Market Week: July 22, 2013

July 22nd, 2013

The Markets

As Federal Reserve Chairman Ben Bernanke continued to reassure investors about the Fed’s future course, the Dow industrials and the S&P 500 once again set new closing records. However, weak earnings reports from some bellwether tech companies hurt the Nasdaq, while a strong week for the small caps of the Russell 2000 helped the index maintain its year-to-date lead. Meanwhile, reduced anxiety about the Fed also allowed the benchmark 10-year Treasury yield to slide for the second week as prices rose. Municipal bond markets remained relatively stable despite Detroit’s decision to file for bankruptcy.

Market/Index

2012 Close

Prior Week

As of 7/19

Week Change

YTD Change

DJIA

13104.14

15464.30

15543.74

.51%

18..62%

Nasdaq

3019.51

3600.08

3587.61

-.35%

18..81%

S&P 500

1426.19

1680.19

1692.09

.71%

18..64%

Russell 2000

849.35

1036.52

1050.48

1.35%

23..68%

Global Dow

1995.96

2201.99

2233.17

1.42%

11..88%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.78%

2.59%

2.50%

-9 bps

72 bps

Equities data reflect price changes, not total return.

Last Week’s Headlines

· In his semiannual testimony before Congress, Fed Chairman Ben Bernanke continued to make soothing statements, saying that the tapering of economic support is not on any “preset course” and will depend on future economic data. He also made headlines by saying that “nobody really understands gold prices, and I don’t pretend to understand them, either.”

· Hampered by a dramatically reduced tax base and overwhelming debt, Detroit became the biggest U.S. city in history to declare bankruptcy. Creditors, including city pensioners and holders of general obligation bonds, will now have to argue in federal court to try to claim a percentage of what they’re owed. Also, Moody’s cut Chicago’s bond rating by three notches to A3, citing pension liabilities and worsening budget problems.

· Consumer prices rose 0.5% in June, with a 6.3% increase in gas prices responsible for roughly two-thirds of the increase. The Bureau of Labor Statistics said that put the consumer inflation rate for the last 12 months at 1.8%.

· Retail sales rose slightly less in June than they did a month earlier. According to the Commerce Department, the 0.4% increase was largely the result of car sales that were 2.1% higher for the month.

· Industrial production accelerated in June; the Federal Reserve said the nation’s factory output rose 0.3%, which was far better than May’s flat reading. That meant that industrial output is up 2% from a year earlier. Also, the Philly Fed manufacturing survey hit 19.8, its highest level since March 2011, while the Fed’s equivalent Empire State survey also rose to 9.5.

· Housing starts tapered off in June, according to the Commerce Department. The nearly 10% decline, most of which was in the often volatile multifamily sector, could be linked to wet weather in many parts of the country, since homebuilder sentiment remains robust. Building permits also fell 7.5% for the month. However, both housing starts and building permits remained solidly higher than the previous June.

Eye on the Week Ahead

As earnings reports continue to stream in, home sales both new and used may be of extra interest this week in light of last week’s weaker housing starts report and the recent jump in mortgage rates. Durable goods orders could be affected by Boeing’s struggles with incidents involving its Dreamliner aircraft. Also, given last week’s disappointments by some key tech companies, earnings reports will be watched for signs of a broader tech slump.

Key dates and data releases: home resales (7/22); new home sales (7/24); durable goods orders (7/25).

Data sources: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

Hope Is Not A Strategy

July 21st, 2013

The summer months are often a time for reflection. It is the time of year when we get a few days, or weeks if you are lucky, to spend time with family, get outdoors, read a good book, and reflect on life. That is what I hope vacation is about.

It is also the time many of us use to think about our goals, both professional and personal, and the strategies we will use to get there. In business often our measure of success is in money terms. “ How much am I making?” is often the underlying question. After all, that dictates a lot about what we can do today.

However, I would argue that another measure of success would be how close you are to replacing your income – permanently. By that measure, you truly know how independent you are from the outcomes of your business and professional life. To take an easy example, say you made $100,000 of annual income from your business, and we assume for the moment that was sufficient to fund your lifestyle. To replace that annual income, you must have enough investments to generate $100,000 annually on an ongoing basis. To calculate that amount we use a statistically significant rule, called the 4% rule. That rule states that to have a reasonable chance of not outliving your assets, your withdrawal rate from your investments should be no more than 4%.

Using the 4% as the benchmark for the withdrawals, we now know that to generate $100,000 of income we would need to have $2,500,000 saved. Now that is a big number for most people. Bear in mind, there are mitigating factors, such as social security, real estate, the sale of your business, and if you are lucky an inheritance. Maybe after all that you only need to gun for $1,000,000. But even that is a big number.

My point here is not to scare the daylight of you, but rather to highlight the fact that in order to accomplish SUCCESS as defined by financial independence, you really need to employ a carefully thought out financial strategy. Hoping that one day you will have enough money to save is NOT a strategy. There are many useful programs that I use not only to save money, but also to create tax deductions for your business. If you or someone you know would like to learn more, please get in contact with me.

Daniel R. Bennett
Managing Director
Advanced Pension Strategies
Insurance & Financial Services
12100 Wilshire Blvd, Ste 800
Los Angeles, CA 90025
T. 310-496-8025
C. 310-968-3161
www.advancedpensions.com

Market Week: July 9, 2013

July 8th, 2013

The Markets

Domestic equities’ recovery from their June swoon accelerated last week. However, bond values continued to take it on the chin as the 10-year Treasury yield soared after Friday’s benign unemployment numbers. Gold also plummeted after the jobs report; the precious metal’s almost $40 loss for the day left its price at roughly $1,213 an ounce. And the threat that Egypt’s civil unrest could potentially affect oil supplies sent oil prices above $103 a barrel.

Market/Index

2012 Close

Prior Week

As of 7/5

Week Change

YTD Change

DJIA

13104.14

14909.83

15135.84

1.52%

15..50%

Nasdaq

3019.51

3403.25

3479.38

2.24%

15..23%

S&P 500

1426.19

1606.25

1631.89

1.60%

14..42%

Russell 2000

849.35

977.48

1005.39

2.86%

18..37%

Global Dow

1995.96

2110.60

2125.38

.70%

6.48%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.78%

2.52%

2.73%

21 bps

95 bps

Equities data reflect price changes, not total return.

Last Week’s Headlines

· The U.S. economy added 195,000 jobs in June, and the Bureau of Labor Statistics estimates for April and May were revised upward. However, because more people tried to rejoin the workforce, the BLS said the unemployment rate stayed stuck at 7.6%.

· Faced with a political crisis in debt-ridden Portugal, the European Central Bank said it plans to continue to keep its key interest rate there at a record low 0.5% for “an extended period,” though there were discussions about whether to set it even lower. The Bank of England also will keep its benchmark rate at 0.5%.

· The Institute for Supply Management’s June gauge of manufacturing activity reversed three months of declines, rising almost 1% above the 50% level that marks the difference between contraction and expansion. The manufacturing index has averaged roughly 50.2% for the last three months. The ISM’s index of the services sector also showed growth in June, though the 52.2% reading was slightly lower than May’s figure.

· Spending on residential construction rose 0.5% in May, and the Commerce Department said it is now 5.4% higher than last May. Private construction remained roughly the same as in April, while nonresidential construction declined 1.4%. Public construction was up 1.8%, with power and water supply facilities seeing the biggest gains.

· The Commerce Department also had good news from the nation’s manufacturers: factory orders were up 2.1% in May. An increase of almost 51% in commercial aircraft orders represented much of the increase, but business spending on equipment also rose by 1.5%.

· The U.S. trade deficit rose more than 12% in May as imports rose and exports fell, according to the Commerce Department. That put the trade gap at $45 billion, its widest point since last November.

· Interest rates on federally subsidized Stafford student loans went from 3.4% to 6.8% on July 1. However, Congress may tackle the issue again after the July 4 recess is over, and any change in the new rate could be applied retroactively.

Eye on the Week Ahead

Given the reaction to the Fed’s June 19 announcement indicating an improving economy (and therefore implying a possible reduction in Fed support), minutes of that meeting will be closely scrutinized for any further clues to the timing of any withdrawal of quantitative easing. With little other economic data to mull over, investors may begin to focus on corporate earnings; the unofficial start of the Q2 earnings season will occur when Alcoa releases its results after Monday’s close.

Key dates and data releases: Federal Open Market Committee minutes (7/10); wholesale inflation (7/12).

Data sources: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

Stuff Always Happens When I Travel

July 3rd, 2013

I’m just back from 2 weeks in Europe: Madrid, Zamora, Porto and Lisbon. Spain and Portugal remain mired in recession, but you wouldn’t know it from casual observation. The streets are bustling, the stores and restaurants busy, and the roads full of cars. But a closer look reveals some problems: buildings in disrepair or boarded up, especially in Lisbon; prices coming down, particularly in real estate. There don’t seem to be as many big trucks on the highway as when I was here in 2010.

But the biggest change from 3 years ago isn’t with the vehicles, but with the drivers. Last time I was in Spain, I noticed that the drivers were careful and polite, particularly compared with the French and warp-speed-driving Italians. But Spanish drivers have become impatient and even a little angry. They’re driving faster, tailgating and cutting people off. One older man even flipped the bird at me when I wasn’t moving fast enough through the winding streets of Salamanca. Economic stress does take its toll, and driving style is apparently a sensitive indicator.

Government austerity is to blame for much of the economic hardship. I won’t comment here on whether austerity was necessary, but even Germany and the Troika have started to realize that they took it too far. And the common people, especially government employees who are most affected, are not amused. The day we left Portugal, there was a general strike of all government workers, including air traffic controllers. Our plane to Frankfurt was 3 hours late and we missed our connection. We ended up staying overnight in Frankfurt and taking a flight the next day out of Munich, bringing us home 20 hours later than planned.

June Gloom

But enough about my European vacation. It seems that the markets like to go a little crazy whenever I leave the country, and they did not disappoint this time. For the month of June, global stocks (as measured by the MSCI All-Country World index) dropped –2.7%, but this rather modest decline obscures significant volatility. At one point, the index had fallen –6.9% in just 4 trading days, only to recover +4.0% over the next three. During the second quarter, global stocks fell –0.62%, with US stocks outperforming again, actually rising +2.9%. For the year so far, global stocks are up +5.5%, making 2013 a remarkably average year through June.

The current decline in equities began on May 22. Since then, the MSCI All-Country world index is down –6.2% as of the end of June, fairly typical for a stock market correction. Peak to trough, the decline reached –9.7%, also typical for a correction (defined as a decline of less than –20% over a period of 1 to 3 months). Stock corrections are surprisingly common, occurring an average of once a year. 2012 had two corrections, and still the global index ended the year up +17.1%. Corrections are thus nothing to fear, but rather an unavoidable consequence of investing.

We may or may not have seen the lows for the current correction. Many have a double bottom, with the second occurring an average of 6 weeks after the first at a roughly similar price level. So while June 24 undoubtedly represents a short-term bottom, it’s possible we’ll see another one sometime in early August. I tell you this now so that you’re not surprised if stocks remain weak over the next few weeks.

Corrections are healthy. They scare marginal investors out of the market (mainly individuals and speculators) and bring the valuations of many stocks to bargain levels. After the correction in the fall of 2011, for example, global stocks rose an impressive +26.7% in the following 12 months. I’m not saying that stocks will do that well after this correction, as the 2011 correction was deeper than most, but history suggests we’re still likely to see some decent appreciation in the year following the current one.

Interest Rates on the Rise

With all the recent volatility in stocks, the real story is in the bond market. If you’ve been reading my newsletters, you know that I’ve been saying that with interest rates at historic lows, the bond market was overpriced and at risk of a decline. Little did I suspect that the first leg of the drop would be so steep. Bonds, because of their lower average returns, are typically much less volatile than equities. But May and June have strained these historical relationships: the Barclay’s Aggregate, heavy with US Treasuries and typically the least volatile bond index, dropped as much as –5.2% from its peak in late April. This is quite a decline for an investment with an expected annual return of only 2.3%.

Other types of bonds have been hit even harder. Long-maturity California municipals, for example, dropped as much as –13.7%, while emerging market bonds fell–16.9% at their nadir. As of June 30, total returns of these bond classes since their peaks have been –8.7% and –9.7% respectively. Not a pretty picture.

Investors have been responding as expected: they’ve been selling like crazy. During the first 24 days of June, bond funds saw record redemptions of $61.7 billion, 50% more than the previous record set during the darkest days of the financial crisis in October 2008. Sounds like a bit of panic to me. The best news is that individual investors almost always do exactly the wrong thing, suggesting that the decline has been overdone. Although I expect bond returns to be mediocre at best in coming years, and below their long-term average, there could well be a near-term recovery in prices. Selling bonds indiscriminately at this point would thus be a mistake.

How badly could bonds get hurt? The worst 1-year performance for 10-year US Treasuries was –7.5% in 1999 (a year when stocks did extremely well, by the way). Even if 2013 should prove to be as bad as 1999, we’ve already seen more than 2/3 of the decline. I suspect, however, that the drop will moderate rather than worsen in the second half of the year. Either way, the worst is probably behind us.

Don’t Get Carried Away

People always search for explanations as to why the markets behave in a certain way. Occasionally, it’s obvious, but most of the time it’s nearly impossible to relate economic and financial news to market moves. The most popular explanation for current market volatility mainly points to statements by the US Federal Reserve that their unusually loose monetary policy will eventually end. This really isn’t news, but supposedly investors were surprised that the Fed might actually begin to tighten sometime in the next year or two. (This would be entirely appropriate, by the way.)

But in my opinion, the real reason for the recent drop in both stock and bond prices traces to Japan—yes Japan—and the “carry trade.” This may be arcane stuff, but it’s what really moves markets in the short-term. Let me explain.

The “carry trade” is a technique by which hedge funds and other big investors (e.g., Goldman Sachs) borrow money very cheaply and then invest that borrowed money in stocks and bonds. Over the past several years, interest rates in Japan have been extremely low, with short-term rates near 0% and even long-term rates under 1%. So if one can borrow money almost for free, any investment, even US Treasuries yielding less than 2%, produces a nice return. The spread between the cost to borrow the funds and the investment return doesn’t have to be very high because so much leverage is involved.

But, as you know, leverage is a double-edged sword. Big gains can quickly turn into big losses. And this is exactly what happened with the Japanese carry trade in early May. For several months previously, conditions had been ideal. Interest rates in Japan were low and getting lower while stocks and bonds were doing well. On top of this, the Yen was rapidly declining in value, so these investors were even making money just by borrowing in Yen: As the Yen became cheaper, the value of their debt was falling in dollar terms, so they were paying back less than they borrowed.

Suddenly, everything changed. Japanese stocks fell sharply, interest rates in Japan rose, and the Yen surged in value. Declines in non-Japanese stocks and bonds followed. It was a perfect storm. Investors had to exit the carry trade—and fast. So they sold many of their leveraged investments and paid off their Yen loans. This, of course, accelerated the decline in stock and bond prices and the appreciation in the Yen. As is typical, rapid moves in asset prices caused other investors to sell, and we had a full-fledged stock and bond correction.

By now, the carry trade has been reduced in size, the Yen has declined in value to about where it was in early May, and asset prices have stabilized. As I said above, there could still be a second leg to this correction, driven by the same or different forces. If so, we’ll probably see it in August. But after that, markets will likely calm down.

Inside the Beltway

Meanwhile, down at the US Supreme Court, the justices have been busy revealing their latest, and most important, decisions for the term just ended. Of most significance to my clients are those regarding California Proposition 8 and the federal Defense of Marriage act (DOMA). In both cases, the Supremes invalidated the laws, letting the Appeals Court decision stand for Prop. 8, and declaring part 2 of DOMA to be unconstitutional. Both outcomes are exactly as I expected. The Prop. 8 decision permits same-sex marriages to restart in California, and indeed they already have. But other states were unaffected, leaving each to decide how to handle unions between gay individuals.

Of even greater significance is the DOMA decision. While the part permitting states without same-sex marriage to ignore those performed in states that have them was untouched, all federal laws mentioning marriage must now apply to same-sex couples as well as heterosexual unions. As there are over 1,400 such laws and statutes, the consequences are wide-ranging. From filing joint tax returns to receiving spousal Social Security benefits, same-sex couples who are married or in civil unions will now enjoy all the benefits (and obligations) under federal law of heterosexual couples. Make no mistake: this was a game-changing decision.

Over the next several months, the consequences of these changes will become clearer. As federal regulations are modified and refined, planning for same-sex couples who are married or in civil unions will evolve. I’ll be addressing these changes and consequent adjustments to client financial plans in review meetings during the rest of this year and the first few months of 2014.

As Heraclitus said over 2,500 years ago, “The only thing that is constant is change.” Sometimes change occurs gradually, sometimes in leaps and bounds. With the overturn of Prop. 8 and DOMA, we’ve seen some great leaps. Let’s make the most of this opportunity.

Congratulations to all the beneficiaries of the Supreme Court’s decisions!

Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)

Market Week: July 3, 2013

July 3rd, 2013

The Markets

Investors seemed to regain some perspective last week. After a rocky Monday, equities began reclaiming some of the territory that had been surrendered the previous week, helped by a revision to economic growth and reassurances from Fed officials who reiterated that any tightening would depend on future economic data. The S&P 500 once again managed to top 1,600, while the Dow briefly surpassed 15,000 but couldn’t hold on to it. The Nasdaq and the small caps of the Russell 2000 substantially outperformed the other two domestic indices for the week, while statements from China’s central bank helped reassure investors in the Global Dow.

Bonds also saw volatility as investors continued to pull money out of bond funds, though a midweek spike in yields seemed to stabilize a bit by week’s end. Gold plummeted once again, losing roughly $60 an ounce to end near $1,220 an ounce.

Market/Index

2012 Close

Prior Week

As of 6/28

Week Change

YTD Change

DJIA

13104.14

14799.40

14909.83

.75%

13..78%

Nasdaq

3019.51

3357.25

3403.25

1.37%

12..71%

S&P 500

1426.19

1592.43

1606.25

.87%

12..63%

Russell 2000

849.35

963.68

977.48

1.43%

15..09%

Global Dow

1995.96

2086.18

2110.60

1.17%

5.74%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.78%

2.52%

2.52%

0 bps

74 bps

Equities data reflect price changes, not total return.

Last Week’s Headlines

· The U.S. economy grew more slowly during the first quarter than previously thought; the final figure for the increase in Q1 gross domestic product was 1.8% rather than 2.4%. The Commerce Department said that despite an improvement in residential construction, consumer spending on services rose less than expected and businesses invested less in buildings and plant facilities. Also, both exports and imports fell instead of showing gains.

· In a landmark ruling that struck down the Defense of Marriage Act, the U.S. Supreme Court paved the way for same-sex couples to claim the same federal tax and other benefits as other married couples in states that recognize same-sex marriages. Some of those benefits include survivor’s/spousal Social Security and military benefits, the ability to inherit a spouse’s estate tax-free, family medical leave rights, spousal visas and IRA contributions, joint federal income tax filings, and certain private pension benefit options.

· April home prices in the areas measured by the S&P 500/Case-Shiller 20-city index were up 12.1% over last year–their largest year-over-year gains in the last seven years. Also, April’s 1.4% increase was the biggest monthly gain in the index’s history.

· China’s central bank attempted to calm turbulent markets there by saying it would help banks with any cash shortfalls, but continued to warn against reckless lending.

· Consumer spending rose 0.3% in May, almost completely reversing April’s 0.3% decline, and incomes rose even more. The Commerce Department said the 0.5% gain in incomes, fueled by higher wages, investment income, and entitlement payments such as Social Security, helped push the personal savings rate up as well; the 3.2% savings rate was the highest since December.

· May sales of new homes were up 2.1% and were 29% higher than in May 2012; according to the Commerce Department, that’s the greatest annual increase since the summer of 2008. The increase occurred despite rising mortgage rates. Freddie Mac said the average rate for a 30-year fixed mortgage hit 4.46% last week. That was its highest level in almost two years, and represented the biggest weekly gain since 1987.

· European finance ministers took an important step toward unifying banks there by agreeing on a joint framework for dealing with failing banks. The agreement provides that regulators will look to bank creditors and investors first, followed by depositors with more than €100,000, to share in the cost of any bank failures–so-called “bail-in” measures–before turning to governments for financial assistance. The agreement must win approval from the European Parliament.

· New durable goods orders followed a strong April with an equally strong May; according to the Commerce Department, new orders were up 3.6% for the month. Business orders for new capital equipment were up 9.3%, with defense-related spending accounting for much of the gain.

· The Commodity Futures Trading Commission charged former MF Global Holdings CEO Jon Corzine and a former assistant treasurer for the company with misdirecting more than $1 billion from customer accounts to cover corporate shortfalls shortly before the firm’s 2011 collapse.

Eye on the Week Ahead

After recent gyrations in multiple markets, investors may welcome an abbreviated trading week, though light trading volumes around the July 4 holiday also could exaggerate market movements. In light of the Fed’s recent announcement, the unemployment rate is likely to be of even more interest than usual, since good economic news has tended to bring down markets lately (and vice versa). Also, Thursday brings a European Central Bank meeting on interest rates.

Key dates and data releases: U.S. manufacturing (7/1); factory orders, auto sales (7/2); balance of trade, U.S. services sector (7/3); European Central Bank meeting (7/4); unemployment/payrolls (7/5).

Data sources: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.