Who wants to be a 1/2-millionaire?
December 31, 2005
Market Summary – 4th Quarter, 2005
A picture is worth 1,000 words, or more precisely, about seven cents. This chart demonstrates the challenge that faces every investor today – accumulating enough assets to actually pay for your lifestyle, today and for years to come in the face of the accumulating effects of inflation.
Inflation is not a virus, but a purposeful money-printing tool of government (and a bi-partisan tool at that) designed to help overcome today’s economic issues. Government doesn’t solve….it prints! The results can be seen in the chart on this page that slaps us across the face with frightening reality.
It is one of the sad ironies of America today that printing money actually helps the government (in the short run) but at the same time drains the value of every dollar you earn and save. “No new taxes” pledges are great, but if at the same time the government is taking action to reduce the value of the dollar, what’s the point?
All of us think of the Federal Reserve as the arm of the government that tries to minimize the impact of inflation. Oddly enough, it is since the Fed has been created (1913) that the dollar has lost about 95% of its value. Prior to that time, through various ups and downs, the dollar basically held the same value in the early 1900s as it did in the late 1700s.
That’s certainly not the case anymore. Since 1955, inflation has eaten away at your purchasing power in every single year. In other words, for 50 years, we’ve been able to say that the dollar you earned last year is worth less this year. If you’re not convinced, take yourself to the Bureau of Labor Statistics website (www.bls.gov). Under the heading “Inflation and Consumer Spending,” click on the Inflation Calculator. Pick any year you want. For instance, $1.00 in 1945 (the end of the World War II and what is considered at least the symbolic beginning of our current economic era) is equivalent to $10.85 today. Back then, a loaf of bread may have cost around dime, and a new house about $5,000.
Your purchasing power is losing ground, almost as you read this. But do you realize the extent of the damage to your pocketbook? That’s what is exemplified in this chart, which we recreated based on statistics drawn up by the American Institute for Economic Research (AIER).
Pennies on the dollar
The chart covers virtually all of our nation’s history. It begins with the dollar valued at – well, $1.00 – in the year that the Mint Act was passed, 1792. Where there are solid lines, the value of the dollar was pegged to the price of gold. Where dotted lines exist, it shows the period of time when the dollar and gold were not directly linked.
Without the gold standard, the dollar is backed by one thing – the government’s decree that it is legal tender – or money by “fiat.” As the AIER pointed out in a recent report, when there is no self-correcting mechanism like the gold standard, there is no system that can bring prices back down after they’ve gone higher. So while the dollar showed an ability to regain value for periods of time through 1911, it has pretty much been all downhill since then.
There was limited convertibility of the dollar from 1945 to 1971, and then the gold standard was completely wiped out. Fiat money took over. As the chart indicates, since that time, the purchasing power of the dollar has declined precipitously. In less than a century, the dollar has lost about 93% of its purchasing power. OUCH!
As investors, we aren’t what you might classify as “chartists.” But in this case, this is one chart that we think tells us a lot – mainly that each of us better have some serious money in place if we plan to live off of our assets in retirement.
Could it be even worse?
If you think this chart paints a bleaker picture than you imagined, remember that it is based on the Producer Price Index, the government’s reported measure of inflation at the wholesale level (not the consumer level). This tends to mirror the Consumer Price Index, which is the government’s measure of inflation for individuals and families. Since the big oil price shock of the late 70s and early 80s, inflation has topped the 5% level in only one year.
The official government statistics offer only an average based on a formula that may not always represent the real world. In many cases, people could be seeing much faster price increases for basic necessities like healthcare, automobile expenses, college education tuition and mortgage payments. Since the late 1970s, expenses related to college tuition, medical care and housing have all risen faster than the average inflation rate. If you eat a lot of BLTs, it should be noted that prices for bacon, lettuce, tomatoes AND bread have all outpaced the rate of growth in the measured CPI since 1990. So depending on where your spending is focused, it could be you are losing even more purchasing power.
Our main concern, of course, is whether we have enough money to pay for retirement. An experimental index called the CPI-E was designed to measure cost-of-living increases for retirees age 62 and older. It suggests inflation is an even bigger issue for this segment of the population. The CPI-E comes in at something like 0.2% higher each year than the CPI. In ten or 20 years, that adds up to a significant dollar difference.
A millionaire? So what?
Go back to 1913, a point at which the purchasing power of the dollar was roughly equal to what it was way back in 1792. Having a million dollars today is equivalent to having $50,000 in the bank in those days. While $50,000 was nothing to sneeze at back in 1913, it hardly put you in a Rockefeller category.
Let’s look at it another way. Based on the Consumer Price Index, just in the last 45 years, the value of $1,000,000 has changed dramatically. To match the purchasing power of a millionaire in 1960, the year JFK was elected President, you would need $6,597,970 today! Go back 25 years, to 1980, and you would need $2,370,150 today to match the buying power of a millionaire at that time.
Even in just the last five years, $1,000,000 of purchasing power has eroded. You need an additional $134,150 to match the value of $1,000,000 in 2000. All of these examples are based on the CPI, and in our judgment, may very well understate the real loss of purchasing power. Sadly, this is a best case scenario.
Unfortunately, many investors have watched their portfolios fail to keep pace with inflation since the start of the new millennium. All too often, we hear or read stories of people who have seen their investments lose value. This is no way to achieve financial security.
Not to dampen your New Year’s spirits any further, but in our opinion, there is every reason to expect that the erosion of purchasing power will continue.
The loss of the gold standard means there is no control if the government decides it wants to print more money. It may sound logical to suggest that the government should be able to print money if it needs it. But we know all too well that needs never end. Today, it isn’t just funding the Iraq war or Katrina relief that’s the problem. It is all of the earmarks, like the famous “bridge to nowhere” in Alaska. Some needs are financed by issuing bonds that other countries buy (thank you China and Japan) but the source of funding for others comes from new money.
Things may be going from bad to worse. According to a newsletter published by the Financial Research Center (FRC), the Federal Reserve (yes, financial hero Alan Greenspan & Co.) have been printing, on average, $20 billion of new money per week, which works out to over $1 trillion in a year! More recently, the amount rose to as high as $42 billion in one week.
The FRC suggests the rate of money growth today is comparable to what it was in the lead-up to the significant inflationary period of the 1970s. Could that mean more severe inflation (and deeper purchasing power erosion) ahead? Time will tell, but it is a realistic concern.
Inflation may be out of your hands, but you can prepare for it. The ideas that worked in the 1990s (concentration on growth stocks and use of index funds) have failed in the 2000s. The simple solution is to grow your assets faster than the inflation rate. If that isn’t happening for you, it is time to get serious. Your future purchasing power is at stake.
Conventional wisdom suggests that periods of higher inflation are not the best of times for financial assets, most notably bonds. Stocks can have problems as well but that doesn’t mean investors can’t find companies that will deliver positive results. Good firms find ways to pass on their added costs to the end user (for instance, 3M recently announced a price increase on Post-It Notes to reflect its higher materials costs, price hikes that are likely to stick—no pun intended). Even in the past few years, with markets underperforming their historic return levels, there were companies that contributed to growth in individual wealth.
If the investments you are using today aren’t working, now is not a time to look for conventional solutions to your portfolio woes. You need to actively address the need by focusing on solid companies that have been overlooked by the rest of the market and show an ability to pass on their higher costs.
Got assets? You’d better. Or you’ll have a lot of explaining to do to your grandchildren.
The energy conundrum
Going back to late 2003, we’ve been extolling the virtues of investing in energy given the likely long-term scenario of depleting oil reserves and increasing demand which will lead to higher prices.
At the time of our first commentary on our bullish outlook for energy stocks, oil prices were just shy of $30/barrel. In 2005, oil topped out at close to $70/barrel and settled in at around $60/barrel as the year came to a close.
Anybody driving an SUV is hopeful that the worst is over, at least for now. In the short term, that’s entirely possible. Just as with the price of gold or day-to-day movements in the stock market, it is hard to make money trying to predict the short-term direction of oil prices.
Over the long run, the basic story still holds. Oil demand has not been curtailed. The claims by many that we have reached the days of peak oil production seem more realistic given the ongoing demand and diminishing reserves. One expert noted in a recent Fortune magazine that in 1988, the world had 15 million barrels a day of surplus production that could be tapped to meet demand. At the time, the world used 55 million barrels a day. Today, we use close to 85 million barrels a day, and there is no surplus production to back us up.
That seems to create a tenuous situation at best for oil prices. Demand certainly isn’t falling. New sources of oil are hard to come by. The laws of supply and
demand dictate that unless something dramatic changes, oil prices have to head higher over time.
Given that fact, we’re comfortable retaining some of our energy holdings, a position that has proven quite profitable since we first spotted the opportunity more than two years ago.
2005 in Review
A quick look at some of the ideas we shared in past newsletters and how things look today:
Growth vs. value
The love affair investors and the media have with headline-grabbing growth stocks often catches our ire. We addressed this both in our first newsletter of the year and again after the third quarter.
And in 2005, it happened again. Value stocks outpaced growth stocks (the S&P 500 Value Index gained 6.33% while the S&P 500 Growth Index was up 3.46%). By index measure, neither growth nor value had barnburner years. But for the sixth year in a row, growth stocks got the short end of the stick*.
In one newsletter, we debunked the popularity of index funds. With the stock market dribbling out meager returns in 2005, the story remains the same. Stock indices aren’t doing much more than the bond markets. And since 2000 (as noted above), passive investors have not kept pace with the rising cost of living.
A summer newsletter took aim at the rising popularity of hedge funds. We’re still troubled by the fact that lots of pension fund money is heading this way, not to mention dollars from non-accredited investors. The media has generally glorified hedge funds, but we were heartened to see a recent write-up by Daniel Gross, economics writer for the online magazine Slate. He bemoaned the fact that, like the boom in mutual funds in the 1990s that led to a lot of mediocre money management, hedge funds are following a similar path, and he expects with similar results. If 2005 is any indication, they are well on their way. The S&P Hedge Funds Index lagged even the modest returns of the S&P 500 in 2005 (2.28% for the Hedge Funds Index versus 3.00% for the S&P 500 excluding dividends).
* Based on a comparison of the S&P 500/Barra Growth and Value Indices, value stocks outpaced growth stocks by 28.16% in 2000, by 1.00% in 2001, by 2.63% in 2002, by 9.63% in 2003 and by 9.57% in 2004.
MPMG is proud to announce the addition of our newest associate. After an 18 month internship it is our pleasure to welcome Laura Harvey to MPMG as our new Operations Associate. Laura is a Bachelor of Arts graduate from the University of St. Thomas with a major in Finance. While working for MPMG as an intern, Laura still was able to complete her coursework in only 3 ½ years. Her work ethic and commitment to achievement have made Laura an asset to MPMG, and we welcome all who have not yet met her to say hello next time you call or visit.
Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted.
The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG’s future investments. As with any investment, there can be no assurance that MPMG’s investment objective will be achieved or that an investor will not lose a portion or all of its investment.