Weekly Commentary August 27th, 2012

The Markets

Close, but not quite.

Last week, the U.S stock market hit an intra-day four-year high, but it couldn’t hold the gain and closed slightly lower for the week, according to MarketWatch. As usual, news flow from Europe and the Federal Reserve helped move prices.

While we often look at the broad market indexes to gauge progress in the stock market, those indexes sometimes send misleading signals. One cause of the misleading signals is the way the indexes are calculated. For example, some indexes, like the Dow Jones Industrial Average, are calculated using the price of each stock. This means a stock with a high price (e.g., IBM) will have a larger influence on the index than a lower priced stock. By contrast, the S&P 500 index is a capitalization-weighted index. This means stocks with a large market value (like Apple) will have a larger influence on the calculated price of the index.

Let’s take a closer look at Apple and see how its massive size influences a sub-index within the S&P 500. Standard and Poor’s subdivides the capitalization-weighted S&P 500 index into 10 major industry groups. Information Technology is one of the 10 industry groups and its biggest component is Apple – the world’s largest company as measured by market capitalization. MarketWatch pointed out that between the all-time stock market high on October 9, 2007 and August 20, 2012, the Information Technology sub-index of the S&P 500 was up an impressive 16.6 percent. However, if you remove Apple from the equation, the index would be down 4.1 percent. That’s a huge change just due to one stock.

Yes, it is important to monitor the broad stock market indexes to gauge the overall health of the stock market. However, it’s also necessary to look under the hood and understand what’s driving the performance. Sometimes the headline performance numbers are misleadingly driven by a relatively small number of stocks that, by quirk of a high stock price or large market cap, have an outsize influence – good or bad – on the headline number.   

WHAT ADDS MORE VALUE TO YOUR PORTFOLIO, CAPITAL GAINS OR DIVIDEND INCOME? When folks invest in the stock market, they hope to get back more money than they put in. This return on their investment can come from either a capital gain, meaning the stock price rises, or it can come from the company paying a dividend, or both. So, historically, has the return from common stocks come mostly from capital gains or from reinvesting dividend payments?

Researchers Elroy Dimson, Paul Marsh, and Roy Staunton of the London Business School crunched the numbers and came to a startling conclusion. Here’s what they discovered:

·         Counting capital gains only, $1 invested in the U.S stock market in 1900 grew to $217 by the end of 2010. This is an annualized return of 5.0 percent.

·         Counting capital gains and reinvesting your dividends, $1 invested in 1900 grew to $21,766 by the end of 2010. This is an annualized return of 9.4 percent.

·         Similar results were found for other markets around the world.

Source: Financial Times article, March 4, 2011

No doubt, capital gains are sexy. Who doesn’t love to go to a cocktail party and talk about the stock you bought which doubled or tripled in value? Yet, as the research shows, the rather boring dividends account for a substantial part of investors’ stock market returns.

A report from ING Investment Management added, “Research shows that companies paying high dividends are likely to become the most profitable, that dividends bring the largest contribution to equity portfolios over the long-term, and, finally, that companies paying high dividends outperform those paying low or no dividends.”

So, yes, dividends matter.

There are times, though, when investors get carried away and bid up the price of dividend-paying stocks such that they’re no longer attractive. Accordingly, ING said, “While companies paying high dividends outperform the market over the long run, they can underperform it over a shorter period.”

Based on the research, it’s clear that over the long term, dividends are an important consideration in building a portfolio.

 

Weekly Focus – Our Crazy English Language…

The English language contains autoantonyms, which are words that have two meanings—which are opposite each other! For example, one meaning of the word “rock” is “solid, unchanging, providing firm foundation.” However, it can also mean, “to move from side to side, especially gently and soothingly.” Same word, but two different meanings! Can you think of any other autoantonyms?

Weekly Commentary August 20th, 2012

The Markets

Like the tortoise beating the hare, the U.S. stock market has been slowly and steadily inching its way up over the past few weeks.

Since touching an intraday low on June 4, the Dow Jones Industrial Average, the NASDAQ, and the S&P 500 index have all rallied more than 10 percent, according to CNBC. In fact, the Dow and S&P 500 have now risen for six consecutive weeks. It feels a bit like a “stealth” rally as volume has been very low and volatility, as measured by the CBOE volatility index, is at its lowest level in five years.

Even Europe is enjoying a strong run. As CNBC reported, “European shares hit 13-month highs, extending their longest weekly winning streak in seven years, amid hopes that euro zone policymakers will work closely to tackle the debt crisis.”

Not everything is going up, though. While improving economic data on the job market, the housing industry, the index of leading indicators, retail sales, consumer purchasing, and consumer sentiment has helped the stock market, it’s done just the opposite to the Treasury market, according to Bloomberg. Prices for the 10-year Treasury just posted their worst four-week drop since December 2010, says Bloomberg. The fall in bond prices – and the corresponding increase in bond yields – suggests traders think the improving economic data may forestall the Federal Reserve from stepping in with another round of monetary stimulus.

Once summer is over and the big Wall Street traders get back from the Hamptons, we’ll get a better read on whether this tortoise-like market will keep inching its way up or decide to take a breather.

SOMETHING BEGAN IN THE STOCK MARKET 30 YEARS AGO that still has people shaking their heads today. Back on August 12, 1982, the Dow Jones Industrial Average closed at its 1980-82 recession low of 776.92, according to The Wall Street Journal. Around the country, it was just an ordinary day in an otherwise economically challenged economy. But, on Wall Street, it was the beginning of something extraordinary.

Depending on your age, you may remember that back in 1982, the prime lending rate peaked at 17 percent, the unemployment rate was near 11 percent, and inflation was on the way down from the double-digit rates of 1979-1980, according to The Wall Street Journal and the Bureau of Labor Statistics. Demographically, the oldest Baby Boomers were a youthful 36 and just getting ready to unleash their penchant for big spending. Ronald Reagan was President, Paul Volcker was head of the Federal Reserve, and, while an unlikely pair, they were about to make history together. 

Reflecting back on the summer of 1982 in a 2009 Wall Street Journal piece, Jason Desena Trennert wrote, “Starting as a trickle, the decline in inflation and long-term interest rates picked up speed that summer, and investors in common stocks began to have confidence that they were being liberated from the shackles of double-digit inflation and interest rates, an innovation-sapping regulatory regime, and a tax code that was antithetical to capital formation.”

Awakening from its slumber the day after August 12, 1982, the stock market took off on an unprecedented 18-year bull market run that saw the Dow Jones Industrial Average rise a spectacular 1,500 percent, according to Bloomberg.

So, here we are, 30 years removed from the start of that great bull market and what do we have to show for it? Well, since that great bull market ended in early 2000, we’ve experienced two harrowing bear markets that saw the broad market decline around 50 percent. And, today, we’re still below the all-time high of late 2007.

Yet, here’s what is extraordinary. Despite the weak markets we’ve experienced since 2000, if you go back to August 1982 and look at the returns for the past 30 years, the market has done extremely well. According to The Wall Street Journal, the total return of the S&P 500 index was a compound 11.3 percent between August 1982 and now. That’s even better than the average return for the entire 20^th century, which was 10.1 percent, according to the Journal.

It’s easy to get too caught up in what’s happening today in the markets and lose sight of the big picture. Instead, it’s better to take the long view. While past performance is no guarantee of future results, the past 30 years have shown that patience may be rewarded.

Weekly Focus – Think About It…

“Patience is a bitter plant, but it has sweet fruit.”

--Old Proverb

Weekly Commentary August 14th, 2012

The Markets

Is the “cult of equity” dying?

Since 1912, stocks have returned on average 6.6 percent per year after inflation, according to Bill Gross, the legendary bond manager from PIMCO. Recently, Gross ruffled some feathers when he wrote that the historic 6.6 percent return “is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned.” Histrionics aside, Gross makes a point that deserves elaboration.

Gross believes that, in the future, less of the country’s wealth will be captured by capital (the financial markets) and more will flow to labor (as higher wages) and government (in the form of higher taxes). For the past 30 years, he said, capital markets were the big winner, as real labor wages and corporate taxes declined as a percentage of GDP. By his analysis, that will start to reverse with the capital markets being on the losing end.

Is Gross right?

Well, his chief critic, Wharton professor Jeremy Siegel, emphatically says no. In an August 2 Bloomberg interview, Siegel made the following three rebuttals to Gross:

1.      The 6.6 percent real return was similar in the 19^th century in the U.S., too, so it’s not just a 20^th century anomaly or “historical freak.”

2.      Other researchers have discovered non-U.S. equity markets with similar 6 to 7 percent real return averages over the past century, further supporting the idea that the U.S. is not an anomaly.

3.      Often, when the media declares “equities are dead,” that’s a sign a bull market is just around the corner – remember the infamous August 1979 BusinessWeek “The Death of Equities” cover story? Three years later, stocks took off on one of the century’s greatest secular bull markets.

So, who’s right, Gross or Siegel?

It turns out they both could be right. The key is your timeframe. Since markets fluctuate, we’ll likely see periods when the market delivers more than a 6.6 percent real return and other times when it’s less. However, simply buying and holding on for dear life hoping Gross is wrong probably isn’t the best strategy. Rather, rigorous analysis of all the investment opportunities and careful portfolio tweaking could be the solution.

COULD THE THREE WORDS “PRIME CHILDBEARING AGE” FORESHADOW the next big up move in the stock market? We’re all familiar with the “Baby Boom” generation and the massive impact they’ve had on society. But, less noticed is their offspring, dubbed the “Echo Boom.” Nearly 80 million strong, “they will be become the next dominant generation of Americans,” according to CBS News.

Today, the number of women in “prime childbearing age” is surging and is at an all-time high. While the recent recession and lingering weak economic environment caused many Echo Boomers to postpone childbirth, this could change quickly if the economy picks up speed.

If this potential pent-up demand for babies actually materializes, we could see a spike in births that helps drive consumer spending, corporate profits, and the stock market higher. This potential demographic trend is one reason to be optimistic about America’s economic future.

   

Weekly Focus – Think About It…

Making the decision to have a child – it is momentous. It is to decide forever to have your heart go walking around outside your body.

--Elizabeth Stone

Weekly Commentary August 6th, 2012

The Markets
Despite disappointment that central banks in the U.S. and Europe offered no new stimulus programs last week, the U.S. stock market rose for the fourth straight week – thanks to one piece of government news, according to Bloomberg.

This particular piece of news is released on the first Friday of each month and investors eagerly await its arrival as it has the potential to move markets. In fact, this news is so sensitive that news reporters are locked up in the Frances Perkins building in Washington, D.C. for 30 minutes prior to its release with absolutely no contact with the outside world. The reporters have 30 minutes to review the report, ask questions, write their story, and then precisely at 8:30 a.m., the government opens the communication gate and the news hits the world.

And, so, last Friday morning, the government released its Employment Situation Report. Within seconds, it was clear that the increase in the number of new nonfarm payroll jobs created in July was much higher than expected and the stock market unleashed a powerful rally, according to MarketWatch. Since employment leads to economic activity, investors pour over this report for clues to the direction of the economy.

Now, here’s where it gets interesting. The data was stronger than expected, but it wasn’t strong enough to prevent the Federal Reserve from adding more monetary stimulus later this year, according to some economists as reported by MarketWatch. In other words, some folks interpreted this as meaning we could have modest economic growth and more monetary stimulus. That’s like a double shot of espresso for the markets.

This is great, right? Unfortunately, it’s not that simple. One month of good employment data does not make a trend and additional stimulus from the Fed is not guaranteed. Even if additional stimulus comes, it could backfire if the market perceives it as too little, too much, or not the right kind. In the end, we’re still left with the hard work of analyzing the economy, the investment opportunities, and doing the best job we can to help you navigate this uncertain environment.

IS THERE A PARTICULAR 24-HOUR PERIOD IN THE STOCK MARKET that is more important to future stock market returns than any other 24-hour period? Since we asked the question, you might have guessed that the answer is yes.

For many years, the Federal Reserve’s (Fed) monetary policy-making body, called the Federal Open Market Committee (FOMC), has convened at pre-scheduled meetings eight times per year. During these meetings, “The Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth,” according to the Fed’s website. And, since 1994, the policy decisions from these meetings have been announced to the public at known times.

Two months ago, the Federal Reserve Bank of New York released a study which contained a startling conclusion. The researchers discovered that, “a staggering 80 percent of the annual U.S. equity premium since 1994 was earned in the 24 hours before FOMC announcements.” Further, if you extend the period to three days, i.e., from the day before the announcement to the day after the announcement, the study shows that effectively 100 percent of the return in the S&P 500 index since 1994 has come from this 3-day window encapsulating the FOMC announcement. And, to put it in even more perspective, Yahoo! Finance said, “This pre-FOMC drift has pumped the S&P 500 more than 50 percent higher than it would be without the gains made in the 24-hour period before Fed statements.”

Hmm.

So, how does the Fed explain this anomaly? They end their research paper by saying, “As of this paper’s writing, the pre-FOMC announcement drift is a puzzle.”

Now that this anomaly is known, is there a way to profit from it? Probably not. For one thing, the frequent trading required to capture these gains and then move to cash until the next meeting would be expensive and tax inefficient. And, second, now that the strategy is known, it will likely disappear as investors try to “game” it.

Well, at least we know our tax dollars are hard at work paying researchers to come up with interesting market studies!

Weekly Focus – Think About It…

Adversity, if you allow it to, will fortify you and make you the best you can be.

--Kerri Walsh, Olympic Gold Medal Champion