Tuesday, May 1, 2012


From the Desk of Joe Rollins

Before I start my financial ramblings, I want to provide those of you who’ve inquired about my children, Josh and Ava, with an update. Josh turned 17-years old today, and he’s a great kid. He’s in his junior year at Woodward Academy, and he continues to excel at golf and is doing quite well in his studies. It’s hard to believe that he’ll be starting college in just over a year – it feels like he was just born yesterday!

As for Ava, she’ll be turning one on May 22nd. Although she’s not quite walking, she is almost 32-inches tall and is nearly 26-pounds. She brings us an awful lot of joy in spite of her undying will to destroy the house and create chaos morning, noon and night. No one said that being a father at 62-years old would be easy, and while it’s not a cakewalk, it is still very rewarding.

And now, on to the less interesting stuff…

The month of April has closed and the first four months of 2012 have provided exceptional stock market returns. For instance, the stock market has already had an increase in value that is more expected for an entire year than just four months alone. The S&P Index of 500 Stocks is up 11.9% for the first four months of the year, the Dow Jones Industrial Average has charged ahead at 9.1%, and the NASDAQ Composite is at 17.3%. These returns are quite unexpected – but welcome – for a four-month period.

In spite of this performance, the public’s skepticism and its distrust of Wall Street and the government has caused some of our clients to want to back off from stock market investing. In this post, I’ll give you some reasons why doing so would be a bad idea.

As much as I’d like to, I can’t forget the devastation that occurred in investor portfolios during the financial meltdown of 2007 and 2008. However, many investors are unfamiliar with the performance of the indices since that time period. If we measured the period from June 30, 2007 through April 30, 2012, the results would reflect that the S&P is up 2.47%. Likewise, the Dow is up 11.22%, and the NASDAQ is up 21.85%. For all the gloom and doom expressed during the 2008 financial meltdown, the indices have recovered every dollar of that downturn, plus a little more.

These are extraordinary times for investing. With all the negative publicity being reported on a daily basis, it’s important to focus on the items that make stock markets increase. Ponder these positive trends:

  • Even though earnings expectations for the last several years have been lofty, actual earnings have actually exceeded those expectations. Earnings are presently greater than at any other time in the history of the United States. Since earnings are what impact stock prices the most, this is the number one driving force of higher stock prices.

  • The U.S. Federal Reserve has essentially guaranteed that interest rates will not be increased until mid-2014. This means that for the next two years, interest rates will continue to border on zero. Higher interest rates can inversely impact stock market prices in that as interest rates increase, stock values go down. Further, higher interest rates create competition for investment dollars.

  • Undoubtedly, we’d all like to see an increase in jobs and the debt sectors of the market start to rally. However, from a stock market perspective, we’re actually better off with GDP being marginally positive but not completely on fire. If we had an economy exploding to the upside, interest rates would almost assuredly need to increase to accommodate higher economic activity. With a GDP reported in the first quarter of 2012 of only 2.2%, we’re currently experiencing a Goldlilocks economy – it’s not too hot, nor is it too cold. For stock market investing, a GDP of 2% to 3% is quite satisfactory.

  • As mentioned above, earnings are at an all-time high. Imagine how high earnings could be if GDP really took off like it should. Earnings could increase even higher if GDP were stronger.

  • Even though the stock market has increased approximately 30% from October 1, 2011 through April 30, 2012, stock prices are still cheap. With the P/E ratio still at moderate levels, it’s possible that the market will continue to expand as the year continues.

  • The 10-year Treasury bond continues to hover below 2% annual interest rates. As long as the 10-year Treasury continues at almost historic lows, you can expect to see stock prices expand. The current dividend rate of the S&P 500 is higher than the rate on the 10-year Treasury bond.

  • Of course, I could also provide a list of negatives, but in my opinion, the positives far outweigh the negatives at the current time. High on the list of negatives, however, is Washington’s total inability to appropriately function. I fully expect capital gains rates to increase in 2013 regardless of who is President – not because they should, but because Congress refuses to work together to accomplish anything. While income tax rates will undoubtedly increase in 2013, I don’t anticipate that to impact the stock market until interest rates start increasing in mid-2014.

    Unquestionably, the U.S.’s extraordinary deficits are a risk to our financial future. As an optimist, however, I doubt the public will allow these deficits to continue running amuck. Therefore, while the deficits are potentially endangering to our long-term financial security, I believe that we’ll soon have new elected officials in Washington who will change that scenario for the better.

    Those who continue to jump in and out of stock market investing are surely learning that it is impossible to be a successful market timer. The market moves up more days than it moves down, and it is believed that the market moves up on twice as many days as it moves down. Moreover, the days with large increases far exceed those days with large decreases. If you try timing your investments, you are certainly more likely to avoid big down days, but more importantly, you dodge the more numerous big up days.

    Knowing when to sell isn’t the hard part of market timing – it’s when to buy. While it’s not difficult to cut long-term risk in the stock market by market timing, it is virtually impossible to boost long-term returns using this technique. Purely on the fact that up days far exceed down days, investors are almost always better off being invested for the long-term rather than utilizing short-term strategies.

    Another positive concerns upcoming lower energy prices. There are almost daily financial news reports concerning the detriment of higher energy prices on the U.S. economy, and after spending billions of dollars on alternative energy efforts, it seems clear that no expenditure will make any type of dent in our need for fossil fuels. Our best bet would be to better utilize those fossil fuels, which is happening in this country. As we exploit new drilling in the U.S., the price of oil will fall as the summer progresses. I project that by the end of 2012, energy should be significantly lower – by at least 15% – than it is today.

    I fully expect the stock market to suffer some sideways movement during the summer months given the large increase in the stock market in the first four months of the year. However, I don’t see a major sell-off due to reasonable valuations, and I certainly don’t foresee us trading out of our positions in order to avoid a small sideways movement. Every day will not be a winner, but by year-end, there should be rewards for having stayed invested.

    With interest rates continuing at low levels and with earnings continuing at higher levels, I expect for the market to continue to rise for the rest of the year and forecast the S&P 500 to be 1,540 by December 31, 2012 (current valuation = 1,394). Therefore, based on a low valuation, it’s perfectly possible for the market to increase 10.5% for the remaining months in the 2012 year. This would mean that the S&P 500 index would have a total return at December 31, 2012 in excess of 20%. Wow!

    My S&P 1,540 forecast above was not just pulled out of thin air. To arrive at this projection, I reviewed Standard & Poor’s estimate for 2012 earnings for the U.S.’s 500 largest stocks, which they have placed at $110. I then placed a low multiple of 14 on that projection to arrive at 1,540. Again, 14 is a relatively modest multiple; over the last 30 years, the average multiple on the S&P has been approximately 20. My multiple of 14 reflects a conservative price from a long-term perspective, and it is not impractical.

    For skeptics who’ve avoided making IRA contributions for fear that the market is in for a big tumble, I can only reemphasize that the market is up over 30% in the last seven months alone and they missed that run-up. Cash sitting in money market accounts is earning practically nothing right now while money invested in securities is creating true long-term wealth. If you are a client, I encourage you to set up a meeting with us so we can show you our strategy for building your assets for a stronger, more secure retirement.

    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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