Weekly Commentary July 29th, 2013

The Markets

If it’s not stocks, it’s bonds!

In a turnaround worthy of Bruce Willis in a ‘Die Hard’ movie, expectations for second quarter’s corporate earnings growth soared from below expectations, on average, in the previous week to beating expectations last week. Earnings growth estimates shot up to 4.1 percent which was a significant change from last week’s 2.8 percent. Of the companies that have reported so far, more than one-half have performed better than expected – an improvement on the last four quarters’ performance.

Whether it is earnings performance or other factors, consumers have become more confident than they’ve been in years – six years to be specific. The Thomson Reuters/University of Michigan's consumer sentiment index beat expectations for June even though consumers expect growth to slow next year.

Things were not so rosy for bond markets which have been selling off since early May on speculation the Fed will temper quantitative easing before the end of the year. Yields on 10-year Treasuries have ascended from about 1.5 percent in early May to more than 2.5 percent last week.

Ben Bernanke’s impending retirement also has bond markets roiled. Speculation about who will become the next chairman of the Federal Reserve, and how his or her policies will differ from Bernanke’s, is unsettling investors and creating potential for bond market volatility, according to MarketWatch.

On the public finance side of the market, municipal bond investors are reeling after Detroit’s bankruptcy declaration. The city’s dire circumstances have caused some pundits to look more closely at municipal credits. According to Barron’s, 83 percent of Moody’s Investors Service’s second quarter municipal bond rating changes were downgrades.

The drama and suspense is likely to continue next week. The Fed begins a two-day policy meeting on Tuesday, and an abundance of economic indicators – including the S&P Case Shiller Home Price Index, PMI Manufacturing Index, and employment situation reports – will be released.

if aesop was right, europe may eventually reach the end of recession. You’ve heard about the tortoise and the hare. It’s a fable that has much to say about unequal partners, overconfidence, and perseverance – topics that leaders of the European Union (EU) may ponder when they’re not poking and prodding member states in efforts to provoke structural reform and growth.

Last year, the head of the European Central Bank (ECB) announced that ECB would do whatever it took to save the euro. Nine months later, Europe still is plodding through recession. During the first three months of this year, gross domestic product in the region declined slightly year-to-year. The European Commission projects the decline will be a bit bigger over the full year (down 0.4 percent). That, however, will be an improvement over 2012’s 0.6 percent contraction.

The good news, according to The Economist, is current account deficits (the difference between a country’s total imports and its total exports) and primary budget balances (budgets without interest payments included) have improved in many EU countries. In fact, this year it appears the biggest primary budget deficit (about 3.9 percent) belongs to the United Kingdom. The bad news is government debt levels remain very high in many EU nations. In May, Peter Praet, a member of the ECB’s executive board, said:

“…the euro area needs to persevere in fiscal consolidation efforts and reduce steadily the government debt ratio. Despite the important progress on fiscal consolidation, debt ratios have yet failed to stabilize in most euro area countries…The euro area government debt ratio is projected to rise further to above 95% of GDP in 2013 – far above the 60% Maastricht reference value – with debt ratios displaying large differences across countries.”

Research from the National Bureau of Economic Research has found growth typically slows – by about 1 percent – when a nation’s debt level reaches 90 percent of gross domestic product. If they’re right, growth in the EU probably will be slow overall. Let’s hope it’s steady, too.

 

Weekly Focus – Think About It

“Health is the greatest gift, contentment the greatest wealth, faithfulness the best relationship.”

--Siddhartha Gautama, also known as Buddha

Weekly Commentary July 22nd, 2013

The Markets

Singing the earnings song…

Each year, in January, April, July, and October, most publicly-traded companies announce their corporate earnings results. These announcements can have a dramatic effect on companies’ share prices – and markets – especially when companies don’t meet analysts’ expectations.

The way a company’s share price moves after an earnings announcement can strike a discordant note. For instance, a company can have a great quarter, but if it earns a few pennies per share less than expected, its share price may tumble. Likewise, a company can be in dire straits, but if it produces a few cents more than expected, its share price may climb.

Last week’s earnings song was a bit melancholy. By the end of the week, about one-fifth of the companies in the Standard & Poor’s 500 Index had submitted their reports and earnings were on track to grow by about 1.5 percent year-to-year. That’s a bit lower than the 4.1 percent earnings growth analysts had expected, but it was in positive territory.

Unfortunately, as The Wall Street Journal pointed out, financial companies have exceptionally easy year-to-year comparisons. When they were pulled out of the mix, earnings hit a low note: down by almost 3 percent from last year, according to FactSet. That’s worse than analysts expected at the start of the quarter.

Earnings were weak relative to expectations, but the S&P 500 still finished higher for the week.  That may be because of the soothing refrain offered by Ben Bernanke (monetary policy will remain accommodative… monetary policy will remain accommodative). The important thing to remember is the Fed’s definition of accommodative monetary policy doesn’t necessarily mean maintaining its quantitative easing program.

there’s been an innovation in measuring innovation. Innovation is one of those things. It’s hard to fully describe, but it can be awfully important to countries and economies.

In recent years, there have been some remarkable innovations, such as car sharing and the Oakland A’s use of sabermetrics; and some less remarkable ones, such as airline baggage fees and the detachable dog sack (which allowed Fido to ride in a cloth carrier attached to the outside of the car).

In March, panelists at the Wharton Economic Summit 2013 discussed the concept of innovation. Although they didn’t all define it in the same way, they suggested innovation is using something new or known in a different way, different time, or a different place; essential for companies to grow; useful; transformative; an approach that addresses a major want or need; not always easy to spot.

It’s clear innovation means different things to different people. Cornell University, INSEAD, and the World Intellectual Property Organization, which collaborate on the Global Innovation Index, said their benchmark, “recognizes the key role of innovation as a driver of economic growth and prosperity, and adopts an inclusive, horizontal vision of innovation applicable to both developed and emerging economies.”

They refined the index for 2013. According to The Economist:

“Instead of objectively counting the inputs and outputs, it relies on nuance. For example, rather than ranking overall education, it looks at the top three universities, since elite institutions may be more important than the average. Instead of counting each patent, it tracks only those filed in at least three countries, which suggests it is a more valuable technology. And, rather than look at scientific journal articles en masse, the index includes how often they are actually cited.”

So, using these innovative metrics, which countries rank the highest in innovation? Among rich countries, the United States, Britain, and Germany are one, two, and three. In middle income countries, China, Brazil, and Russia take top honors.

 

Weekly Focus – Think About It

“Health is the greatest gift, contentment the greatest wealth, faithfulness the best relationship.”

--Siddhartha Gautama, also known as Buddha

Weekly Commentary July 15th, 2013

The Markets

One of these things is not like the other… If you find yourself humming that old Sesame Street standard when you think about financial markets and world economies, you’re probably not alone.

To the consternation of many, the Dow Jones Industrials Average and the Standard & Poor’s 500 Index rocketed to new highs last week just as the International Monetary Fund (IMF) cut its global economic growth forecast for 2013 and 2014.

Many in the media pointed fingers and announced, “That’s the problem right there!” Of course, the fingers were pointing at Ben Bernanke and the Federal Reserve which continued to dither about Quantitative Easing (QE) last week. While it may feel good to lay blame, the Fed is just one tree in the forest of market volatility and economic growth.

Let’s take a look at another section of the forest: emerging markets. They are expected to power 60 percent of the world’s economic activity by 2030. Yet, just last week, China’s exports slumped, and Brazilian and Indonesian central banks raised interest rates (which generally slows growth). Turkey’s central bank may do the same next week. Is slowing growth in emerging markets the Fed’s fault?

While higher rates in the U.S. may hurt emerging markets, many of those countries have problems of their own, including infrastructure bottlenecks and excessive credit expansion. Last March, the Financial Times quoted Deutsche Bank strategist John-Paul Smith who wrote:

“We believe that 2013 will mark the year when economists and investors focus on the underlying imbalances within the Chinese economy and, accordingly, reduce their expectations of sustainable growth over the medium term. The deterioration in the perception of China is likely to have a very disruptive effect on (global emerging market) equities...”

Smith’s forecast proved out. Early last week, the International Monetary Fund (IMF) lowered expectations for China’s growth to the high-seven percent range.

Of course, it’s not easy to predict the future. Irrefutable evidence of that arrived a few days after the IMF’s report when Lou Jiwei, China’s Minister of Finance, said his country’s growth rate could fall to 7.0 percent or even lower. Economists gasped.

China’s official growth target (set by the National People’s Congress) is 7.5 percent, not 7.0 percent or lower. According to The Wall Street Journal, “Such a sharp downshift in China's growth would send ripples around the world economy, hitting everything from iron-ore demand in Australia to sales of luxury handbags in Hong Kong stores.”

 

 

in america, people are still pulling themselves up by their boot straps. Three-fourths of the folks who participated in the 2013 U.S. Trust Insights on Wealth and Worth (all of whom have $3 million or more in investable assets) made their money the old fashioned way. They worked, owned businesses, and/or invested.
 

Most believe they’re financially secure and feel confident about the future. While that proved true for many aspects of financial planning, the study uncovered some unrecognized risks, many of which have been created by a volatile investment environment and changing tax laws. They include:
 

• Incomplete retirement planning. Although the vast majority of those surveyed are very confident about having the income they need during retirement, many have overlooked factors which affect income and assets such as lifestyle expectations, out-of-pocket healthcare expenses, long-term care costs, and others.

• Financial support for extended family. Almost one-half of those surveyed provide significant support to members of their extended families (including parents, in-laws, siblings, and grown children). However, the majority have not included that fact in their financial plans.

• Conflicted emotions about investing. The majority of survey participants said growing assets is more important than preserving them today; however, they also said lowering risk is a higher priority than pursuing higher returns.

• Tax law changes. A majority of wealthy people do not understand the ways in which tax law changes may affect their income, investments, or estates. Few understand the tax strategies which may be available to them.

 

Weekly Focus – Think About It

“Tell me and I forget. Teach me and I remember. Involve me and I learn.”

--Benjamin Franklin, inventor and statesman

 

Weekly Commentary July 8th, 2013

The Markets

The second quarter offered a level of drama often found in homes with teenagers.

When investors realized their good friend, quantitative easing, might have an earlier-than-expected curfew, they threw a hissy fit that resounded through global markets. The outburst interrupted the trajectory of Standard & Poor’s 500 Index, which finished June lower after hitting record highs in May. As stocks fell, yields on the benchmark 10-year Treasury bond hit a 22-month high.

Higher treasury yields and a strengthening greenback proved attractive to investors and capital flowed out of emerging markets during the quarter. As interest rates moved higher, the cost of borrowing rose sharply in many emerging countries. That may impede economic growth, which has slowed already, in many developing countries. Economies in emerging Asia, Latin America, and Europe grew by about 4 percent on average year-on-year during the first quarter as compared to 6.4 percent on average during the past decade.

When compared to growth rates in developed countries, such as the European Union (EU), that’s still a pretty attractive growth rate. The EU has suffered seven consecutive quarters of recession. It’s hard to say the recovery is going well, but experts are hopeful because the Spanish economy is contracting at a slower rate, Italian business activity isn’t declining as fast as it once did, the French downturn is moderating, and the German economic growth is in positive numbers.

It’s a different story in the United States. By the end of second quarter, economists were predicting 2014 could prove to be the best year for U.S. economic growth since 2005. The Wall Street Journal’s monthly survey found that, “Economists… expect gross domestic product to expand at a 2.3 percent annual pace this year and 2.8 percent next year. The Federal Reserve edged up 2014 growth forecasts to between 3 and 3.5 percent, from a March estimate of 2.9 to 3.4 percent.” Encouraging economic signs include:

·         Housing market vigor: Experts say housing market strength will be critical to economic performance in the second half of the year.

·         Employment gains: Unemployment has dropped from double-digits to 7.6 percent, although there are still about 2.4 million fewer jobs than there were before the recession.

·         Confident consumers: After years of paring spending and paying down debt, Americans are feeling optimistic. Consumer confidence now stands at a five-year high.

While optimism about the American economy is good news, it’s important to remember world economies are like members of a family. What happens to one country or region often has a significant influence on what happens in the others.

 

 

She can bring home the bacon and fry it up in a pan… From 1960 through 2011, the percentage of households with children under the age of 18 and mom as the primary or sole breadwinner increased from 11 to 40 percent. According to the Pew Research Center report, ‘Breadwinner Moms’ fall into two distinct groups: married moms who earn more than their husbands (37 percent) and single mothers (63 percent). The earnings gap between the two groups tends to be very large:

 

“The median total family income of married mothers who earn more than their husbands was nearly $80,000 in 2011, well above the national median of $57,100 for all families with children, and nearly four times the $23,000 median for families led by a single mother.”

 

It’s interesting to note an educational gap has been developing between husbands and wives, as well. A growing proportion of married women are better educated than their husbands. According to Pew Research, “the share of couples in which the mother has attained a higher education than her spouse has gone up from 7 percent in 1960 to 23 percent in 2011.” This probably shouldn’t be a surprise since more women than men have been receiving college degrees of all types – associates, bachelors, masters, and doctorates – every year since 1982.

 

Perceptions about women’s roles in both the workplace and the family appear to be changing, too. According to another Pew report, almost three-fourths of American adults say having more women in the workforce has been a change for the better. About 60 percent say family life is more satisfying when both spouses work and they share responsibility for housework and child care.

 

Weekly Focus – Think About It

 

"If we become increasingly humble about how little we know, we may be more eager to search."

--Sir John Templeton, Global investing pioneer

 

Weekly Commentary July 1st, 2013

The Markets

Soothing words from Federal Reserve Bank officials helped settle investors’ fears last week, and U.S. stock markets moved higher. The Dow Jones Industrials Average was up 0.7 percent, the Standard & Poor’s 500 gained 0.9 percent, and the NASDAQ rose by 1.4 percent.

Markets were more stable during the week, and the CBOE Volatility Index (VIX), which gauges investors’ fear by measuring volatility expectations for the coming 30-day period, fell by 2 percent to finish the week just below 17.

Economic data was mixed. On the negative side, U.S. Gross Domestic Product (GDP) growth from January through March was revised downward from 2.4 percent to 1.8 percent annually. On the positive side, U.S. home prices gained more than 12 percent in April, which was the biggest year-to-year gain since 2006. Home sales for May also were strong, reaching a level last seen six years ago, according to the Denver Post.

Gold suffered another difficult week. Some believe the sell-off is the result of changing expectations as fear that quantitative easing might lead to hyperinflation, systemic collapse of the financial system, or devaluation of currency have begun to ease.

U.S. stock markets delivered positive performance for the quarter, as well. The Dow gained 2.3 percent, the S&P 500 was up 2.4 percent, and the NASDAQ rose by 4.2 percent. Year-to-date, the S&P 500 gained more than 12 percent during the first six months of 2013. That was its best first half of the year performance in more than a decade, according to Yahoo! Finance.

This week, some experts foresee the possibility that Fourth of July fireworks could be followed by a new round of market volatility as investors and analysts try to use the June employment report to predict the timing of monetary policy changes.

they say actions speak louder than words, but that doesn’t appear to be the case when it comes to Federal Reserve monetary policy. For some time, the Fed has been communicating its intention to gradually cut back its bond purchasing program (a.k.a. quantitative easing) while keeping the target fed funds rate steady. The target fed funds rate is the interest rate at which banks borrow money from each other overnight. The Fed has not taken action yet, but its words have caused nominal bond yields to rise and inflation expectations to fall. Typically, these changes are associated with tightening monetary policy.

The Fed’s words also triggered significant market volatility. An article in The Economist suggested:

“Fed officials are doubtless annoyed by the market’s skittish reaction to the idea of tapering. In its view a more leisurely pace of buying does not amount to tightening. Fed economists reckon the size of the central bank’s balance-sheet is what matters most: so long as its asset pile is growing, policy is getting looser. By the Fed’s estimates, halving the monthly rate of asset purchases would be equivalent to trimming the federal-funds rate by five basis points per month instead of ten.”

The gap between the Fed’s perceptions and the markets’ response has been significant, and investors and analysts are scrambling to interpret the economic tea leaves. Researchers at Barclays Capital, whose work was cited in The Economist, have tried to determine how tapering may affect investment assets. Since stock markets in emerging countries and high-yield bond markets in the United States and Europe responded the most to the Fed’s quantitative easing program, experts anticipate these markets also may respond the most strongly when tapering begins.

 

Weekly Focus – Think About It

“Fear comes from uncertainty. When we are absolutely certain, whether of our worth or worthlessness, we are almost impervious to fear.

 

--William Congreve, English playwright and poet