Dear Valued Investor:
Continued concern over the debt burden of the developed world combined with the deeply divided political landscape in Washington, D.C. has many investors questioning the sustainability of the economic recovery following the Great Recession of 2008. Growth has slowed and we believe the chance of revisiting a recession has increased to approximately 35%. However, the most likely scenario remains that global growth will continue at its modest pace, which could offer an upside surprise for an increasingly bearish-biased market.
While these volatile markets are sending many investors scrambling for a rock to hide under to wait out the uncertainty, I believe turning over those rocks in search of investment opportunities may prove fruitful over the long term. Fear and emotion oftentimes defines short-term market reactions. However, when fear is at its pinnacle, a patient temperament, faith in your investment plan, and a commitment to opportunistic investments can ultimately turn short-term market challenges into long-term investment success.
One does not have to go far into the history books to find two periods where short-term fear transitioned into investment triumphs. Today’s investment environment is causing investors to face similar challenges to those that haunted them in 2008 and again during the summer of 2010. In both of those periods, prices had declined further than their fundamental values and proactive policy action by central banks served as the catalyst to lure opportunistic investors back into the market. I believe that the same environment exists today and the same elixir is needed for these uncertain times.
The crowded trade certainly remains bearish, but policy actions to stoke the economic growth fire have begun again in earnest. The Federal Reserve Bank announced today that they will provide additional stimulative monetary policy through Operation Twist. Moreover, many central banks around the world that had been intentionally slowing their country’s growth in an attempt to head off inflation are now switching from the brake to the gas pedal to provide more stimulus to jump start growth and the stalling global economic recovery.
The market appears to be suffering much more from a lack of clarity and a wave of uncertainty than it is a degradation in economic fundamentals. While growth has undoubtedly slowed, most corporations are still on pace to post near-record third quarter profits, business spending continues to be strong, and retail sales remain positive. In fact, buoyed by surging auto production and sales following the disruption caused by Japan’s springtime natural disaster, economic growth this quarter for the United States may be poised to not only be the fastest of the year, but also to be faster than the first two quarters of the year combined.
Despite this modest and far from disastrous outlook, uncertainty has outweighed optimism and question marks have outpaced clarity. The market is essentially suffering from a recession of confidence. With the mood decidedly bearish, the market does not believe in this recovery and investors do not have faith that policy makers can avert the second recession in three years. But, it is fear and emotional disbelief that often serves as the catalysts to lower expectations—and stock prices—to levels that even market bears see the value of owning. While the market still faces a challenging environment and has a wall of worry to overcome, I believe that patience and a vigorous commitment to your investment plan is the best strategy to weather this bout of uncertainty and serve as yet another example of the resiliency of the markets, the global economy, and American business.
As always, I encourage you to contact your financial professional with any questions.
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 me 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.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The Federal Open Market Committee action known as “Operation Twist” began in 1961. The intent was to flatten the yield curve in order to promote capital inflows and strengthen the dollar. The Fed utilized open market operations to shorten the maturity of public debt in the open market. The action has subsequently been reexamined in isolation and found to have been more effective than originally thought. As a result of this reappraisal, similar action has been suggested as an alternative to quantitative easing by central banks.
This research material has been prepared by LPL Financial.
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Tuesday, September 27, 2011
Monday, September 26, 2011
Weekly Commentary September 26th, 2011
The Markets
The Federal Reserve did “The Twist,” but the financial markets ended up in “A Knot.”
In a much anticipated action dubbed “Operation Twist,” the Federal Reserve announced last week it would reshuffle its balance sheet by selling $400 billion of shorter-term Treasury securities and use the proceeds to buy longer-term securities. The Fed said it hopes the action will lower longer-term interest rates and, “contribute to a broad easing in financial market conditions that will provide additional stimulus to support the economic recovery.”
So far, as it relates to interest rates, the Fed’s action has worked. The yield on the 30-year Treasury bond declined from 3.2 percent the day before the Fed’s announcement to 2.9 percent just two days later, according to data from Yahoo! Finance. That’s a rather dramatic decline for such a short period.
Unfortunately, the stock market failed to respond positively to the Fed’s announcement as the S&P 500 index lost 6.4 percent for the week. The market’s drop, though, went beyond disappointment in the Fed’s action. The following also contributed to the market’s red ink:
• Intensified fears of a Greek default.
• Rising concern of a world-wide financial crisis, with sovereign debt at the epicenter.
• Growing signs of sluggish economic growth in China, which had been one of the few countries immune to economic turmoil.
• A 13 percent drop in the price of copper on Thursday and Friday of last week, which is concerning because the price of copper is often viewed as a proxy for worldwide industrial growth.
Sources: Wall Street Journal, MarketWatch, Bloomberg
With the market’s blood pressure rising, it reminds us of what flight attendants often say, “Ladies and gentlemen, the Captain has turned on the fasten seat belt sign. We are now crossing a zone of turbulence. Please return to your seats and keep your seat belts fastened. Thank you.”
Likewise, as your “Financial Captain,” we know there may be market volatility along the way, but, as always, we’re focused on trying to help you arrive safely at your financial destination.
AN OFTEN OVERLOOKED ASPECT OF SUCCESSFUL STOCK INVESTING is the importance of dividends. In bull markets, investors tend to focus on price appreciation, meaning, they look for stocks that can increase in price. In heady times like the late 1990s, investors feasted on stocks that would double or triple in a matter of months. Watching a stock go from $20 a share to $40 or $60 a share is exhilarating and makes for good cocktail party chatter. On the other hand, watching a stock sit at $20 a share for several years while you collect and reinvest a 3 percent dividend is rather boring and not worth sharing on the social circuit.
However, just like the old story about the tortoise and the hare, the slow and steady growth of dividends plays a very important role in making money grow over time.
The past 10 years is a great example of how dividends have helped improve the returns of an otherwise disappointing stock market. Here’s the data:
• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 1.3 percent excluding reinvested dividends.
• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 3.6 percent including reinvested dividends.
• As shown above, receiving dividends and reinvesting them added 2.3 percentage points per year to an investor’s return compared to the return generated by price appreciation alone of the underlying stocks in the S&P 500.
Sources: Morningstar, Yahoo! Finance
In today’s environment of low returns, finding a way to possibly eke out an extra 2.3 percentage points of return per year is attractive.
Over a longer period, receiving dividends and reinvesting them has accounted for one-third of the total return of the S&P 500 index over the past 80 years, according to Standard & Poor’s.
Standard & Poor’s also points out the following benefits of dividends:
• Dividends allow investors to capture the upside potential while providing some downside protection in the down markets.
• When bond yields are low, like they are now, dividend paying stocks might be a way to enhance an investor’s current income.
Just like any other investment, though, you need to figure out how dividends fit within your overall investment strategy. Are you looking for dividends to provide stability, income, or growth within your portfolio? Or, perhaps it’s some combination of all three.
Considering how dividends fit within our clients’ portfolios is just one more way that we’re trying to add value.
Weekly Focus – Think About It
“Do you know the only thing that gives me pleasure? It's to see my dividends coming in.”
--John D. Rockefeller
The Federal Reserve did “The Twist,” but the financial markets ended up in “A Knot.”
In a much anticipated action dubbed “Operation Twist,” the Federal Reserve announced last week it would reshuffle its balance sheet by selling $400 billion of shorter-term Treasury securities and use the proceeds to buy longer-term securities. The Fed said it hopes the action will lower longer-term interest rates and, “contribute to a broad easing in financial market conditions that will provide additional stimulus to support the economic recovery.”
So far, as it relates to interest rates, the Fed’s action has worked. The yield on the 30-year Treasury bond declined from 3.2 percent the day before the Fed’s announcement to 2.9 percent just two days later, according to data from Yahoo! Finance. That’s a rather dramatic decline for such a short period.
Unfortunately, the stock market failed to respond positively to the Fed’s announcement as the S&P 500 index lost 6.4 percent for the week. The market’s drop, though, went beyond disappointment in the Fed’s action. The following also contributed to the market’s red ink:
• Intensified fears of a Greek default.
• Rising concern of a world-wide financial crisis, with sovereign debt at the epicenter.
• Growing signs of sluggish economic growth in China, which had been one of the few countries immune to economic turmoil.
• A 13 percent drop in the price of copper on Thursday and Friday of last week, which is concerning because the price of copper is often viewed as a proxy for worldwide industrial growth.
Sources: Wall Street Journal, MarketWatch, Bloomberg
With the market’s blood pressure rising, it reminds us of what flight attendants often say, “Ladies and gentlemen, the Captain has turned on the fasten seat belt sign. We are now crossing a zone of turbulence. Please return to your seats and keep your seat belts fastened. Thank you.”
Likewise, as your “Financial Captain,” we know there may be market volatility along the way, but, as always, we’re focused on trying to help you arrive safely at your financial destination.
AN OFTEN OVERLOOKED ASPECT OF SUCCESSFUL STOCK INVESTING is the importance of dividends. In bull markets, investors tend to focus on price appreciation, meaning, they look for stocks that can increase in price. In heady times like the late 1990s, investors feasted on stocks that would double or triple in a matter of months. Watching a stock go from $20 a share to $40 or $60 a share is exhilarating and makes for good cocktail party chatter. On the other hand, watching a stock sit at $20 a share for several years while you collect and reinvest a 3 percent dividend is rather boring and not worth sharing on the social circuit.
However, just like the old story about the tortoise and the hare, the slow and steady growth of dividends plays a very important role in making money grow over time.
The past 10 years is a great example of how dividends have helped improve the returns of an otherwise disappointing stock market. Here’s the data:
• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 1.3 percent excluding reinvested dividends.
• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 3.6 percent including reinvested dividends.
• As shown above, receiving dividends and reinvesting them added 2.3 percentage points per year to an investor’s return compared to the return generated by price appreciation alone of the underlying stocks in the S&P 500.
Sources: Morningstar, Yahoo! Finance
In today’s environment of low returns, finding a way to possibly eke out an extra 2.3 percentage points of return per year is attractive.
Over a longer period, receiving dividends and reinvesting them has accounted for one-third of the total return of the S&P 500 index over the past 80 years, according to Standard & Poor’s.
Standard & Poor’s also points out the following benefits of dividends:
• Dividends allow investors to capture the upside potential while providing some downside protection in the down markets.
• When bond yields are low, like they are now, dividend paying stocks might be a way to enhance an investor’s current income.
Just like any other investment, though, you need to figure out how dividends fit within your overall investment strategy. Are you looking for dividends to provide stability, income, or growth within your portfolio? Or, perhaps it’s some combination of all three.
Considering how dividends fit within our clients’ portfolios is just one more way that we’re trying to add value.
Weekly Focus – Think About It
“Do you know the only thing that gives me pleasure? It's to see my dividends coming in.”
--John D. Rockefeller
Monday, September 19, 2011
Weekly Commentary September 19th, 2011
The Markets
Are the world’s economic leaders focused on solving the wrong problem related to Europe’s sovereign debt woes?
As you may know, Greece and several other European countries are in debt up to their eyeballs. Much of their debt is held by European banks and there’s a big worry that if Greece or some other countries default, then some European banks may face major write-offs that could severely jeopardize their viability.
Unfortunately, what the powers that be in Europe are doing is akin to you going to the doctor and being treated for severe back pain with a heavy dose of pain medication. Rather than “heal” your back, the pain killer simply “masks” the pain.
Last week, five of the world’s leading central banks announced a coordinated action that made it easier for European banks to borrow U.S. dollars to help fund their loan needs, according to The Wall Street Journal. This move addresses the “liquidity” of European banks, but not the “solvency” of them. In other words, it helps ease the symptom of the problem without actually solving the problem.
Simply put, a liquidity problem means you are short on cash and unable to meet current payments due. Typically, it’s a temporary situation that’s resolved by a loan or selling an asset to raise cash. By contrast, a solvency problem is much different. It means you have a structural defect and your revenue/assets are not high enough to support your expenses/liabilities. In effect, your business model is unsustainable. Frequently, it leads to a restructuring or bankruptcy.
In Europe, Greece has both a liquidity problem and a solvency problem. And, by extension, the banks heavily exposed to Greece and some of the other weak euro zone countries may be facing a solvency issue if they don’t raise additional capital.
So far, European leaders have been unable to agree on a once and for all solution to solve the liquidity and solvency problems facing the euro zone. Until they make the tough decisions, we may be stuck in this volatile market environment.
“BEWARE OF GEEKS BEARING FORMULAS.” --Warren Buffett
On October 19, 1987, the Dow Jones Industrial Average went into a free-fall that was exacerbated by computerized “portfolio insurance” trading strategies. By the end of the day, about $1 trillion of market value evaporated, according to CNBC.
In the fall of 1998, hedge fund Long-Term Capital Management imploded and had to be bailed out by a consortium of investors orchestrated by the Federal Reserve, according to Investopedia. The fund was led by Nobel-Prize winning economists and employed sophisticated computerized trading strategies that eventually ran amuck.
During the week of August 6, 2007, as the subprime mortgage crisis was gathering speed, several large hedge funds employing quantitative investment strategies “blew up” and lost billions of dollars in just a few days, according to Scott Patterson, author of the book, The Quants.
A “Flash Crash” on May 6, 2010 wiped out $862 billion in market value in a matter of minutes and was triggered by a computer-driven sale, according to Reuters and Bloomberg. Within four days, the entire loss was recouped, according to data from Yahoo! Finance.
Last week, Goldman Sachs announced that it was closing one of its well-known hedge funds that relied on computer-driven trading strategies after it racked up substantial losses this year. At its peak, the fund had $12 billion in assets, according to CNBC.
Despite the occasional headline-grabbing failure of computerized high-frequency trading, it still accounts for roughly 50 percent of all trading volume in the United States, according to Bloomberg. Based on complex mathematics, computer-driven trading is defined as, “A technique that relies on the rapid and automated placement of orders, many of which are immediately updated or canceled, as part of strategies such as market making and statistical arbitrage and tactics based on momentum,” according to Bloomberg.
With this technology takeover of Wall Street, a new element of unpredictability has entered the financial markets. The above examples show how volatile things can get when computer models go haywire.
So, some of the volatility we see in the markets these days may be exaggerated by computerized trading—both on the upside and downside. While we may not like it, we need to get used to it.
Weekly Focus – Think About It
“Interest on debts grow without rain.” --Yiddish Proverb
Are the world’s economic leaders focused on solving the wrong problem related to Europe’s sovereign debt woes?
As you may know, Greece and several other European countries are in debt up to their eyeballs. Much of their debt is held by European banks and there’s a big worry that if Greece or some other countries default, then some European banks may face major write-offs that could severely jeopardize their viability.
Unfortunately, what the powers that be in Europe are doing is akin to you going to the doctor and being treated for severe back pain with a heavy dose of pain medication. Rather than “heal” your back, the pain killer simply “masks” the pain.
Last week, five of the world’s leading central banks announced a coordinated action that made it easier for European banks to borrow U.S. dollars to help fund their loan needs, according to The Wall Street Journal. This move addresses the “liquidity” of European banks, but not the “solvency” of them. In other words, it helps ease the symptom of the problem without actually solving the problem.
Simply put, a liquidity problem means you are short on cash and unable to meet current payments due. Typically, it’s a temporary situation that’s resolved by a loan or selling an asset to raise cash. By contrast, a solvency problem is much different. It means you have a structural defect and your revenue/assets are not high enough to support your expenses/liabilities. In effect, your business model is unsustainable. Frequently, it leads to a restructuring or bankruptcy.
In Europe, Greece has both a liquidity problem and a solvency problem. And, by extension, the banks heavily exposed to Greece and some of the other weak euro zone countries may be facing a solvency issue if they don’t raise additional capital.
So far, European leaders have been unable to agree on a once and for all solution to solve the liquidity and solvency problems facing the euro zone. Until they make the tough decisions, we may be stuck in this volatile market environment.
“BEWARE OF GEEKS BEARING FORMULAS.” --Warren Buffett
On October 19, 1987, the Dow Jones Industrial Average went into a free-fall that was exacerbated by computerized “portfolio insurance” trading strategies. By the end of the day, about $1 trillion of market value evaporated, according to CNBC.
In the fall of 1998, hedge fund Long-Term Capital Management imploded and had to be bailed out by a consortium of investors orchestrated by the Federal Reserve, according to Investopedia. The fund was led by Nobel-Prize winning economists and employed sophisticated computerized trading strategies that eventually ran amuck.
During the week of August 6, 2007, as the subprime mortgage crisis was gathering speed, several large hedge funds employing quantitative investment strategies “blew up” and lost billions of dollars in just a few days, according to Scott Patterson, author of the book, The Quants.
A “Flash Crash” on May 6, 2010 wiped out $862 billion in market value in a matter of minutes and was triggered by a computer-driven sale, according to Reuters and Bloomberg. Within four days, the entire loss was recouped, according to data from Yahoo! Finance.
Last week, Goldman Sachs announced that it was closing one of its well-known hedge funds that relied on computer-driven trading strategies after it racked up substantial losses this year. At its peak, the fund had $12 billion in assets, according to CNBC.
Despite the occasional headline-grabbing failure of computerized high-frequency trading, it still accounts for roughly 50 percent of all trading volume in the United States, according to Bloomberg. Based on complex mathematics, computer-driven trading is defined as, “A technique that relies on the rapid and automated placement of orders, many of which are immediately updated or canceled, as part of strategies such as market making and statistical arbitrage and tactics based on momentum,” according to Bloomberg.
With this technology takeover of Wall Street, a new element of unpredictability has entered the financial markets. The above examples show how volatile things can get when computer models go haywire.
So, some of the volatility we see in the markets these days may be exaggerated by computerized trading—both on the upside and downside. While we may not like it, we need to get used to it.
Weekly Focus – Think About It
“Interest on debts grow without rain.” --Yiddish Proverb
Monday, September 12, 2011
Weekly Commentary September 12th, 2011
The Markets
Are we heading toward a “currency war?”
When there’s turmoil in the stock market or in the geopolitical environment, investors sometimes flee toward perceived “safe havens” in the hope of protecting a portion of their assets. While there’s no guarantee that any investment will be free from risk, the following assets have sometimes been on the receiving end when times get tough:
• U.S. dollar
• Swiss franc
• Japanese yen
• U.S. Treasury securities
• Gold
Sources: Goldline.com, U.S. Census Bureau
For example, Europe’s debt woes have soured investors on the euro (the European common currency) and pushed investors to the Swiss franc. This flight to the franc has been so strong that in early August, the franc hit a record high against the euro, according to The Wall Street Journal.
Unfortunately for the Swiss, the high value of the franc created countrywide economic problems. The Wall Street Journal said the soaring franc, “pushed some weaker Swiss exporters into bankruptcy, and sent others scrambling to slash prices to hold onto business.” In addition, “Tourists, an important source of income for the Swiss economy, now find it more expensive than ever.” Essentially, the strong franc created domestic havoc.
Well, last week, the Swiss National Bank decided enough was enough. The bank announced that it would cap the value of the soaring franc and, “buy euros in ‘unlimited quantities’ whenever the single currency fell below 1.20 francs,” according to The Wall Street Journal. Within minutes of that announcement, the value of the franc plunged 8 percent against the euro, according to Bloomberg.
Without getting bogged down in the details, this was an extremely bold move by the Swiss and could lead to, “a currency war, in which a growing band of countries seek to lower the values of their currencies to protect their economies,” as reported by The Wall Street Journal.
Dramatic currency intervention like this adds one more wrinkle to the uncertain worldwide economic environment. While we can’t control situations like this, it’s on our radar and we’ll monitor it and adjust for it on your behalf as best we can.
9/11 – 10 YEARS LATER
The past week was filled with remembrances of that tragic day 10 years ago when we lost nearly 3,000 of our loved ones and the country lost its feeling of peace and security. We will never forget the grief, the heroism, and the pulling together of the nation as we all tried to heal in the days and months following that fateful event.
Much has changed since then and, in a way, we all lost some of our innocence and perhaps some of our optimism. But, as Americans, we are a resilient nation. We’ve endured tragedy and war before and we always found the strength and the courage to overcome. The pain of the terrorist attacks is still with us, the images still vivid, the effects still lingering, but persevere we do and prevail we will.
While it pales in comparison to the human toll of 9/11 and its aftermath, the U.S. financial markets and the economy have been relatively weak in the years since that day. Here are some examples:
• Over the 10 years between September 10, 2001 and September 9, 2011, the S&P 500 index rose only 5.6 percent -- that’s a compound average annual return of only 0.6 percent excluding dividends. Source: Yahoo! Finance
• Over the 10 years between September 10, 2001 and September 9, 2011, the price of one ounce of gold rose 581.8 percent -- that’s a compound average annual return of a whopping 21.2 percent. The rise partly reflects inflation concerns, currency debasement, and a general flight to safety. Source: London Bullion Market Association
• The U.S. experienced two recessions since 2001. Source: National Bureau of Economic Research
From the terrorist attacks and their aftermath to the sluggish economy, it’s been a difficult 10 years for our country. And, just like it has taken time to process the 9/11 tragedy, it will take time for our global financial system to deleverage and cleanse itself. As this unwinding continues, there will be setbacks. But, over time, our human spirit will strengthen, our economy will improve, and the world will be a better place.
Weekly Focus – Think About It
“Enjoy the little things, for one day you may look back and realize they were the big things.”
--Robert Brault
Are we heading toward a “currency war?”
When there’s turmoil in the stock market or in the geopolitical environment, investors sometimes flee toward perceived “safe havens” in the hope of protecting a portion of their assets. While there’s no guarantee that any investment will be free from risk, the following assets have sometimes been on the receiving end when times get tough:
• U.S. dollar
• Swiss franc
• Japanese yen
• U.S. Treasury securities
• Gold
Sources: Goldline.com, U.S. Census Bureau
For example, Europe’s debt woes have soured investors on the euro (the European common currency) and pushed investors to the Swiss franc. This flight to the franc has been so strong that in early August, the franc hit a record high against the euro, according to The Wall Street Journal.
Unfortunately for the Swiss, the high value of the franc created countrywide economic problems. The Wall Street Journal said the soaring franc, “pushed some weaker Swiss exporters into bankruptcy, and sent others scrambling to slash prices to hold onto business.” In addition, “Tourists, an important source of income for the Swiss economy, now find it more expensive than ever.” Essentially, the strong franc created domestic havoc.
Well, last week, the Swiss National Bank decided enough was enough. The bank announced that it would cap the value of the soaring franc and, “buy euros in ‘unlimited quantities’ whenever the single currency fell below 1.20 francs,” according to The Wall Street Journal. Within minutes of that announcement, the value of the franc plunged 8 percent against the euro, according to Bloomberg.
Without getting bogged down in the details, this was an extremely bold move by the Swiss and could lead to, “a currency war, in which a growing band of countries seek to lower the values of their currencies to protect their economies,” as reported by The Wall Street Journal.
Dramatic currency intervention like this adds one more wrinkle to the uncertain worldwide economic environment. While we can’t control situations like this, it’s on our radar and we’ll monitor it and adjust for it on your behalf as best we can.
9/11 – 10 YEARS LATER
The past week was filled with remembrances of that tragic day 10 years ago when we lost nearly 3,000 of our loved ones and the country lost its feeling of peace and security. We will never forget the grief, the heroism, and the pulling together of the nation as we all tried to heal in the days and months following that fateful event.
Much has changed since then and, in a way, we all lost some of our innocence and perhaps some of our optimism. But, as Americans, we are a resilient nation. We’ve endured tragedy and war before and we always found the strength and the courage to overcome. The pain of the terrorist attacks is still with us, the images still vivid, the effects still lingering, but persevere we do and prevail we will.
While it pales in comparison to the human toll of 9/11 and its aftermath, the U.S. financial markets and the economy have been relatively weak in the years since that day. Here are some examples:
• Over the 10 years between September 10, 2001 and September 9, 2011, the S&P 500 index rose only 5.6 percent -- that’s a compound average annual return of only 0.6 percent excluding dividends. Source: Yahoo! Finance
• Over the 10 years between September 10, 2001 and September 9, 2011, the price of one ounce of gold rose 581.8 percent -- that’s a compound average annual return of a whopping 21.2 percent. The rise partly reflects inflation concerns, currency debasement, and a general flight to safety. Source: London Bullion Market Association
• The U.S. experienced two recessions since 2001. Source: National Bureau of Economic Research
From the terrorist attacks and their aftermath to the sluggish economy, it’s been a difficult 10 years for our country. And, just like it has taken time to process the 9/11 tragedy, it will take time for our global financial system to deleverage and cleanse itself. As this unwinding continues, there will be setbacks. But, over time, our human spirit will strengthen, our economy will improve, and the world will be a better place.
Weekly Focus – Think About It
“Enjoy the little things, for one day you may look back and realize they were the big things.”
--Robert Brault
Tuesday, September 6, 2011
Weekly Commentary September 6th, 2011
The Markets
Two four-letter words -- “debt” and “jobs” -- are hanging over the economy like a noose that keeps tightening.
This is not news; we’ve known for several years that debt is too high and jobs too scarce. Unfortunately, they’ve become intractable problems with no solution in sight.
Last week, the government reported the U.S. economy had a net gain of zero new jobs in August. On top of that, the unemployment rate remained stuck at a disappointingly high 9.1 percent and the number of unemployed people rose to 14 million -- including more than 6 million workers who have been out of work for 27 weeks or longer, according to MarketWatch.
With jobs hard to come by, consumer confidence is suffering, too. The Conference Board reported its consumer-confidence index for August fell to the lowest level since April 2009, according to MarketWatch.
The weak economy and uncertain outlook have led to a dramatic decline in interest rates. The yield on the 10-year Treasury dropped to 2.0 percent last week and the 30-year Treasury yielded just 3.3 percent, according to Bloomberg. This decline in longer-term interest rates is, “a sign of heightened fears about a recession in the U.S. and more actions from the Fed,” according to The Wall Street Journal.
When you put the pieces of the economic puzzle together, it starts to paint a picture that a new recession may be looming. While we’re not in the business of making projections like that, we do monitor the economy and, right now, it’s sending unsettling signals.
Whether a new recession is coming or not, we continue to do our job of helping you reach your financial goals regardless of what the market and economy may put in our way.
THERE’S THIS PESKY LITTLE THING CALLED THE P/E RATIO and changes in this number could have a big effect on whether stock prices rise or fall. Normally, stock prices are driven by earnings. As earnings rise, stock prices tend to rise and vice versa. Granted, it’s not a straight-line relationship. Instead, it tends to come in sync over time -- even though “over time” could mean several years.
We now have some great examples of how changes in the P/E ratio can dramatically affect the returns on certain stocks.
First, a definition. The P/E ratio is simply the price of a stock divided by its previous 12 months earnings per share. For example, if XYZ Company earned $1 per share in the past 12 months and its stock is selling for $15 per share, then it has a P/E ratio of 15.
For a real example, let’s look at Microsoft. Ten years ago, on August 23, 2001, Microsoft stock traded at $26.60 per share. Ten years later, on August 23, 2011, Microsoft stock traded at $24.72 per share. As you can see, the stock price actually declined over that 10-year period. However, during those 10 years, Microsoft’s earnings per share actually skyrocketed by 193.33 percent, according to a September 3 Barron’s article.
The obvious question is, “How can Microsoft’s earnings nearly triple in 10 years while the stock price drops during that period?” The answer is… the P/E ratio declined dramatically.
The next obvious question is, “What causes the P/E ratio to change?” Ah, that’s the million-dollar question. Barron’s pointed out that back in 2001, companies like Microsoft were viewed as exciting growth companies and investors were willing to pay a higher than normal premium for each dollar of earnings. Flash forward 10 years and Microsoft did indeed grow its earnings dramatically. But today, Microsoft is viewed more as a “steady Eddie” and the multiple on each dollar of earnings that investors are willing to pay is less, hence, the slight decline in its stock price over the past 10 years.
There are a couple lessons here for investors.
First, when you buy a stock, it’s important to know the P/E ratio. If it’s higher than the market average, then you need to be extra careful. You could run into a Microsoft situation where the earnings actually rise, but the stock price doesn’t.
Second, buying a stock with a low P/E ratio is not necessarily a bad thing. Using Microsoft again as an example, its P/E ratio is currently low relative to 10 years ago. If the ratio starts to expand, then the stock price could actually rise faster than its earnings over the next few years. Microsoft is mentioned as an example and not meant as a buy or sell recommendation.
Nobody said investing was easy and figuring out the direction of a stock’s P/E ratio is one reason why.
Weekly Focus – Remembering 9/11
“Time is passing. Yet, for the United States of America, there will be no forgetting September the 11th. We will remember every rescuer who died in honor. We will remember every family that lives in grief. We will remember the fire and ash, the last phone calls, the funerals of the children.”
--President George W. Bush
Two four-letter words -- “debt” and “jobs” -- are hanging over the economy like a noose that keeps tightening.
This is not news; we’ve known for several years that debt is too high and jobs too scarce. Unfortunately, they’ve become intractable problems with no solution in sight.
Last week, the government reported the U.S. economy had a net gain of zero new jobs in August. On top of that, the unemployment rate remained stuck at a disappointingly high 9.1 percent and the number of unemployed people rose to 14 million -- including more than 6 million workers who have been out of work for 27 weeks or longer, according to MarketWatch.
With jobs hard to come by, consumer confidence is suffering, too. The Conference Board reported its consumer-confidence index for August fell to the lowest level since April 2009, according to MarketWatch.
The weak economy and uncertain outlook have led to a dramatic decline in interest rates. The yield on the 10-year Treasury dropped to 2.0 percent last week and the 30-year Treasury yielded just 3.3 percent, according to Bloomberg. This decline in longer-term interest rates is, “a sign of heightened fears about a recession in the U.S. and more actions from the Fed,” according to The Wall Street Journal.
When you put the pieces of the economic puzzle together, it starts to paint a picture that a new recession may be looming. While we’re not in the business of making projections like that, we do monitor the economy and, right now, it’s sending unsettling signals.
Whether a new recession is coming or not, we continue to do our job of helping you reach your financial goals regardless of what the market and economy may put in our way.
THERE’S THIS PESKY LITTLE THING CALLED THE P/E RATIO and changes in this number could have a big effect on whether stock prices rise or fall. Normally, stock prices are driven by earnings. As earnings rise, stock prices tend to rise and vice versa. Granted, it’s not a straight-line relationship. Instead, it tends to come in sync over time -- even though “over time” could mean several years.
We now have some great examples of how changes in the P/E ratio can dramatically affect the returns on certain stocks.
First, a definition. The P/E ratio is simply the price of a stock divided by its previous 12 months earnings per share. For example, if XYZ Company earned $1 per share in the past 12 months and its stock is selling for $15 per share, then it has a P/E ratio of 15.
For a real example, let’s look at Microsoft. Ten years ago, on August 23, 2001, Microsoft stock traded at $26.60 per share. Ten years later, on August 23, 2011, Microsoft stock traded at $24.72 per share. As you can see, the stock price actually declined over that 10-year period. However, during those 10 years, Microsoft’s earnings per share actually skyrocketed by 193.33 percent, according to a September 3 Barron’s article.
The obvious question is, “How can Microsoft’s earnings nearly triple in 10 years while the stock price drops during that period?” The answer is… the P/E ratio declined dramatically.
The next obvious question is, “What causes the P/E ratio to change?” Ah, that’s the million-dollar question. Barron’s pointed out that back in 2001, companies like Microsoft were viewed as exciting growth companies and investors were willing to pay a higher than normal premium for each dollar of earnings. Flash forward 10 years and Microsoft did indeed grow its earnings dramatically. But today, Microsoft is viewed more as a “steady Eddie” and the multiple on each dollar of earnings that investors are willing to pay is less, hence, the slight decline in its stock price over the past 10 years.
There are a couple lessons here for investors.
First, when you buy a stock, it’s important to know the P/E ratio. If it’s higher than the market average, then you need to be extra careful. You could run into a Microsoft situation where the earnings actually rise, but the stock price doesn’t.
Second, buying a stock with a low P/E ratio is not necessarily a bad thing. Using Microsoft again as an example, its P/E ratio is currently low relative to 10 years ago. If the ratio starts to expand, then the stock price could actually rise faster than its earnings over the next few years. Microsoft is mentioned as an example and not meant as a buy or sell recommendation.
Nobody said investing was easy and figuring out the direction of a stock’s P/E ratio is one reason why.
Weekly Focus – Remembering 9/11
“Time is passing. Yet, for the United States of America, there will be no forgetting September the 11th. We will remember every rescuer who died in honor. We will remember every family that lives in grief. We will remember the fire and ash, the last phone calls, the funerals of the children.”
--President George W. Bush
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