Market Week: May 27, 2014

May 28th, 2014

The Markets

After spending weeks bouncing around just under 1,900, the S&P 500 finally managed to top it on Friday, setting a new record closing high in the process. And after a lot of back and forth at the beginning of the week, the Nasdaq and the Russell 2000 small caps rebounded strongly from their travails of recent weeks, though the small caps are still down for the year.

Market/Index

2013 Close

Prior Week

As of 5/23

Weekly Change

YTD Change

DJIA

16576.66

16491.31

16606.27

.70%

.18%

Nasdaq

4176.59

4090.59

4185.81

2.33%

.22%

S&P 500

1848.36

1877.86

1900.53

1.21%

2.82%

Russell 2000

1163.64

1102.91

1126.19

2.11%

-3.22%

Global Dow

2484.10

2533.44

2550.46

.67%

2.67%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

3.04%

2.52%

2.54%

2 bps

-50 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

· Discussion among members of the Federal Reserve’s monetary policy committee has begun to turn to how best to manage the impact of the end of supportive economic measures, whenever that seems appropriate. According to minutes of the committee’s most recent meeting, the state of the labor market was a major point of debate and will continue to play a major role in Fed policy.

· As more homeowners put their houses on the market in April, sales of existing homes rose 1.3% over the course of the month. It was the first monthly increase this year, but the National Association of Realtors® said that still left home resales 6.8% lower than the previous April.

· New home sales also jumped in April; the Commerce Department said they were up 6.4% for the month, though that was 4.2% below April 2013.

· Parties campaigning on anti-European Union themes gained ground in the EU’s parliamentary elections over the weekend. However, a majority of seats are still held by mainstream parties, so financial assistance programs for weaker members shouldn’t see any immediate disruption.

· Credit Suisse agreed to pay $2.5 billion to settle federal charges that for decades it had helped Americans avoid taxes by concealing assets in undeclared bank accounts. The Swiss bank also pleaded guilty to a criminal charge of conspiracy.

· China’s manufacturing sector was on the brink of expansion in May, according to the Markit Purchasing Managers Index. The reading on the monthly survey hit a four-month high of 49.7% (a reading of 50% indicates expansion). China also gave Russia some relief from Western economic sanctions by signing a $400 billion agreement to purchase gas from Russia’s leading supplier.

· A Pennsylvania federal grand jury charged five members of a Chinese military unit with stealing industrial secrets by hacking computers at six U.S. enterprises in the nuclear, solar, and metals industries. The indictment is said to be the first involving a governmental body rather than an individual corporation.

Eye on the Week Ahead

During the holiday-shortened week, investors will assess the results of the EU elections. They also will get a second look at Q1 economic growth and a smattering of manufacturing, housing, and consumer data.

Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). 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 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.

This Week’s Tickler

May 24th, 2014

I’ve been very active in the market, with a lot of success, and a few positions that…..well, you will see below.

I sold 5 puts on EBAY with a strike price of 52.20 and collected $2,200. I’m under water on the strike price but slightly ahead on gain. The stock is around 51.50 so if it goes up just a bit I’ll have a much nicer profit.

I sold 5 puts on CRM just before they announced earnings and took in $2,100. I expected the stock to jump up based on the announcement. The announcement was VERY favorable and the stock dropped 5%! Then it came back 5%. So I have a small profit with the stock now at 54, and like EBAY if it moves up just a bit I’ll have a very nice profit.

I continue to sell covered calls on Mattel with strike price of $40, and the stock is hovering just below that. I’m making a nice return on the investment. If you buy it below $40 and write calls on it I think it’s a good idea. It dropped enough so that it seems safe at around $38.

I continue to hold FCX because I still think copper will have its day, the only question is when.

I sold the $17 puts on Bank of America because I thought it was worth more than that, but they cancelled the dividend and the stock dropped to $14. There’s no significant premium in the calls right now so I’m just holding the stock. Someday, maybe soon, when they start to pay a dividend I believe the stock will go up nicely. If it doesn’t happen by next December I’ll take my $2,000 loss and write it off against some profits.

And I was snookered on WFM, that I sincerely believe in. I bought 500 shares at $55 based on it’s expansion program, and it dropped to about $38 for no reason that I can see. So I’ve sold 5 puts at $37.50 and if I acquire it there it will be a nice averaging play, and if not I’ll keep selling puts for premium income. But unless and until the stock goes back up it doesn’t look like it was a good trade.

I’m staying out of internet stocks: that sector seems too volatile and too competitive. I know there is money to be made there but it’s for people who know more than I do about the sector. Owning Apple stock is bad for my fingernails.

I’m looking at American Realty Capital Properties, Kinder Morgan, and Johnson and Johnson as buys if they dip.

Pretty much all of my other holdings are up nicely, but not spectacularly, and my portfolio continues to grow faster than inflation. What more can I ask for? Merv

Insights in 140 words

May 21st, 2014

Macro

Indian elections – Narendra Modi is expected to perform miracles. He can start by pleasing the rain gods. Weathermen forecast a one in two chance of monsoon rainfall being more than five per cent below normal this year. The last three times that happened agriculture growth in India averaged zero. While only 15 per cent of total output, agriculture has significant second order effects. For instance between one-quarter and one-half of cars and two-wheelers are sold in rural areas. Estimates for the impact of a poor monsoon range from 0.5 to 1.75 percentage points off output and up to 2 percentage points on inflation. But Modi mania has pushed up Indian stocks by one-third since September in dollar terms – a valuation premium to regional equity indices not seen since markets cheered the 2009 election results. Investors need to pray for some rain too.

Strategy

Market extremes – The problem with historical comparisons when interpreting markets is they can be useless for a long time – until suddenly they explain everything. As the S&P 500 briefly touched 1900 this week its capitalisation overtook the annual output of the US economy. The ratio of market cap to output now lies squarely between 92 and 125 per cent, the cyclical peaks of 2000 and 2007 respectively. Those worrying about the current rally also point to Shiller’s cyclically adjusted price to earnings multiple at 25 times – well above the long-term average of 17. The trouble is that the last two times the CAPE crossed 25 (in 1996 and 2003) the bull market was just getting started and ran for another four years. Similar ‘extreme but may go extremer’ arguments exist for volatility, eurozone periphery sovereign yields, high-yield corporate bond spreads and more.

Stocks

Sony – It is becoming harder to put Sony’s epic implosion into words. Let’s try. This week’s warning of a loss for the year (analysts expected a ¥60bn profit!) means the Japanese electronics maker will have been in the red for six out of the last seven years. Indeed aggregating Sony’s net profits over a decade gives you a negative number. So much for ten years of restructuring, which has now cost one trillion yen (a lot of money in any currency) over the period. As well as being unprofitable no one wants what Sony makes either – its revenues are exactly the same today as in 2004 (as is the yen versus the dollar by the way). By contrast sales at Apple grew more than twenty fold. Sony shares are down 50 per cent in that time. Even dozy Microsoft’s have doubled.

Finance

Investment banking – Investment bankers say it is all about returns nowadays but inside they still vibrate to movements in market share and rankings. So who were the winners and losers over the first quarter? At first glance it looks like the same old procession with JPMorgan top in terms of global capital markets revenues and Goldman Sachs second – where they have placed respectively since 2011. But the former lost the number one spot in both FICC trading and advisory during the quarter. Citigroup is now top dog in FICC – with 10 per cent global share – and indeed wins the most improved award moving from seventh in 2011 to third place overall. Heading the other way Barclays global capital markets share dropped below 6 per cent for first time since 2007. More existentially UBS now risks falling out of the top ten altogether.

Digestif

Young achievers – Mark Zuckerberg turned 30 on Wednesday, with a billion dollars for every year alive. What next? Many greats peaked at 30. Alexander the Great, for instance, or John Lennon when The Beatles split. Bjorn Borg retired at 26. But others are just getting started at 30. Half of Sachin Tendulkar’s 16,000 test runs came later in life, ditto ten of Jack Nicklaus’s 18 majors. Michelangelo had finished his Pieta and David statues by 30 but still had the Last Judgment and Sistine Chapel to come. A 30- year old Marx penned the Communist Manifesto. Einstein’s special theory of relativity came in his twenties with the general theory to follow later. Some greats changed course completely at 30. It was when the Buddha supposedly gave up his wealth in search of enlightenment. Mark still has 12 years to become America’s youngest president.

Market Week: May 20, 2014

May 19th, 2014

The Markets

Equities were very much a mixed bag last week. After the Dow and S&P 500 set fresh all-time closing records early in the week, a strong downdraft on Thursday flattened out the S&P for the week and took the Dow back into negative territory year-to-date. The Nasdaq, which has suffered in recent months, saw a positive week, while the small-cap Russell 2000 ended the week down almost 9% from its March high. The pain in domestic equities left the Global Dow the year-to-date leader. Meanwhile, a rally in the 10-year Treasury sent the yield to its lowest level since last October.

Market/Index

2013 Close

Prior Week

As of 5/16

Weekly Change

YTD Change

DJIA

16576.66

16583.34

16491.31

-.55%

-.51%

Nasdaq

4176.59

4071.87

4090.59

.46%

-2.06%

S&P 500

1848.36

1878.48

1877.86

-.03%

1.60%

Russell 2000

1163.64

1107.22

1102.91

-.39%

-5.22%

Global Dow

2484.10

2520.55

2533.44

.51%

1.99%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

3.04%

2.62%

2.52%

-10 bps

-52 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

· After a strong surge in March, retail sales flattened out in April, rising just 0.1%. The Commerce Department said online sales, sales of electronics/appliances, and those at restaurants and bars all declined, while clothing, auto, and department store sales saw gains.

· Wholesale prices saw a sharp increase last month, rising at their fastest pace since September 2012. The Bureau of Labor Statistics said April’s 0.6% increase followed a 0.5% jump in March, and was evenly distributed between goods and services. April’s increase put wholesale inflation for the last 12 months at 2.1%.

· Consumer prices also increased in April at a rapid pace; the 0.3% increase was the biggest monthly jump since last June. A 2.3% increase in the cost of gas and a 0.4% increase in food (beef alone was 2.9% higher) were key. April’s increase put the consumer inflation rate for the last 12 months at 2%, which is the level the Federal Reserve has informally targeted as appropriate.

· The Federal Reserve’s manufacturing indexes were both positive in May. The reading on the Empire State index rebounded 18 points from a weak March, while the Philly Fed reading declined slightly but had its third consecutive positive month.

· U.S. industrial production fell 0.6% in April after a 1% gain in both February and March. The Federal Reserve said milder weather cut the need for heat, which led to a 5.3% decline in utilities output, while mining production rose 1.4%. Use of total capacity at the nation’s factories slid 0.7% and was 1.5% below its average over the last 40 years.

· Housing starts rose strongly in April, with a nearly 43% increase in apartment construction responsible for most of the gain. The Commerce Department said new starts were up 13.2% for the month, and were more than 26% higher than in April 2013. Building permits–an indicator of future activity–were up 8% from March and were almost 4% higher than a year earlier.

· The eurozone economy grew 0.2% during Q1, roughly the same pace as the previous quarter, while the 0.3% growth in the 28-member European Union was slightly less than the 0.4% of Q4 2013. The strongest growth was in Germany, Hungary, Poland, and the United Kingdom. The Q1 figure meant that the eurozone grew 0.9% (1.4% for the EU) compared to the same quarter a year earlier. Meanwhile, the official EU statistical office said the inflation rate rose slightly in both areas, to 0.7% in the eurozone and 0.8% for the EU. Though both inflation rates were an improvement, they were still far below those of the previous year, and the annualized rate for seven countries was negative.

Eye on the Week Ahead

In a week that’s light on economic data, minutes of the most recent Fed meeting, a report on Chinese manufacturing, and housing market statistics could receive more-than-usual interest.

Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). 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 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.

Market Week: May 13, 2014

May 12th, 2014

The Markets

A fresh closing high on the Dow on Friday finally enabled it to edge back into positive territory for the year, while the S&P 500 ended the week basically flat. However, after the prior week’s respite from selling pressure, the Nasdaq and the small caps of the Russell 2000 returned to their recent losing ways.

Market/Index

2013 Close

Prior Week

As of 5/9

Weekly Change

YTD Change

DJIA

16576.66

16512.83

16583.34

.43%

.04%

Nasdaq

4176.59

4123.90

4071.87

-1.26%

-2.51%

S&P 500

1848.36

1881.14

1878.48

-.14%

1.63%

Russell 2000

1163.64

1128.80

1107.22

-1.91%

-4.85%

Global Dow

2484.10

2523.17

2520.55

-.10%

1.47%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

3.04%

2.60%

2.62%

2 bps

-42 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 U.S. services sector accelerated in April. The Institute for Supply Management’s gauge rose 2.1% to 55.2%. It was the 51st straight month of growth.

· Greater demand overseas for U.S. exports of natural gas and oil as well as aircraft helped cut the U.S. trade deficit by 3.6% in March, according to the Commerce Department. Exports were up 2.2%, while imports also rose 1.7% to their highest level in two years.

· Federal Reserve Chair Janet Yellen told a congressional committee that the Fed sees a rebound in the economy from winter’s weather-induced slump, but that low inflation and slack in the housing and labor markets will most likely continue to permit interest rates to remain near zero for some time.

· Yet another data point from the Federal Reserve confirmed winter’s impact on the economy during Q1. Business productivity slumped at an annualized rate of 1.7%, a far cry from the previous quarter’s 2.3% increase. However, productivity was 1.4% ahead of Q1 2013. Even though workers put in more hours during the quarter, reduced output helped push unit labor costs up 4.2% for the quarter.

· The European Central Bank once again left its key interest rate unchanged at 0.25% and said that ongoing low inflation might lead to stimulus measures next month, especially if the situation in Ukraine worsens.

Eye on the Week Ahead

With the bulk of Q1 earnings reports now in the rear-view mirror, investors will have to look to manufacturing and retail reports in both the United States and China for guidance. Inflation at both the consumer and wholesale levels is expected to remain subdued, while housing starts could show whether the housing market is emerging from its winter doldrums.

Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). 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 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.

Apple & China: Still growing strong

May 11th, 2014

After the market closed last Wednesday, Apple Inc. (NASDAQ: AAPL) reported its 2nd quarter earnings to much delight. Apple addressed a number of issues in its earnings report, including:

(1)   Revenue and net income (“earnings”) per share as well as earnings forecasts for next quarter

(2)   The status of its share repurchase program

(3)   The announcement of a cash dividend

(4)   The announcement of a 7-for-1 stock split

When a company reports earnings, they hold a public conference call where key members of management (CEO, CFO, etc.) discuss operating results for the quarter and offer guidance (projections) for the future, while simultaneously releasing materials on their website. They also use the conference call to make important announcements about the company that are of interest to shareholders and analysts. Afterwards, there’s a Q&A when management attempts to answer pesky analysts’ questions, which is typically the most entertaining part.

Owing to Apple being such a popular stock and company, and to the fact that so many issues were addressed in one earnings release, some of you may be confused as to what this barrage of financial jargon means. We think it makes sense to clear up some of the confusion and explain these topics in non-technical English.

Earnings measures

At the very top of the income (profit & loss) statement we have revenue (or sales)—how much money Apple brought in during the last quarter from selling its stuff. Going from revenue to net income (aka “earnings,” which we divide by the number of outstanding shares to get “earnings per share”) is a tedious, mind-numbing process from which we will spare you. The quick explanation is that we subtract cost of goods sold, operating expenses, depreciation, interest, taxes, etc. to arrive at net income—the amount shareholders actually have left after paying everybody else.

Long before the actual numbers become public, analysts have already provided revenue and earnings per share estimates, and the stock price at any given time before the earnings release factors in the consensus levels from analysts who cover the stock. If earnings come in better than expected, the stock typically jumps; conversely, if earnings are worse than expected, the stock price typically sags.

But Wall Street is not always so straightforward. There are times when earnings for a company are stronger than expected but some other announcement casts doubt on the future, and the stock falls despite better-than-expected earnings. Similarly, unexpectedly low earnings can be offset by an announcement that makes analysts more excited about the company’s future prospects, causing the stock to rise despite disappointing earnings.

“Capital Return Activities”: Dividends and Share Repurchases

Apple executed about $21 billion worth of capital return activities during the March quarter, including $2.7 billion in dividend payments and roughly $18 billion in share repurchases.

Dividends, the most common form of capital return, are cash payments distributed by the company to shareholders. They are more likely to be paid by mature companies (those that have passed the rapid growth phase) and companies with predictable cash flows, as well as those with hoards of cash. Apple fits into all of these categories. A young biotech firm will need all of its capital to reinvest in future growth, but a company like Apple has more than enough cash to fund current operations and future projects; thus, its shareholders prefer to have a portion of their investment returned via a dividend. You can read more about dividends in our blog post from 2012.

When a company buys back (repurchases) its own shares, this is also a form of “capital return.” Instead of paying cash directly to shareholders, the company purchases its own stock (in the case of Apple, purchases in Q2 were made both on the open market and via an investment bank through two rounds of “Accelerated Share Repurchase” programs). By reducing the number of shares outstanding, the company has effectively increased each shareholder’s piece of the company pie.

A company typically buys back its own shares when it believes that its market price is low relative to its intrinsic (true) value. If Apple believes each share is actually worth, say, $1,000, it can add value for existing shareholders by buying shares back in the low-$500 range (where Apple stock was trading pre-earnings release).

Stock Splits: Don’t be misled by the numbers

Apple also announced that its shares will undergo a 7-to-1 stock split, meaning that each shareholder will receive 6 additional shares of AAPL for every 1 share currently owned. The net impact of a stock split on the value of your investment in Apple or any other company is exactlyzero. Instead of having 1 Apple share worth $590.09, you will have 7 shares of Apple stock worth about $84.30 each. This assumes, of course, that the price of the stock doesn’t change between the announcement of the split and when it actually occurs.

A company like Apple splits expensive shares to increase the number of potential buyers of the stock—both institutional buyers who may have rules limiting the maximum price of shares they can hold, and individual investors who are scared off by stocks selling for much over $100/share. Also, there is speculation that Apple may be paving the way for potential inclusion in the Dow Jones Industrial Average (DJIA), the popular price-weighted index composed of 30 large-cap US companies.

We always tell people not to compare stock prices to one another, as these numbers don’t mean anything. A share of Coca-Cola Company (NYSE: KO) trades at $40.79, while PepsiCo, Inc. (NYSE: PEP) stock is priced at $85.89, more than twice the price of a share of Coke. However, Coke’s market capitalization (the total market value of its equity) is almost $180 billion, while Pepsi’s is barely over $130 billion. In other words, the price of one share tells you nothing about the overall value of a company, nor whether the shares are “cheap” or “expensive” relative to other companies’ stocks.

China Loves Apple

As many of you know, Ken just returned from a trip to China. We’ll be including some of the highlights of that trip that are relevant to finance and investing in our next few eNewsletters, starting with this one. As the trip included the Forbes Investment Cruise, Ken listened to and spoke with several prominent investment professionals and other experts, and we’ll share some of those insights with you as well.

So speaking of Apple, are they doing well in China? The dry statistics tell you something: in the most recent quarter, Apple’s China sales were up +13%, and China now accounts for 20% of Apple’s total sales. China is now Apple’s 3rd biggest market, and will soon pass Europe to take second place to the US. Talk about growth!

On the ground, Apple’s presence is obvious. Stores selling Apple products are everywhere—primarily licensed dealers but also a dozen company-owned Apple stores. There are iPhones everywhere as well, including lots of iPhone 5S models, which are supposedly too expensive for the Chinese. There are quite a few Androids as well, but the iPhone seems to be the smartphone of choice for the Chinese.

Apple products aren’t the only Western “luxury goods” in China. There are designer stores on almost every corner, many stuffed into huge, modern malls with dozens or even hundreds of stores. Want a Rolls Royce or Aston Martin? No problem. There are currently 22 Rolls Royce and 14 Aston Martin dealerships in China. Gucci, Prada, Louis Vuitton? The number of stores selling these designer brands in China number in the hundreds.

From Out of Nowhere, an Economic Juggernaut

From a communist backwater with little wealth and well over 1 billion subsistence farmers, China has recently become the second largest consumer economy after the US, surpassing Japan in 2013. The Chinese love Western luxury goods, from Rolls Royce cars to Chateau Lafite Rothschild wine. But this obsession by the wealthiest Chinese masks far greater increases in consumption (on an aggregate basis) by the 300 million Chinese who are now considered “middle class.” They make a lot less than the US middle class, and they can’t afford a Rolls Royce, but a Toyota Yaris or iPhone 5C is well within their grasp.

Note that the size of the middle class in China is roughly equal to the entire US population. By 2022, it’s estimated that China’s middle class will number 630 million—nearly twice the population of the US. They won’t yet be spending as much on average as US consumers, but their sheer numbers mean that China will be a voracious buyer of all sorts of goods and services. 2022 is also the year in which it is predicted that China’s GDP will surpass that of the US. We shall see.

The transformation of China is from backwater to world economic power is nothing short of astounding. Take Pudong, for example, which is an area in Shanghai on the east bank of the river (“pu dong” means “east bank”). Prior to 1993, when the Chinese government designated it as a “Special Economic Zone,” it was entirely farmland, with a population of just a few thousand. Today, Pudong has over 5 million inhabitants and dozens of skyscrapers, including the Shanghai World Financial Center, the tallest building in China at 101 floors and 492 meters. (Shanghai overall has 24 million people.)

And the construction continues at breakneck pace (if this is a “slowdown” I can’t imagine what it was like during the peak). Just across the street from the World Financial Center is the nearly finished Shanghai Tower. At 632 meters and 121 floors, it will be the new tallest building in China and the second tallest in the world after the Burj Khalifa tower in Dubai that was featured in the last Mission Impossible movie.

We’ll be posting photos of our trip to the web so that you can get some idea of the scale of the new China. (There will also be pictures of the old China, such as the Great Wall and the Forbidden City.) In future eNewsletters we’ll write more about the people and culture of China, as well as about investment opportunities there. If nothing else, it will be fascinating to watch how China continues to grow and evolve.

Zai hui (Until we meet again),

Adam

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

Adam Bragman
Director of Business Development – 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.

UBS EQUITIES REPORT: This month’s Market Outlook

May 7th, 2014
The recent volatility on the stock market has left the S&P 500 in slightly positive territory year-to-date.1 However, this environment has been associated with deep intra-market dislocations, which has made it feel more painful for many investors than it would appear on the surface. Indeed, certain segments of the market that had performed well through the beginning of this year have come under significant pressure recently, including parts of the IT sector, biotechnology and small-cap growth stocks. More generally speaking, across global financial markets previous winners are being sold off, while losers, including emerging market equities, are receiving strong bids.

This raises two related questions, namely whether this change in market leadership a) is set to continue, and b) should be viewed as an early signpost for a directional change in the stock market, i.e., the end of the bull market. We believe that the key to answering these questions is to focus on the still solid fundamental earnings and valuation picture. We conclude that the recent volatility and market rotations represent a temporary consolidation and that at an index level, most prior trends should resume over the course of our six-month tactical time horizon. Our recommended tactical positioning, therefore, continues to reflect a preference for equities over bonds, for cyclical over defensive equity sectors, for growth over value stocks and for small caps over large caps.

Fundamental picture still intact
We started off the year with the basic thesis of a global economic recovery led by developed nations, in particular the US and Europe. This thesis remains in place. While the unusually harsh winter affected economic data in the US and led some observers to question the strength of the US growth picture, more recent data releases appear to confirm our more sanguine view. Consumer confidence keeps improving and has reached post-recession highs, thus supporting retail sales. Industrial production growth accelerated to an annual rate of 3.8% during the first-quarter, leading industrial capacity
utilization to rise to levels last seen in early 2008. The labor market is tightening further with, for instance, weekly jobless claims reaching new lows. Credit conditions continue to improve supported, in particular, by steady growth in commercial lending by smaller banks. And, finally, we are seeing the first signs of the much awaited capital expenditure recovery.
Turning to overseas markets, the Eurozone seems to have started 2014 on a very solid footing, helped by thawing credit conditions and led by Germany, thereby leaving its recession further behind. In China, where growth expectations have come down since the beginning of the year, we remain confident that renewed policy support will cushion further downside risk and avoid a hard landing scenario.

Against this macro backdrop, we believe US first-quarter earnings will prove reasonably supportive for the market. S&P 500 earnings-per-share (EPS) growth likely slowed to 4–5% after a 9% rise in the fourth- quarter. However, the weather-induced slowdown was well anticipated and bottom-up consensus expectations have been managed down to roughly flat growth for the first-quarter, leaving room for upside surprises. Looking forward, and in line with our economic projections, we expect a pick-up in earnings growth rates as the year progresses and forecast 2014 EPS growth of 9% followed by 7% in 2015. With valuations, as measured by the price-earnings ratio, in line with the long-term average, the stock market is neither cheap nor expensive. Under these circumstances, we believe that it is reasonable to expect stock price appreciation in line with earnings growth both in the US and in the Eurozone.

Meanwhile, bond markets should continue to face pressure against the backdrop of the Fed’s tapering of asset purchases, which should drive bond yields progressively higher during the course of the year.

Remain mindful of geopolitical risks
While the fundamental backdrop remains supportive for risk taking, we continue to monitor the situation in Ukraine carefully. It remains our view that this crisis will not spill over and affect global markets, unless the energy supply is impacted. Our emerging markets team published an updated assessment of the relevant scenarios. They concluded that a mild sanctions regime remains the most likely outcome. However, they did increase the probability of further escalation to 45%. We therefore believe that the crisis can be expected to keep energy prices elevated in the near term, despite supply and demand fundamentals that would point to lower prices.

Investment conclusions: upgrade risk assets
In view of all the aspects described above, we have opted to increase our recommended tactical position in risk assets and reduce US fixed income. We are closing the commodity underweight position, opened in January, and which has worked against us. While supply and demand considerations still argue for lower commodity prices, the Ukraine crisis poses an increasing risk to such a position. The commodity upgrade is funded by reducing US equities and US fixed income. Note, however, that in portfolios that exclude commodities altogether (and where they cannot be upgraded), we would recommend upgrading risk assets by adding to international equities at this stage, while reducing US fixed income.

1As of April 2014

Market Week: May 5, 2014

May 5th, 2014

The Markets

Generally encouraging data that suggested winter’s economic deep freeze might be thawing led to broad-based gains for equities despite some slippage at week’s end. The Dow finally managed to surpass briefly the record closing high it hadn’t seen since New Year’s Eve. However, of the four domestic indices in the table below, the S&P 500 remained the only one still in positive territory year-to-date. Meanwhile, the Fed’s steady-as-she-goes approach to tapering helped boost demand for the benchmark 10-year Treasury, whose yield fell to its lowest level so far this year.

Market/Index

2013 Close

Prior Week

As of 5/2

Weekly Change

YTD Change

DJIA

16576.66

16361.46

16512.83

.93%

-.38%

Nasdaq

4176.59

4075.56

4123.90

1.19%

-1.26%

S&P 500

1848.36

1863.40

1881.14

.95%

1.77%

Russell 2000

1163.64

1123.03

1128.80

.51%

-2.99%

Global Dow

2484.10

2496.82

2523.17

1.06%

1.57%

Fed. Funds

.25%

.25%

.25%

0 bps

0 bps

10-year Treasuries

3.04%

2.68%

2.60%

-8 bps

-44 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

· As expected, economic growth stalled during the first quarter, falling from 2.9% in Q4 2013 to the current 0.1% (though that figure will be subject to two revisions over the next two months). The Bureau of Economic Analysis said lower exports, less spending by businesses on fixed investments and inventory, and reduced spending by local and state governments were key to the decline.

· The unemployment rate saw its biggest drop since December 2010, falling from 6.7% to 6.3% in April; that’s the lowest it’s been since September 2008. Also, the Bureau of Labor Statistics said the number of new jobs created–288,000–was far greater than the last 12 months’ 190,000 monthly average and represented the strongest job creation in more than two years. Gains were broadly distributed, led by employment in business and professional services, retail, restaurants/bars, and construction. However, the report wasn’t all good news; the drop in the unemployment rate resulted partly from 806,000 people leaving the labor force.

· Consumer spending rebounded from the previous two months’ deep freeze, rising an inflation-adjusted 0.7% in March. Even better, the Commerce Department said the spending was widespread, with the biggest gains in durable goods, which rose 2.7% (about half of which was purchases of cars and car parts). The bad news? Spending on durable goods was down 2.2% from the previous March, and one reason for March’s higher sales was a 0.5% jump in the cost of food. Nondurable goods were up 0.9% for the month, while spending on services rose 0.4% and personal income was up 0.5%.

· Business for U.S. manufacturers also accelerated coming out of the frigid winter. The April reading on the most recent Institute for Supply Management survey rose to 54.9%, its highest level since December, and all but one of the 18 industries reporting saw gains. In addition, the Commerce Department said orders at U.S. factories were up 1.1% in March; a 3.5% jump in business spending on capital equipment (not including the volatile aircraft sector) was the biggest increase in that figure since January 2013.

· Home prices in the cities tracked by the S&P/Case-Shiller 20-City Composite Index were relatively flat for the month, rising only 0.2% as 13 of the 20 cities showed declines. Also, the 12.9% year-over-year gain was slightly lower than the previous 12 months’ 13.2% increase.

· As expected, the Federal Reserve’s monetary policy committee once again cut its monthly bond purchases by $10 billion, leaving them at $45 billion a month. The committee also reiterated its belief that its target interest rate will remain at its current level well after bond purchases end.

Eye on the Week Ahead

With few economic reports on tap this week, investors’ focus could be overseas. Heightened tensions over Ukraine could counterbalance any data-induced optimism, as they did last Friday. Also, the European Central Bank will meet Thursday, when additional economic stimulus measures could be on the table.

Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprices.org (spot gold/silver); Oanda/FX Street (currency exchange rates). 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 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.