Déjà vu (French for “Already seen”)
In both 2010 and 2011, the years commenced with an enthusiastic stock market rally, only to sag into serious corrections during the spring and summer months. Last year’s market entered a period of torrid recovery from the heavy sell-off during the summer of 2011, thanks largely to “goosing” by the Federal Reserve and loosening credit policies by the European Central bank. New recovery highs were seen for indexes and many stocks chalked up new all time price highs in recent weeks. Corporate balance sheets are generally healthy and the improved balance sheets of American consumers have sustained healthy revenues for companies ranging from Verizon to Intel, from PPG (a glass and coatings company) to Simon Property, the shopping mall giant. But it seems we have again entered the season of market correction. And while I’ll leave the “why” to the quoted economists below, I cannot help but worry when commodity indexes and the new high/new low equity indicator are cascading downward while bond yields are registering new all time lows (and the price of older bonds is rising).
The conservative way in which we at Trusted Financial invest, in the “Value/balanced” style,should serve our clients well in the current darkening environment. There are many Big Picture reasons for the current sell off, and I’ve selected three analysts from whom to quote for your reading pleasure, below. Why do I quote others? Because my job and talent is not in assessing Macro economic trends but in reacting to them appropriately when deciding what to buy, what to sell and what to hold. Still, I do have a sneaking suspicion that we may be living through a replay of the 1930’s, in which a rapacious market crash, 1929, gave way to a healthy market rally, only to slump once again under the weight of unwise government policies, a persistent unwinding of real estate excesses and strangulation by over-regulation. The 1930’s became known as the Great Depression, but the decade was, in fact ,a series of recessions, interspersed with meaningful market rallies. The best investment during this era high was quality government and corporate bonds.
Our client holdings became heavily weighted toward fixed income instruments beginning in 2007 and continuing right through the present day. We continue to favor higher yielding investment grade instruments. These are becoming pretty scarce, but when they do become available, in smaller secondary market offerings from time to time we look closely and often buy. As a relatively small investment advisor (we manage about $65MM with the average account being about $400,000, we are able to help our clients by snapping up “odd lot” offerings or those with a relatively light volume. This is not possible for $billion dollar bond mutual funds or large institutional investors such as the California Public Employees Retirement System. As an example, I’m still accessing preferred stocks from good quality issuers, with annual yields well over 6%.
As for equities, I continue to like energy related issues, especially those with dividends. Certainly,common stock floated by strong companies that are able to continue paying dividends remain generally attractive and this well describes the stocks our clients hold. Problem is, if the entire stock market slump continues, even the great companies will likely slump along with “Mr. Market”.
It’s not just the stock market that is in a slump. Commodity price indexes have cratered, something that may portend a recession. It may be that this is due to a slowing economy in China and recession in Europe, but equities markets appear to be signaling that the USA will catch the same cold that is affecting other areas of the globe.
In response, we have lightened up on certain holdings to raise cash for the cold summer that seems to be ahead. This has usually been spurred when a stock gives an alarming technical signal.
Looking ahead, our clients’ rising cash cushion, generated by recent sales, should protect them from possible additional stock market weakness. It also means that, if I’m being too cautious and we have a surprise rally, your short term performance will be sluggish. Some hopeful analysts are predicting another magical move by the US Federal Reserve that might cause stocks and bonds to rally once more. I, for one, doubt such action would be particularly effective. I worry that we are seeing the beginning of the next leg of a secular bear market that began in 2007. Still, with major indices approaching the 200 day moving average, a rally may be the next surprise, but I doubt its longevity.
We have been in a prolonged era in which stock investing and real estate investment have been damaging to the financial health of many. “Safe” investments like CD’s and T-bills and money market funds provide little more return than would burying the money in the back yard. Yet, I was pleased to be able to report our composite performance history to clients this past week, showing better returns over nearly a decade than the Standard & Poors 500 stock index and with a considerably smaller decline during the market plunge of 2007-2009. For regulatory reasons, we do not quote percentage returns here at our website, but I’m always happy to provide our performance history, quarter-by-quarter, to interested parties on an individual basis.
Having reviewed performance experience for a number of prospective clients of late, I’ve discovered that it is common that most of them have not yet regained their account values of 2007. They were too heavily invested in stocks when the Crash hit, then abandoned the market when they should have been holding on or buying values during the slump. They either did this to themselves, or were badly advised by others, usually commissioned salesmen. If the value of our 38 years navigating financial waters needs to be proven, I feel our clients’ experience during the last bear market and subsequent recovery offer such proof.
Gary Miller
Here are those observations by some credible sources:
Liz Ann Sonders, Schwab’s Chief Economist (05 14 2012)
“Saving the worst for last
I think investors and the media may be underestimating the impact the coming “fiscal cliff” is having on market and business psychology. The fiscal cliff refers to the near-simultaneous January 2013 expiration of the Bush tax cuts, the payroll tax cuts, emergency unemployment benefits and the sequester (automatic spending cuts) established in last summer’s debt-limit agreement.
The range of estimates for its ultimate impact are, unfortunately, quite wide. The lowest estimate I’ve seen comes from NDR, using Congressional Budget Office assumptions, with the impact at a relatively “low” 2.4% of US gross domestic product (GDP). Most estimates tend to cluster around 3.5% of GDP.
It’s impossible to know what’s right because different assumptions are being used. But the consensus is closing in on a worst-case scenario of about 4% of GDP. ISI recently put the numbers into three distinct buckets, each with about $200 billion of impact:
1. Provisions likely to create a fiscal drag (approximately (?) $221 billion or 1.4% of GDP):
? Cuts to discretionary spending (?$84 billion)
? Tax increases on upper-income Americans included in the Affordable Care Act (?$21 billion)
? Payroll tax cut (?$116 billion)
2. Bush tax cuts (?$200 billion or 1.3% of GDP, although likely impact would be spread over several years)
3. Items unlikely to be allowed to take affect and thus aren’t likely to create a fiscal drag (?$179 billion or 1.1% of GDP):
? Huge increase in number of Americans paying the alternative minimum tax (?$94 billion)
? Sequester cuts (~$85 billion)
There are three additional items that don’t fall neatly into ISI’s three buckets, including tax extenders, extended unemployment insurance benefits and the “doc fix,” which would together total about $75 billion. These items are not expected to create a significant fiscal drag.
I actually think this is having a larger impact on psychology than many believe, especially on the confidence of corporate leaders and their ability to plan (and guide Wall Street’s analysts) for the future.
Muscle memory may fail us this year
In sum, there’s much to fret about, and volatility is likely to remain elevated until this correction has run its course. But a lot has changed in the past two years—much for the better—particularly for domestically oriented US companies. There’s at least a little bit of decoupling underway, certainly between the United States and Europe, and that’s likely to assist in keeping the correction from mirroring the ones in 2010 and 2011.”
Goldman Sachs Research 05 16
“What’s next…Contraction or back to Recovery?
From the current Slowdown phase, transitions are quite ambiguous and that ambiguity tends to linger. After three months, more than 60% of the time the cycle remains stuck in the Slowdown phase, with about an equal probability (20% each) that the cycle has reaccelerated into the Expansion phase, or that growth has turned negative too and the cycle has entered the Contraction phase (see Exhibit 8). While about equally likely, the two potential outcomes portend vastly different asset market performance.
In the current context, however, a literal interpretation of the recent data and resulting GLI moves suggest that it may be a bit more likely that the next move is less favorable – a descent into Contraction – than more favorable – a rebound into Expansion.”
Bill Gross (PIMCO) 05 14 quoted at Financial Times website
“While all monetary systems are a struggle between debtors and creditors, it is usually creditor nations that establish the rules for transitions to new regimes. Such was the case in the late 1960s as France threatened to empty Fort Knox unless a new standard was imposed. Now, with dollar reserves widely dispersed in China, Japan, Brazil and other surplus nations, it is fair to assume that there will come a point where 2 per cent negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds.
There is the potential for both public and private market creditors to effect a change in how credit is funded and dispersed – our global monetary system. What that will look like is a conjecture, but it is likely to be more hard money as opposed to fiat-based, or if still fiat centric, less oriented to a dollar-based reserve currency.
The world’s financial markets seem obsessed with daily monetary and fiscal policy evolutions in euroland which form the basis for risk on/risk off days in the marketplace and the overall successful deployment of carry strategies so important to asset market total returns. Euroland is just a localized tumor, however. The developing credit cancer may be metastasized, and the global monetary system fatally flawed by increasingly risky and unacceptably low yields, produced by the debt crisis and policy responses to it. The great white whale lies on the horizon. Investors should sail carefully.”
