Weekly Commentary Feburary 24th, 2014

The Markets

Behind the dark clouds of volatile markets there appears to be a silver lining. That may be hard to believe when so many are focused on whether economic weakness is due to bad weather or, well, economic weakness, but here are a few of the signs that things may take a turn for the better:

·         Business climate: On February 20, The Economist/FT Global Business Barometer, which surveys 1,500 business leaders around the world, found more than one-half of them expect the global business climate to improve during the next six months and more than one-third plan to increase capital investment in the coming year. A slight majority believe America will have a greater influence on their regional growth than China.

·         Consumer confidence: Consumer confidence climbed for the second month in January 2014. The Director of The Conference Board Consumer Confidence Index® said, “Consumers’ assessment of the present situation continues to improve, with both business conditions and the job market rated more favorably. Looking ahead six months, consumers expect the economy and their earnings to improve, but were somewhat mixed regarding the outlook for jobs. All in all, confidence appears to be back on track and rising expectations suggest the economy may pick up some momentum in the months ahead.”

·         Cash-rich companies: Corporate America is sitting on a lot of cash – about 91 weeks' worth of net income, according to Barron’s. It has been using that cash primarily for stock buybacks, but could use it for other things. An economist quoted in Barron’s said, "The purpose of the capital markets is to fund growth… it's difficult to call this de-equitization an economic equilibrium: Public companies should not make money just to buy back stock."

Of course, positive prospects don’t mean everything is coming up roses (especially not in this weather). Consider one of the effects of stock buybacks which is there is a lot less stock in our stock markets than there used to be. As Barron’s pointed out, “The Wilshire 5000 may have seen its list of components shrink by half since 1998, but its total market cap has doubled from $11.7 trillion to $22.5 trillion in that span. Unless you're a government statistician, you just might call that inflation.” Oh! Inflation. That’s something we may need to think more about soon.

what is an entrepreneur? Merriam Webster defines an entrepreneur as “one who organizes, manages, and assumes the risks of a business or enterprise.” The Library of Economics and Liberty said successful entrepreneurs find ways to derive greater profit from materials or skills while unsuccessful ones don’t. The website shared this insight to entrepreneurship:

“An entrepreneur who takes the resources necessary to produce a pair of jeans that can be sold for thirty dollars and instead turns them into a denim backpack that sells for fifty dollars will earn a profit by increasing the value those resources create… Losses mean that an entrepreneur has essentially turned a fifty-dollar denim backpack into a thirty-dollar pair of jeans. This error in judgment is part of the entrepreneurial learning, or discovery, process vital to the efficient operation of markets.”

Knowing this, it’s not all that surprising that traditional gauges of entrepreneurship measure things like the number of small businesses or self-employed people or business startups in a country. According to The Economist, these measures tend to provide misleading results with Egypt often appearing to be more entrepreneurial than America.

A new paper from the Research Institute of Industrial Economics offers a different way to measure entrepreneurial success. It focuses on Schumpeterian entrepreneurship. Austrian-American economist Joseph Schumpeter believed entrepreneurs were innovators, people whose ideas and execution produced high-growth companies that often upset and disorganized existing models for doing business – think Thomas Edison and electricity, or Steve Jobs and Bill Gates and computing.

The paper looked at Forbes Magazine’s billionaires list from 1996 through 2010 and focused on self-made billionaires who earned their dough founding new businesses. There were almost 1,000 of them in 50 different countries. (By the way, four of every 10 global billionaires are found in the United States, predominantly in California, New York, and Texas.) The researchers’ conclusion was the Forbes’ list offered, “an alternative – albeit imperfect – cross-country measure of Schumpeterian entrepreneurship with more intuitive results than small business activity.”

 

Weekly Focus – Think About It

“Think left and think right and think low and think high. Oh, the thinks you can think up if only you try!”

--Dr. Seuss (a.k.a. Theodor Seuss Geisel), American writer, poet, and cartoonist

Weekly Commentary Feburary 18th, 2014

The Markets

With the enthusiasm of new love, American stock markets pushed higher during Valentine’s week.

Were investors enamored of the Federal Reserve’s new Chairwoman, Janet Yellen, who spoke on behalf of the Fed for the first time last week? Some suggested investors appreciated her dedication – she spent almost six hours answering questions from members of the Financial Services Committee – and were soothed by her commitment to continuing the policies of her predecessor. The New York Times said stock markets rose as a result of Ms. Yellen’s testimony and were further buoyed when the House voted to raise the government’s borrowing limit until March 2015 without any conditions.

Perhaps investors saw the good in employment numbers that were released recently. An analyst quoted in Barron’s said the American labor market “just might be tighter than most of us expected.” His argument was while long-term unemployment remains high, “…2.5 percent, higher than peaks seen in prior recessions, and much worse than the 50-year average of 1.1 percent,” the short-term jobless rate (measuring people who are out of work briefly) is 4.2 percent which is below the 50-year average of 5 percent. The article shared the thoughts of another expert, Michael Darda of MKM Partners:

“If our job market can mend even when gross domestic product (GDP) growth averaged a lousy 2.4%, what happens if growth picks up? Last week, Treasury data showed the federal fiscal deficit shrinking to just 3% of GDP from more than 10% four years ago thanks to higher taxes and restrained government spending. At this pace, our budget deficit could fall to zero next year, and we could run a surplus by 2016.”

Tarnishing this shiny outlook is the fact 36 percent of Americans who want a job and can’t find one have been unemployed for more than 27 weeks.

Maybe it was an unrequited desire for better weather. Huge swathes of the United States have been gripped by snow, ice storms, and freezing weather which Reuters.com suggested caused many investors to discount weak economic reports in the belief consumer spending and the company performance might have been stronger if weather conditions had been more favorable.

How many hours do you work each week? It’s a topic that has garnered significant interest for some time. In 1930, British economist John Maynard Keynes wrote:

“For many ages to come the old Adam will be so strong in us that everybody will need to do some work if he is to be contented. We shall do more things for ourselves than is usual with the rich to-day, only too glad to have small duties and tasks and routines. But beyond this, we shall endeavor to spread the bread thin on the butter – to make what work there is still to be done to be as widely shared as possible. Three-hour shifts or a fifteen-hour week may put off the problem for a great while. For three hours a day is quite enough to satisfy the old Adam in most of us!”

If you’re a hard-driving, competitive person who logs well over 40 hours of work each week in pursuit of higher earnings, plum promotions, and peer respect, Keynes’ predictions may be mystifying, not to mention unrealized.

While it’s true that Keynes’ expectations for the future haven’t panned out (he also anticipated accumulation of wealth would lose social importance resulting in a changed moral code), the average work week did get shorter in many developed countries between 1990 and 2012. It’s interesting to note, as The Economist pointed out, more productive and better-paid workers often put in less time at the office. The publication offered this example:

“The Greeks are some of the most hardworking in the OECD (Organization for Economic Cooperation and Development), putting in over 2,000 hours a year on average. Germans, on the other hand, are comparative slackers, working about 1,400 hours each year. But German productivity is about 70% higher.”

When it comes to hours worked, America is an aberration relative to other developed nations. We’re highly productive and we tend to work longer hours.

 

Weekly Focus – Think About It

“I do not want to foresee the future. I am concerned with taking care of the present. God has given me no control over the moment following.”

--Mahatma Gandhi, a leader of India's independence movement

Weekly Commentary Feburary 10th, 2014

The Markets

American stocks bounced last week like a skier pounding moguls on an Olympic freestyle course. Some found it difficult to understand why stocks had their best week since December of 2013. Barron’s said:

“We just can’t figure out why the markets were strong. It’s not like the news this week was terribly good. The Institute for Supply Management’s manufacturing survey fell to 51.3, well below forecasts for 56.5. The U.S. added just 117,000 jobs, well below forecasts for 170,000. You would think investors would be worried that the economy was running out of steam.”

Experts cited in the article suggested banks have been easing lending standards. Historically, that has been a positive for the economy and may offer insight to gross domestic product growth, industrial production, employment, and profit margins months from now. Others believe the downturn was due to hedge funds derisking their portfolios, and some credit earnings with stocks’ positive movement as almost 66 percent of companies in the Standard & Poor’s 500 Index that have reported this quarter have exceeded earnings expectations forecast by analysts.

Bonds aren’t doing what they were expected to do either. When the Federal Reserve sounded the bell in January – marking the beginning of the end for its third and biggest round of bond buying (called quantitative easing or QE) – it seemed logical bond prices would fall and interest rates rise. After all, basic economic theory suggests less demand should drive prices lower. Perversely, despite the Fed reducing its purchases, Treasury bonds have gained value and yields have fallen. The same thing happened when the Fed ended the first two rounds of quantitative easing and may reflect fear that economies will lose momentum without the Fed’s strong monetary support.

Let’s hope markets continue to do as well as America’s snowboarders. Last week, Americans took Olympic gold (in the men’s and women’s events) on a slope-style course many competitors had trouble navigating and believed might be too risky.

how have low interest rates affected economies, governments, and individuals during the past few years? Late last year, McKinsey & Company released a report that took a closer look at “the distributional affects and risks” of quantitative easing (QE) and low interest rates. In other words, who was affected by QE and low rates and how?

If you’re an investor with an interest in income, you’ve probably got a pretty good idea about how it affected you! The report found, from 2007 through 2012, households in the United Kingdom and the United States:

“…together lost $630 billion in net interest income, although the impact varies across groups. Younger households that are net borrowers have benefited, while older households with significant interest-bearing assets have lost income.”

The other side of that coin is declining yields caused the value of previously-issued bonds to increase. McKinsey estimated corporate and government bonds in the Eurozone, United Kingdom, and United States gained about $16 trillion in value during the period. Housing prices also may have benefitted as the cost of mortgage credit fell.

British and American households weren’t the only ones affected by central bank policies. McKinsey found governments in both regions benefited to the tune of about $1.6 trillion! In part, this was because debt service costs – the money required to cover the payment of interest and principal on debts – was significantly reduced during the period.

Corporate profits also got a boost from low rates. The study found U.S. and U.K. corporate profits also benefitted as companies in each country gained about 5 percent during 2012 because of ultra-low interest rates. Higher profits, unfortunately, did not translate into higher investment possibly because of tighter lending standards and uncertainty over recovery. According to The Economist:

“In the United States, net private non-residential investment fell by 80 percent as a percentage of GDP between 2007 and 2009. Although it has recovered since then, U.S. business investment is still at its lowest level as a share of GDP since at least 1947. Investment in Europe is similarly weak.”

Why look at distributional impacts? It helps economists identify risks countries may face in the future. For instance, The Economist estimated governments may see debt service costs increase by as much as 20 percent. In the United States, that would translate into $75 billion annually.

 

Weekly Focus – Think About It

“The best and most beautiful things in the world cannot be seen or even touched – they must be felt with the heart.”

--Helen Keller, American author and political activist

Weekly Commentary Feburary 3rd, 2014

The Markets

If investors were fishermen, they’d probably toss January 2014 right back into the stream. At the end of the month, U.S. stocks (S&P 500) had lost 3.6 percent of their value, according to Barron’s. Other asset classes hadn’t fared well either. Bond yields fell and emerging markets were all roiled up. If you are like some fisherman (and you know who you are) and like to review portents and signs, here are a few to consider:

January Barometer: The Stock Trader's Almanac’s January Barometer is a theory that gives credit to the idea the performance of the Standard & Poor’s 500 Index during January indicates the direction of the stock market for the remainder of the year. This year’s weak performance suggests things may be headed south during 2014.

How accurate is it? An article on NASDAQ.com said, “The Barometer theory sounds about as scientific as spin-the-bottle and, while impressively accurate pre-1984 (70 percent accuracy on bullish calls and a whopping 90 percent accuracy on bearish calls), its accuracy on the bearish calls has declined dramatically. Since 1985 its batting average for predicting down markets has come down to a lowly 50 percent.” Maybe flipping a coin would work just as well.

Super Bowl indicator: The theory goes like this: When a team from the old NFL wins, the stock market will have a winning year. If a team from the old AFL wins, markets will not do so well during the year. So, in theory, a Broncos win would cast markets in a bearish light and a Seahawks win would put them in a bullish one.  Except, as Barron’s pointed out, both teams have their roots in the AFC.

The Skyscraper Curse (tallest is negative), The Hemline index (shorter is positive), and The Presidential Approval effect (unpopular is better), The Triple Crown indicator (one horse winning it is negative), and The Sports Illustrated Swimsuit Issue Cover gauge (an American model is a positive indicator) are like chum in the water for some investors.

We would all like to be able to predict the future and, clearly, many try to do just that. As much fun as oddball indicators are, it seems likely, however, that investors’ time would be better spent identifying long-term financial goals and building portfolios that can help meet those goals over time.

What’s in an ad? If you were one of the millions of people watching the Super Bowl on Sunday, then you probably got an eyeful of some of the most enticing advertisements television has to offer. They better be! According to experts, the average cost of a 30-second Super Bowl commercial was expected to be about $4 million this year. That’s right – $4 million – up from about $3.8 million last year. Of course, it was predicted more than 100 million people would watch the game and that’s a sizeable audience!

Whether a company is trying to reach a lot of people at once or target a very specific audience, advertising isn’t as easy as it once was. As a recent article in The Economist pointed out:

“Poor admen… Their industry is going through a particularly difficult time. Not only are they confronting a proliferation of new “channels” through which to pump their messages, they are also having to puzzle out how to craft them in an age of mass skepticism. Consumers are bombarded with brands wherever they look – the average Westerner sees a logo (sometimes the same one repeatedly) perhaps 3,000 times each day – and, thus, are becoming jaded. They are also increasingly familiar with the tricks of the marketing trade and determined to cut through the clutter to get a bargain.”

A survey intended to measure the benefits of 700 brands on both personal and community levels found, “The majority of people worldwide wouldn't care if 73 percent of brands disappeared tomorrow.” Americans are more skeptical than others. In the United States, people would not care if 92 percent of brands disappeared. The U.S. survey results suggested just nine percent of brands are thought to actually help improve the quality of life in America.

Are Super Bowl ads money well spent? Some say yes; others say no. A 2010 study commissioned by Fox Sports (the Super Bowl is shown on the Fox network) reported an 11 percent increase in sales of products and services advertised during the big game. The January 2014 issue of Advertising Age reported just 20 percent of Super Bowl ads lead to sales. Maybe the better gauge is you. Did Super Bowl ads change your purchase decisions or attitude toward a particular brand?

 

Weekly Focus – Think About It

“Of life's two chief prizes, beauty and truth, I found the first in a loving heart and the second in a laborer's hand.”

--Khalil Gibran, Lebanese-American poet and author