Thanksgiving Musings

November 28th, 2013
It’s again that time when we start to review the past year and make plans for the next one.  2013 has already seen plenty of excitement, both financially and politically. At least the markets have so far provided the kind of excitement we prefer, rather than the pain we experienced in 2008! Politics is another story, as the folks inside the Beltway continue to supply juicy material for the news media and late-night comedians.
With all the infighting in DC, one might forget that the US is still one of the best places in the world to live. We continue to boast the highest average standard of living (though the distance between rich and poor does continue to widen) and, unlike Germany, actually have a federal government. (More than 2 months after the election, a coalition government has yet to form.)
Our economy, while not growing as quickly as China’s, is doing rather well, and looks to continue modest to moderate growth for some time to come. The financial excesses from the years leading up to the Great Recession have mostly been cleansed, providing a stable base on which to build. Most importantly, innovation continues unabated, from the Cloud to fracking to Facebook.  In post-industrial society, knowledge is not just power—it’s money. And though no longer hosting the only game in town, the US still leads in this department.
With so many skilled people out there, it’s too bad the federal government can’t hire competent programmers. The considerable problems with the Obamacare website are well known, and still a long way from being fixed. Granted, it’s one of the most complex pieces of software ever created, but seriously folks: they’ve had a couple of years to figure this out. If they’d outsourced it to Google, it would probably be in far better shape.
And then there’s Iran. An historic deal was signed last weekend between the Islamic Republic and the P5+1 (the five permanent members of the UN Security Council plus Germany). Though there’s still a lot of work to do, these countries made an important first step in finally limiting Iran’s nuclear program to peaceful applications and taking the “bomb” off the table. Some people are apparently not happy with this turn of events, but don’t let the public rhetoric confuse you. Israel, for example, will be pleased as punch if Iran really does give up making a nuclear weapon.
Much of the opposition results from fears of how the balance of power will be shifting in the Middle East. Saudi Arabia has the most to lose with this deal, and Russia suddenly becomes much less of a player. For those who are interested, I can forward some geopolitical analyses of what the agreement really means (assuming Iran sticks to its word this time), and why the US-hating Islamic government would even consider such a move. But make no mistake: this is not just another Iranian head fake, and will mold a very different geopolitical landscape throughout the region. It could also have significant investment implications as Iran and Iraq modernize their oil infrastructure and become major competitors to Saudi Arabia and Russia in petroleum exports.
But enough about politics and investing. Enjoy the Thanksgiving holiday, be grateful for what you have that so many do not, and eat until you can’t move. Then get some exercise on Friday and Saturday (I do not mean shop until you drop). But most importantly, take a step back from the rat race to reflect on life and make some realistic plans for 2014—not resolutions that will fade away by February. You’ll be glad you did.
Peace on Earth and Happy Everything!
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Kenfield Capital Strategies℠ (KCS) is a registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with comprehensive financial, estate and tax planning services.

Market Week: November 27, 2013

November 27th, 2013

The Markets

Another week, another record: The Dow’s seventh consecutive week of gains ended with a close above the psychologically significant 16,000 level for the first time ever, while the S&P 500 surpassed 1,800 for the first time. Meanwhile, the price of the benchmark 10-year Treasury note fell midweek after minutes of the Fed’s most recent monetary policy meeting were released, but managed to regain some strength by the end of the week.

Market/Index

2012 Close

Prior Week

As of 11/22

Week Change

YTD Change

DJIA

13104.14

15961.70

16064.77

.65%

22.59%

Nasdaq

3019.51

3985.97

3991.65

.14%

32.20%

S&P 500

1426.19

1798.18

1804.76

.37%

26.54%

Russell 2000

849.35

1116.20

1124.92

.78%

32.44%

Global Dow

1995.96

2430.80

2442.03

.46%

22.35%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.78%

2.71%

2.75%

4 bps

97 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Last Week’s Headlines

· A nearly 3% decline in gas prices cut consumer inflation by 0.1% in October, according to the Bureau of Labor Statistics. That put the annual inflation rate for the last 12 months at 1%. Gas prices also were largely responsible for a 0.2% drop in the wholesale inflation rate during October, leaving the increase in wholesale prices over the last 12 months at a mere 0.3%.

· Retail spending by U.S. consumers rose 0.4% in October, and retail sales were 3.9% higher than a year earlier. The Commerce Department said sales of autos, electronics/appliances, and clothing saw the strongest monthly gains. Auto sales were up almost 12% from last October, and sales at nonstore retailers rose more than 8% during the same time.

· Minutes of the Federal Reserve’s most recent monetary policy committee meeting suggested that tapering of the Fed’s economic support is still likely to happen sometime over the course of the committee’s next few meetings. Members also suggested that once the Fed begins to cut back on its bond purchases, it may attempt to provide more guidance on the future of interest rates.

· Two key gauges of U.S. manufacturing activity showed signs of slowing growth in October. The Philly Fed survey fell to 6.5% from October’s 19.8%, while the Empire State survey declined 2.2%, its first negative reading since May.

· Sales of existing homes were down for the second month in a row, according to the National Association of Realtors®, though sales were 6% higher than the same time last year. October’s 3.2% decline was attributed to the relatively low number of homes for sale as well as double-digit year-over-year price increases for the last 11 months.

· Recurring uncertainty about the U.S. debt ceiling and budget battles, as well as the anticipated impact of future Federal Reserve policy, threaten global recovery even more than financial conditions in the eurozone and Japan, according to the Organisation for Economic Co-operation and Development. The OECD’s semiannual forecast for global growth fell roughly half a percent to 2.7% for 2013 and 3.6% for 2014, with the United States seeing growth at 1.7% and 2.9% over the same time frames.

Eye on the Week Ahead

Housing is likely to be the focus of the holiday-shortened week as two months’ worth of data on housing starts and building permits, as well as the most recent data on home prices, will be released. Estimates of Q3 economic growth will undergo revision.

Key dates and data releases: housing starts for September and October, home prices, second estimate of Q3 GDP (11/26); durable goods orders, personal income/spending (11/27).

Data sources: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market data: U.S. Treasury (Treasury yields); WSJ Market Data Center (equities); Federal Reserve Board (Fed Funds target rate); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold, NY close); Oanda/FX Street (currency exchange rates). 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.

Making the Most of Tax Loss Selling Season

November 23rd, 2013
Capital gains taxes can be a major burden for investors, especially in California where they are taxed at the same rate as ordinary income. To calculate your taxable capital gains during a year, you must net out your realized gains and losses on investments sold that year, plus any losses carried forward from prior years. While California taxes all capital gains at the same rate, the federal government differentiates short-term gains on assets held for one year or less from long-term gains on assets held for longer than one year. The federal government taxes short-term gains at the same rate as ordinary income, while long-term gains are taxed at 15% for most investors (20% for the highest income brackets, 0% for the lowest bracket).
What is tax loss harvesting?
Savvy investors can reduce their capital gains taxes through tax-loss harvesting. This involves taking losses to offset capital gains (or even ordinary income up to $3,000). Investors usually wait until December to do their tax-loss selling, but there’s no reason you can’t do this at any time of year.
Let’s suppose, for example, that you have $15,000 in realized investment gains for the year and want to wipe out the taxes on those gains. To do this, you sell one or more positions at a loss. If the loss on these sales equals or exceeds $15,000, then you will owe no capital gains taxes for the year. If you take a bigger loss, you can use up to $3,000 to offset ordinary income, and carry the rest over to future years. While tax-loss harvesting sounds easy in theory, it can be emotionally difficult to take a loss on a stock you thought was going to perform well, especially if you still like it as a long-term investment.
You could, if you are still bullish on a security, sell it for a loss and buy it back, but you must wait at least 31 days. If you buy it back within 30 days, this constitutes a “wash sale” and the IRS will not allow you to recognize the loss.
Substitution
If you want to avoid the wash-sale rule and also not be underinvested for 31 days (during which, according to Murphy’s Law, the stock you just sold will surge in price), you can use substitution and buy a security that’s similar to the one you just sold. In particular, you’re looking for a stock whose price movement correlates with the one you sold: highly correlated stocks move almost in tandem with one another.
Let’s say your ATT (NYSE: T) position has lost value since it was purchased, and you want to sell your ATT stock to offset capital gains. You could substitute the ATT with a similar company whose stock movement correlates highly with ATT stock. Not surprisingly, industry sector is a major determinant of correlation between two stocks, and high correlation is more likely between two companies in the same industry. In this case, Verizon (NYSE: VZ) is a good substitute.
If you sell $10,000 of ATT stock at a loss, you can put that $10,000 into Verizon stock and probably capture the same benefits you would have gained by holding onto your AT&T. Certainly there are events that could affect the stock price of one US telecom giant but not the other (such as the recent purchase of 49% of Verizon Wireless from Vodafone), but over the long term these stocks move so similarly that the risk of non-correlation is small—and worth it for the certain reward of tax savings. Also, if you wish, 31 days after you sell your ATT stock you could put it back into the portfolio and sell Verizon.
Keep in mind that ATT/Verizon is a rare example of two companies that are extremely similar (same industry sector, same sub-sector, similar revenue bases, similar size, etc.) and you won’t always be able to find such close substitutes. While there is no such thing as a perfect substitute, almost every stock has a similar company you can plug into your portfolio to take advantage of a tax-saving opportunity.
Tax loss selling and the January Effect
You may have heard of the “January Effect,” which describes the observation that small-cap stocks typically outperform larger ones during the month of January. There have been many explanations for this phenomenon, but one that I like is the effect of tax loss selling the previous month.
Individuals are more likely to engage in tax loss selling than institutions, many of which are not taxed. Smaller stocks have historically been owned mainly by individuals, and their smaller trading volumes make them more volatile than larger stocks. Thus, when many individual investors are selling their small-stock losers in December, their prices can drop significantly on top of the losses incurred in the prior 11 months. In January, this selling pressure disappears and buyers swoop in to purchase these relative bargains.
You can take advantage of this effect by: 1) selling your losers before the crowd, in late November or early December, so as to avoid tax-loss-selling-induced price drops; and 2) buying, in late December, stocks that have been pushed down in price by tax loss selling. This trick can also work with larger stocks, but the price swings are rarely as dramatic.
How do you find good candidates to buy? Well, I’d tell you, but then I’d have to kill you. I’ll give you a hint, though: look at the biggest losers for the year as of early December and then pick a few you like and watch their prices during the rest of the month. Chances are, several of them will go lower—perhaps much lower—sometime during the month. Then swoop in and buy some of those.
Do both and reap bigger rewards
At KCS, we routinely engage in tax loss harvesting to minimize our client’s taxes. This is the exact opposite of what you see with most mutual funds, which can hit you with quite a bit in taxes, including short-term gains taxed at your ordinary income rate. We also look for those December bargains that come from other people’s tax loss selling. It’s a win-win all around.
At this point, you may be wondering how one can keep up this process every year. Eventually, there are no more losers and the stocks that are left have bigger and bigger gains. This is true to some degree—although we do take gains as stocks become overpriced or too large a part of a portfolio. But even in a good year, there are nearly always a few losers that can be used to offset gains. And postponing gains far into the future has benefit in itself, both from paying taxes later and from investing the money that would otherwise go to the IRS.
There are even ways to avoid ever paying capital gains tax on your winners. But that’s a story for another day.
Yes, taxes are inevitable, but there’s no reason you should pay more than you have to. Tax loss harvesting is just one of many tools that we use to keep the IRS (and the California FTB) out of your pockets.
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Kenfield Capital Strategies (KCS) is a registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with comprehensive financial, estate and tax planning services.

Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®

Founder and President – Kenfield Capital Strategies (KCS)

Kenfield Capital Strategies (KCS) is a registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with comprehensive financial, estate and tax planning services.

Reaping the benefits of dividends

November 18th, 2013
101613_After the bell

Investors don’t seem to think much about dividends. But in a sense, the dividend that a company pays can be the most important indicator of value that we have. For example, when interest rates are low, and bonds can’t provide more than 3 percent at best, and savings accounts give almost nothing, a stock that pays a dividend of 2 to 3 percent seems like a good investment.

But, people say, “I might get the dividend, but lose it all back in a decline in stock price.” Technically that’s true, but the fact that the dividend exists provides a very good hedge against much decline in the price of the stock. This is because if the stock price goes down, the percentage return of the dividend goes up, and if the percentage return gets higher than other stocks of equal quality, lots of buyers will come out of the woodwork and drive the price back up.

But, or course, that depends on the financial strength of the company.  Last year, as a test (my wife says a “lark”) I bought four stocks that paid dividends between 9 and 17 percent just to follow them and see what happens. One is out of business. Two are limping along, but still paying a dividend. One is doing well and the price of the stock is up. But, overall, I am losing money on this test. And that’s what I would expect with low quality, high risk stocks.

But there are lots of stocks out there that are really solid and pay a nice dividend. One of these is Apple (AAPL), which, for a while, paid a dividend over 3 percent. Today the dividend is 2.5 percent, but that’s better than I can get at my bank. And if the stock goes down, the dividend itself will make it attractive to investors.

Sovereign Self Storage (SSS) has been a very profitable holding for me.  True, it’s at a new high right now, and I might take my profit and run.  But it still looks like a good solid buy, and it pays a dividend right now of 2.8 percent. If it dips I would buy it.

Aflac (AFL) is another solid company, and currently pays a 2.2 percent dividend. I bought it recently (along with Whole Foods, which does not pay much of a dividend) as a growth stock investment.

Another high yield stock is China Mobile (CHL). That company is a bit less solid that the others I’ve mentioned because it has a lot of competition. But there is a possibility that it will make some deal to represent and distribute Apple products in China, and that could be very profitable for them. In spite of a run-up in the stock, at today’s price it still pays a dividend of 3.5 percent. For a stock with significant upside, that seems like a good risk. I bought some.

If you are interested in taking advantage of high dividends, one way is to invest in one of the many funds that specialize in high dividend stocks.  Cullin and JP Morgan are two sources that have been recommended to me.

Years ago I had a friend that was a very successful financial manager.  His clients included a number of the royal families in Saudi Arabia and other Mideast oil producing countries. He only bought large cap stocks that had not only paid a good dividend for at least 10 years, but during that period the dividends had increased by a certain percentage. For a long time it was an amazingly successful strategy.

Then came the hi-tech bubble, and the market shifted from solid large-cap stocks to high-risk start ups with huge upside potential — and huge potential for you to lose all your investment. My friend’s strategy was no longer mainstream, as other managers showed astronomical returns.

This might be a good time to revisit his strategy. That’s not to say that the tech sector is not good. I think this is a good time to invest in it. But don’t buy stock into just one company: I’m investing only in the QQQ index to reduce the risk of a big loss.

Finally, a couple of miscellaneous observations. I’m seeing more warnings about volatility between now and the end of the year. So this might be a good time to hedge your portfolio with short-term inverse options. For the long term I continue to suggest getting out of bonds.  The bond market is not looking good for 2014.

Market Week: November 19, 2013

November 18th, 2013

Market Week: November 18, 2013

The Markets

Another Dow record on Monday was followed by three more record closes for the index during the week, while the S&P 500 notched its 36th record closing price of the year. Meanwhile, the Nasdaq and small-cap Russell 2000 maintained their year-to-date leadership as the Nasdaq reached a level not seen in more than 13 years.

Market/Index

2012 Close

Prior Week

As of 11/15

Week Change

YTD Change

DJIA

13104.14

15761.78

15961.70

1.27%

21.81%

Nasdaq

3019.51

3919.23

3985.97

1.70%

32.01%

S&P 500

1426.19

1770.61

1798.18

1.56%

26.08%

Russell 2000

849.35

1099.97

1116.20

1.48%

31.43%

Global Dow

1995.96

2395.85

2430.80

1.46%

21.79%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.78%

2.77%

2.71%

-6 bps

93 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Last Week’s Headlines

· Growth in the eurozone was sluggish in the third quarter, slowing to 0.1%; that represents an annual rate of just 0.4%, compared to the second quarter’s annualized 1.2% rate. Powerhouse Germany, which saw 2.9% growth in the second quarter, had less than half that in Q3.

· President Obama said insurance companies that have cancelled existing policies that do not meet the standard of the Affordable Care Act will now be allowed under the act to extend those policies for existing policyholders into 2014. However, state insurance regulators would also have to agree to the extensions. Also, insurers must outline the coverage provisions available under the ACA that are not included in those policies, and notify the policyholders that they may also shop for another policy through an insurance exchange.

· Janet Yellen reassured members of the Senate Banking Committee that if confirmed to replace Ben Bernanke to chair the Federal Reserve Board, she would continue the Fed’s current “data-driven” approach to tapering Fed economic support.

· Cleared for takeoff: The Justice Department agreed to settle an antitrust suit and permit the $17 billion merger of American Airlines and US Airways, which will create the world’s largest airline carrier. The agreement will require a reshuffling of airline service, since the two airlines will have to relinquish some of their gates, primarily at Washington’s Reagan National and New York’s LaGuardia but also at five other airports.

· A Miami-based mutual fund company offered to buy portions of the federal government’s stake in mortgage guarantors Fannie Mae and Freddie Mac. Fairholme Capital Management, which already owns preferred shares in the two companies, said it would lead a consortium of investors interested in the mortgage-guarantee business. The companies, which have been under federal authority since the 2008 financial crisis, have become profitable; after third-quarter earnings, Fannie Mae will have paid the government almost $114 billion (after having gotten $116 billion in financial assistance), while Freddie Mac will have paid the Treasury $9 million more than the $71.3 billion worth of aid it has received.

· The International Energy Agency said that OPEC countries’ role in the global energy market is being diminished by increased production in the United States and Brazil. The IEA forecast that the United States could temporarily surpass Saudi Arabia as the world’s largest producer of natural gas and oil by 2016, though that trend would likely reverse by the middle of the following decade. India and Southeast Asian countries will join China in helping to increase consumption by as much as one-third by 2035.

Eye on the Week Ahead

Data on U.S. manufacturing, housing, and retail sales could suggest whether the Q4 economy got off to a good start, while minutes of the Fed’s most recent monetary policy committee meeting are always of interest.

Key dates and data releases: international capital flows, homebuilders survey (11/18); employment cost index (11/19); consumer inflation, retail sales, home resales, business inventories, Federal Open Market Committee minutes (11/20); wholesale inflation, Philly Fed manufacturing survey, leading economic indicators (11/21).

Data sources: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market data: U.S. Treasury (Treasury yields); WSJ Market Data Center (equities); Federal Reserve Board (Fed Funds target rate); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold, NY close); Oanda/FX Street (currency exchange rates). 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.

Don’t bond with your bonds, buy short term

November 17th, 2013

My friend Bill showed me his managed investment account the other day.  “While the S&P 500 is up 14 percent for the year, my account is only up 8 percent,” he moaned.

When I looked at his account, I saw the main reason. Like most investment advisers, Bill’s put 50 percent of his funds into bonds, and the other 50 percent into stocks and funds. The bonds had not gone up in value at all, and were producing about a 3 percent yield at best. So only 50 percent of the account was really in the market, and that 50 percent had actually outperformed the market a bit.

So why does anyone invest in bonds if they don’t perform as well as stocks and funds? That’s a debate that has been going on for a number of years. The rationale is that no one should put all their eggs into the market basket. If the market takes a real dive, you won’t lose all your eggs.

In the good old days that was a pretty good idea because bonds were paying a return greater than inflation. Today it is more questionable. During the past few years bonds have been paying very low returns, and while that might be in line with what the government says is the inflation rate, it doesn’t feel that way in the pocketbook. Investing in bonds over the last few years has not been very profitable.

And yet I do it. But I’m very careful about how I do it. Here’s the potential problem. When interest rates are as low as they are now, the only projected future for them would be to go up. But as interest rates go up, the value of bonds goes down. That’s because nobody wants your stinking 2 percent bonds if they can buy bonds just issued that are paying 3 percent. So your old 2 percent bonds become worth about $70 for every $100 dollars you paid for them.

Of course the saving grace for bonds is that unless the issuer goes out of business (another issue to discuss) upon maturity you will get back the amount you put in. If you think of bonds as a holding tank for some of your investment dollars, it’s a pretty good idea. But the trick when interest rates are low is to only buy short-term bonds, say two to three years in duration. Then you know that you will get your money back in a reasonably short period of time, and the value of the bonds will not go down so much because the money is not tied up for very long.

Another consideration is the financial credibility of the issuer. The best issuer, of course, is the U.S. government. But they pay the least return since everyone knows that it is a safe investment — 100 percent guaranteed. If the U.S. government goes out of business, your money is no good anyway, so you might as well have bonds. Even confederate bonds from the Civil War now have historical value.

As you move away from the most secure, you go to corporate bonds, and you can move from really solid companies to less solid, inappropriately called “junk bonds.” In fact, many are not junk, just not as safe as the best AAA companies. The junk bonds can pay much higher interest rates than government bonds or AAA company bonds.

Many investment advisers recommend only U.S. bonds because they don’t think the increased interest rate warrants the risk. I feel just the opposite. I think that if you buy a short-term junk bond fund, or a group of bonds in diverse industries, so that your risk is diversified, the larger dividend is well worth the risk.

Then there are some alternative bond investments, such as municipal bonds, which are generally tax free and pay an even lower interest rate (but since the return is tax free, the net after-tax result is typically about the same) and BND, the stock market exchange-traded fund for bond funds. That’s been moving down steadily in the recent past.

How to select a municipal bond is worth an article by itself.

One last point: the big advantage of bonds is that on maturity you get your money back. Remember, that’s not really true when you buy a bond fund. So, while bond funds are an easy way to diversify, they eliminate that one big element.

–Mervyn Hecht

Le Downgrade

November 17th, 2013
Last week Standard & Poors (S&P) lowered its credit rating on France’s debt for the second time in two years. With a growing fiscal deficit, even after increasing tax revenues by €30 billion ($40 billion) in 2012, the rating agency believes France’s medium-term growth prospects remain bleak. In our opinion, while the country faces many challenges in healing its economy, there is one core issue in France’s financial conundrum: an uncompetitive labor market.

A broken system
French unemployment is currently 11% and expected to rise next year, not a positive sign for an economy “being repaired,” as Finance Minister Pierre Moscovici would have us believe. Thanks to notoriously “tough” labor unions, it is incredibly expensive for French companies to lay off employees, and the next best option (closing shop) can lead to riots and protests.
There are two ways to shrink a deficit—increase revenues or decrease spending. The consensus opinion is that another tax hike in the near future is unlikely given the political unrest that resulted from previous tax increases. Instead, the government proposed what it calls “unprecedented” spending cuts for its 2014 budget, yet neither economists nor S&P believe these measures will be nearly enough to get France back on track.
Even after exhausting most of its ability to increase revenue and cut spending, the situation in France remains messy. S&P projects France’s net government debt will peak at 86% of GDP in 2015, higher than Germany’s and Spain’s current government debt percentages of 57% and 72%, respectively. Paying down all this debt will be difficult, as real GDP growth looks to be anemic going forward—close to zero in 2013 and a projected average of 1% annually for 2014 and 2015.
Just how broken, you ask?
Many of the issues holding France back from being a globally competitive labor market were on display in February, when the CEO of American tire manufacturer Titan International (NYSE: TWI) declined to purchase Goodyear’s (NASDAQ: GT) failing tire plant in Amiens, France. Titan has a 40-year history of buying unprofitable factories and returning them to profitability, but CEO Maurice Taylor found the deal to be so unattractive that he walked away and publicly expressed his criticisms of French employees, unions and labor laws.
Amid financial troubles in 2007, Goodyear offered a proposal to the staff of its Amiens Nord plant that would have required them to change production shifts to enhance productivity, but no jobs would be cut. When that proposal was rejected, management had no choice but to lay off 402 employees; however, French labor laws permitted these workers to sue the company on the grounds that the layoffs were unlawful. In 2009 Titan began negotiations to purchase some of Goodyear’s European plants (including Amiens Nord), but was unable to secure court approval for a restructuring project that would have cut 817 jobs. Taylor’s final offer was that he would keep about half the plant’s staff for two years guaranteed, but the union demanded that employees’ jobs be secure for seven years!
So instead of allowing Titan to return several French tire plants to profitability, the French government let them walk. Even if Titan had restructured the plants and cut jobs, there would still have been operational factories employing French workers, and these companies would have continued to pay taxes to the French government. Instead, Goodyear decided to shut down the Amiens Nord plant and has cut tire output by 90% to 2,000 tires a day. Yet they are still required to keep all the workers employed and pay them full salary even though most of them only work 2 hours per day. This episode illustrates what a difficult business environment French labor laws and unions have created, and why high unemployment persists. Soon, these people will all be out of work and this plant (and many others) will send zero tax revenue to the government.
What does this mean to investors?
Investors were unfazed by the credit downgrade—French equity indexes and yields on French debt barely moved. This doesn’t mean that investors aren’t concerned about the economic stability of the country; rather, they had already priced this uncertainty into the market.
While French government debt has been affected by the country’s economic problems, that doesn’t mean its companies cannot thrive in this environment. The main exception may be French banks, as they are sensitive to interest rates and likely hold a significant amount of government debt on their balance sheets.
Going forward
There is nothing “simple” about fiscal policy and budget deficits, but the long-term solution isn’t terribly complex—you have to increase revenue or cut spending, or do both. Tax hikes and spending cuts have been all but exhausted for the near future, which leaves only one solution: increase tax revenues by making the French labor force competitive, helping to make the country a desirable place to do business.
Currently many companies are closing down French operations or taking their businesses elsewhere. If France has any hope of digging themselves out of debt, its leaders will have to follow the example set by Spain over the last few years: embrace drastic labor reforms and deal with the protests and other consequences knowing they are making long-term decisions that are best for the French economy and the French people.
Vive (encore) la France!
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Kenfield Capital Strategies℠ (KCS) is a registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with comprehensive financial, estate and tax planning services.

October Surprise

November 11th, 2013
October is considered by many to be the scariest month for the stock market. This is mainly because big and unexpected market moves often happen during October. In fact, three of the biggest one-day drops in stock market history—1929, 1987 and 2008—all happened in October. This year, we had a showdown in the DC corral over Obamacare and the debt ceiling that led to a federal government shutdown along with lots of angst over a possible US debt default. The conditions were ripe for another stock market crash.
But the October surprise of 2013 was that, despite all the scary news and October’s reputation, nothing bad happened. Instead, the MSCI All-Country World index rose +3.7% during the month. It turns out that an improving economy and good corporate earnings trumped economic losses from the government shutdown and gridlock in DC. The lesson from all this should be that forecasting the near-term direction of the stock market is impossible, and always will be.
How to predict equity returns over a decade or more.
On the other hand, longer-term equity returns (10 years and more) are somewhat more amenable to forecasting. This is partly because the variation in return from one decade to the next is far less than from month to month and year to year. In addition, in the short term, lots of competing influences can affect stock prices, but over the longer term, corporate earnings and valuation matter most of all.
Let’s take the last decade as a case in point. In 2000, stock valuations were the highest they have ever been (even higher than in 1929). Based on that knowledge alone, one could surmise that the next decade would likely provide sub-par equity returns. And indeed, that’s just what we saw: from January 1, 2000 through December 31, 2009, the MSCI World index gained a mere +0.35% per year, far below its 40-year average of +8.7%. The excessive valuations suggested that no matter how well the economy did in subsequent years, stock market performance would be subpar. (Investor sentiment, on the other hand, was wildly optimistic.)
Let’s look at another decade, the one that began in 1982. In late summer of that year, equities reached valuations similar to those seen during the Great Depression. That knowledge alone suggested that stocks would likely do better than average over the subsequent decade. Again, they did just that. The MSCI World index, from September 1, 1982 through August 31, 1991, grew +16.5% annually—nearly double its historical average. Late 1982 was clearly a buying opportunity, yet few took advantage of it.
The next decade is still looking good.
March 2009 was another time when valuations were unusually low (lower even than in 1932 and 1982—see my article for an explanation). We’re a little less than halfway through the first decade since this historic low, and so far the MSCI World index has gained an average of +21.7% per year, dramatically above its long-term average. Typically, the largest gains occur in the first few years after a major market bottom, but secular (long-term) bull markets can continue for decades. After the Depression-era bottom, it was nearly 40 years until the next major bear market. I don’t know if we’ll be so lucky this time, but I’m confident that the next decade or two will be considerably better than the last one.
Equity valuations today, depending on how you measure them, are still somewhat below average, suggesting that we could continue to have above-average returns for a while longer. But even if the market did just average from here for the next 10+ years, +8.7% per year is nothing to sneeze at, particularly with inflation rather low. At this rate, your investments double in just over 8 years.
There are lots of ways experts try to more precisely predict future equity returns over periods exceeding 10 years, none of them particularly accurate. One that’s probably as good as any other is to look at the yield on high-yield (junk) bonds. In December 2008, a few months before the stock market’s ultimate bottom in March 2009, junk bonds were yielding 13.1%. Since then, equities have returned 1.66 times that per year. Today, junk bonds yield a much more reasonable 6.4%. Using the same multiplier, this suggests equities should return about +10.6% annually over the next 5 to 10 years. That’s a reasonable guess (but it’s only a guess) and supports the view that stock valuations are on the cheap side today.
Stocks continue to be more attractive than bonds.
Ten percent per year compares favorably with returns on other types of investments, particularly bonds. While high-yield bonds should return roughly 6.4% annually over the next several years and are reasonably priced (though not cheap), US Treasuries remain overpriced. Even if interest rates don’t rise from here (an unlikely scenario over the next decade), 10-year Treasuries will only return about +2.6% per year, not much above today’s 1.7% inflation rate, and even closer to the bond market’s expected inflation rate of 2.2%. And if inflation or interest rates rise, look out! The bond market rout of this past spring should have convinced everybody that bonds, while less risky than stocks, are far from risk free: in the 4 months from May 1 through early September, long-term US Treasuries (with maturities of 20 years and up) lost -16.6% of their value. Even stocks rarely crater so fast!
But don’t dump your bonds yet.
In client portfolios, I do own bonds—sometimes a significant amount if the portfolio is conservative. But in even the most risk-averse portfolio, I put some equities to balance out the risk of rising interest rates and inflation. In addition, I diversify among many different types of fixed-income (bond-like) investments, and have been underweighting (or even completely avoiding) the most overpriced bonds such as US Treasuries and TIPS. At some point in the future, I’ll put more Treasuries into client portfolios, but that time is still a long way off.
And don’t bail on stocks, either.
If you believe what I’ve been saying, you should think twice before taking profits after this year’s stock market rally. We’re obviously a long way from the dark days of 2008, but I believe this bull market still has room to run. And certain countries and sectors still look particularly cheap, including parts of Western Europe and many of the emerging markets. Materials, energy and even a lot of technology stocks also appear underpriced, as does real estate outside the US. In short, don’t run away because you’re starting to get vertigo. At the same time, don’t think bonds have seen their day and no longer have a role in any portfolio. The future for investors continues to look bright, in spite of—or more accurately, because of—the 2008 financial crisis.
Is your portfolio up to par?
If you’re a client, you’ve probably seen a number of trades in your portfolio in recent months. (If you haven’t yet, you will soon.) We don’t like to trade often because it increases costs and doesn’t usually help performance, but there are times when major rebalancing is advisable. This is one of those times.
For non-clients, I’m again offering free portfolio reviews to anyone who wants one. If yours is like many I have seen, it’s too overweighted in the winners and missing out on the bargains that could become tomorrow’s high fliers. I can show you how to rebalance your portfolio so as to be fully diversified and at the right risk level for you. Give us a call if you’re interested.
Stay balanced,
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Kenfield Capital Strategies℠ (KCS) is a registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with comprehensive financial, estate and tax planning services.

Market Week: November 12, 2013

November 11th, 2013

The Markets

Despite some headline-driven mood swings, the Dow industrials managed to set a new record closing high for the 34th time this year, while the other domestic stock indices trailed in their wake. An unemployment report that was stronger than expected renewed fears of Fed tapering, sending the benchmark 10-year Treasury yield up for the second week in a row as prices dropped; the 10-year yield has now risen almost a quarter of a percent in the last two weeks.

Market/Index

2012 Close

Prior Week

As of 11/8

Week Change

YTD Change

DJIA

13104.14

15615.55

15761.78

.94%

20.28%

Nasdaq

3019.51

3922.04

3919.23

-.07%

29.80%

S&P 500

1426.19

1761.64

1770.61

.51%

24.15%

Russell 2000

849.35

1095.67

1099.97

.39%

29.51%

Global Dow

1995.96

2405.36

2395.85

-.40%

20.03%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.78%

2.65%

2.77%

12 bps

99 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Last Week’s Headlines

· The U.S. economy added 204,000 new jobs in October, according to the Bureau of Labor Statistics. However, the unemployment rate inched up 0.1% to 7.3%, in part because worker furloughs caused by the federal government shutdown may have distorted the figures. The BLS said the shutdown did not appear to have affected the data on new jobs, which is based on a survey of employers rather than households.

· The U.S. economy grew at an annual rate of 2.8% in the third quarter, according to the Bureau of Economic Analysis. The initial estimate, which is subject to two future revisions, represents an improvement from Q2’s 2.5% and matches the pace hit a year earlier.

· After two months of declines, U.S. manufacturers saw a 1.7% increase in new orders in September, according to the Commerce Department. However, a nearly 58% increase in commercial aircraft orders accounted for much of the increase; excluding the notoriously volatile transportation sector, new orders were down 0.2%.

· The eurozone is now forecast to grow just 1.1% next year rather than the 1.2% previously expected by the European Commission. However, that would still be better than the 0.4% contraction anticipated for 2013. The commission also sees 2014 unemployment rising slightly to 12.2%. To try to stimulate growth and combat a 0.7% annual inflation rate that is seen as too low to support economic recovery, the European Central Bank lowered the interest rate at which it lends to member banks to a record low of 0.25%. The move helped cut the euro to roughly $1.33 against the U.S. dollar.

· Despite the government shutdown, growth in the U.S. services sector accelerated in October, rising a full percentage point from September’s 54.4%. That represents the 46th straight month of growth for the Institute for Supply Management’s index of the sector.

· After more than a decade of investigation, the Securities and Exchange Commission announced that SAC Capital Advisors, one of the country’s largest hedge funds, had agreed to plead guilty to five criminal charges of insider trading and to pay a record $1.2 billion penalty. The fund also will no longer be able to accept outside investors.

· Technical problems with obtaining quotations once again led to a halt in trading of certain securities. The Financial Industry Regulatory Authority suspended all trading in over-the-counter stocks–so-called penny stocks–for more than three hours on Thursday because of difficulties with OTC Markets Group’s quotation system. The problems followed two outages at Nasdaq the previous week.

Eye on the Week Ahead

Data on eurozone economic growth will be available, as will two Federal Reserve gauges of manufacturing strength. Investors also will pore over the testimony of Federal Reserve Chairman nominee Janet Yellen at her confirmation hearing for any insights into future Fed action.

Key dates and data releases: balance of trade (11/14); industrial production, Empire State manufacturing survey, options expiration (11/15).

Data sources: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market data: U.S. Treasury (Treasury yields); WSJ Market Data Center (equities); Federal Reserve Board (Fed Funds target rate); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold, NY close); Oanda/FX Street (currency exchange rates). 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.

Market Week: November 5, 2013

November 4th, 2013

The Markets

After leading domestic equities for so much of the year, the small caps of the Russell 2000 took a hit last week, while the larger caps remained basically flat. Meanwhile, lingering worries about the timing of Fed monetary action sent the yield on the benchmark 10-year Treasury up strongly on Friday, though it still remained well below its almost 3% year-to-date high.

Market/Index

2012 Close

Prior Week

As of 11/1

Week Change

YTD Change

DJIA

13104.14

15570.28

15615.55

.29%

19.17%

Nasdaq

3019.51

3943.36

3922.04

-.54%

29.89%

S&P 500

1426.19

1759.77

1761.64

.11%

23.52%

Russell 2000

849.35

1118.34

1095.67

-2.03%

29.00%

Global Dow

1995.96

2414.28

2405.36

-.37%

20.51%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

1.78%

2.53%

2.65%

12 bps

87 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Last Week’s Headlines

· The Federal Reserve’s monetary policy committee provided little guidance on when it might begin tapering other than to say it wouldn’t be now. The announcement noted the recent slowing of the housing recovery and confirmed again that the unemployment rate would need to be closer to 6.5% before the Fed would begin raising interest rates.

· Home prices continued to rise in August, seeing their biggest year-over-year gains (nearly 13%) since early 2006, according to the S&P/Case-Shiller 20-City Composite Index. However, the pace of those gains has begun to slow over the last several months, and August’s 1.3% increase was the smallest gain of any month since March. Average home prices are back to mid-2004 levels, but are still roughly 20% below their mid-2006 peaks.

· Increases in the cost of energy and housing pushed consumer prices up 0.2% in September, according to the Bureau of Labor Statistics. That put the inflation rate for the past 12 months at 1.2%, its lowest level in almost 3 years. Wholesale prices fell 0.1% during the month, leaving wholesale inflation for the last 12 months at a paltry 0.3%.

· A 2.2% decline in auto sales cut retail sales by 0.1% in September, according to the Commerce Department. However, non-auto sales were up 0.4%, and total sales were still 3.2% higher than a year earlier.

· The Institute for Supply Management’s gauge of U.S. manufacturing saw little change in October, rising just 0.2% from October’s 56.2%. However, the reading still represents the index’s highest level so far this year.

· And the hits keep coming: Mortgage lender Fannie Mae filed suit against nine of the world’s largest banks, charging that it had lost $800 million because the banks had deliberately manipulated the London Interbank Offered Rate (Libor), which determines a variety of interest rates around the world. Bank of America, JPMorgan Chase, and Citigroup were named in the suit along with international institutions Barclays, UBS, Deutsche Bank, Credit Suisse, the Royal Bank of Scotland, Rabobank, and the British Bankers’ Association.

Eye on the Week Ahead

Data on U.S. economic growth in the third quarter will finally be available, and investors will see whether the federal government shutdown affected the October unemployment rate. Also, the European Central Bank meets on interest rates and will announce its decision on Thursday.

Key dates and data releases: factory orders (11/4); U.S. services sector (11/5); initial estimate of Q3 gross domestic product, European Central Bank monetary policy announcement (11/7); unemployment/payrolls, personal incomes/spending (11/8).

Data sources: All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. Market data: U.S. Treasury (Treasury yields); WSJ Market Data Center (equities); Federal Reserve Board (Fed Funds target rate); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold, NY close); Oanda/FX Street (currency exchange rates). 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.