Weekly Commentary June 30th, 2014

The Markets

Last week, the U.S. Department of Commerce delivered news that was about as welcome as a report of a great white shark sighting off a popular beach during the Fourth of July holiday. The Commerce Department’s third revision of its estimate for economic growth in the United States during the first quarter of 2014 was revised downward – by a lot. Instead of contracting by 1 percent, the economy shrank by 2.9 percent. It was the worst single-quarter contraction in five years.

According to Barron’s, “The number was so bad… it suggested that something more than the weather was to blame for the plunge in economic activity – and that a recession could be in the offing.” Other factors did contribute to the economy’s first-quarter reversal including a reduction in healthcare spending sparked by the Affordable Care Act and the end of emergency unemployment benefits in January.

However, experts warned against making too much of backward-looking data. ING economist James Knightley told The Guardian reaction to the news should be fairly muted as many economists expect second quarter numbers to show significant improvement. PNC Financial Services senior economist Gus Faucher, who was also quoted in the article, concurred:

“The contraction in the first quarter is old news, and things are looking much better for the rest of this year. Most importantly the labour market remains solid… Job gains are allowing households to increase their spending, with higher stock prices and home values also helping. Recent data have been solid, with big jumps in new and existing home sales in May, and consumer confidence recovering after it took a hit in the winter. An expanding global economy will help boost exports...”

Comments from St. Louis Federal Reserve President James Bullard reinforced the view that economic growth remains steady. Last Thursday, he predicted the Fed would raise interest rates early in 2015. Bloomberg.com reported Bullard expects the jobless rate to drop below 6 percent and inflation to close in on 2 percent by the end of 2014.

the bull market in bonds has persisted for more than 30 years. It began when The Cosby Show was in its heyday, when the first Apple Macintosh computers arrived in homes, and when Clara Peller famously asked, “Where’s the beef?” in a popular television commercial. The bull market began late in 1981 when 30-year U.S. Treasury bond rates hit an all time high of 15.2 percent and 10-year Treasuries topped out at 15.8 percent. Thirty-three years later, in mid-2014, 30-year Treasuries and their 10-year brethren offered rates in the low single digits.

MarketWatch.com says the lengthy bull market in bonds has important implications:

“… Assuming the typical investor doesn’t seriously start thinking about investing until he is 25 or 30 years old, especially about investing in bonds, that means that anyone today not in, or very close to, retirement has only known a bond bull market. That’s an amazing historical and psychological fact, the significance of which cannot be overstated. It means that very few investors today have the long-term perspective with which to properly assess whether bonds are likely to suffer major declines in coming years.”

After 30-odd years of declining interest rates, some experts believe investors should prepare for a period of rising rates. Since there is an inverse relationship between bond prices and interest rates, higher rates could mean declining bond prices. How much could the price of a bond decline? It all depends on the bond’s duration. Duration is expressed as a number of years and measures the sensitivity of a bond to interest rate movements. The longer the duration of a bond, the more sensitive it is to changing rates, and vice-versa. Investopedia.com describes duration like this:

“The duration number is a complicated calculation involving present value, yield, coupon, final maturity, and call features. Fortunately, for investors, this indicator is a standard data point provided in the presentation of comprehensive bond and bond mutual fund information. The bigger the duration number, the greater the interest-rate risk or reward for bond prices.”

If rates move higher, a portfolio with long-term, long-duration bonds may experience a significant reduction in value.

 

Weekly Focus – Think About It

“Hard work spotlights the character of people: some turn up their sleeves, some turn up their noses, and some don't turn up at all.”

--Sam Ewing, American baseball player

Weekly Commentary June 23rd, 2014

The Markets

The Federal Open Market Committee (FOMC) press release wasn’t quite as catchy as España Cañí — the Spanish song played to rile crowds at events as varied as baseball games and bullfights — but it helped motivate investors as they pushed American stock markets higher last week.

The markets’ optimistic surge was a bit difficult to understand. Since April, the U.S. economy has offered mixed signals. As it turns out, the economy actually suffered a contraction — not a slight expansion, as was originally thought — during the first quarter of 2014. Unemployment has been relatively steady with employers adding about 200,000 jobs in each of the last four months.  However, inflation numbers have some pundits concerned.

The Bureau of Labor Statistics’ Consumer Price Index Summary (CPI) showed the CPI increased by 0.4 percent in May, but that doesn’t really tell the whole story. The price of food was rising faster (0.7 percent) than the CPI and in May, the food index posted its largest increase since August 2011. In addition, the cost of electricity and gasoline rose 0.9 percent.  When questioned about the discrepancy, Chairwoman Janet Yellen indicated the numbers around inflation could be just ‘noise.’  The Fed’s attitude toward inflation had The Guardian accusing it of magical thinking.

“…Consumers are surrounded by rising prices on all sides – paying higher bills, paying more money at the market, paying more just to get to work. At the same time we’re shelling out more for these necessities, our incomes are stagnant. No more money is coming in. Yet the Fed, which just wrapped a two-day meeting to diagnose the economy, is dismissing these real-world costs as a trick of the charts – a mere math problem rather than a real snapshot of the challenges facing Americans.”

If economic signals are mixed, why were markets so optimistic? Reuters suggested investors’ confidence had a lot to do with the markets’ resilience during 2014 to-date (in the face of events in Ukraine and the Middle East, among others), as well as economic improvement, earnings growth, and the availability of cheap credit.

Decimate is a very interesting word…In the early 1500s, according to OxfordDictionaries.com, decimation (an earlier version of decimate) referred to tithing—paying a tenth of your income to an organization that was usually religious in nature. By the end of the 1600s, “An English Dictionary defined [decimate] as both ‘to tythe or take the [tenth]’ and ‘also punishing every tenth man.’”  More recently, decimate has been defined as destroying a large portion of something or drastically reducing the strength or effectiveness of something.

When it comes to retirement, the great decimator could be healthcare costs. The Employee Benefits Research Institute (EBRI) estimated that, in 2013, men needed $65,000 and women needed $86,000 to have a fifty-fifty chance of covering healthcare expenses during retirement. At least, that’s how much they needed to pay for Medigap premiums, Medicare Part B premiums, Medicare Part D premiums, and out-of-pocket expenses.

Of course, if they wanted better odds, people had to save more. Let’s say a person wanted a 90 percent chance of having enough money to pay the healthcare costs listed above. In that case, a man needed $122,000 and a woman $139,000. A married couple (both with drug expenses in the 90^th percentile) needed $360,000 in savings. EBRI Notes said, “Individuals can expect to pay a greater share of their costs out-of-pocket in the future because of the combination of the financial condition of the Medicare program and cutbacks to employment-based retiree health programs.”

Of course, it’s important to note that these targets don’t include any expenses associated with early retirement or long-term care costs. A new study estimates that a couple retiring at age 62 will pay about $17,000 in out-of-pocket expenses each year until they become eligible for Medicare.  No matter when they retire, 70 percent of Americans eventually need long-term care services and support, according to LongTermCare.gov.  The cost of long-term care depends on the services required, but it is not insignificant. One survey estimated that the average cost of care for one year in a private nursing facility was about $96,000 in 2014.

Putting sound financial strategies in place can help prevent healthcare expenses from decimating your retirement.

 

Weekly Focus – Think About It

“People who think they know everything are a great annoyance to those of us who do.”

-- Isaac Asimov, American author and biochemistry professor

Weekly Commentary June 16th, 2014

The Markets

Investors remain oddly complacent even in the face of unexpected events that have the potential to disrupt global markets.

Last week, news media reported civil war in Syria has boiled over into Iraq, and ISIS (Islamic State of Iraq and Syria), a Sunni extremist group, has seized control of hundreds of square miles. According to CNN.com, the group’s ambition is to create an Islamic state that encompasses the Sunni regions of both Iraq and Syria. [1] The Economist pointed out the potential for volatility in world energy prices is enormous because significant portions of the world’s energy reserves are controlled by Middle Eastern nations (factor in Russia and Venezuela, too). [2]

Governor of the Bank of England, Mark Carney, let markets know the United Kingdom’s central bank may raise rates sooner than expected to help turn the country’s recovery into a durable expansion. [3] His speech sparked speculation about the timing of rate hikes in the United States. President of the Federal Reserve Bank of St. Louis, James Bullard, told The Wall Street Journal the Fed is likely to raise rates sooner than expected if the U.S. economy meets performance expectations during 2014. [4]

Russian politicians are encouraging a de-dollarization of their economy, and leaders of several Russian banks have indicated they are bypassing the U.S. dollar in their international transactions. [5] China and Brazil are settling some of their trade with their currencies, the renminbi and the real (respectively). According to Barron’s, “The world is actively seeking an alternative to the greenback. Major nations don't want to pay the virtual toll in the cost of acquiring dollars to conduct trade. The maturation of their own financial markets increasingly allows them to bypass the dollar-centric financial system.” [6]

U.S. stock markets largely finished the week lower; however, the CBOE Volatility Index (VIX) (the so-called fear gauge) remained at levels suggesting investors remain relatively unruffled. [6]

Paul, the German octopus oracle, did pretty well predicting outcomes of 2010 World Cup matches. Paul’s approach wasn’t too scientific and, now that he is gone, a lot of folks are turning to animal prognosticators. China has a team of baby pandas and Germany has put Nelly the elephant on the task. [7]

In case you’re not a soccer aficionado, The World Cup – soccer’s version of the Super Bowl, World Series, Stanley Cup, etc., etc. – began last weekend. SBNation.com’s soccer glossary describes the event like this:[8]

“The World Cup is the most important soccer tournament on the planet. It is contested over 64 games by 32 national teams every four years and tends to be watched by a significant fraction of the global population… Long story short: it's the most important trophy in the world's most popular sport.”

The World Cup also provides a lesson on sentiment-driven markets. Market sentiment reflects the optimism or pessimism of investors on the whole – crowd attitude – and it can send markets higher or lower. It can affect markets even when there’s no change in underlying fundamentals. [9]

So, how does it work? Goldman Sachs publishes a 67-page report, complete with a dream team line-up and interviews, titled The World Cup and Economics. It could be a program brochure for the event. Regardless, the report includes data about the performance of countries’ stock markets following a victory or defeat in the finals. [10]

Stock markets in winning countries tend to outperform by about 3.5 percent for the first month after the win but gains fade by the three-month mark, and markets tend to underperform the following year. When you remove significant outliers, runner-up countries’ markets typically underperform during the three months following the loss. It seems nobody is too pleased about coming in second. [10]

 

Weekly Focus – Think About It

“Some people think football [soccer] is a matter of life and death. I assure you, it's much more serious than that.”

--Bill Shankly, Scottish footballer and manager of Liverpool Football Club [11]

Weekly Commentary June 9th, 2014

The Markets

“Is there any point to which you would wish to draw my attention?”

“To the curious incident of the dog in the night-time.”
“The dog did nothing in the night-time.”
“That was the curious incident,” remarked Sherlock Holmes.”

Sometimes, it’s what doesn’t happen that deserves our attention. In the case of what’s missing in U.S. markets, according to The Economist, is volatility:

“Certainty about monetary policy has stripped volatility out of bond yields which in turn has drained a major source of uncertainty out of stock prices. At root, volatility simply represents uncertainty about the value of an asset's cash flows, so when volatility falls, the risk premium required to hold the asset also falls, driving price-earnings ratios for stocks up and bond yields down… I do worry that by squeezing out short-term volatility, we may be storing up long-term volatility.”

In the United States, the CBOE Volatility Index (VIX), a.k.a. the fear gauge, has been falling for some time. According to Reuters, some experts believe when the VIX trades below its historic averages, the market is getting toppy and investors may be in denial. Only time will tell whether this view has merit. In the meantime, let’s review what has happened so far during the second quarter of 2014:

Strength in America

The U.S. Federal Reserve continued to goose the U.S. economy with accommodative monetary policy. Toward the end of this quarter, the Fed was buying $45 billion of Treasury and mortgage-backed assets each month rather than $85 billion as it did prior to tapering. At this rate, its quantitative easing efforts will end in late fall or early winter.

The U.S. economy appeared to rebound after contracting slightly during the first quarter of 2014. Better-than-expected economic data late in this quarter spurred optimism in markets across the globe.

Redirection in Russia

Tensions between Russia and Ukraine remained high. At the St. Petersburg International Economic Forum, Russian President Vladimir Putin told CNBC, “The standoff with Ukraine and the threat to European gas supply are ‘not due to Russia but to the situation in the Ukraine, which abuses its position.’”

Meanwhile, one of Russia’s large state-backed energy companies signed a $400 billion, 30-year contract to supply gas to China. Reuters reported China received a significant discount on the deal which was priced at about $10 to $10.50 per million British thermal units (BTUs). This is well below the current price level of around $13 per million BTUs.”

Not long after that deal was announced, Russia, Belarus, and Kazakhstan signed documents creating a Eurasian Economic Union (EEU) late in this quarter. The Diplomat reported Russia was pushing for a common parliament, common passport, and common currency within the EEU; however, the other member states preferred a purely economic union. According to Reuters, forming closer ties between Russia and China is at the heart of the EEU.

Slow growth in China

China missed its government’s gross domestic product (GDP) growth target for the first quarter of 2014. The bull’s eye was 7.5 percent growth. China delivered 7.4 percent. The Chinese government took measures to encourage growth, and The World Bank recently reported China’s growth is expected “to slow to 7.6 percent in 2014, and 7.5 percent in 2015, from 7.7 percent in 2013.” The report said economic growth could be slower due to high levels of local government debt, issues in real estate markets, or economic weakness in developed countries.

 

 

we’ve all talked about spending time, but how many people really think of it as currency? The Economist offered an interesting commentary on the value of time last week or, more accurately, on the hidden cost of wasted time. It seems two billion people around the world have watched the Korean music video “Gangnam Style” on YouTube. The Economist commented, “At 4:12 minutes, that equates to more than 140 million hours, or more than 16,000 years.” That’s about how long it would take to build:

 

·         20 Empire State buildings

·         4 Great Pyramids of Giza

·         6 Burj Khalifas (skyscraper in Dubai, United Arab Emirates)

·         Another Wikipedia (write and edit all revisions)

 

So, was that time poorly spent? The Economist pointed out the opportunity cost was fairly high. The opportunity cost of a choice (watching a music video instead of doing something else) is equal to the value of the choice that has not been made. Of course, if watching the video gets the creative juices flowing and inspires an invention or innovation then, depending on how profitable the idea is, the opportunity cost may be negligible.

 

Weekly Focus – Think About It

“Most folks are as happy as they make up their minds to be.”

--Abraham Lincoln, 16^th American President

 

Weekly Commentary June 2nd, 2014

The Markets

If you’re a fan of home renovation TV shows then you’re probably familiar with the types of bad news home inspections can uncover. Last week, the Commerce Department inspected its previous estimate for real gross domestic product (GDP) growth during the first quarter of 2014 and found some bad news. As it turns out, the rate of economic growth in the United States declined by 1 percent rather than increasing slightly, as previously thought.

The revision sparked debate among economists and politicians about the health of the U.S. economy. According to The Guardian, some economists found the revised numbers difficult to reconcile because they seem to contradict other first quarter economic data – such as expansion of non-farm payrolls, healthy manufacturing activity, and stronger retail sales – which indicate a more positive growth trend.

News that the U.S. economy might have shrunk slightly didn’t deter investors at all. The Standard & Poor’s 500 Index finished the week at a new record high. This could mean investors are confident economic growth will rebound in the second quarter of 2014 or it may reflect a belief economic weakness in the United States will encourage a more stimulative monetary policy.

The Wall Street Journal suggests signs of slower growth in the United States and Europe are behind the resurgent popularity of emerging markets. If you recall, investors pulled about $60 billion from emerging countries early in 2014 as they worried these markets would be affected negatively by the U.S. Federal Reserve’s less stimulative monetary policy. In May, a Reuters’ poll found 51 investment houses in the United States, Japan, and Europe had reduced their cash positions to the lowest levels since last November and invested the proceeds in emerging markets.

One expert cited by The Wall Street Journal called the rush into emerging markets a “global chase for yield.” No matter what you call it, last Friday, Morgan Stanley Capital International's emerging markets stock index rose to its highest level since October 2013. It was up 3 percent for the year.

how do you make a peanut butter and jelly sandwich? If you’ve ever been asked to write clear instructions for a seemingly simple task, you know the challenge is in the details. To illustrate how to make a PB&J, you start with bread, peanut butter, jelly (in a squeezable bottle), and a knife. Then you need to remember to tell the reader to open the bread bag, unscrew the top of the peanut butter jar, and turn the jelly bottle upside down before squeezing it. You have to provide a lot of very concise information.

Communicating financial and investment ideas effectively also can be challenging. It appears a significant number of Americans are not receiving all of the information they may need. For several years, the Financial Industry Regulatory Authority’s (FINRA) Investor Education Foundation has employed a five-question quiz to evaluate financial literacy. The questions include fundamental concepts related to financial knowledge and decision-making. If you want to test yourself, take the quiz at http://www.usfinancialcapability.org/ (the link is the first one in the upper left corner).

In 2012, about 30 percent of Americans were able to answer three of the five quiz questions correctly. That was about the same number of questions that were answered correctly when the quiz was first offered in 2009. The percentage of respondents who were able to answer four or five quiz questions correctly varied significantly by generation:

·         24 percent of Millennials (born between early 1980s to early 2000s)

·         38 percent of Gen Xers (born between early 1960s to early 1980s)

·         48 percent of Baby Boomers (born between 1943 to early 1960s)

·         55 percent of the Silent Generation (born between 1925 to 1942)

When a similar quiz was offered to people in countries throughout the world, financial literacy was linked (in all countries) to retirement planning or participation in private pension plans. In most countries, people who were financially literate were more likely to plan for retirement which requires an understanding of interest rates, risk, and diversification.

If someone you care about would benefit by knowing more about financial matters, please give us a call. We would be happy to sit down and talk with them about a specific topic or recommend some good reading materials.

 

Weekly Focus – Think About It

“Courage is the most important of all the virtues, because without courage you can't practice any other virtue consistently. You can practice any virtue erratically, but nothing consistently without courage.

--Maya Angelou, American author and poet