Weekly Commentary December 30th, 2013

The Markets

Like the mother of a bride reviewing flower arrangements and fretting that a brilliantly sunny day could be marred by dark clouds hidden just beyond the horizon, pundits have been parsing the exceptional year-to-date performance of U.S. stock markets and fussing over the future.

It’s true. U.S. stock markets look like they may be headed toward a fizzy champagne finish even after retreating a bit last Friday. Through Thursday, the Dow Jones Industrial Index had closed at record highs 50 times this year and the Standard & Poor’s 500 Index wasn’t far behind with 44 record high closes, according to NASDAQ.

U.S. stocks aren’t the only markets analysts are stewing over. They’re also pondering the potential effects of higher interest rates. Last week, the yield on benchmark 10-year Treasury notes ascended beyond 3 percent for the first time since 2011. It’s possible higher yields (and a potential drop in bond values) will cause investors to seek out better performing assets next year, but that may not be all bad, according to Barron’s.

“IS TOPPING 3% A BAD THING? Not necessarily, considering the reason for the 10-year yield's march higher: the Federal Reserve's decision to taper $85 billion a month in Treasury purchases, starting with $10 billion less in January. It's a small paring, but sends a big message: Maybe – just maybe – after years of recovery, the U.S. economy is returning to normal.”

Returning to normal in the United States may not prove to be any easier than seeking a new normal in China. Top communist party leaders in China recently implemented policies that give markets a more significant role in the country’s economic development. Concern that high levels of local government debt could pose a risk to ongoing economic growth has the People’s Bank of China (PBOC) employing some unconventional measures to manage interest rates.

Last week, those actions caused China’s seven-day repurchase rate to rise precipitously which triggered the worst case of interbank jitters since June’s liquidity crunch in China. The PBOC “injected fresh money into the markets on Tuesday, easing the pressure on the financial system and quelling fears about a credit crisis.”

As an investor, it’s important to remember that no one knows what the future holds or how central banks and markets will respond.

what’s the difference between a bull and a bubble?  During 2013, stock markets in the United States and Europe generally delivered very attractive returns so it’s not all surprising that talk of market bubbles fills the air. After all, bubbles are not a new phenomenon and they’ve done some damage in the past.

In the 1800s Charles Mackay penned Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. The book chronicled some of the earliest bubbles, including Holland’s Tulipmania of 1624 during which tulip bulbs were valued more highly than gold. He also describes the popularity of the South Seas Corporation whose shares traded higher and higher (on little more than word of mouth) until the stock crashed. More recently, we’ve experienced bubbles in stock markets, real estate, technology stocks, and other types of assets.

So, how do we tell the difference between a bull market and a bubble? According to The Economist, Nobel Laureate Robert Shiller of Yale University, “Describes a bubble as ‘a psycho-economic phenomenon. It’s like a mental illness. It is marked by excessive enthusiasm, participation of the news media, and feelings of regret among people who weren’t in the bubble.’ They are often enlarged by an expansion of credit.”

Shiller measures valuation levels using cyclically-adjusted price-to-earning ratios (CAPEs). According to Barron’s, the Shiller CAPE for the S&P 500 Index was at 21 in January of 2013. That was higher than its long-term average and lower than its recent trend so U.S. equities were somewhere between neutral and significantly over valued. Since January 2013, some U.S. stock markets have delivered returns in the double digits, pushing the Shiller CAPE toward 25. On the face of it, U.S. equities appear to be highly valued.

However, in early December, The Economist reported Shiller was “not yet ready to declare a bubble in American equities… There is nothing like the same excitement about shares that was seen in the late 1990s; net flows into mutual funds only just turned positive this year. Another measure of public indifference is CNBC, a television station that tracks the financial markets, suffered its lowest ratings since 2005 in the third quarter.”

So, is this a bubble or a bull market? The experts aren’t certain. Keep your eyes peeled for signs of irrational exuberance.

 

Weekly Focus – Think About It

Every day of the week, The Economist explains a new topic on its website. The most popular explanations during 2013 included:

• What is the difference between Sunni and Shia Muslims?
• How does copyright work in space?
• Why are your friends more popular than you?
• How did Estonia become a leader in technology?
• Why are there so many tunnels under London?
• Why don't Americans ride trains?
• How might your choice of browser affect your job prospects?

Weekly Commentary December 23rd, 2013

The Markets

To borrow a word from the legendary Gomer Pyle: G-o-l-l-y!

In 1955, just five years before The Andy Griffith Show became a big hit, William McChesney Martin, Jr., then Chairman of the Board of Governors of the Federal Reserve System, made an often-quoted speech in which he said, “The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.”

Last week, Fed Chairman Ben Bernanke didn’t confiscate the punch. He simply modified the recipe by adding a lower proof of spirits when he announced the Fed would begin to taper its bond buying program. Starting in January, the Fed will spend $10 billion a month less on bonds (the amount will be evenly split between Treasuries and mortgage-backed securities). Taking away the punch bowl would have entailed ending all bond purchases and increasing the discount rate. The Fed has indicated it will not change the discount rate for some time.

After an initial dip on the news of impending tapering, many markets around the world moved higher. The Dow Jones Industrial Average and the Standard & Poor’s 500 Indices pushed to record highs. Britain’s FTSE 100, Germany's Dax, and France's CAC indices all pushed higher on Wednesday, as did Japan’s Nikkei 225 Index. In the bond market, U.S. Treasury yields rose and then fell on the day of the announcement.

The beginning of the end of quantitative easing wasn’t the only news that drove markets higher last week. On Friday, the U.S. Commerce Department reported that U.S. gross domestic product (GDP) – a measure of our nation’s productivity – accelerated faster than originally thought during the third quarter. The reasons for the upward revision were increased consumer and business spending.

Life may have been simpler in fictional Mayberry R.F.D. – and they certainly had fewer choices as consumers – but economics and the responsibilities of the Federal Reserve weren’t any less complicated.   

in the EARLY DAYS OF BANKING IN THE wild west, there weren’t too many rules about what banks could and couldn’t do. According to The New York Times, in the early1900s:

“…Commercial banks established security affiliates that floated bond issues and underwrote corporate stock issues. (In underwriting, a bank guarantees to furnish a definite sum of money by a definite date to a business or government entity in return for an issue of bonds or stock.) The expansion of commercial banks into securities underwriting was substantial until the 1929 stock market crash and the subsequent Depression.”

After the crash, thousands of banks failed.

In 1933, Congress passed the Glass-Steagall Act (a.k.a. the Banking Act). The Act defined the difference between commercial and investment banking activities. Commercial banks primarily took deposits and made loans while investment banks helped companies issue stock and invested in securities. The Act prohibited commercial banks from participating in investment banking activities. It also created the Federal Deposit Insurance Corporation (FDIC) whose job was to protect commercial banks’ clients’ deposits up to a certain amount.

In 1999, after years of financial prosperity, Congress changed its mind and passed the Gramm-Leach-Bliley Act (GLBA) which effectively repealed the parts of Glass-Steagall that prevented commercial banks from participating in investment banking activities. Some believe the change in rules played a significant role in the global credit crisis during which commercial banks suffered billions of dollars in losses because of their investment banking activities.

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in response to the global credit crisis and subsequent government bailout. The 953-page Volcker Rule is part of the Act and was passed by regulators in December of this year. It establishes a set of rules that are intended to prevent FDIC-insured banks from making risky bets with customers’ deposits. In particular, banks that rely on taxpayer guarantees are largely prohibited from proprietary trading and hedge fund investments. We’ll know more when regulators decide how the rules will apply and who will enforce them.

George Bernard Shaw said, “We are made wise not by the recollection of our past, but by the responsibility for our future.” Let’s hope when it comes to U.S. banking law, he proves to be right.

 

Weekly Focus – Think About It

“As a child my family's menu consisted of two choices: take it or leave it.”

--Buddy Hackett, American comedian

Weekly Commentary December 16th, 2013

The Markets

You really need to take predictions with a grain of salt. Consider these esteemed opinions:

• "I think there is a world market for maybe five computers." Thomas Watson, Chairman, IBM, 1943
• "Who wants to hear actors talk?" H. M. Warner, Founder, Warner Brothers, 1927
• "Everything that can be invented has been invented." Charles Duell, Commissioner, U.S. Office of Patents, 1899

 

It’s an important to remember the fallibility of experts as we head toward a new year and pundits begin pontificating about the events of the past and predicting what may be ahead.

Barron’s recently pointed out how well U.S. stock markets have performed this year: “Not since 1995, when stocks climbed 34 percent without as much as a 3 percent dip, have we enjoyed a year as agreeable as this. No pain, all gain has turned U.S. stocks into a consensus favorite, the People's Choice award winner, the king of the hill. But, it's no longer the road less traveled.”

The publication tweaked market optimists by pointing out economists’ consensus opinion the U.S. economy will grow by 2.6 percent – admittedly a pretty modest pace for growth – may not seem like a stretch, but it could be. The point was 2014 is almost certain to bring some jarring economic transitions like less monetary support through quantitative easing. Reduced liquidity could negatively affect economic growth (Gross Domestic Product growth in 2013 is projected to be just 1.7 percent).

In a separate article, Barron’s shared insights from 10 strategists – Wall Street professionals who acknowledged 2014 may offer investors a bumpy road. However, their consensus expectation is the Standard & Poor’s 500 will finish 2014 higher. “…Their mean prediction is 1977. The bullish consensus might trouble contrarians, but Wall Street's pros see ample reason for optimism, given their expectations of a stronger economy and rising corporate profits.” 

As you read conflicting opinions about where we’ve been and where we’re going, it’s critical to remember short-term macroeconomic and market predictions should not be given too much weight. You built your investment strategy to meet your long-term investment goals.   

is that a drone? flying through my neighborhood? There may be a new entry on the list of military inventions that have been repurposed for commercial use: Unmanned Aerial Vehicles (a.k.a. UAVs or drones) may soon join global positioning systems (GPS), duct tape, EpiPens, cargo pants, microwaves, and a wealth of other goods Americans rely on in everyday domestic life.

Drones are remote-controlled flying robots. They may be as small as insects or as large as jumbo jets. Today, they’re most known for delivering stealth attacks on selected targets and military service which has included stints on domestic border surveillance and overseas reconnaissance. In the future, they may be thought of as handy tools that help manage a variety of tasks. While no one can be sure which opportunities will pan out and which won’t, there are a lot of potential applications including:

·         Information gathering. Journalism students at the University of Missouri in Columbia are learning to fly drones! They’re gathering pictures, videos, and other news-worthy information. Yes, there are some privacy issues. Already, 42 states are considering bills restricting drone use.

·         Improving agriculture. Students at Oklahoma State University are researching the roles drones could play in increasing yields and monitoring crops for blight and diseases.

·         Disaster relief. The Harvard-MIT Division of Health Sciences and Technology received a grant to develop drones to deliver vaccines and medicines to remote locations and disaster areas.

·         Wildlife research. The U.S. Geological Survey has been using a camera-equipped drone to complete aerial counts of sandhill cranes, and scientists in Indonesia are using drones to study endangered Sumatran orangutans from above the treetops.

·         Shipping goods. American internet retailers are experimenting with using drones to ship goods from fulfilment centers directly to customer’s doors. It may be 2015 before you receive a drone delivery because the Federal Aviation Administration still needs to issue some rules governing drone operations.

So, if you’ve been asking yourself, “What’s the next big thing?,” you might want to read up on drones. They could be it.

 

Weekly Focus – Think About It

“Peace is not absence of conflict, it is the ability to handle conflict by peaceful means.”

--Ronald Reagan, 40^th American President

Weekly Commentary December 9th, 2013

The Markets

If every piece of positive news was a petal, then you might say the American economy was in bloom last week. Moving into the holiday season, consumer confidence was at a five-month high.

Early in the week, manufacturing showed improvement. On Thursday, the U.S. Commerce Department unfurled the news the American economy grew faster than expected during the third quarter of 2013. The next day, it was reported the unemployment rate was at the lowest level since 2008. Hourly earnings increased, as did the length of the work week. Participation in the work force improved slightly, although it remains at historical lows.

There are sound reasons to expect America’s resurgence will continue into 2014, according to The Economist. They reported America’s progress was due, in part, to:

• Policymakers in the U.S. providing direct government support for failing companies and creating liquid capital markets that helped companies recover after the financial crisis.
• Companies benefitting from an increase in domestic energy production. Often the fuel comes from unconventional sources.
• American businesses leading the way in social media. They are expected to blaze the trail when finding ways to profit from Big Data and developing a sharing economy.

There was good news in other parts of the world, too. A global trade agreement – the first major deal in 20 years – was reached that could simplify customs procedures and speed up the flow of goods across the world. CNN Money hailed it as the most significant multilateral trade pact since the World Trade Organization was founded. The agreement has the potential to reduce trade costs by as much as 15 percent, saving developing nations about $445 billion each year, and boost the global economy.

Despite the good economic news, U.S. stock markets slumped through Thursday of last week largely because of investors’ concerns that positive economic news would encourage the Federal Reserve to end quantitative easing sooner rather than later. Those concerns seemed to dissipate with the release of positive employment numbers on Friday and markets surged higher.

Let’s take a stroll down memory lane… In a recent issue, The Economist pointed out during March 2009 the prospects for American companies were pretty sketchy:

“…The Dow Jones Industrial Average closed below 6,627, a 53% decline from its all-time high less than two years earlier. The number of American firms in the global top ten by market capitalization was on its way down from six to three, and America’s share of the top 50 companies from 50% to 40%. Once regarded even in Communist China as the business model for the world, corporate America had lost its crown.”

Oh, the difference just a few years can make! According to an November 18, 2013 article on Economist.com, If we look ahead to 2014, American firms are expected to comprise the majority of the global top ten (when measured by market value) and make up almost two-thirds of the top 50 companies in the world. It’s not all that surprising when you consider the fact, as a headline in Forbes announced, corporate profits are at an all-time record peak making up almost 70 percent of U.S. gross domestic product.

That may have something to do with the way Americans are spending their money. Citing an expert from Bank of America Merrill Lynch, Barron’s reported:

“U.S. import growth has shrunk from 11% to less than 1% between 2010 and 2013, while job growth has repaired from a negative 1.7% to 1.6%... Domestically produced energy now accounts for 87% of what we consume, up from 70% five years ago, and the share of vehicles sold here that are manufactured stateside has risen from 63% to 73%… We're also spending more on domestic goods and services... Nearly 40,000 Americans turn 65 every week, and aging boomers tend to steer more of their disposable income toward services like medical care, accommodation, and recreation that are typically made in America.”

Perhaps what Alexis de Tocqueville, French historian and political thinker, said about America still holds true, “The greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults.”

 

Weekly Focus – Think About It

“When even one American who has done nothing wrong is forced by fear to shut his mind and close his mouth, then all Americans are in peril.”

--Harry S. Truman, American President

Weekly Commentary December 2nd, 2013

The Markets

In 2006, Time Magazine’s Person of the Year was ‘You.’ The magazine declared that 2006 was about:

“…Community and collaboration on a scale never seen before… It's about the many wresting power from the few and helping one another for nothing and how that will not only change the world, but also change the way the world changes.”

Last week, J.P. Morgan named EVERYONE the winner of the "Most Promotional Retailer Award." While communities across America are very interested in Black Friday sales, these events are less about empowerment and more about brawling for consumer goods. It’s a popular activity. In fact, a case could be built that one of the newest Thanksgiving holiday traditions involves the telling of riveting Black Friday (and now Thanksgiving Day) tales that describe retail shopping bravado and adventure.

It may prove to be a short-lived tradition if mobile devices and online sales continue to gain popularity. According to IBM Digital Analytics Benchmark, which collects data from roughly 800 U.S. retail sites in real time, as cited in Barron’s, online sales were up 20 percent on Thanksgiving Day this year as compared to last year. They slowed a bit on Black Friday, up just 9 percent relative to last year by mid-afternoon. Many of the folks who chose to forego shopping in stores made their purchases using mobile devices which accounted for 37 percent of online sales on Friday.

Holiday shoppers and retailers aren’t the only ones who appreciate robust holiday sales, so do state governments. Ron Alt, senior research associate at the Federation of Tax Administrators, was cited by USA Today as saying “about 10 percent of annual state sales taxes come in to state coffers in January from holiday season sales, topping most other months in which about 7 or 8 percent of the taxes are collected.”

We hope your Thanksgiving holiday was filled with wonderful people and adventures.

Pensions around the world… Here’s something a lot of people are thankful for: pensions. There are public pensions, which generally are funded by tax dollars, and private pensions, which generally are funded by companies. Merriam-Webster.com defines pension as, “an amount of money that a company or the government pays to a person who is old or sick and no longer works.” The Economist takes a slightly different view although its focus was on public pensions:

“A pension is a claim on the earnings of future workers. Some countries choose to pay these claims out of future taxes; others set up special funds to invest in financial assets. But these assets (equities, bonds and property) will be able to pay pensions only because future workers generate the income to make them valuable.”

In the late 2000s, tax-financed pensions made up almost 60 percent of gross income on average for people age 65 and older who lived in the 34 countries that comprise the Organization for Economic Co-operation and Development (OECD). Europeans were the most dependent on their governments. Older Belgians and Finns, on average, received about 80 percent of gross income from the state. Older Chileans, Americans, and Canadians were the least reliant. Chileans over age 65 received less than 10 percent of gross income from the government. For Americans and Canadians, government pensions made up about 40 percent of income on average.

In general, public and private pension funds have done pretty well in 2013. They were helped by rising stock prices and higher bond yields. However, the challenges they face, including increasing longevity and volatile markets, are relatively daunting. That’s one reason private pensions have been disappearing in United States. The number of employer-sponsored defined benefit pension plans reached an all-time low of about 22,700 single-employer plans in early 2013. That’s down from just over 112,000 in 1985.

 

Weekly Focus – Think About It

“When you rise in the morning, give thanks for the light, for your life, for your strength. Give thanks for your food and for the joy of living. If you see no reason to give thanks, the fault lies in yourself.”

--Tecumseh, Native American leader of the Shawnee