Weekly Commentary May 29th, 2012

The Markets

Judging by what’s happening in the bond market, it appears that some investors are more concerned about the return of their money than the return on their money.

When investors get nervous about the stock market, you often see money flow into the government securities of perceived safe haven countries such as Germany, Japan, U.K., and the U.S. This increased demand helps drive down the yield on their bonds. In fact, take a look at the following chart to see some amazingly low government securities yields:

Country	Maturity	Annual Yield
Germany	2 Years	0.07%
Japan	10 Years	0.89
Germany	10 Years	1.41
Finland	10 Years	1.73
U.S.	10 Years	1.74
U.K.	10 Years	1.79
Netherlands	10 Years	1.89

Sources: The Wall Street Journal, May 23, 2012; and The Wall Street Journal, May 25, 2012

By contrast, yields on government securities in perceived “risky” countries such as Italy (10-year yield of 5.76 percent) and Spain (10-year yield of 6.10 percent) are much higher, according to The Wall Street Journal.

Unfortunately, even the government securities of the “safe” countries may experience a loss in “purchasing power.” For example, with inflation running at 2.3 percent in the U.S. for the 12 months ending in April, investors in 10-year U.S. government securities may lose purchasing power since the yield is less than the inflation rate, according to the Bureau of Labor Statistics. On top of that, if interest rates rise over time, the bonds could experience a capital loss as the price of the bond adjusts to reflect current interest rates.

So, what should an investor do to try and stay ahead of inflation and grow their portfolio without taking inappropriate risk? Here are three things:

1.      Know your comfort level. We work with you to figure out what level of market fluctuation is acceptable to you.

2.      Diversify your portfolio. We try to diversify by asset class and time horizon based on your acceptable level of fluctuation. While this does not protect against a loss, it may help smooth out the ride.

3.      Monitor your portfolio. We keep tabs on what’s happening in the economy and in your portfolio so we can be proactive in making changes when necessary.

Our goal is to help you receive “a return of and a return on” your money. 

IF THE WORLD WAS A LAUNDROMAT, the U.S. might be the “cleanest dirty shirt” in the store. As new signs point to a global slowdown, we’re on the lookout for countries that might hold up better in the rinse cycle and the U.S. could be that country, according to U.S. News & World Report.

The “cleanest dirty shirt” analogy comes from Mohamed El-Arian of PIMCO who says, “When you're on a business trip that gets extended and you don't have any more clean shirts, you wear the one that's least dirty.” In our case, you invest in the country that’s “least bad.”

“Least bad” may not sound like a great way to invest, but consider this. With the U.S. fiscal situation in horrible shape, you might expect investors to shun the U.S. dollar on fear the government will print dollars and reduce its value. Well, recently, investors have been clamoring to buy dollars. For example, last week, “The ICE dollar index, which measures the U.S. unit against a basket of major currencies, rose to 82.416 – its highest level since 2010,” according to MarketWatch.

In the dollar’s case, nobody is suggesting that, in isolation, it looks great. Rather, when you compare it to another currency such as the euro – which represents 17 countries in Europe – it looks relatively better because Europe’s problems seem more pressing than ours.

Just like taking a dirty shirt to the Laundromat to get it cleaned, investments over time may turn from “dirty” to “clean” as problems get worked out and situations improve. There’s money to be made during this cleansing cycle and we’re doing our best to “clean up.”

Weekly Focus – Did You Know…

The average life expectancy at birth in the United States for the population in general is 78.37 years. For males, the average life expectancy is 75.92 years and for females it’s 80.93 years (2011 estimate). This places the U.S. at #50 in the world and well behind #1 Monaco at 89.73 years.

Sources:

https://www.cia.gov/library/publications/the-world-factbook/geos/us.html

https://www.cia.gov/library/publications/the-world-factbook/rankorder/2102rank.html

Weekly Commentary May 21st, 2012

The Markets

There wasn’t much to ‘Like’ in the financial markets last week as stocks took a hit on another round of global worries. High on the list of concerns were:

·         Continuing anxiety over Greece’s ability to avoid default and remain in the euro.

·         Rising borrowing costs for Italy and Spain.

·         Ongoing fears of an economic slowdown in China.

·         Loss of faith in the banking system due to JPMorgan’s $2 billion (and growing) bad bet.

·         A very tepid response to the highly anticipated stock market debut of Facebook.

Source: CNNMoney

Investors are particularly frustrated that the European debt situation keeps popping up like dandelions. After two years and 17 euro zone summits, the issue is still not resolved. In fact, it might be worse than ever as Europe is quickly running out of road to kick the can down, according to BusinessWeek.

Greece is at the epicenter of this worldwide concern despite the fact that its population is less than the state of Ohio. Like the subprime crisis before it, investors are concerned that Greece may be the falling domino that kicks off a series of undesirable effects. If Greece has a disorderly collapse, it could spread to other weak European countries and then ripple out to the rest of the world.

Unfortunately, the time for easy solutions has long passed. Central banks and governments around the world have already added trillions of dollars to their balance sheets so they don’t have much room to maneuver. And, here in the U.S., we have a potentially bruising election and looming tax and fiscal matters to deal with by the end of the year.

When you add it up, 2012 is on track to be another dramatic year in world affairs.     

WOULD YOU GIVE YOUR MONEY TO THE U.S. GOVERNMENT for 10 years and lock in a negative yield? Well, that’s exactly what happened last week as investors handed over $13 billion to the government and, in return, received 10-year Treasury Inflation Protected Securities (TIPS). These securities were sold at a record low negative yield of 0.39 percent, according to The Wall Street Journal.  

TIPS are a bit different from traditional government securities because, “The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater,” according to the Treasury Department.

Now, why would anybody buy a TIPS with a negative yield when they could buy a traditional 10-year government security with a yield of about 1.7 percent last week? The answer lies in the difference between the two yields.

As reported by Bloomberg, the yield difference between a 10-year TIPS and a comparable 10-year Treasury security was 2.04 percentage points on May 17. Analysts call this the “break even inflation rate.” It means investors were expecting inflation to average 2.04 percent over the next 10 years. When you add the 2.04 percent expected inflation rate to the negative 0.39 percent yield of a TIPS, you get close to the yield of a traditional 10-year government security.

From an investment standpoint, if inflation averages more than 2.04 percent over the next 10 years, then owning TIPS might be a better deal than owning the traditional 10-year government security. Likewise, if inflation averages less than 2.04 percent over the next 10 years, then owning the traditional 10-year security might be better, according to The Vanguard Group.  

With its built-in inflation protection component, TIPS are traditionally viewed as a hedge against inflation rather than a play on interest income.

As an advisor, it’s important for us to know the break even inflation rate that is embedded in TIPS. Knowing the market’s best estimate of inflation provides data we can use to help us value and analyze other investments that may be affected by changes in investors’ inflation expectations.

Weekly Focus – Did You Know…

There is only one word in the English language with all five vowels in reverse order. Try to guess what it is before reading below for the answer.  

Source: http://www.byfaith.co.uk/paul2028.htm  

The answer is “subcontinental.”

Weekly Commentary May 14th, 2012

The Markets

Even the smartest guy in the room sometimes makes mistakes.

Jamie Dimon, CEO of the huge U.S. bank JP Morgan, has been called the smartest guy in the room for his ability to effectively steer the bank through the economic crisis. And, while most of the other big U.S. banks have tarnished reputations, Dimon’s firm was the one that stood out from the crowd.

Unfortunately, that all changed last week.

In a hastily arranged conference call with investors, Dimon revealed that the bank lost $2 billion in just the past six weeks on “bets aimed at shielding the bank from the market fallout of Europe's deepening mess,” according to The Wall Street Journal. These “bets” lost money due to “unusual movements in the relationships between various derivative indexes focused on investment-grade and junk-bond corporate debt, both in the U.S. and Europe,” according to the Journal.

This debacle points to three important investment lessons:

1.      Keep it simple. Trading fancy derivatives or using complex black box trading strategies might give you an air of sophistication, but it may also lead to your downfall. As Leonardo da Vinci said, “Simplicity is the ultimate sophistication.”

2.      Pick and track your investments closely. In describing the trades that blew up, Dimon said, “The new strategy was flawed, complex, poorly reviewed, poorly executed, and poorly monitored,” according to Bloomberg. Clearly, in this ever-changing world, a “set it and forget it” investment strategy won’t cut it.

3.      Be humble. Even a smart guy like Dimon can trip up. One of the biggest errors in investing is self-deception – thinking and acting like you are the smartest guy in the room. It’s better to worry about what could go wrong – and plan for it – than think you’re invincible.

The investment landscape is littered with formerly sharp investors who forgot these three lessons. We plan on keeping them front and center.

DOES IT MAKE SENSE that a painting sells for $120 million in this economic environment?

You may have seen the recent headline that Edvard Munch’s painting, “The Scream,” sold for a record-breaking $120 million. It made us wonder what the implications are of an anonymous bidder forking over that kind of cash for a pastel on canvas just three years out from a horrible economic crisis. Does this mean happy days are here again?

Placed in broad context, the high sale price for a work of art might be symptomatic of policymakers’ response to the economic crisis, according to The Wall Street Journal. When the economy began collapsing in 2008, governments around the world responded by cutting interest rates and flooding their economies with monetary stimulus. All this money sloshing around had to end up somewhere – and some of it might have found its way into hard assets such as commodities, precious metals, collectibles, and, yes, an Edvard Munch painting.

There’s something called the law of unintended consequences, which means solving one problem might inadvertently create a new one. In this case, the massive stimulus in recent years propped up the economy in the short run, but it may have unintentionally masked the real problem and simply delayed a day of reckoning.

With the following economic and political issues in play, that day of reckoning may be nearing:

·         Eleven European countries have experienced two consecutive quarters of economic contraction.

·         The unemployment rate across the eurozone has matched a record high.

·         Job growth in the U.S. is slowing.

·         The Chinese economy is slowing.

·         The political situation in Greece is chaotic.

·         France has a new Socialist president.

Sources: MarketWatch, The Wall Street Journal

Now, the good news. In any economic environment, there will be winners and losers. As the steward of your financial life, we do everything we can to try and help you land on the winning side regardless of what the economy and markets throw in our way.

Weekly Focus – Think About It

“Nature is pleased with simplicity. And nature is no dummy.”

--Isaac Newton, English physicist, mathematician, astronomer, natural

philosopher, alchemist, theologian… yes, a really smart guy!

Weekly Commentary May 7th, 2012

The Markets

The most important news last week may have actually happened this past weekend.

On Sunday, voters went to the polls in France, Greece, and Germany and the results could have a major impact on world markets. French voters sent incumbent president Nicholas Sarkozy packing and, instead, elected Socialist Party candidate Francois Hollande. Hollande “has pledged to shift the burden of economic hardship onto the rich and to resolve the protracted euro sovereign-debt crisis by softening the current prescription of austerity,” according to The Wall Street Journal. While his strategy is debatable, it will likely cause a rift with Germany and add uncertainty to recent eurozone agreements.

Greek voters also went to the polls and “delivered a stinging rejection of the two incumbent parties, with many people casting ballots for smaller, far-left and far-right parties,” according to the The Wall Street Journal. This, too, will likely result in more political and economic uncertainty. And in Germany, incumbent Angela Merkel’s party suffered some setbacks in state elections.

What’s leading to all the angst in Europe? Here are three things:

1.      Recession fears – 11 European countries have now experienced two consecutive quarters of economic contraction.

      2.      Unemployment fears – the unemployment rate across the eurozone is at a record high.
      3.      Business confidence fears – April’s read on the manufacturing PMI for the eurozone – a measure of confidence among businesses – fell to the lowest since June 2009.
Sources: MarketWatch, The Guardian

The bottom line is citizens are voting for change, but “political realities will complicate even more what is an already delicate economic and financial outlook for Europe, the world’s largest economic area,” according to Mohamed El-Arian, CEO and Co-CIO of PIMCO, as reported by CNBC.

These elections show that the economic crisis that began in 2008 is still rippling throughout the world.

WHAT DO DOTS HAVE TO DO WITH BEING A BETTER INVESTOR? In his fascinating new book, Imagine: How Creativity Works, author Jonah Lehrer describes the creative process and what steps we can all take to be a little more creative. One of those steps is to talk to more people and expose yourself to new situations. By “colliding” more often with people who are not like you and throwing yourself into new environments (like a foreign country), your mind will come up with more new ideas than you could have thought of on your own.

And, while business owners may not like this, Lehrer’s research suggests, “The most important place in every office is not the boardroom, or the lab, or the library. It’s the coffee machine.” It’s those casual conversations with colleagues that generate new interactions and spark ideas.

This leads to an important point about investing.

Brian Uzzi, a professor at the Kellog School of Management, studied the instant messages (IM) sent by traders at a large hedge fund over an eighteen-month period. As reported in Lehrer’s book, these traders sent more than two million messages over that period and the average trader was involved in 16 different IM conversations simultaneously – talk about multitasking! Essentially, these traders were rapidly communicating with each other and trying to make sense of the latest news so they could profitably trade on it.

As summarized by Lehrer, Uzzi concluded, “The best traders were the most connected, and people who carried on more IM conversations and sent more messages also made more money.” Further, Uzzi said, “The act of investing is like solving a difficult puzzle. These traders are trying to connect the dots. Because the traders are listening to their network, they manage to accomplish what they could never have done by themselves.”

In essence, successful investing partly relies on “connecting the dots” of information that bombard us. While we’re not day traders like the people Uzzi studied at the hedge fund, the concept of connecting the dots still applies – albeit on a much longer timeframe. And, to connect the dots, we have a large network of colleagues who can help us separate the daily noise from what’s truly meaningful.

Weekly Focus – Think About It

“Everyone who's ever taken a shower has had an idea. It's the person who gets out of the shower, dries off, and does something about it who makes a difference.”

--Nolan Bushnell, founder of Atari, Inc. and Chuck E. Cheese’s Pizza-Time Theaters