-bonds, Julia...they're called 'high-yield' bonds. I don't say you're in 'junk-waitressing'..."

  14. tjjenkins


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    14   3:21pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    I have been investing in CA muni bonds for many years now. I continue to believe they are a good investment for many reasons (note: most of these comments are directed at GO's):

    1. The rate of return on CA long bonds is about 4.25% right now. I am currently in the 35% federal and 9.3% (or whatever it is now) state tax bracket. Doing the match, this works out to a yield of more than 7% on a tax adjusted basis. Pretty good.

    2. Taxes are (probably) going up on high incomes. The top bracket is likely to hit 39.6% federal and over 10% for state. That will increase my tax-adjusted return over corporate bonds or dividends, which will soon be taxed at these higher rates. Moreover, because these bonds will become more attractive to high income residents of California, the underlying value of these assets will increase.

    3. The favorable 15% tax on dividends will probably be replaced with a 39.6% tax rate if proposals to tax dividends as ordinary income are passed. This will make seeking an income stream from equities much more difficult, and, in turn, increase the value of munis.

    4. California will not default. Note that the state Constitution mandates that GO's get payed after education, and before everything else. In other words, for bonds not to get paid, the amount of revenue coming in would have to fall to the point where only education and GO's could be paid. We are nowhere near that point. Indeed, revenues could fall by 25% and there would still be enough money to pay bondholders. Other things that are probably more important (police, fire, [fill in whatever you think is important here] etc.) might not be paid but the state Constitution mandates that these things go unfunded if necessary to pay bondholders. Other states do not have a similar provision and this is often overlooked when the saftey of CA bonds is reviewed.

    5. California will also not default because the rest of the world (and the federal government) would never let that happen. California, as a sepatate economy, is one of the world's largest. Much, much larger than Greece. Yet, look at the absolute panic to save Greece from default. A default by a much bigger entity like CA would never be allowed to occur because it would drag the whole world down.

    6. High income residents of California have a disproportionately large say in what happens in California. That is how it works pretty much everywhere in the world. Since most bonds are held by high income residents, and default would be at their expense. Note a likely outcome given their influence on government policy. Note that it does not matter which party is in power - - both parties are beholden to their largest donors.

  15. msilenus


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    15   3:36pm Wed 9 May 2012   Share   Quote   Permalink   Like (1)   Dislike  

    tjjenkins says

    California, as a sepatate economy, is one of the world's largest. Much, much larger than Greece. Yet, look at the absolute panic to save Greece from default.

    Greece didn't have to go bankrupt for investors to be force-fed a writedown.

  16. tjjenkins


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    16   3:37pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    A few more comments about funds (or ETF's) vs. individual muni bonds. Advantages to both. Since individual muni bonds do not trade over an exchange like equites, they generally must be sold through a full service broker with a 1% commission. Not great, but not a problem if you hold them to maturity. I hold about 70% on my muni bond assets as individual bonds - - the portion I plan to hold to maturity. For shorter term bonds. I like CMF. Trades easily, with little to no commission and fairly low mgt. fees. Also, and this is important, CMF buys only "non-AMT" munis - - not all munis in CA are non-AMT even if they are otherwise tax free under the code. A couple of negatives on ETF's: they are not "no fee" like an individual bond held to maturity. Also, they usually hold quite a few non GO's which do not have the same default protections. (Although, unlike GO's, much of CMF's portfolio are insured, for what that's worth).

  17. tjjenkins


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    17   3:48pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    msilenus says

    tjjenkins says



    California, as a sepatate economy, is one of the world's largest. Much, much larger than Greece. Yet, look at the absolute panic to save Greece from default.


    Greece didn't have to go bankrupt for investors to be force-fed a writedown.

    The key difference here is that Greece does not have a constitutional obligation to pay its bondholders at the expense of everybody else. Greek lawmakers had the legal power and ability to default, and that gave them leverage to force a haircut on the bondholders. In effect, they could say take X on the dollar or we will default. California does have a constitutional obligation to pay its bondholders (at least with regard to GO's) at the expense of other creditors (except education). California therefore lacks the legal power to default unless and until it has eliminated all funding for everything (except education). Needless to say, this will never happen. California does not have anywhere near the leverage in dealing with its bondholders as Greece does.

    Note too that states, unlike cities, counties, and private persons and corporations, do not have the legal option of bankruptcy. They were intentionally excluded from the bankruptcy code. This further reduces CA's leverage over bondholders in a fiscal crisis.

  18. PockyClipsNow


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    18   4:18pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    7% return after tax is pretty damn good right now.

    It compares nicely to buying up rental homes with all cash (which would return more but are more work/risk).

  19. msilenus


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    19   4:27pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    tjjenkins says

    The key difference here is that Greece does not have a constitutional obligation to pay its bondholders at the expense of everybody else.

    Do you live in California?

    This is our state constitution's table of contents. Does anything look odd to you?
    http://www.leginfo.ca.gov/const-toc.html

  20. tjjenkins


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    20   4:35pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    Yes, I live here. I have been an attorney in CA for 15 years and am familiar with the state constitution. What is it that you think should appear odd?

  21. msilenus


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    21   5:00pm Wed 9 May 2012   Share   Quote   Permalink   Like (1)   Dislike  

    It's a little long, dotcha think?

    You were right above, when you identified the constitutional constraint as the major difference between Greece and California. In most other ways you list they are or will be similar. But when you make the argument that this distinction is key, you are ignoring the soul-crushingly awful fact that our constitution --presumably unlike that of Greece-- is only slightly less mutable than your middle school homeroom's blackboard. It is perenially vandalized to advance whatever the populist craze of the day happens to be.

    Hence Article thirty five, Medical Research; among others. Heck, we're one of the most liberal states in the nation, and we managed to outlaw gay marriage through constitutional amendment. If you think voter confusion was decisive in that matter, then you can even call that an accident.

    Look, I love my state dearly. And it's wonderfully successful, in its way. It owes that success to the universally inoffensive climate, and to an unabashedly statist view of higher education. No one moves here for the sanctity of our political institutions, and I wouldn't invest based on them, either.

  22. tjjenkins


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    22   5:02pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    PockyClipsNow says

    7% return after tax is pretty damn good right now.


    It compares nicely to buying up rental homes with all cash (which would return more but are more work/risk).

    I agree. Yes, one might make a better return buying rental homes but that would also require work and time. Buying bonds and collecting interest is much easier.

  23. tjjenkins


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    23   5:29pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    msilenus says

    You were right above, when you identified the constitutional constraint as the major difference between Greece and California. In most other ways you list they are or will be similar. But when you make the argument that this distinction is key, you are ignoring the soul-crushingly awful fact that our constitution --presumably unlike that of Greece-- is only slightly less mutable than your middle school homeroom's blackboard.

    Yes, our constituion can be changed directly by the voters. But, even assuming that the courts would uphold such a change, which is less than clear, I disagree with your comment that "in most other ways you list they are or will be similar." Not true. Here is why. The creditors in California control the people (government officials) that will make the decision as to whether a default will occur. This is very different from the situation in Greece. A default by Greece would harm the holders of its debt - - mostly banks in Germany and other European countries. These people do not control the government of Greece, or, more to the point, they do not control the people who run Greece and are in a position to decide whether Greece will default. In marked contrast, a default by California would most directly harm high income residents of California, since they are the largest holders of GO bonds. High income residents of California, as in every state, through political donations, favors, social ties, etc., exercise substantial control over the officials that run the state. This makes non-payment much less likely in California. Nobody can get elected to high office in California without the support of rich liberals (D) or rich conservatives (R), so the interests of these people will always be given top priority by whichever political party is in power.

  24. PockyClipsNow


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    24   5:43pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    The bondholder of General Motors got totally screwed by executive decision at the federal level. I thought they got 10% on the dollar and the union ended up owning the company when the bondholder were supposed to paid out ahead of them or something....

    Very scary to imagine some similar 'haircut' in the future on bonds.

  25. msilenus


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    25   5:44pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    tjjenkins says

    The creditors in California control the people (government officials) that will make the decision as to whether a default will occur.

    Tell that to Gray Davis.

    Money usually triumphs in politics --that much is certainly true-- but the conditions that motivate orderly default are not usual ones. In unusual situations, populist rage frequently rears its ignorant, unthinking head. These waves, though rare, exert far more force than meer lucre.

  26. tjjenkins


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    26   5:49pm Wed 9 May 2012   Share   Quote   Permalink   Like   Dislike  

    It is true, in the end, that no investment is 100% safe. At any rate, taxes on incomes are probably going up to the old 39.6% mark, and the favorable 15% rate on dividends will probably go to 39.6%, as has been proposed. I think this makes munis a good play for the reasons I listed above.

  27. freak80


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    27   7:15am Thu 10 May 2012   Share   Quote   Permalink   Like   Dislike  

    Given the state's finances and politics I can't see myself investing in CA bonds. Seems everyone is "yield chasing" these days and I don't want to follow the crowd into risky bonds.

  28. Vicente


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    28   10:15am Thu 10 May 2012   Share   Quote   Permalink   Like   Dislike  

    So are dividends on NUC & NOC paid quarterly or annual?

  29. iwog


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    29   11:05am Thu 10 May 2012   Share   Quote   Permalink   Like   Dislike  

    Vicente says

    So are dividends on NUC & NOC paid quarterly or annual?

    Monthly.

  30. iwog


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    30   1:51pm Wed 5 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    So far so good. I picked up more today on the assumption that dividend seeking will move from taxable to non-taxable as the new tax rates hit on January 1st.

    I'm going to assume there will be no budget deal although I'm a lot more bullish on the economy than when I first wrote this. Thank god for a good election result.

  31. bmwman91


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    31   2:58pm Wed 5 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    iwog says

    I'm going to assume there will be no budget deal although I'm a lot more bullish on the economy than when I first wrote this. Thank god for a good election result.

    Good, or less-bad-than-the-alternative?

  32. iwog


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    32   3:12pm Wed 5 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    bmwman91 says

    Good, or less-bad-than-the-alternative?

    Good. Very good. Deficit spending is a boogey man that sounds scary when people are going on about endless trillions, but in fact is a major benefit because it liberates spending money and creates demand/jobs.

    I think Obama and the Democrats get this, which is why they have backed off radical spending cuts and now simply want taxes cut.

    I have a lot of respect for Obama holding the line this time. If he gives in to Republicans, that respect will evaporate, but right now it seems as if Obama and the rest of the country can't lose.

  33. Bellingham Bill


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    33   3:28pm Wed 5 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    That's the beauty of Japan. Their deficit spending is just funding social welfare spending and . . . interest on their debt.

    Theoretically they're going to have to raise taxes some day, but there's always maƱana . . .

  34. iwog


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    34   7:58pm Wed 5 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    E-man says

    Iwog,

    Great call on the bond purchase. Do you still believe this recovery s short-lived? I guess PK and I are more optimistic than you.

    Nope, this recovery is long lived. What a difference a new housing boom and a Democrat president can make.

    If we actually do face a fiscal cliff, and it isn't resolved quickly, I think we'll see a minor bump in the road but nothing more. The next cycle is gaining steam.

  35. Ceffer


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    35   11:13pm Wed 5 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    I love it when people say "Never". Real Estate prices will "never" go down, "they" will "never" let California default. It seems that time and again, "never" is just around the corner. Just cook up some mythical fundamentals to back up the "never" and roll in the suckers.

    I read rumors last year that there are Congressional committees operating in strict secret that are drafting the frameworks for states to go bankrupt.

    They wouldn't be doing that if they didn't regard it as more or less inevitable that massive state insolvency would occur, and the states incapable of resolving their own debt messes through their grafty, chicken shit politicians will need a legal structure to re-negotiate EVERYTHING.

    Caveat Emptor on those high yield bonds.

  36. Facebooksux


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    36   6:08am Thu 6 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    iwog says

    E-man says

    Iwog,

    Great call on the bond purchase. Do you still believe this recovery s short-lived? I guess PK and I are more optimistic than you.

    Nope, this recovery is long lived. What a difference a new housing boom and a Democrat president can make.

    If we actually do face a fiscal cliff, and it isn't resolved quickly, I think we'll see a minor bump in the road but nothing more. The next cycle is gaining steam.

    What planet are you living on?

    The following is an excerpt of a periodic report I receive from my financial advisor at UBS. Fundamentals are still shit and the fiscal cliff is a big deal no matter how it gets resolved. Pay attention to where he explains how the governmebt tacked on another 0.7% to GDP.

  37. Facebooksux


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    37   6:08am Thu 6 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    Dear Clients and Friends of the Novak Group:

    Ever since the election, the news has been dominated by discussions of the Fiscal Cliff. The markets have risen and fallen based on who was first to the microphone following meetings in Washington, D.C. As we draw closer to the end of the year, and the edge of the cliff, I wanted to take a moment to mention some basic facts about the cliff.

    First, and perhaps most importantly, solving the cliff issue means making choices between two very bad alternatives. If we go over the cliff, according to the Congressional Budget Office, the impact on the economy will be $671 billion, and will cost the country 3.4 million jobs, pushing the unemployment rate (U.3) back over 9.0%, and seriously weakening our economy.

    At the other end of the spectrum, if Congress chooses to kick the can down the road by postponing our date with the cliff, roughly that same amount will be added to the already unsustainable national debt, also seriously weakening our economy. The answer lies in some difficult combination of revenue increases and spending cuts. The problem in my mind is that the people working diligently to solve this mess are the same people who created it unnecessarily, and assured us that we would never get to the point we find ourselves at right now.

    As a prominent analyst wrote last week, we need a solution right now. Deferring the inevitable is only a political option when there is no immediate damage from doing so. That time has past.

    One question that keeps coming up is whether a solution can be found that will prevent our economy from slipping back into recession. According to the Economic Cycle Research Institute, that is a moot issue because the economy fell back into recession in July of this year. It just hasn't been officially recognized yet.

    There are four main determinants of an official recession: industrial production, personal income, sales, and employment. The first three turned negative in July, and are continuing a downward trend. Employment continues to climb very slowly, but it is the one lagging indicator in the group. In past recessions, employment has continued to climb for up to eight months before turning negative. Historically, this combination of declining indicators has not occurred outside of a recession in the last fifty years, but it has occurred in every recession during that time.

    Another report last week showed that the U.S. economy actually grew at a 2.67% pace in the third quarter of this year. It was perhaps the most "seasonally adjusted" report I have ever seen. Fortunately, as I have written in the past, the government not only gives us the headline figure, it tells us how that number has been adjusted, so that we can back out the adjustments, and see what the situation really looks like. In this case, a detailed analysis was done by the Consumer Metrics Institute, who reported the actual growth figure for the quarter was just 0.57%.

    Why such a wide difference? The major source of economic growth in the third quarter came from a dramatic surge in government spending. Spending for salaries, materials and construction grew at an annualized rate of 10.5%, and defense spending grew at 13.9%. Much of the defense spending was attributed to the stockpiling of materials prior to the fiscal cliff, and the mandatory cuts in defense spending.

    Both sources of spending are unsustainable. The growth rate calculation also benefited from an inflation assumption that was over 40% less than the Bureau of Labor Statistics inflation figure normally used. Dividing by a smaller inflation number resulted in a higher growth rate. It's that simple; except that eventually things like this tend to catch up with the economy and the markets, and not in a positive way.

    Lastly, a few words on the Federal Reserve's current quantitative easing program program (QE3). The goal of these three programs has been to put enough money into circulation that consumers will feel comfortable saving and spending, since consumer spending accounts for between 71% and 73% of total U.S. economic activity. The effectiveness of these programs is measured by looking at what is known as the wealth effect - the impact on the saving rate, and consumer spending during, and following the QE programs.

    During QE1, which ran from late November 2008 through March of 2010, the Fed injected $1.4 trillion, or nearly 10% of total U.S. GDP, into the economy. The savings rate was already at 6%, and the wealth effect, or the increase in consumer spending, was 3.2% - much less than had been anticipated and forecast.

    QE2 ran from November of 2010 through June of 2011. It cost $600 billion. The savings rate was 5%, and the increase in consumer spending was 1.7%. QE3 began in September of this year, and consists of $85 billion per month, with the open-ended promise to continue the program until the economy stabilizes and recovers. So far, the savings rate is 3.7%, and the increase in consumer spending is just 0.3%. In short, the trend is going to wrong way, and it looks like all the additional money is having virtually no effect.

  38. FortWayne


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    38   9:24am Thu 6 Dec 2012   Share   Quote   Permalink   Like   Dislike  

    Well they just passed prop 30, so you should still get your dividends for next few years at least.

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