As financial advisors, we look at a broad range of market and economic forces to form our investment decisions. In our monthly economic report, we take a look at the effects these forces have had on markets nationally and globally during the month. This broader perspective helps us to provide more insightful investment and financial planning advice to our clients. Click Here to see our April 2012 report.
“My crystal ball is in the shop.” That’s how I usually answer the impossible question of where things are headed in the markets over the coming days, weeks, and years. And I’ve been getting that question a lot recently as change seems to be the new normal.
On an almost daily basis, we’re hit with a barrage of new information and geopolitical shifts that will have an effect on our investments. We’re then left to wonder what the ramifications are of China’s slowing economy, or what the fallout will be from the Greek debt crisis or what will happen next with the political situation in Iran.
For those of us in the investment world, all of this uncertainty can keep us up at night – especially because we can’t accurately predict what will happen in the aftermath of all this change. My point is that, even if we knew what would happen in the world, could we profit from it?
Consider what happened after Japan was struck by a devastating earthquake and tsunami. Not only was the nation forced to deal with the fallout from damaged nuclear plants, it’s export-driven economy nearly ground to a halt. From a predictive standpoint, you might have guessed that these horrific events would have sent the Yen, Japan’s currency, tumbling. But that’s not what happened. The Yen soared so much, that the G7 nations had to intervene –one of the first times they have done so since WWII to keep it from going higher.
Another example of economic unpredictability came when when Standard & Poor’s downgraded the U.S. government’s credit rating. President Obama himself predicted that if the credit rating dropped, it would become more expensive for the government to borrow money, which would only further exacerbate the country’s debt problems. However, after the S&P’s action, investor demand in U.S. Treasuries spiked and interest rates actually plummeted.
As a third example, let’s go back to the tragic events of Sept. 11, 2001. Given what happened that day and all the uncertainty it created around the world, it would have been reasonable to assume that prices for commodities like oil and gold would have soared in the days that followed. But the price of a barrel of oil went up just $1 before it plummeted by some 25% over the next six months. Similarly, the price of gold rose modestly before settling in at about the same pre-9/11 price at year’s end.
Of course, after the fact, we know why these things happened. In the wake of the credit downgrade, for instance, investors bought U.S. Treasuries because they’re still considered the safest investment around. Oil prices dropped after 9/11 because people stopped traveling, which decreased demand.
Again, the point is that as investors, it’s become increasingly hard to predict how markets will react to major events around the world because, oftentimes, the opposite of conventional wisdom occurs.
That’s why as I manage my client’s money, it’s become essential to stress test our portfolios against such unpredictability, and to then hedge our bets. There are several ways to do this, and I recommend doing at least the following 6 things:
1. Don’t just make the leap that certain assets will soar (i.e. gold, oil) if there is trouble around the world. Much like the earlier examples, counterintuitive reactions can and do happen, leading many investors to make the wrong move. When stress-testing your portfolio, it’s important to consider the actual financial impact of an event (stronger dollar/weaker dollar) rather than the geopolitical event itself (war in the Middle East).
2. Just in case half the world is correct and we see higher interest rates, make a list of what assets are likely to be sensitive and consider how they will react. In general, the best performing bonds over the past year are those that have benefitted from falling rates. These may underperform if rates rise.
3. Evaluate the underlying sectors and holdings within funds you own. Many of the best performing funds in the first two years of this recovery did so with foresight to own commodities and materials stocks. Combining these with other holdings in the direct commodity space – stocks or sector funds – left many overexposed in 2011.
4. Use the transitive property you learned in high school. If assets are all tied to one factor (economy, price of the dollar, etc), then they are tied to each other. So if both emerging market stocks and your global bond fund benefit from a weakening dollar, they may get hit if we see a strengthening dollar like we saw during periods last year. (Yes, Mr. Pierce, I just used the transitive property as a grown-up)
5. Consider investments whose performance is not so closely tied with global / macro issues or interest rates. One investment we have used for years is a strategy called merger arbitrage. In essence, these look to make a small profit on announced and pending mergers. This is probably the simplest of the alternative strategies, and both the Merger Fund MERFX and the Arbitrage fund ARBNX are no-load with 20 and 10 year track records respectively.
6. Invest with managers who pride themselves on investing in companies without global exposure. Van Harrisis of Champlain CIPSX sees plenty of opportunity in US small caps, but avoids companies that cannot finance their own debt, or have any sort of government interference. This traditionally keeps them out of banks and media companies. He believes that most of their companies would continue to do business even if credit once again dries up.
In these cases, we are not trying to predict (or debate) what may happen globally, or even what may result financially. We are being prudent to test our diversification strategies to be sure we are not overexposed.
When it comes down to it, my role as a financial planner and investment manager is to prepare for the best – and the worst – of anything. The world is just too unpredictable to do anything less.
The following debt facts were published in an article by Jill Schlesinger of CBS Money Watch in February 2012. They are an excellent recap of our nation’s debt from 1791 to now. Read on to find out why you need to know these facts.
1. The U.S. national debt on Jan. 1, 1791, was just $75 million dollars. Today, the U.S. national debt rises by that amount about once an hour.
2. Our nation began its existence in debt after borrowing money to finance the Revolutionary War. President Andrew Jackson nearly eliminated the debt, calling it a “national curse.” Jackson railed against borrowing, spending and even banks, for that matter, and he tried to eliminate all federal debt. By Jan. 1, 1835, under Jackson the debt was just $33,733.
3. When World War II ended, the debt equaled 122 percent of GDP (GDP is a measure of the entire economy). In the1950s and 1960s, the economy grew at an average rate of 4.3 percent a year and the debt gradually declined to 38% of GDP in 1970. This year, the Office of Budget and Management expects that the debt will equal nearly100% of GDP.
4. Since 1938, the national debt has increased at an average annual rate of 8.5%. The only exceptions to the constant annual increase over the last 62 years were during the administrations of Clinton and Johnson. (Note that this is the rate of growth; the national debt still existed under both presidents.) During the Clinton presidency, debt growth was almost zero. Johnson averaged 3% growth of debt for the six years he served (1963-69).
5. When Ronald Reagan took office, the U.S. national debt was just under $1 trillion. When he left office, it was $2.6 trillion. During the eight Regan years, the US moved from being the world’s largest international creditor to the largest debtor nation.
6. The U.S. national debt has more than doubled since the year 2000.
7. FY 2013 budget projects a deficit of $901 billion in 2013, representing 5.5% of GDP, down from a deficit of $1.33 trillion in FY 2012, which was the fourth consecutive year of more than $1 trillion dollar deficits.
8. The U.S. national debt rises at an average of approximately $3.8 billion per day.
9. The US government now borrows approximately $5 billion every business day.
10. A trillion $10 bills, if they were taped end to end would wrap around the globe more than 380 times. That amount of money would still not be enough to pay off the U.S. national debt.
11. The debt ceiling is the maximum amount of debt that Congress allows for the government. The current debt ceiliing is $16.394 trillion effective Jan, 30, 2012.
12. The U.S. government has to borrow 43 cents of every dollar that is currently spends, four times the rate in 1980.
For those of you who don’t spend your days and nights thinking about the intricacies of the global economy, sorting out what really triggered the onset of the 2008 recession and how that continues to affect us today might be somewhat daunting.
You might be wondering how something called a collateralized debt obligation, or CDO, played a role in the collapse of the housing market or how the mortgage default rate in the U.S. helped bring down Iceland’s economy. You might even wonder why the news here spends so much time talking about the riots in Greece.
I often have to explain to our clients why these things are important, and how these seemingly far-flung issues are related to their retirement or other financial goals.
The truth is that these are all pieces of a global financial puzzle. And by far the best book I’ve come across that helps clearly explain how the pieces fit together, and the book I have handed out to clients and friends over the past six months, is Boomerang: Travels in the New Third World, by best-selling author Michael Lewis.
Interestingly, it was in writing his previous book, The Big Short, in which he explored how some people made a lot of money after the U.S. housing market collapsed, that Lewis came to understand the bigger picture of what was happening throughout the global economy. “One of the hidden causes of the current global financial crisis is that the people who saw it coming had more to gain from it by taking short positions than they did by trying to publicize the problem,” Lewis writes.
In Boomerang, Lewis seeks the roots of the problem by taking readers on a journey around the world – stopping in places like Iceland, Germany, Greece, and Ireland – to show how events there are connected to actions taken here in the U.S. But Lewis is also master storyteller in that he can teach you about esoteric financial topics without you even realizing it. You’ll learn how fisherman in Iceland became investment bankers overnight, for instance, and why the people of Greece apparently don’t like to pay their taxes. You’ll even get some insight into why the state of California’s economy might be in the worst shape of all.
But Lewis is also funny. Hilarious, even, when it comes to sharing tales from his travels. I remember when I handed Boomerang to my wife and how she literally howled out loud in laughter when she was reading Lewis’ insights into the German people (I’ll let you read the book to find out for yourself what was so funny!)
Just as importantly, after reading Boomerang, my wife – who has had to live with me, not just through this financial crisis, but others like the collapse of the dot-com stock bubble – began to understand what was really going on in the global economy. “Barry,” she told me. “I finally get how all the pieces fit together.”
The truth is that the global economy is more intertwined than ever and it’s only becoming more so– a fact that Boomerang makes astonishingly clear even if you’ve never taken an economics class in your life.
What makes this book so valuable is that it helps paint a picture of how we are all tied together, whether we realized it or not. The key, then, is that the better we get at understanding how unrelated events in nations abroad could impact things back here at home, and closer to home in our own portfolios, the better investors we can become in the long run.
At a private fundraising event on Sunday, Mitt Romney gave us the first indication of tax deductions that are on his chopping block. Top on his list is the second home mortgage deduction for high earners.
While Congress left the deduction of mortgage interest intact back in 1986, Romney is targeting the second home mortgage deduction, one that many believe Congress never intended to be used to promote second home ownership.
But for the majority of Americans who don’t own second homes, why should they care if the second home mortgage deduction is eliminated? With more than 11 million residential mortgages underwater, the loss of the second home mortgage deduction could have ramifications to a housing market still struggling to recover.
To illustrate this point, our Second Home Mortgage infographic shows the areas of the country that might be most affected. Using 2010 Census data, we highlighted the states with the highest percentage of second home ownership, the greatest number of second homes and the percentage change since the 2000 census.
Click HERE to enlarge.
While we found it interesting that Maine has the highest percentage of second homes, we were not surprised to learn that Florida has by far the largest number of second homes, and Nevada has had the greatest percentage increase.
Also, not surprising is the increase in underwater mortgages in those states. According to CoreLogic, a market research firm, Nevada leads the nation with over 60% of their homes with mortgages worth less than what they owe. Florida is third with 44.2% of their mortgages underwater. The greatest impact will be felt in the pockets of communities within these states where most of the homes are non-primary residences.
Vacation resorts that are not necessarily retirement destinations may feel the most price pressure. Ocean City, Maryland, for instance is a fine place to visit in the summer, but not teeming with seniors or retirees. Maryland’s residential market is also under pressure with almost a quarter of their mortgages underwater. Second homeowners may need to replace mortgage deductibility with rental income and other offsets like depreciation and expenses to help them make their mortgage payments.
A rebound in home prices continues to be a long way off. Homeowners with negative equity are now back to 2009 levels with 22.8% of all residential mortgages underwater nationwide. Any additional costs, like the loss of the second home mortgage deduction may be enough to keep would-be buyers away. The impact will be found in the smaller line of people willing and able to buy the home.
As one looks to qualify for the mortgage on a second property, lenders will need to incorporate the new higher non-deductible cost and disqualify those who exceed acceptable standards.
Then there is the actual increase in cost. Based on a 4% 30-year mortgage, homeowners will find the following cost increases based on the size of their mortgage and their tax bracket:
These additional costs may not sway most to give up on their dream of owning a place in the mountains or at the shore. But a time when we remain skeptical of a housing rebound, and with many primary residences underwater on their mortgages and lenders holding their funds ever so tightly, these additional costs add up to greater pressure on second home prices over the coming years.
My hope is that our infographic starts a conversation about second home ownership in each state, and particularly the communities in each with a larger number of second homes. Since 49 states have counties where second homes account for at least 10% of all homes, these communities, some already under the strain of foreclosures and weak sales are certain to feel the loss.
For most of the past two years, investors have been pre-occupied with the fiscal catastrophe in Europe – and with good reason. However, the relative health of the world’s second largest economy arguably deserves more consideration.
A year ago, China’s stock market led the broader emerging markets down due to pervasive inflation concerns. Official figures reached as high as 6.5%, and some reports of pork and other food price inflation reached double-digit levels. Chinese authorities were forced to slow down the pace of their economy by raising bank reserve ratios and key lending rates.
Coinciding with these efforts to “cool” overheating growth, they have embarked on a more far-reaching goal of transitioning China from a manufacturing-led, export economy to a more consumer-oriented, self-sufficient one.
Indeed, more than half of GDP in 2011 was driven by public and private consumption – the first time this had occurred since 2001. Unfortunately, some question the methods through which China has pursued this objective including the Organization for Economic Co-operation and Development (OECD), which believes that public infrastructure investment financed off-budget has made up most of the domestic demand.
Still, there are other signs that China is seeking greater economic liberalization. None may be more important than a fix of its troubled financial sector, which is saddled with bad debt and failing to meet private sector demand. The failure of the Chinese banking system to service the private sector has created a “shadow” lending system, in which some lending rates reach 100% annualized.
While fears of a “hard landing” in China helped drive prices of H-shares (stocks available to foreign investors) to an 18% loss in 2011, Chinese stocks rebounded in late 2011 and early 2012 as inflation cooled and growth began to stabilize. The MSCI China index rose 18% in January and February of this year, among the top performing global markets during that period.
However, China looks to be re-entering a soft patch. Industrial production advanced 11.4% in the first two months of the year, well below China’s 15% average. In early March, China officials lowered their target growth rate for the first time in eight years.
Investors have taken notice. A 7% loss in March by the MSCI China index was the worst return in the global index, resulting in a first quarter return to investors of 9.9%, trailing even Europe, which is mired in a technical recession.
Most believe that Chinese officials have the resources and control to manipulate its economy effectively. However, one cannot help but question the relative firepower available to the government. Following a massive $586 billion stimulus program launched in late 2008, on top of the virtual peg of the renminbi, the amount of Chinese currency pumped into the economy over the past few years is staggering.
Inflation remains the key to what flexibility China has. Officials had successfully pushed down inflation to a 21-month low of 3.2% in February, but new data revealed prices spiked back to 3.6% in March – well above estimates of a 3.4% rise. The data underscores just how delicate China’s situation remains.
Just as with every month, traders focused particular attention on the March employment report, which was released after the markets closed for the week. It was fortunate that markets were closed, because the report introduced new uncertainty into the economic outlook.
As a recap, 120,000 jobs were added to payrolls in March and the unemployment rate dipped slightly to 8.2%. Economists expected job growth of 201,000.
The disappointing report followed job growth of 275,000 and 240,000 in January and February, respectively.
Even though recent data suggested growing confidence in the private sector, private sector payrolls only grew by 121,000 in March.
Economists were hopeful the labor markets were finally moving towards greener pastures, particularly given the consistent improvement in initial claims for unemployment insurance, which are at post-recession lows.
Adding further frustration to economists’ view of labor, underlying components are simply not improving. The employment-population ratio currently stands at 58.5%, levels last experienced in the 1980s.
In addition, for those individuals without a job, the picture is difficult, at best. More than 40% of the unemployed have been without work for at least 26 weeks, accounting for 5.4 million people.
There were small pieces of good news sprinkled in the labor report, though. For instance, the underemployment rate, which includes marginally attached workers, dropped to 14.5%, the lowest level of the past 3.5 years.
March data was obviously quite disappointing, but it is difficult to determine whether this was simply a hiccup in the trend of broader improvement or the start of a new round of weakness.
As financial advisors, we look at a broad range of market and economic forces to form our investment decisions. In our monthly economic report, we take a look at the effects these forces have had on markets nationally and globally during the month. This broader perspective helps us to provide more insightful investment and financial planning advice to our clients. Click Here to see our March 2012 report.
At the end of 2011, the Long-Term Refinancing Operation (LTRO) brought a modicum of stability to financial markets in Europe. When coupled with the “orderly” default of Greece, the situation in Europe is seemingly on a road to more pleasant ground. Just as soon as investors place Europe in their periphery, however, problems once again begin bubbling to the surface. In recent weeks, the spotlight has turned to Spain, where unemployment is near 24% and the government is expected to run a 5.9% budget deficit for 2012. Greece created a roadmap for sovereign defaults, but the sheer size and magnitude of a potential Spanish default is weighing on investors’ recent bullishness.
Spain, as one of the largest economies in the European Union, received a reprieve from investors last year as most attention was focused on Greece. The introduction of the LTRO effectively squashed investors’ concerns about the solvency of Spain, but those fears reemerged in early March.
The Spanish government announced that it expected a budget deficit equal to 5.8% of gross domestic product in 2012, lower than its 8.5% deficit in 2011, but well above the 4.4% it agreed to with the European Commission.
Spain subsequently announced plans to reduce its deficit through a combination of spending cuts and revenue increases, bringing the estimated deficit to 5.3% of GDP, but investors were already on high alert.
Yields on Spanish 10-year debt, which jumped as high as 6.5% last year but fell to 4.9% following the LTRO, have been on the rise in the last 30 days. After falling below 5% in early March, yields on 10-year Spanish debt are back to 5.3%.
While the government is aggressively seeking ways to reduce the deficit, the stark reality remains that Spain is a country with an unfavorable outlook. GDP is expected to shrink by nearly 2% this year, and its unemployment rate is the worst in the EU at 24%. Among those under 24 years old, the unemployment rate is a staggering 50%.
Spain’s problems are massive in the context of Greece, which was a relative drop in the bucket. Resolutions for Spain are limited, but the EU is scrambling to come up with a contingency plan. Many expect that the same Troika that oversaw Greece’s austerity measures will become involved in Spain. That means officials from the European Commission, International Monetary Fund and European Central Bank are all expected to become involved in Spain’s fiscal management this year.
Until we cross that precipice, expect markets to renew their focus on European sovereign debt issues, with a particular eye towards Spain. Spain will prove to be a bigger headache than Greece ever was, merely due to its size and economic importance, so this is an issue that could drag on for an extended period of time.
By now, I’m sure you’re familiar with Greg Smith of Goldman Sachs who launched himself and his firm into the international spotlight by publishing his “resignation letter” in last week’s New York Times Op-ed.
His scathing article about the dubious business and sales practices at Goldman Sachs are more than just the rantings of a disgruntled former employee. He opened the door, and many of their clients’ eyes, not only to how Goldman Sachs conducts its business, but what their business culture is really like – and it’s not pretty.
I always thought that the difference between the ways my firm does business and that of Goldman Sachs was wide. But based on the revelations by Greg Smith, the difference is like looking from one side of the Grand Canyon to the other.
It cannot be surprising that some firms have and continue to abuse their clients’ trust for their own financial gain. While not surprising, it still pains me to hear about these practices because it is a black eye for everyone in our industry.
As a business owner and leader, I believe that both the structure and the corporate culture must align with a firm’s core values. When a firm like Goldman Sachs has the ability to have conflicts of interest, and their corporate culture takes advantage of their responsibilities by putting their own interests first, they no longer serve their clients.
I’ve received several calls from clients about the Op-ed – some to gossip and some to confirm the differences in their experience with us vs. those of Goldman Sachs’ clients. Mostly, they said they were grateful that we have a fee-only structure, a culture imbued with integrity, and a history of always putting our clients’ interests first.
What I said to those who called is simply this: We do not get paid more to recommend one investment strategy over another. We have no product to sell, no quota to achieve. As a fee-only firm, we are fiduciaries and are held to a higher standard of care. It’s important for those seeking financial advice to understand this.
Our worth lays in the value our clients place in us, in the advice and resources we offer to help them live more confidently knowing that they don’t have to worry that there may be other ulterior motives.
We invest a great deal of time and resources developing a firm culture that is dedicated to serving our clients and their families. My hope is that they always experience this level of care whenever they work with anyone at our firm.
As long as firms like Goldman Sachs place a higher value on their own profits rather than the interests of their clients, or Muppets as they like to call them, then there will always exist a chasm between our firms. The success of Glassman Wealth Services is aligned with the success of our clients. We wouldn’t have it any other way.
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