Weekly Commentary October 27th, 2014

The Markets

After a week that left investors wondering what’s next – much like fishermen on a lake as the wind kicks up and the water gets choppy – the wind settled and the fish started biting. U.S. stock markets posted their best weekly returns in almost two years last week. When all was said and done, investors were $900 billion richer on paper, according to experts cited by Barron’s.

One of the most interesting things about the week was that little changed. The Eurozone’s precarious economic state did not stabilize. The Middle East remained in an uproar. The Russia-Ukraine conflict persisted, complete with sanctions. Ebola continued to be a threat, although vaccines are in the works. The pace of growth in China did not accelerate. In fact, a working paper published by the National Bureau of Economic Research suggested:

“There are substantial reasons that China and India may grow much less rapidly than is currently anticipated. Most importantly, history teaches that abnormally rapid growth is rarely persistent, even though economic forecasts invariably extrapolate recent growth. Indeed, regression to the mean is the empirically most salient feature of economic growth.”

Some things related to China changed last week, though. It launched a new infrastructure bank along with 20 other countries, including India. The bank is intended to complement or rival the World Bank, depending on whose rhetoric you believe.

So, why did markets bounce? Barron’s said it had a lot to do with the Federal Reserve. As monetary policy has become less easy and volatility has picked up, “turbulence was in the direction of deflation, with commodities – especially crude oil – sliding and government bond yields plunging further around the globe.” Enter St. Louis Fed President James Bullard who suggested quantitative easing could be extended, if economic data supported it.

In other words, weak inflation numbers could shape Fed policy and delay interest rate increases. That was the story the numbers on the Chicago Mercantile Exchange told, anyway. The probability of the Fed raising rates by September 2015 declined sharply last week, moving from 81 percent to 42 percent. The market’s strong positive response has been dubbed the ‘Bullard Bounce.’

fourth place! When it comes to financial literacy, the International Financial Literacy Barometer indicates the United States ranks fourth out of 28 countries. If you’re thinking those sophisticated Europeans must have an edge on us, you’re wrong. The top five countries were Brazil, Mexico, Australia, United States, and Canada.

The rankings were determined by the answers to five questions:

1.    Do you have and follow a household budget? The best budgeters were in Brazil, Japan, Australia, South Africa, and Canada. The United States placed sixth.

2.    How many months worth of savings do you have set aside for an emergency? The best savers were in China, Taiwan, Hong Kong, Japan, and Canada. The United States placed seventh.

3.    How often do you talk to your children ages 5-17 about money management issues? Parents who talked most frequently about money with their children were in Mexico, Brazil, Serbia, Bosnia, and Lebanon. The United States placed sixth.

4.    To what extent would you say teenagers and young adults in your country understand money management basics and are adequately prepared to manage their own money? More adults in Vietnam, Indonesia, India, Colombia, and Mexico believed kids understood financial basics than in other countries. The United States placed 27^th.

5.    At what age do you think governments should require schools to teach financial literacy to children so they can better understand money management issues? People in Brazil, Morocco, Thailand, Belarus, and Egypt wanted to talk with kids about money at the earliest ages. Americans said the government should require children to learn about money at about age 12. That put us in 21^st place.

It’s remarkable we placed fourth when our ranking on individual questions was lower in every instance. Our final ranking was higher, in part, because the first three questions were weighted more heavily than the latter two.

If you’re interested in educating your children about money, a good place to start (with younger children) may be with the Tooth Fairy. In 2014, the Tooth Fairy left 8 percent less, on average, under kids’ pillows than in 2013. American children received about $3.40 per tooth. Ask your children why that might be? Are kids losing more teeth so the Fairy is paying less? Did the Fairy budget badly? Are some teeth worth more than others (cavities versus no cavities)? It’s always easier to learn when you’re interested in the subject!

 

Weekly Focus – Think About It

“Age is an issue of mind over matter. If you don't mind, it doesn't matter.”

--Mark Twain, American author

Weekly Commentary October 20th, 2014

The Markets

It’s a little early for Halloween, but markets sure got spooked last week. After a 21-month ride to mid-September highs, stock markets jolted and shook investors last week like the most dramatic and scream-inducing rollercoaster at an amusement park’s fright night. Barron’s described it like this:

“The Dow Jones Industrial Average endured dizzying swings each day, with a 460-point move midday on Wednesday. That’s when the market came closest to hitting a correction phase – that is, down 10 percent from the highs. The Standard & Poor’s 500 index fell to 1,820.66, or down 9.5 percent intraday from the all-time closing high of 2011.36, before closing on Wednesday down 7.4 percent from highs.”

Despite the wild ride, by Friday’s close, major U.S stock indices were down about 1 percent for the week.

Restoring some perspective

After a week like last week, it’s important to take a deep breath and cast a calm eye over current financial and economic circumstances. This can help restore perspective and ensure sound decision-making. Here are a few points to consider:

Ø  Markets go through corrections: Last week’s drop didn’t quite meet the definition of a market correction, but it came close. It’s no secret stock market corrections can be unnerving but, as Kiplinger’s explained recently, “Corrections are an inevitable part of investing. Since 1932, declines of 10 percent to 20 percent (the traditional definition of a correction) have occurred an average of every two years, according to InvesTech Research.” Based on history, 10 percent corrections are normal and to be expected. It has been three years since our last correction.

Ø  There is a lot happening in the world: ‘When it rains, it pours,’ as they say. A whole host of factors contributed to last week’s market volatility. Let’s take a brief look at some prominent concerns:

§  Monetary policy adjustments in the United States. The Federal Reserve has been moving away from the highly accommodative monetary policies it has pursued in recent years and that has some investors worried. Quantitative easing is expected to end this month. The next step is raising the Fed funds rate which is expected to happen next year. Last week, St. Louis Fed President James Bullard reassured markets when he suggested, “The central bank should extend its asset-purchase program when policy makers meet later this month. U.S. stocks erased losses and Treasury yields rose on expectations the Fed will take action to insulate the United States from global economic weakness,” reported Bloomberg.

§  Possible deflation in the Eurozone. It’s not here yet, but some Eurozone countries have fallen back into recession and the region is showing no growth. The European Central Bank reduced rates in June and September and is expected to begin a round of bond buying next week. These efforts may improve productivity and spur growth.

§  The strengthening U.S. dollar could affect global liquidity. While a strong dollar has potential to slow growth in emerging countries, liquidity issues may be balanced out by the effect of falling oil prices. Reuters reported, “The falling oil price… will improve household budgets in the United States hugely – one study from Citi estimates the global windfall so far at $660 billion which includes a $600 per-household bonus in the United States.” More money in the pockets of U.S. consumers may translate into stronger emerging market economies.

§  Slowing overseas economic growth. Slower growth in China is affecting markets around the world. Germany has experienced some economic weakness recently. Brazil is in recession. U.S. economic growth is slow but steady and is not expected to change.

§  The potential spread of Ebola. “This is a terrible human tragedy but Ebola’s transmission – through bodily fluids – appears to be more difficult than SARS… The cost will be high in human terms but, so far, there is nothing to suggest it won’t eventually be contained,” reported Barron’s.

§  Political unrest and military conflicts persist. Ukraine, the Middle East, Hong Kong, and other regions of the world are embroiled in conflict. Unrest often impedes economic growth.

When you add to the mix human emotion and anxiety that has lingered since the financial crisis, you create the potential for a week like the one we just had.

Ø  Growth is healthy in the United States: Despite last week’s market volatility, U.S. stock market fundamentals haven’t changed. Barron’s said:

“Fundamentally, the market is fairly valued, but not overvalued, and the economic backdrop remains healthy. The U.S. economy looks to be growing at a healthy pace – 4.6 percent in the second quarter and an estimated 3 percent in the third. Third-quarter earnings are expected to rise 5.1 percent year-to-year, according to FactSet. Employment and manufacturing growth reaffirm the trend and, while retail sales slipped 0.3 percent in September, falling gasoline prices have boosted consumer confidence.”

Barron’s also pointed out that, at Thursday’s close, 35 percent of the companies in the Standard & Poor’s 500 had dividend yields that were higher than the 2 percent yield on 10-year U.S. Treasuries. The point being, market downturns often create opportunities.

Ø  Accommodative monetary policy has suppressed volatility: The Fed’s policies have kept market volatility lower in recent years than it might have been otherwise. If you think back, you may remember the Chicago Board Options Exchange's Volatility Index (VIX), also known as Wall Street’s fear gauge, was at extraordinarily low levels this year. It moved from 12 to 26 during the past month. The historical average for the VIX is 20, and it reached 80 during the financial crisis. We need to get used to the idea that markets are likely to be more volatile as monetary policy normalizes, according to experts cited by Barron’s. The thing to remember is market fluctuations are not unusual. They may make us uncomfortable, but they should be expected.

Maintaining a disciplined approach

As you know, we have a disciplined investment process that was designed to help you work toward your financial goals. While we monitor economic and market developments closely, we don’t let the noise of day-to-day events determine our actions. We will not take action until our process indicates we should. It’s important for you to understand we make decisions about your account all the time, and much of the time we decide to do nothing. Although no strategy is assured success or protection against loss, we have confidence in our process. It is the reason we sleep well at night.

 

 

Weekly Focus – Think About It

“Wealth is the ability to fully experience life.”

--Henry David Thoreau, American author

 

Weekly Commentary October 13th, 2014

The Markets

Keep Calm and Carry On.

The slogan comes from a United Kingdom Ministry of Information propaganda poster designed to boost morale if the United Kingdom was invaded during World War II. Despite its current popularity, the poster was never distributed.

The slogan offers some sound advice for anyone who was unnerved by last week’s stock market volatility. Investor optimism caught fire when Federal Open Market Committee meeting minutes indicated economic growth might not proceed quickly:

“Most viewed the risks to the outlook for economic activity and the labor market as broadly balanced. However, a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.”

Slower economic growth could translate into delayed monetary policy tightening (lower interest rates for a longer period of time), and that notion sparked the biggest rally of the year on Wednesday with U.S. stock markets making significant gains.

What goes up must come down. For every action, there is an equal and opposite reaction. Okay, the laws of physics generally don’t apply to stock markets. That said, a lot of folks saw Wednesday’s market highs as an opportunity to take gains off the table, according to Barron’s. Consequently, we saw steep stock market declines on Thursday with major U.S. markets losing 2 percent or more.

Yields on longer-term Treasuries also fell last week. Reuters reported weak economic data in Germany, which raised concerns about growth in the Eurozone, and revised forecasts from the International Monetary Fund indicating global growth may be lower than expected, caused investors to seek the safety of U.S. Treasuries.

collaborative consumption is causing creative destruction! Back in 1942, economist Joseph Schumpeter said creative destruction is the way of the free market. It’s messy but as an entry in The Concise Encyclopedia of Economics explained:

“Lost jobs, ruined companies, and vanishing industries are inherent parts of the growth system. The saving grace comes from recognizing the good that comes from the turmoil. Over time, societies that allow creative destruction to operate grow more productive and richer; their citizens see the benefits of new and better products, shorter work weeks, better jobs, and higher living standards. Herein lies the paradox of progress. A society cannot reap the rewards of creative destruction without accepting that some individuals might be worse off, not just in the short term, but perhaps forever.”

At first, the collaborative or sharing economy was thought to be a response to the Great Recession. Some people needed to reduce costs and others needed to make money, so they found ways to use resources more efficiently by making the most of available time and assets. This is affecting companies in a variety of industries:

·       Transportation: Ride-sharing apps connect people who want rides with people who are willing to use their personal cars to provide rides. (If you’ve wondered about autos sporting big pink mustaches, they belong to a particular app’s drivers.) These apps are taking money out of the pockets of cab companies.

·       Hotels: You can reduce travel costs by renting someone’s spare bedroom, castle, or villa through an online community marketplace. The downside, according to one study in Texas, is traditional hotels have lost revenue as these communities have gained popularity.

·       Finance: When banks and traditional lenders made borrowing a challenge, peer-to-peer lending and crowdfunding platforms provided individuals and entrepreneurs with a new way to source capital. A report from the Cleveland Fed found, “Since the second quarter of 2007, the total amount of money lent through bank-originated consumer-finance loans has been declining on average 2 percent per quarter... Meanwhile peer-to-peer lending has been growing rapidly at an average pace of 84 percent a quarter.”

Whether you want to provide or consume goods or services – cooking meals or eating them, running errands or having them run, hosting a pet or leaving one behind while you vacation – there is probably someone out there who is willing to share their resources.

 

Weekly Focus – Think About It

“Always remember that you are absolutely unique. Just like everyone else.”

--Margaret Mead, American cultural anthropologist

Weekly Commentary October 6th, 2014

The Markets

 “Life is fine! Fine as wine! Life is fine!”

 During the third quarter of 2014, U.S. investors remained as optimistic as the narrator in Langston Hughes’ poem, Life Is Fine. All major U.S. indices pushed higher during the quarter despite mixed economic signals, monetary policy concerns, and geopolitical tensions.

 U.S. Treasury bond markets continued to confound investors and analysts during the quarter. Rates have remained low even with the end of quantitative easing in sight and the Federal Reserve preparing for the next step in unwinding monetary policy which is raising the Fed Fund’s rate. Although the timing of the rate increase remains uncertain, in theory, bond rates should be moving higher in anticipation of the change. A Bloomberg survey found economists anticipate 10-year Treasury yields will reach 2.78 percent by the end of 2014. They began the year at 2.98 percent and finished last week at 2.45 percent.

 Bond yields have remained low, in part, because of geopolitical conflicts. Relations between Ukraine, Russia, and the West deteriorated further when an international commercial airliner carrying hundreds of passengers was shot down over Ukraine by a surface-to-air missile. Sanctions imposed by the European Union (EU) and United States have negatively affected the Russian economy. BBC.com reported about $75 billion in capital has fled Russia and the country’s economy appears to be on the brink of recession.

 Sanctions also hurt economic growth in the EU where recovery has been as precarious as a newborn foal trying to stand. World stock markets were disappointed, late in the quarter, when the European Central Bank confirmed it was ready to pursue further stimulus but failed to offer any specifics. Over the quarter, interest rates in Europe drifted lower. The Wall Street Journal reported, “Record-low interest rates in Europe have flipped bond investing on its head. Some bond buyers, typically paid for lending out their money, have begun paying borrowers to look after their cash.”

 Renewable energy issues aggravated problems in Germany. “On June 16… the wholesale price of electricity fell to minus €100 per megawatt hour (MWh). That is, generating companies were having to pay the managers of the grid to take their electricity,” reported The Economist. The problem was less predictable forms of energy, like solar and wind, create challenges for utilities accustomed to power plants that run constantly and produce a predictable amount of energy.

 Throughout the quarter, geopolitical issues increased at a rate that might rival Fibonacci’s hypothetical rabbit population (okay, maybe not quite that fast):

• The Ebola crisis captured the attention of governments around the world. Safety trials for experimental vaccines are underway in the United Kingdom and the United States, and the first unexpected case arrived on U.S. shores.

·       Violence continued to roil through the Middle East and North Africa. ISIL/ISIS accomplished what many had thought impossible – uniting most countries in the world against a common enemy.

·       In Hong Kong, protests supporting free elections and opposing the Chinese government’s vetting of political candidates were marked by an increase in violence.

·       Japan suffered its worst volcanic disaster in 90 years.

 The third quarter of 2014 was many things, but it certainly wasn’t boring.

Is another industrial revolution upon us? Sure, sure, historians still debate whether the term ‘revolution’ is a misnomer since the first industrial revolution began in the 1700s and sort of merged into the second industrial revolution in the mid-1800s. Revolution is apt when a new way of doing things completely replaces an old way. However, the changes in agricultural techniques, technology, and industrial organization happened so slowly it was hardly a revolution in the traditional sense of change occurring rapidly.

 The Economist suggests we are in the throes of another period of sweeping change:

“A third great wave of invention and economic disruption, set off by advances in computing and information and communication technology in the late 20th century, promises to deliver a similar mixture of social stress and economic transformation. It is driven by a handful of technologies – including machine intelligence, the ubiquitous web and advanced robotics – capable of delivering many remarkable innovations: unmanned vehicles; pilotless drones; machines that can instantly translate hundreds of languages; mobile technology that eliminates the distance between doctor and patient, teacher, and student.”

 Industrial revolutions have been characterized by painful change; although, they created broad swatches of economic opportunity. While this revolution eventually may bring incredible improvements and open new economic opportunities across all levels of global societies, currently, it is “opening up a great divide between a skilled and wealthy few and the rest of society.”

Weekly Focus – Think About It

 Believe you can and you're halfway there.”

--Theodore Roosevelt, 26^th President of the United States