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From the Desk of Joe Rollins
The media has been shouting for the last several days that the financial markets are in turmoil and a severe correction has started. If you read the front page of many national publications, you can almost rest assured that the information is sensationalized. While the markets have undoubtedly been extraordinarily volatile over the last three weeks, there is no reason for investors to panic.
The markets have been down in excess of 500 points over the last two days, but don’t be so quick to forget that on Monday and Tuesday together, they were up greater than 200 points. These movements in the market are symbolic of trader activity – traders who were likely trying to take a position before June’s triple witching day. This is the third Friday of March, June, September and December, and it is the expiration day for three types of standardized contracts: stock options, stock index options and stock index futures. Investors often unwind their positions on these contracts during or immediately before triple witching days, leading to increased trading volume. Unfortunately for us, none of these items have to do with investing – they have to do with speculation.
At approximately 3:00 p.m. EST on Wednesday, June 19th, Federal Reserve Chairman Ben Bernanke gave a press conference regarding the economy. Almost immediately afterwards, the markets took a huge nosedive. The sell-off continued on Thursday, causing the Dow to fall 354 points for the day – its biggest loss of the year. What did Bernanke say that caused such an adverse effect on the markets? That the economy was falling into a recession or depression? That unemployment was getting ready to skyrocket or that the U.S. government was going to default on its bonds? Nope, not at all.
Bernanke said Wednesday that, based on current positive economic conditions, the Fed might start to cut back its bond purchasing starting in the fall and stop buying them entirely during 2014. He also said that the Fed would hold onto the securities it owns and reinvest the interest from them, which he expects would help keep long-term rates low.
There’s been great anticipation in the investing world as to what the Fed would do with its bond buying program. The Fed is currently buying $85 billion monthly in bonds in the open market to keep interest rates low, and they have been tremendously successful in keeping interest rates near zero which is helping the real estate market. Bernanke basically gave us his strategy in the bond buying program, and said that if the economy does not perform as expected, then they would not cut back and ultimately end its bond purchasing. What explanation could have been clearer?
Responding to a question from the audience, Bernanke made it absolutely clear that he didn’t anticipate any interest rate increases until 2015. Make sure you understand that he is talking about a two-year period from today before the Fed even contemplates increasing interest rates – a move that they will only make if the economy can support such increases. I can’t imagine anyone who was paying attention to his words misinterpreting Bernanke’s specificities and the Fed’s intentions.
Not only was the information relayed by Bernanke good news for investing, it also provided two other important positive indicators for investing. Specifically, the Fed moved up its GDP projection for 2014 to a range of 3% to 3.5%. This isn’t robust, but it’s a long way from negative. The Fed also forecasts the U.S. unemployment at 6.5%-6.8% in 2014, a remarkably better percentage than the current rate of 7.5%. Therefore, the Fed’s analysts feel that the economy is set to improve through 2014. Once again, this is a very positive sign for equity investing.
As a supplement to the other financial information, the Fed reported that its anticipation for inflation actually ticked down. They expect inflation over the next few years to be less than 2%. In fact, the core rate (excluding gas and food) for the last 12 months is only up less than 1%. Low inflation in an improving economy is a very positive sign for the stock market.
Given all of the positive information provided by Bernanke, who would’ve expected the negative reaction by the financial markets? In addition to the Dow’s 5% sell-off, bonds were absolutely crushed over the last two days. The 10-year Treasury bond has gone from 1.4% in May to 2.43% - a historic move in such a short period of time. And did I mention that the anticipation for inflation was virtually zero, which would imply lower bond yields, not higher interest rates? Duh – what is going on here?!?
My point is this – the reaction from traders should be ignored by investors. Investors need to evaluate the underlying investing environment and not worry about the day-to-day volatility brought on by traders. The truth of the matter is that for the month of June alone, the S&P is down only 2.5% and continues to be up 12.4% year-to-date. This performance is quite remarkable only 5.5 months into this investment year.
There’s no question that bonds have been crushed over the last few months, but I believe this topic has been grossly exaggerated. For the first time in years, a 10-year Treasury actually has a positive real rate of return. If you can buy a Treasury bond at 2.4% and inflation is only 2%, you are finally actually making some money. That has not been the case over the last three years when Treasuries have had a negative real rate of return.
While the correction in bonds has been severe, I anticipate that they’re highly likely to make money over the next year. It’s unlikely for the rates to continue going up an enormous amount over the short-term. My forecast is that a few years into the future, interest rates will have to increase and bonds will have negative rates of return. But, I don’t believe that is an immediate concern for the next 12 months.
As for equities, virtually every positive economic indicator remains intact:
Corporate earnings continue increasing going forward.
The economy is forecasted to continue to expand up through 2014.
The Fed has indicated there will be no significant interest rate increases through 2015.
Even though interest rates are higher, they are still at historic low levels.
Because interest rates are still low, buying Treasuries or CDs provides rates of return that barely matches the cost of living.
Money markets are paying virtually nothing.
Corporate balance sheets are rock solid.
Corporations and individuals currently have $3 trillion of un-invested cash in money market accounts.
There’s no question that the economy is improving in our part of the country. There’s new residential construction everywhere around my house, and the house across the street from mine (which was vastly overpriced) sold in less than 30 days. Potential homeowners are finally seeing that when interest rates start to move up, they need to move quickly to purchase property before the move occurs. Economic activity, again, is created every time a new house is built or sold.
I will provide a more in-depth analysis after the end of the financial quarter (June 30th), but because of the high volatility in the markets this week, there were some things I wanted to point out to you regarding investing. At Rollins Financial, we are not traders, and if you are an investor, nothing that has happened in the last 30 days has been anything but positive for investing into the future.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
From the Desk of Joe Rollins
Congress, it seems, explains its economic actions by its inability to define whether their actions have actually done any good or not. The economy hasn’t really improved, but according to Congress, it probably would’ve been a lot worse if they hadn’t taken the actions they took. I’ll get to that point shortly, but in the meantime, I want to relay the financial results for the month of February 2013.
February was an excellent investing month, and while it certainly wasn’t as good as January, it was still quite satisfactory in almost every respect. The S&P 500 had a 1.4% return for February, and for the first two months of 2013, it is up 6.6%. The Dow Jones Industrial Average is even better, with a 1.7% gain for the month of February and a gain of 7.7% year-to-date. The tech-heavy NASDAQ Composite lagged, but it still had satisfactory returns of .7% for February and is up 4.8% year-to-date.
The NASDAQ is heavily weighted by a single stock – Apple. Due to the large valuation of Apple, the NASDAQ basically is connected to whichever way Apple moves. Since the beginning of 2013, Apple has declined approximately 15%, and therefore, the NASDAQ has struggled with it. While there’s nothing wrong with Apple’s outlook, it arguably got ahead of itself and needed to be adjusted. The NASDAQ’s year-to-date performance, however, is still quite excellent given that its largest participant has been a drag on the aggregate composite.
There are some other interesting trends that have developed during 2013. The small cap Russell 2000 has had an excellent run, and it was up 1.2% for the month of February and up 7.5% for the first two months of 2013. Additionally, the Barclays Capital Aggregate Bond Index is finally adjusting to the reality that bonds shouldn’t perform like stocks. Unfortunately, this bond index continues to be down for 2013 thus far. We are still seeing some strength in high yield bond funds, which are up a little over 1% for the year-to-date, but almost all other types of bond funds are recording losses. Almost every form of government bonds, investment grade bonds, international bonds and even emerging market bond funds are negative year-to-date.
When I report these results, I can’t help but be amused by the unbelievably low returns that many investors are receiving in money market accounts and CDs. I met with a client last week who indicated that he was getting ready to commit to a five-year CD paying a .9% annualized interest rate. If this weren’t so sad, I would have laughed.
The confirmed inflation rate is basically 2%, although many argue that it may increase to 2.5% in the new few years. Therefore, anyone entering into a 5-year CD paying less than the rate of inflation rate would have a guaranteed loss of purchasing power. Given that the S&P 500 was up 1.4% for February alone, stock returns would exceed in one month what CDs will earn in a single year. I only wish I could successfully emphasize to investors how futile it is to invest in these fixed-rate CDs at the current time.
As the 4th quarter reporting period for the S&P 500 earnings comes to a close, a new earnings record was established yet again. It appears that the total gain will only be 4% to 8% higher than the previous year, but the most important aspect is that it was a gain.
I continue to hear commentators exclaim dismay that the percentage increase in earnings has been decreasing over the last several years. I suppose these commentators have never heard the theory of big numbers. In the 1980s, it was believed that Wal-Mart would grow its earnings every year by 25%. In fact, there were many commentators who indicated that this growth in earnings would go on for 30 or 40 years since Wal-Mart was in an expansionary stage. The only problem with their exclamation was that due to Wal-Mart’s vast size, if it had grown at a 20% compounded rate then in a few years it would have every retail dollar sold in America, and shortly thereafter, it would have every retail dollar sold in the world. You cannot continue to compound numbers and expect that trend to not decline. The fact that the earnings increased this quarter – even after record earnings last quarter – should be enough comfort for most investors.
As for my comments regarding counterintuitive economics, I will provide you with a few examples: We were led to believe that if we greatly expanded the federal budget and provided virtually unlimited stimulus plans, the economy would explode upward and GDP growth would be impressive. Five years into the current administration, we see that none of that has happened. In fact, for the 4th quarter of 2012, the GDP growth was virtually zero.
However, the argument we continue to hear is that while the economy hasn’t grown, it would have been catastrophic if those stimulus actions hadn’t been taken. I am one of the few who believe that the vast expansion of federal debt in order to achieve whatever gains have occurred in the economy may not be worth the price paid. Over the last five years, the federal debt has increased by a mind-numbing $6 trillion. My point is that it’s time to try another alternative to increase growth since clearly this one hasn’t worked.
The other counterintuitive economic theory that continues to baffle me is proposing economic fixes that have been universally proven not to work. Recently, it was proposed that we increase the minimum wage to $9 per hour from its current basic minimum rate of $7.25 per hour. The theory is that if the minimum wage is increased, it would benefit the people being paid those low wage minimums.
While increasing the minimum wage may seem intuitive, decades of research has revealed this to be incorrect. An increase in minimum wage hurts employees rather than helps them. While those who work at minimum wage are helped in the immediate, the number of people employed actually decreases when the minimum wage is increased. Therefore, to argue that it helps employees is just incorrect. If you keep calling a cat a dog, it won’t make it come true. Unfortunately, in economics few things have not been tried before, and certainly the history of economic reality in this regard is well documented.
I’ve been asked by a number of clients if I believe that sequestration will hurt stocks. My only opinion regarding sequestration is that it’s good that spending is finally being cut. It appears that Congress is so inept that it can’t find a way to cut federal spending on its own. If a corporate executive was asked to cut 3% out of their annual budget, they would laugh at that ridiculously low budget cut. Certainly, 3% can be cut out of anything very quickly, but our Congress couldn’t even agree on this minor budget reduction. Therefore, sequestration may be positive for the stock market since it will finally demonstrate that there’s an attempt being made to control federal spending.
I do not see anything in the current economic environment that would lead to a massive decrease in prices. Earnings continue to be quite good, interest rates continue to be low, and while the economy is not growing, it’s not declining, either. All of those are extraordinarily positive attributes for higher stock prices going forward.
As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
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
From the Desk of Joe Rollins
No surprises here – at the close of the 2-day Federal Open Market Committee (FOMC) meeting on Wednesday, the Fed announced its latest effort to encourage the economy – a strategy to help further lower long-term interest rates and decrease mortgage rates consistent with expectations and my forecasts discussed in . Here’s the meat of the plan:
- By the end of June 2012, the Fed will be purchasing $400 billion of mid- and long-term Treasury securities (maturities of 6 to 30 years), and it will sell an equal amount of short-term Treasury securities (maturities of 3 years or less).
- The Fed will also reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities with remaining maturities of 3 years or less.
- The Fed will keep the target range for the federal funds rate at 0 to ¼ percent.
- As anticipated, the Fed will not be printing any new money in this plan.
Market Reaction
With the FOMC pointing out “there are significant downside risks to the economic outlook” as its decision to extend the maturity of its securities holdings, the world markets tumbled yesterday. But this is likely a short-term hiccup, and as I stated on Tuesday, the Fed’s move is better than doing nothing. It will hopefully spur companies to start investing their cash and also allow for better borrowing terms and an increase in household spending. All of these positives would ultimately help increase employment and promote price stability – the Fed’s two statutory mandates.
Even so, the Fed’s somewhat dour outlook along with signs of a slowing in Germany’s economy and a shrinking in China’s manufacturing hammered stocks and commodities yesterday. Meanwhile, the Dollar Index climbed to 1.3% – a 7-month high – and 30-year Treasuries dropped to record lows. Still, the FOMC did say in their announcement that they expect the economy to improve, stating that “The Committee continues to expect some pickup in the pace of recovery over coming quarters.” This statement wasn’t discussed much in the press, which mostly focused on the dismal news. As you may recall, the first two quarters of 2011 were marginally positive. With the Fed’s forecast of an increase in the recovery pace, I can only assume that they believe the second half of the year will be better than the first.
Last week, the market had a positive return of over 5%. Over the last two days, the market has gone down over 6%. To me, this emphasizes the volatility of the market and not the overall direction in which the market is heading. As I write this post, the S&P is down 10% for the year, and as last week’s performance indicated, this could be cut in half in only five trading days.
This morning on CNBC, Jack Welch, the former Chairman and CEO of General Electric, stated that of the 11 public companies for which he consults, not one of them is down. He optimistically opined that U.S. corporations are functioning okay on the low side and fabulous on the high side. His sentiment is that corporate America is leaner, more productive and more profitable than ever. Hence, what has happened in the market since the Fed’s announcement on Wednesday is a mystery to those of us who evaluate the market based upon these fundamentals.
It feels like we’re receiving an avalanche of misinformation regarding the U.S. economy. I’m not sure if this is because technology spreads news like wildfire – much of which seems to be distorted – or if politicians intentionally misstate financial facts and data. During last night’s fifth GOP presidential debate, there was a lively discussion regarding Fed Chairman Dr. Ben Bernanke – with some candidates suggesting that Bernanke was intentionally destroying the value of the dollar and undermining our future by cutting the international value of the U.S. dollar. Interestingly, the value of the dollar is actually unchanged for the last four years – another reason to not believe politicians when they spout off economic “facts.”
In spite of the market’s performance, the Conference Board, a global research association of independent business leaders, released a report on Thursday reflecting that the index of U.S. leading indicators was higher than its original forecast in August, signifying accelerated growth heading into 2012. So while the market may seem disappointed that the Fed delivered only what was expected and nothing more – and even with the bleak economic news around the world – I don’t foresee the markets continuing to spiral downward.
I also disagree with those who say ‘Operation Twist” will likely fail and that the U.S. is on the verge of falling into another severe, prolonged recession. As I’ve indicated on numerous occasions, while growth certainly isn’t robust, I still believe there will be a pickup in recovery over the coming quarters and the unemployment rate will decline – even if only at a gradual pace. So, while my belief that equities will improve in the months ahead remains the same, we will continue to watch the markets closely and make any necessary changes to our portfolios under management. For now, however, I still believe that we are better off invested in stocks than anywhere else.
The worldwide sell-off in the equity markets is riddled with inexplicable contradictions. For the first time since 2008’s broad market sell-off, equities and gold took a simultaneous nosedive; these asset classes typically move inversely to one another. With the rally of the dollar, almost all commodities were hard-hit yesterday. But the price of crude oil was down dramatically, which is a direct positive for the economy and an indirect positive for the stock market.
Last night I reviewed the worldwide GDP growth to make sure I haven’t been hallucinating. It appears that China will have GDP in 2011 of approximately 9%. India’s GDP growth is anticipated to be 6% to 8%, and Brazil is expected to have GDP growth of 5%. From the raw data, it appears that Europe will be flat or marginally negative, and the U.S. will be flat or marginally positive. There are currently no solid facts that would explain such a massive market sell-off under these predictions.
I mentioned that the U.S. GDP for the first two quarters of 2011 was marginally positive, and it certainly appears to have picked up in the 3rd quarter of 2011. Based on my rough calculations, it appears that the GDP will be about 2% positive for the 3rd quarter, which ends next Friday. That’s certainly not robust, but it’s not negative or indicative of a major ongoing recession, either.
I see very few solid facts to back-up the selling spree on Wall Street. Fear seems to be the main driver, which – in a contrarian sort of way – is positive. With dividend yields on utility stocks now in excess of 6%, it is hard for me to imagine a knowledgeable investor continuing to sit in a 10-year Treasury at 1.7% when AT&T can be bought with a 6% dividend yield. That being said, I fully understand the apprehension when the market is so volatile. Corrections are often painful to endure, but the natural mechanism of the market is that there are major swings on both the upside and the downside due to traders trying to gain an advantage. Investors should expect a market move of 10% to 20% at any time, and should certainly not be surprised by such moves. In the end, however, fundamentals will rule – and the current fundamentals concerning earnings bode well for investors.
It was also argued that the market sell-off was due to a rotation from equities into the safety of Treasury bonds. However, the 10-year Treasury is currently trading at 1.73%. No savvy investor would buy a 10-year bond at this low rate when inflation is expected to exceed 2%. These buyers are either dramatically concerned about a possible worldwide depression or they simply do not understand the time value of money. It’s hard for me to join the depression camp when I’ve not read a single reputable economist projecting negative GDP in the next few years.
This sell-off is also contradictory because it is happening in the face of extraordinary earnings. It now appears that 3rd quarter earnings will reflect the highest earnings ever recorded for the S&P 500. How is a major stock market sell-off even reasonable in the face of such extraordinary earnings? The S&P 500 has a dividend yield in excess of the yield on the 10-year Treasury bond, which has happened only a few other times in history. This brings to light the major difference between traders and investors. Aside from those investors making fear-based decisions, most investors would never buy a 10-year Treasury earning 1.73% when the S&P index generates 2.25%. Moreover, the 30-year bond is trading at 2.8%, which is the lowest yield ever recorded on such a long-term bond. While everyone would like to believe that inflation will be less than 2.8% over the next 30 years, there’s certainly no historic evidence to indicate that to be true.
My next post will focus on the difference between traders and investors. Traders work on short-term variations while investors look to the long-term, and I will provide my complete analysis on this subject and how it impacts the stock market early next week.
Lastly, I want to reiterate our standing invitation to discuss your portfolio and financial matters with us in person or over the telephone, whichever is more convenient for you. We’re aware that the markets have been worrisome over the last few months, and we want you to know that we are always available to discuss your questions and concerns and our strategy for your financial goals. Please contact us at 404-892-7967 if you would like to schedule a meeting to review your personal financial plan.
As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
From the Desk of Joe Rollins
While readers of the Rollins Financial Blog are probably interested in my thoughts regarding yesterday’s substantial market sell-off, I’d already written the following month-end report. Blogs must be posted by 3:00 p.m. to be emailed to subscribers the same day, so my thoughts regarding the market sell-off will be published tomorrow, Saturday, August 6th. In the meantime, I thought it was still relevant to provide you with my opinions concerning the debt ceiling crisis and the market results for the month of July. So without further ado…
As I accurately predicted in my STAY FOCUSED post, on August 2nd Congress and White House leaders finally came to an agreement on increasing the debt ceiling just in the nick of time. Our incompetent leaders made it very easy for me to forecast that turn of events, as it seems like the most important agenda item for each of them is campaigning for another term and not looking out for what’s best for our country.
While the Tea Party members of Congress have been greatly criticized, I am grateful to them. Without them, there would be no conversation regarding reducing federal expenditures. Even though the amount approved was essentially just a token amount, it at least started the conversation that will ultimately have to be addressed in the upcoming budget conversations.
What bothers me the most is that on Tuesday, the Democrats, Republicans and the President were all in a circle singing “Kumbaya” about the great job they did in reducing federal expenditures. I think a more important discussion would be exactly what they really did. If you recall, the federal debt limit was increased by $2.4 trillion just to get through the 1st of November, 2012 election. Think about that reality for a second. If they needed to increase the federal deficit by $2.4 trillion over the next 15 months, that tells you they really intend to spend exactly that much money – more than they receive – between now and then. This means more debt.
Without the Tea Party’s intervention, I am sure the amounts would have been even greater, but at least there is a conversation and discussion regarding bringing these amounts under control. I will discuss the budgetary process for the next fiscal year later in this post, but I also wanted to discuss the month of July and the equity markets.
For the month of July, the S&P 500 was down 2% along with the Dow Industrial Average down a like amount. The NASDAQ was down .6% for the month. What’s interesting about the results of the month of July is that for the final week of July, the S&P 500 was down approximately 4%. If it hadn’t been for this severe sell-off, the month of July actually would’ve been up. With all you hear in the media regarding the negative stock market, I doubt you rarely hear anyone indicate that July was still a very satisfactory month for stock market performance.
The first week of August has been an altogether different situation. Due to the complete incompetence of Congress, the markets have essentially lost confidence in Washington’s ability to govern. Even though the debt ceiling was increased and signed on Tuesday, the major market indices sold off at 264 points on the same day. I received a great many questions asking why the market continues its massive sell-off when the deal was done.
In fact, the reason had nothing to do with an event that was totally predictable, but had everything to do with the banks in Italy announcing that they were essentially insolvent. It appears now that all of Europe is on the verge of financial calamity, and only Germany and France have the financial resources to support the rest. Isn’t it interesting that so many in the United States want us to be like Europe, but if anything, Europe is much worse off than we are.
I always wonder why people who invest in Treasury bonds wouldn’t make a similar investment in something like the Coca-Cola Company. The dividend rate on the Coca-Cola Company is 2.8%, which is higher than the current return on the 10-year Treasury. Additionally, you would be buying one of the great franchises in the world along with the potential for the stock price to go up. People who are making financial decisions to buy 10-year Treasury bonds today are not making that decision for investment purposes, but rather, for trading purposes. We focus our practice on investing, not on trading.
Even though Congress has approved “reductions of federal expenditures of over $2 trillion over the next decade,” even with these cuts, the federal deficit is projected to exceed $18 trillion over this timeframe. Essentially, this country is running the risk of financial calamity if it doesn’t address the massive overspending that has occurred in Congress over the last five or six years. It should also be very clear to you from this most recent debate on increasing the debt limit that the administration and the Democrats in Congress intend to keep spending as quickly as they can for as long as they have electoral control. It’s going to be interesting to see the new federal budget debate, which must be completed before September 30th, and exactly what the Congress approves.
What is most interesting about the budget debate is that there was never a federal budget approved for the fiscal year in which we are in. While the President submitted a budget to Congress in February for 2012, it was voted down in the Senate by a majority vote, including all members of his own party. The House approved a budget which was not even considered in the Senate. Now we are facing a deadline of September 30th for a new budget and Congress will not even be back in session until after Labor Day. If you thought political theater was bad on this most recent national debt increase, wait until the budget comes up in September.
You may rest assured that the political theater that we suffered through during the debt ceiling increase will only be a token amount as compared to what we see in the budgetary process. Since the country so clearly desires a smaller federal government, it should be a gigantic struggle between those that want to spend and those that want to save.
It appears that the U.S. economy is, in fact, quite stable. Contrary to what is being reported in the media, employment is improving, interest rates are low, and profits are skyrocketing. It is almost exactly the opposite of what is going on in the Eurozone. Seemingly, all of the European countries that have supported the “cradle to grave” mentality of the government taking care of its citizens are now failing one at a time – first Greece, Portugal and Ireland, and now the larger economies of Spain and Italy. The major effect on our markets has more to do with the failure of Europe than the failure of the U.S. economy.
Isn’t it fascinating that 2009 began with the political commitment to make the U.S. more like Europe? Fortunately for us, before Washington could implement a “cradle to grave” philosophy in the United States, the model on which it was based has completely imploded. It doesn’t take a rocket scientist to understand that bigger and bigger government can’t be financed by fewer and fewer taxpayers. Now that they’ve discovered that in Greece, Portugal, Ireland, Spain and Italy, maybe we’ll get the hint here in the U.S. without going through the destructive phases.
Unlike the European banks, the United States recapitalized all of its banks in the last three years that are ultra-strong and ultra-well-funded. Virtually none of the banks in Europe have that economic cushion.
This is not to say that things are rosy in the United States, but they are stable. As I view things today, it’s almost impossible to assume that the U.S. would fall into another recession given the economic conditions of today. However, it would not be unheard of for the recession occurring in other parts of the world to drag the U.S. “kicking and screaming” into a like financial situation. But that’s not something I am foreseeing.
More tomorrow…
As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
