The Current Economic EnvironmentSubmitted by Antaeus Wealth Advisors on December 18th, 2011
The current environment can be summarized as follows: low government bond yields; low equity market Price-Earnings (P/E) ratios; elevated commodity prices; high volatility; and above-average correlations across asset classes. As of December 14th, year to date performance of the major indices had been weak: +7.0% for the Barclays Aggregate Bond; -2% for the S&P 500 Index; -5% for the S&P Goldman Sachs Commodity Index; and -16% for the MSCI Europe, Australasia and Far East Index. In terms of sectors, utilities and health care stocks have outperformed, whereas financial stocks have continued to struggle.
Today’s bloated debt levels, a legacy of the global financial crisis, are concentrated in developed markets. Whereas the epicenter of the 2008 financial crisis was subprime mortgage debt held by American banks; the epicenter of a potential financial crisis today is European government debt, created by years of unsustainable borrowing. If perceptions of European sovereign debt credit quality continue to deteriorate, and the backstops to its financial institutions are seen as inadequate, shareholders and depositors may flee, with the ensuing panic pulling down global markets and the global economy. Quite frankly, we are witnessing the unwinding of the biggest “moral hazard” trade in history, and such situations seldom end in an orderly fashion.
Antaeus sees three major headwinds to a significant bull market for equities: U.S. fiscal irresponsibility and Congressional bickering; the European debt crisis; and the possibility of a double dip recession. We also believe that Washington’s lack of clarity with long-term corporate tax rates and regulations is a wet blanket on markets. In short, while macroeconomic uncertainty has caused “Mr. Market” to under-value stocks, corporations actually are in excellent shape: 28% of their current assets in cash (vs. 14% in 2000), and they have enjoyed an astounding 74% increase in earnings over the past 4 years. Note: the 31% decline in housing prices during this same period, and today’s household debt at 114% of income vs. an average of 76% since 1952, are good examples of the massive discrepancy between the economic situation of many Americans and the financial health of corporations.
With the above background, Antaeus continues to advocate above average allocations to cash until the economic picture becomes less murky and/or substantial bargains arrive with a sharp sell-off. We also believe that artificially low interest rates have created an environment where those with heavy allocations to bonds will experience unsatisfactory returns over the coming years. Not only will bond holders probably suffer capital losses if the Fed raises rates, but with the 10 Year Treasury yield below 2%, and headline inflation (CPI) around 3.5%, buying such bonds today locks is an annual return of -1.5% before taxes! Therefore, as we go into the first quarter of 2012, Antaeus recommends getting in front of this trade by underweighting bonds by 5%, and overweighting dividend-paying “blue chip” stocks by 5%, as compared to our long-term strategic allocation models. Additional arguments for this strategy are that corporations are paying out less than 1/3 of their earnings in dividends, indicating exceptional dividend coverage; and for the first time in almost 50 years, the S&P 500’s dividend yield is higher than the 10 Year Treasury’s yield.
Emerging markets currently comprise 48% of world’s GDP, and the demand of consumers living in these countries now exceeds the aggregate demand of consumers in Europe, the U.S. and Japan. This shift is another reason why we favor buying the stocks of stable companies that are succeeding in selling to consumers of developing countries. Finally, with monthly mortgage payments now below rental rates, a rare occurrence, and just 650,000 annual housing starts for a population growing at an annual rate of 2.5 million, U.S. real estate has become quite compelling.
Additional Observations and Recommendations:
- We like certain alternative investment strategies for periods of high volatility in equities.
- Dollar weakness remains a core long-term concern with structural U.S. deficits, and swelling entitlement liabilities. For example, in 2000, the American national debt was $20,000 per person, and today it is $46,000. Excessive sovereign debt and easy monetary policies historically have led to weaker currency and high inflation; hence, we continue to be pro-active in hedging the dollar and preparing for inflation.
- Bonds with adjustable rates are attractive in a potentially rising interest rate environment.
Remember that short-term returns are different than long-term returns: a dollar invested in gold in 1802 would be worth $4 at the end of 2010, whereas a dollar invested in U.S. stocks would be worth $726,230. 1 Whether we witness a partial breakup of the European Union or another U.S. credit downgrade, remember that opportunities arise during times of uncertainty. Similarly, when you feel the urge to invest heavily in an asset class that has performed well recently, bear in mind Warren Buffett’s famous words: “What the wise man does in the beginning, the fool does in the end.”
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Disclosure: Indices mentioned are unmanaged and it is not possible to invest directly in an index. No single strategy can assure profit or guarantee against loss. Past performance does not indicate future returns. The opinions expressed in this commentary are those of Antaeus Wealth Advisors, LLC and are based on information believed to be reliable; however, these views may change as information changes or becomes out of date.
The opinions expressed in this article are those of Antaeus Wealth Advisors, LLC. Securities offered through Cambridge Investment Research, Inc., a Broker-Dealer, and member FINRA/SIPC. Investment advisory services and financial planning offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Antaeus and Cambridge are not affiliated companies.
1 Source: Dr. Jeremy Siegel.