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I N V E S T M E N T S T R A T E G Y O U T L O O K Market Vantage for Investment Clients January 24, 2005 * * * WEEKLY COMMENTARY Ponzi's Revenge On December 26, 1919, Carlo Ponzi, an immigrant from the town of Parma, Italy, founded The Security Exchange Company, an enterprise which dazzled investors with the promise of a 50 percent return in 90 days. In point of fact, those fabulous returns were paid out of funds received by enticing new investors. The critical factor behind Signor Ponzi's success, of course, was the public's continuous optimism and belief that such outrageous returns were possible. There was a big catch, however: without money from new investors, "dividends" could not be paid out. Without those remarkable payments, the public lost confidence, and the "fund" supporting the enterprise collapsed. Ironically, skeptics who first cast doubt on Ponzi's investment vehicle were reviled by the public and denounced by those profiting from the arrangement. Even when Ponzi was deported to Italy (after serving a few prison terms throughout the U.S.), thousands of well-wishers turned up at Boston Harbor to see him off. George W. Bush is now becoming familiar with this same public pillaring, as he casts doubt on the largest "Ponzi Scheme" in history. . . . We are, of course, referring to the Social Security Act of 1934. Perhaps the trouble with the current debate about Social Security is more elementary than we care to admit: while our esteemed representatives are good with words and sound bites, when it comes to basic arithmetic they struggle. So, they tend to focus on the words and the hyperbole (which they enjoy) and ignore the math (which, seemingly, they don't). And, so, they've created a lot of "good" phrases to describe Social Security, like "trust fund," "pension system," or "retirement plan." The problem with these words is that none of them have a shred of truth. The sad fact is Social Security has essentially been a welfare-type system from the outset. It was never "funded" and "contributions" were really just taxes that were taken from one generation and redistributed to an older one, based on a formula. There is no correlation between how much you "contribute" to the system, any "investment returns," or what you get paid at retirement. And, it has always been that way. Consider the case of the first recipient of a monthly Social Security check, Ida May Fuller. On January 1, 1940, Ida May received her first check for $22.54. Before retirement, Ida May had paid a total of $24.75 into the system. Unfortunately for the system (but, no doubt, happily for Ida May), she lived to be 100 years old. In total, she collected $22,888.92 from the government. That's an annual return of 2,642 percent. Ponzi was a piker compared to the Social Security Administration. Of course, in order for Ida May to have gotten a 2,642 percent return, it means that a whole lot of other people must get seriously negative returns. Ironically, those negative returns were also by design. When the system was established, the retirement age was set at 103 percent of life expectancy — which in 1935 was 62.8 years. The government expected most people that paid into the system to die before they collected their first dollar. Since everyone was forced to pay (and they would hopefully die young), there was no worry about the Ida May Fullers of this world taking a disproportionate share of the money. Similarly, if the current retirement age was 103 percent of life expectancy (78.7 years), the system could probably go on forever — baby boomers or no. Of course, to accomplish this we'd need to instantly cut off payments to millions of retirees, which would send the AARP into convulsive spasms. AARP is sort of the William McMaster character in this drama. McMaster was a well-respected PR guy Ponzi hired to improve his image after the government began to question Ponzi's enterprise. Unlike the AARP, McMaster stopped representing his "client" after a few weeks. He determined Ponzi was a fraud and said so publicly. McMaster's character and integrity were more important to him than the fees he got from Ponzi. Here's where McMaster and the AARP seem to diverge. The AARP receives almost $500 million a year in direct payments from the beneficiaries of Social Security. We don't think they should be accorded any credible voice in this debate. If you want to find out if you are on a winning level of this pyramid, it's easy to do so. The Social Security Administration habitually sends out statements to contributors. My recently arrived analysis states that by the time I retire I will have likely amassed contributions of $285,425.00. This, presumably, will allow me to receive payments of $1,499 per month at age 62. If I live until 78 (my life expectancy), I will receive $287,808.00 in checks. In case you're wondering, the imputed IRR on this amount for my 16 years of retirement is 0.10 percent per year. Yes, that is not a typo — 10 basis points per year. The investment returns on the accumulated contributions prior to retirement are exactly zero. Ida May, my hat is off to you! -------------------------------------------------------------------------------- Kindness of Strangers The market has begun to focus on the monthly release of "Foreign Transaction in Long Term Securities with U.S. Residents." Bond buyers breathed a collective sigh of relief when the number $81 billion was revealed, a figure substantially higher than last month's. If those friendly folks offshore stop buying our bonds, then our rates may rise. Happily, there are not many good alternatives to the "full faith and credit" of good ol' Uncle Sam. Elsewhere, inflation is still on sabbatical. PPI, ex-food and energy, was up a modest 2.2 percent. The same notion is reflected in spread between the inflation-indexed TIPS bonds and the 5-year Treasury, which has declined to 2.5 percent (from 2.7 percent) in the last month. The forwards are telling us about another 100 bps of rate increases in the Fed Funds rate this year. See you at 3.25 percent in September. -------------------------------------------------------------------------------- End Note There is a rumor circulating that the board of directors at Martha Stewart Living/OmniMedia Group has asked a federal judge to extend Ms. Stewart's sentence another six months. Since Martha's comportment at Camp Cupcake has been nothing short of exemplary, it's not clear why judge would entertain their request. We hear she's even taught napkin-folding techniques and flower arranging to the other residents of her cell block. When asked on what basis her jail time could possibly be increased, our anonymous source simply said, "The board is examining that concept now. Keep in mind that this board's total focus has always been on increasing shareholder value." Martha Stewart Living/OmniMedia Group stock has risen 236 percent since Martha was first sentenced back in July. And, to borrow Martha's own words, "That's a good thing." -- Jim Anderson, Chief Investment Officer * * * VC QUARTERLY UPDATE Silicon Valley Bank publishes a quarterly synopsis of VC investment trends, and it is now available. As a weekly reader of Investment Strategy Outlook, SVB Asset Management invites you to download this valuable report at http://www.svb.com/pdfs/vc_2004_q3.pdf. (210 k) * * * MONEY MARKETS Deficits Fatigue Fed Bush may be facing a hangover that has little to do with inaugural festivities: his longtime honeymoon with the Federal Reserve is showing signs of ending. The Fed and its chairman, Alan Greenspan, gave their blessing to the Bush tax cuts and tiptoed around criticism of the ever-soaring federal deficit. Recent comments suggest, however, the U.S. trade and financial deficit has become a preoccupying factor with many members, who fear that the imbalance can weigh down any or all aspects of the recovering economy . . . and perhaps bring public disagreement with the Bush administration. (NY Times) Slower Growth, Treasury Growth U.S. Treasury notes rose last week, pushing the yield on the benchmark 10-year security to the lowest in a month, as consumer prices declined and measures of consumer confidence and manufacturing were lower than forecast. The reports led traders to pare expectations for how much the Federal Reserve will raise its benchmark interest rate this year. The 2-year note's yield, more sensitive to expectations for monetary policy than longer-maturity debt, fell for the first week in four. (Bloomberg) S.F. Fed's Yellen: No Inflation Threat "The U.S. economy is in a 'self-sustaining' expansion and inflation is likely to remain "well contained," said Janet Yellen, president of the Federal Reserve Bank of San Francisco. The central banker said she wanted to explain her views on inflation following the Jan. 4th release of minutes from the Fed's December interest rate meeting. Those documents said some policy makers viewed rising prices as "likely to become a clearer intermediate-term risk to sustained good economic performance." Investors pushed up yields on U.S. Treasury 10-year notes after the minutes were released. (Bloomberg) * * * TECH/LIFE SCIENCES/VC Asian Telecom Races Ahead The Asian telecom industry is booming with companies like India's Reliance Infocomm, which is surpassing Western rivals. Typically, Asian firms are not hampered by legacy systems and can offer advanced features (e.g., TV and news-clip downloads on most phones). The regional firms have bought up some $32.7 billion in global telecom infrastructure from U.S. companies, reducing the need to route traffic through the U.S. One area of security concern: some parts of a nation's communications infrastructure may now be controlled by those who don't share that nation's interests. (Red Herring) Google: Dark-Fiber Lord? Recent job postings for dark fiber experts on the Google Web site have lead to speculation that the company may be preparing to build a global fiber-optic network. Dark fiber is fiber-optic cable that has been laid out but is not in use. During the telecom boom of the late 1990s, thousands of miles of fiber was put in place, but never used because of the high cost of making it operational. (CNET.com) Chip-Tool Bookings The December book-to-bill ratio for North American chip-gear makers fell to 0.95, signaling a declining demand for semiconductors. A ratio above one indicates growth. Bookings for the industry fell 7.1 percent from the November total and the three-month average declined 2.6 percent (San Jose Mercury) NIH Bows to Publisher Pressure The National Institutes of Health (NIH) has scaled back a proposal that would make the results of federally funded research available to the public for free within six months of publication. Now the plan extends the deadline to one year, as a result of pressure by publishers who argued that the original proposal would have cut their profits and harmed scientific enterprise. (Boston Globe) Greater Scrutiny, Lower Valuations In the wake of concerns over Vioxx®, experts postulate that small biotech firms may face lower valuations. U.S. Food and Drug Administration regulators may demand that drugs pass more complex and costly clinical trials to ensure product safety. This could mean biotech startups would need to go through additional rounds of financing if their products take longer to get to market. And VCs will have a greater stake and influence in the companies' direction. (Dow Jones NewsWires) Venture Investment High . . . According to VentureOne, 2004 venture investments rose to $20.4 billion in 2,067 deals, compared to $18.9 billion in 2,092 deals for 2003. Early- and seed-stage fundings comprised 33 percent of all deals, up from 31 percent in 2003, and 37 percent of all Q4 deals, the highest percentage since 2001. Experts expect final numbers to show that VCs raised more for new funds in 2004 - between $16 billion and $17 billion, compared with $8.7 billion the prior year — enabling firms to invest at an earlier stage. Industry experts are encouraged by the positive trend, calling 2003 the bottom of the market. (Wall Street Journal) . . . Or Even Higher? The MoneyTree survey published by Venture Economics, PricewaterhouseCoopers, and the National Venture Capital Association also shows that 2004 investment levels are up over 2003, estimating the total at $21 billion, slightly higher than VentureOne's calculations. The survey notes that VCs are focused on Internet and consumer-related deals and the Asian market. (Private Equity Week) IPO Prospects Brighter in 2005 Thomson Financial estimates that 2005 IPO issuance could match or exceed 2004's totals: 248 IPOs, raising $48.12 billion. January promises to be a good month, with a pickup in the number of deals (an early indicator of investor appetite for new issues). "There's good reason to feel the market will support these deals. Of the IPOs that came to market in December, 80 percent are still trading above their offering prices," said Renaissance Capital's Paul Bard. (Dow Jones NewsWires) * * * GENERAL ECONOMY Consumer Confidence Falls Unexpectedly U.S. consumer confidence unexpectedly fell in early January, the first drop in three months, as stocks declined and oil prices crept up. The University of Michigan's preliminary Index of Consumer Sentiment slipped to 95.8 for the month, from 97.1 in December, as expectations for the future dimmed, fueled by a lackluster stock market, rising oil prices, and slow job growth. The assessment of present conditions rose to a four-year high. January's reading in the general index still exceeds the 88.1 average since a monthly version began in 1978. The index averaged 95.2 last year. (Bloomberg) Leading Indicators Rise Again U.S. economic prospects brightened in December, as the Index of Leading Economic Indicators increased by 0.2 percent. It was the second straight gain after five months of declines. November's gain was revised to 0.3 percent from 0.2 percent. The slump in the second half of 2004 was probably "only a pause in the rising trend that has been under way since March 2003," the board said. The behavior of the index, designed to forecast economic trends six to nine months ahead, "is consistent with the economy continuing to expand in the near term, but more slowly than its long-term trend line," the Conference Board said. (CBS.MW) Consumer Spending Fuels Q4 Growth Gross domestic product, the sum of all goods and services produced in the U.S., probably rose 3.5 percent at an annual rate in Q4, economists expect the Commerce Department to report on Jan. 28th. In the prior three months, the economy rushed ahead at a 4.0 percent rate. Americans' need for iPods® and digital TVs bolstered the U.S. economy in the final three months of 2004. Corporate spending on new equipment and inventory building did its share, too. A record trade deficit kept the economy from growing even faster at year-end. (Bloomberg) * * * FORWARD YIELD CURVE - ACTIVE U.S. GOVERNMENTS See this week's graph: http://www.svb.com/images/iso/curve012405.gif * * * ECONOMIC CALENDAR See this week's table: http://www.svb.com/images/iso/calendar012405.gif * * * For more information, call 415.512.4264 or visit http://www.svbassetmanagement.com. * * * Copyright 2005 SVB Asset Management is a registered investment advisor and non-bank affiliate of Silicon Valley Bank established in 2002. SVB Asset Management manages short-term, fixed income investments for primarily U.S.-based corporate clients. Investment products offered through SVB Asset Management are not insured by the FDIC or any other federal government agency. They are not deposits of or guaranteed by Silicon Valley Bank, or any bank affiliate, and may lose value. SVB Asset Management claims compliance with the AIMR Performance Presentation Standards. (AIMR-PPS®), the U.S. and Canadian version of GIPS®. AIMR has not been involved with or reviewed SVB Asset Management's claim of compliance. To receive a complete list and description of SVB Asset Management's composites and/or a presentation that adheres to the AIMR-PPS standards, contact Adam Dean, 866.719.9117, adean@svbassetmanagement.com. SAM Headquarters Address: 185 Berry Street, Lobby 1, Suite 3000, San Francisco, Calif. 94107 You have expressed interest in learning more about SVB Asset Management and have provided us with your e-mail address. SVB Asset Management cares about your privacy and does not sell online client information to any outside company or third party. If you do not wish to receive any further newsletters visit http://www.svb.com/media/unsubscribe.asp or send an e-mail to Unsubscribe@svbank.com with your e-mail address in the subject line. View our Privacy Statement at http://www.svb.com/corp/legal.asp?privacy |