history of interest rates
TRANSCRIPT
January 2014 Vol. No. 1 Investment Updates
Advisor Corner
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History of Interest Rates
It is commonly known that interest rates have been athistorically low levels for a few years now. But howlow are they? The image illustrates the characteristicsof interest rates of various maturities. On average, long-term government bonds delivered the highest yield of5.2%, while intermediate-term government bonds and30-day Treasury bills provided an average yield of4.6% and 3.5%, respectively. Current interest rates arepositioned relatively close to the all-time lows,especially on the lower end of the maturity curve.
A rising interest rate environment seems to be thegenerally accepted forecast for the future. While ratescan’t drop much lower from their current level, thetiming and magnitude of the rise still remains highlyuncertain.
Dieter Drews, J.D.Founder/CEO
Prism Capital Management, LLC Investment Updates January 2014 2
Economic Outlook for 2014
As the end of 2013 draws near, the U.S. economyappears very much like an ocean liner, finding it verydifficult to change either speed or direction. As thetable illustrates, overall GDP growth rates,employment growth and consumption have all beenstuck in a very narrow range for the last three years.
Morningstar economists expect little change in theoverall GDP growth rate for 2014, although thecomposition of that growth is likely to be somewhatdifferent. Inventories should be a much smallercontributor to growth, net exports are likely to be alarger subtraction from GDP as imports grow, andgovernment spending should be a much smallernegative in 2014.
Consumption, housing and business investments(excluding inventories) are likely to change little fromtheir 2013 growth rates. Other forecasts may be morebullish on overall GDP growth, but Morningstareconomists suspect growth rates in autos willdecelerate, existing home sales will likely be flat, andgovernment spending will still be a drag, albeit smallerthan the rather large subtraction in 2013.
With little change in the 2% GDP growth rate,employment growth may not change that much,either. Slow growth, a wide output gap (a fancycapacity utilization measure) and a bumper farm cropshould all keep inflation in check in 2014, thoughmedical costs may rise faster than in 2013, bringing upthe overall rate of inflation. With the Fed nowofficially tapering bond purchases, 10-year Treasurybond rates should move up to reflect the inflation rateplus a spread. Auto sales should continue to do well in2014 with continued employment growth, newmodels, and an aging fleet. Unfortunately, auto salesare now approaching previous highs and the law oflarge numbers is beginning to set in, with year-over-year growth rates likely to slow. An acceleration inhousing starts may still occur, as it has taken homebuilders some time to gear up for increased demand(zoning, land acquisition, etc.). However, existinghomes will be hard pressed to grow much with higherrates, more competition from new homes, tightinventories, and lower affordability.
Probably the biggest news in the fourth quarter wasthat the Fed would begin tapering its large $85 billionbond purchase program. This program was a trulyextraordinary measure; never before has the Fedreacted so boldly and so beyond its sphere of short-term interest rates. Given extraordinarily tight fiscalmeasures and a slow-growth economy, the programwas both helpful and necessary. With the economy atleast a little better and an easing of the fiscal tensions,however, it was probably time for it to end. Marketshad already anticipated the tapering last spring, andinterest rates had previously made their move up.Further rate increases are possible, but the worst maybe behind us.
Prism Capital Management, LLC Investment Updates January 2014 3
Morningstar Research ExaminesRetirement Costs
Morningstar Investment Management published newresearch in December that examines the mostcommon assumptions used to estimate retirementneeds and lays out a framework for investors to take amore personalized approach to setting retirementsavings goals.
“There are three common assumptions that manysoftware tools and financial advisors use to come upwith a retirement savings goal—a 70 or 80 percentreplacement rate based on pre-retirement income, anincome need that rises with inflation, and a 30-yearretirement time horizon,” David Blanchett, head ofretirement research for Morningstar InvestmentManagement, said. “When we looked at actual retireespending patterns and life expectancy, however, wefound that these assumptions don’t hold true for manypeople and, on average, can significantly overestimatehow much people will actually need to fund theirretirement.”
Many expenses disappear after retirement, such asMedicare taxes, Social Security taxes, and retirementsavings. The paper first demonstrates the effect onreplacement rate calculations of accounting for taxableand non-taxable expenses that are no longer paid afterretirement. Next, using government data, the analysisexplores the actual spending patterns of retirees, andfinds that they grow at a rate lower than inflationthrough most of retirement and then accelerate in lateryears because of higher health care costs. While thedifference between the actual spending growth rateand the inflation rate is relatively small, it has amaterial effect over time. When the researchersmodeled actual spending patterns over a couple’s lifeexpectancy, rather than a fixed 30-year period, thedata showed that many retirees may needapproximately 20% less in savings than the commonassumptions would indicate.
Results from this research show the actual replacementrate is likely to vary considerably by retiree household,from under 54% to over 87%. Retiree expenditures donot, on average, increase each year by inflation or bysome otherwise static percentage; the actual “spendingcurve” of a retiree household varies by totalconsumption and funding level. Specifically,
households with lower levels of consumption andhigher funding ratios tend to increase spendingthrough the retirement period and households withhigher levels of consumption but relatively lowerfunding ratios tend to decrease spending through theretirement period. When consumption and fundinglevels are combined and correctly modeled, the truecost of retirement is highly personalized based on eachhousehold’s unique facts and circum¬stances, and islikely to be lower than amounts determined usingmore traditional models.
“While a replacement rate between 70 and 80 percentmay be a reasonable starting place for manyhouseholds, we find that the actual replacement ratecan vary considerably,” Blanchett continued. “Take,for example, a high-income couple, living in a highincome tax state like California, and saving asignificant amount for retirement each year. If thatcouple retires in Florida or Texas, where there is noincome tax, the replacement rate might be closer to 60percent. By contrast, a low-income couple saving verylittle for retirement and retiring in California couldhave a replacement around 85 percent. It’s importantfor investors to consider their level of pre-retirementhousehold income, expenses that discontinue afterretirement, and post-retirement taxation.”
These findings have important implications forretirees, especially when estimating the amount thatmust be saved to fund retirement. A more advancedperspective on retiree spending needs can significantlychange the estimate of the true cost of retirement.
Source: David Blanchett, CFA, CFP, Head ofRetirement Research, Morningstar InvestmentManagement: Estimating the True Cost ofRetirement, Working Paper, Nov. 5, 2013.
Prism Capital Management, LLC Investment Updates January 2014 4
The End of the Recession
In September 2010, the National Bureau of EconomicResearch announced the long-awaited news: an enddate for the recession that had begun in December2007. The NBER determined the official end date asJune 2009, quieting down (if not completely silencing)double-dip fears. NBER defines a recession as asignificant decline in economic activity spread acrossthe economy, lasting more than a few months,normally visible in real GDP, real income,employment, industrial production, and wholesale-retail sales. Looking back at the performance of themain asset classes during the recession and in the yearsfollowing the official end date, gold was the bestoverall performer, and long-term government bondsoffered consistent positive returns. Out of theinvestments with the worst performance during therecession, REITs posted the most impressive return inthe four post-recession years.
©2013 Morningstar, Inc. All Rights Reserved. The information contained herein (1) is intended solely for informational purposes; (2) is proprietary to Morningstar and/or the content providers; (3) is notwarranted to be accurate, complete, or timely; and (4) does not constitute investment advice of any kind. Neither Morningstar nor the content providers are responsible for any damages or losses arisingfrom any use of this information. Past performance is no guarantee of future results. "Morningstar" and the Morningstar logo are registered trademarks of Morningstar, Inc. Morningstar MarketCommentary originally published by Robert Johnson, CFA, Director of Economic Analysis with Morningstar and has been modified for Morningstar Newsletter Builder.
Dieter Drews, J.D.Founder/CEO
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