Wednesday, June 8, 2011


From the Desk of Joe Rollins
I received a lot of criticism from readers of the Rollins Financial Blog regarding my June 1st post, “News for May, 2011 – A Satisfactory Month.” In it, I indicated that even though May was a negative month for the stock market overall, it was still satisfactory because it kept the upward trend of the bull market intact.

Several readers questioned how I could possibly view the results for May as being satisfactory, especially in light of the significant change in economic conditions and the seemingly constant negative news coming out of Washington for the last two weeks. Some readers wondered why I am not forecasting another meltdown like we suffered in 2008. My suggestion to those readers is that they should stop, think and analyze before they push the button to sell.

I’m having a hard time understanding the correlation to 2008 that some of my readers are drawing. I suppose that if you watch the news long enough, you might come to the same conclusion. However, there are many differences between 2008 and what we are currently experiencing. While the growth in employment for the month of May was only in the 50,000 range, those results are significantly better than in 2008 when 650,000 jobs were being lost per month. And while GDP was anemic at 1.8% for the first quarter of 2011, that percentage is light years better than it was when it was negative 6.0% in 2008.

In 2008, credit was contracting at a staggering rate while interest rates are low today. Moreover, for the first time in many years, banks are actually lending. Besides all of that, there are plenty of explanations as to why employment and GDP were weak in the first quarter. One only needs to reflect on the catastrophes in Japan this winter which cut down the supply line of automobile parts and cars to the United States. Additionally, weather in the Midwest has been horrible, and many of the agricultural workers have yet to even plant their fields, much less harvest them. Of course, we all certainly know that the home building industry has virtually shut down. Natural disasters, high energy prices, etc. – these are all short-term issues that should not bring long-term negatives to the economy. Therefore, drawing economic parallels between 2008 and 2011 is not reasonable.

You might think that we’re experiencing a significant market correction, but we actually are not. Since the market reached a temporary high in April 2011, there’s been a decline of 5.9%. This relatively modest decline could hardly be described as significant. It is perfectly possible to suffer a 10-15% decline before the market begins to turn up again. Moreover, even though it might not feel like it, the markets are still positive for 2011.

Another major component impacting the market is professional traders. Professional traders do nothing but trade all day long, day-in and day-out. They really don’t care whether the market is up or down; they’re only interested in incremental gains on large transactions. After the market’s nearly straight-up increase since March of 2009, it wouldn’t be surprising for professional traders to try to force the market down before they would reverse course to make it go up again. With all the short-term bad economic news, it would’ve been surprising if the professional traders hadn’t tried to force the market lower to enable stock purchases at a lower price.

At 3:30 p.m. yesterday, the Dow Industrial Average was up 89 points when Dr. Bernanke began a televised key speech at the International Monetary Conference in Atlanta. Bernanke indicated that the economy had lost momentum, but was expected to accelerate in the last half of 2011 (only three weeks away). As Dr. Bernanke spoke about the economy having lost momentum, the Dow Industrial Average turned completely around and wound up closing 19 points down for the day.

Yesterday’s large swing in the Dow could only be attributed to professional traders, since it’s highly unlikely many typical investors were actually watching TV at that time of day. If there were investors watching Dr. Bernanke’s speech, they would’ve heard what he had to say after he noted that the economy had lost momentum – that he expected the economy to pick up during the last half of 2011.

Since I began managing assets for clients 20 years ago, I’ve been asked time and time again why we wouldn’t bail out for a few weeks when the market is declining and then buy back in once the market hits a bottom. I wish it were that easy, but it’s been proven through numerous studies that market timing simply doesn’t work – no one can precisely time the market.

If we traded out our positions for the short-term, then we would have to pick another type of investment that we would deem to be better than what we currently own. Let’s evaluate our options to see what’s available:

  • Investing in cash –Money market accounts are currently returning almost zero. In fact, municipal money market accounts actually have a negative rate of return right now. Also, if you’re paying a maintenance fee on your account, it’s highly likely that over the course of the year, a positive return would only be marginally possible. Of course, as we all know, inflation (which is at about 2% right now) would likely cause a negative rate of return in purchasing power at the end of the first year for cash invested in money market accounts.

  • CDs – This is another type of investment that is currently paying an almost zero return. Like cash, CDs are providing negative rates of return once you take inflation into consideration. I’ve heard many people say that these products are appealing because they care less about making money than losing money. However, due to the inflation component, it’s almost guaranteed that a CD investor will actually lose money or purchasing power over the CD’s term.

  • Treasury bonds – As of today, the 10-year Treasury bond is paying a rate of approximately 3%, which is practically an all-time low. It’s almost assured that this rate will go higher in the coming months. Given that the rate of inflation is approximately 2% and the Treasury rate almost always exceeds the rate of inflation by 3%, then you can see that Treasury rates need to be at least 5% to protect you from the current rate of inflation. These bonds may lose money over the next few years, especially if interest rates increase significantly.

  • Residential real estate -- It’s well known that this hasn’t been a good investment for the last decade or so. Almost daily, a client tells me they want to buy a property down the block “because it is so cheap.” In each and every case, I advise the client to sit tight, because it’s highly likely that the property will be just as cheap three or four years from now. I’m not negative on residential real estate, but I do think it’ll be a slow climb out of the rut we’re in and other investments are much more attractive.

  • High-yield bond funds – These funds are attractive right now because they pay a high rate of interest and are also not as impacted by higher interest rates into the future. We own many high-yield bond funds in our client portfolios.

  • Stocks – This is the most attractive asset class for investing at the current time. Corporate profits are at all-time highs and corporate America has never had such solid balance sheets. With cash held by American corporations, you have the triple advantage of high corporate profits, solid balance sheets and excess cash available for new investments. Stocks have rarely offered such compelling advantages over income securities in the past.

  • Utility stocks – These stocks offer the opportunity of high dividend payments that are significantly greater than interest bearing certificates with a major tax advantage over interest earned on money markets and CDs. For taxpayers in higher income brackets, interest income is taxed at 35% while dividends are taxed at 15%. The disadvantage to these stocks is that they very rarely have significant market appreciation, as utilities typically exhibit lower overall volatility than the broad market. However, if you are looking for a return on your investment, it makes little sense to invest in cash, which returns almost zero when you can invest in high quality utility stocks earning 5% or greater with more favorable income tax rates.

  • It should be fairly evident to investors that nothing has really changed due to the soft economic numbers from the last several months. It should also be clear that the situation in Japan, the higher gas prices, and the turbulent weather led to a very soft GDP in the first quarter of 2011. However, almost every economist, including Dr. Bernanke, is forecasting higher GDP growth for the rest of 2011. While it won’t be gangbuster growth, unlike in 2008, it will still be growth.

    Given that corporate profits are high and getting higher and corporations are very cautiously hiring additional employees, we should see higher stock prices in the second half of 2011. The only time to anticipate a stock market decline is when GDP is plunging and corporate profits are deteriorating. We have neither of those scenarios today.

    One of the interesting aspects of current corporate America is that we receive the benefits of U.S. and international profitability. As of today, 40% of American corporations’ profits are realized in international commerce. It’s estimated by Bob Doll, Chief Equity Strategist and Lead Portfolio Manager for BlackRock (one of the world’s leading providers of investment, advisory and risk management solutions) that 70% of the profits of U.S. corporations will be international in the next five years. U.S. corporations are now accomplishing the best of the developed and the emerging markets in one entity. Unlike any other time in recent memory, these corporations are generating extraordinary profits even with the U.S.’s tame GDP growth (but superior 6% GDP growth in the emerging countries). I can only imagine what corporate profits will be if GDP continues to increase here in the U.S.

    There is no solution for the problems in our government; they have proven themselves to be inept at doing anything to help the economy. The economy is being held back by endless bureaucracy, red tape and government intervention, and it’s unlikely that these obstacles will be removed within the next few years. But even with all of the headwinds that American corporations are up against today, their profits continue to be spectacular. Given the available options of different investments I have listed above, stocks, high yield bonds and dividend-paying stocks are the best choices. And that is exactly where Rollins Financial has substantially invested the portfolios under our management.

    As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

    Best regards,
    Joe Rollins

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