Global economy cloudy but U.S. firing on many cylindersSubmitted by Antaeus Wealth Advisors on January 23rd, 2015
- Due to low COLAs, Social Security beneficiaries have lost 1/3 of their buying power since 2000. (Senior Citizen’s League)
- The last calendar year when China’s economy did not grow by 7%+ was in 1991. The last calendar year when the U.S. economy grew by 7%+ was in 1984. (World Bank)
- Total assets of U.S. households and nonprofit organizations as of 09/30/14: $95.4 Trillion. Total liabilities: $13.9 Trillion. (J.P. Morgan Asset Management)
- Total outstanding Treasury Securities as of 09/30/14: $12.54 Trillion. Percentage owned by foreign governments: 32%. (Federal Reserve)
- 2014 U.S. Gross Domestic Product (GDP) per capita: $54,980. China’s GDP per capita: $7,333. (International Monetary Fund)
- U.S. stocks’ percentage of global market capitalization in 2014: 50%. European stocks (including U.K.): 24%. Emerging markets stocks: 11%. Japanese stocks: 7%. (Standard & Poor’s, MSCI)
- Percentage of revenue from companies doing business in Alaska derived from the oil and gas industry: 89%. (Moody’s)
- Percentage of purchases of new and existing homes by first time home buyers in 2014, the lowest in 27 years: 33%. (National Association of Realtors, October 2014)
- Estimated loss in value of the global 500 largest State Owned Enterprises (SOEs) since 2007: 33% to 37%. (The Economist, 11/22/14)
- Percentage of Americans who say that money is the number one factor affecting their stress level: 73%. (American Psychological Association, 2004)
- In any given month, the stock market is down 40% of the time. In any rolling 5-year period, the stock market is down 12% of the time. In any rolling 12 year period, the stock market has never been down (Haver Analytics, 2014).
- Percentage of U.S. crude oil imports from OPEC in 1976: 88%. In August 2014: 40%. (Department of Energy)
- Change in amount of electricity generated from natural gas in the United States from 1990 to 2013: 300%. Change generated from coal during the same period: 0%. (EIA)
- Return needed to break-even after a portfolio decline of (25%): 33%. After a portfolio decline of (80%): 400%.
- The Federal Reserve’s main interest rate minus the European Central Bank’s at year end in 2008: (2.4%). At year end 2014: +0.05%.
- Estimated decrease in U.S. net oil imports since 2006 in millions of barrels per day: 8.7.
The divergence from U.S and non-U.S. growth has become more prominent: the U.S. economy is firing on many, many cylinders, whereas the outlook for the global economy has become cloudier. The U.S. economy has accelerated, and Antaeus anticipates continued expansion in 2015. We are perhaps in the 6th or 7th inning of this recovery with corporate profits growing roughly 6% – 7% per year; and note that the average economic expansion for post-bust recoveries is more than 100 months (current expansion = 66 months). Consumer debt payments as a percentage of disposable personal income continue to fall, the unemployment rate continues to decline (though not in high paying jobs), and the U.S. appears to be in the early stages of a manufacturing renaissance driven by competitive wage rates for employers and low natural gas rates compared to those in the rest of the world.
In 2014 the total return (price appreciation + dividends) of various stock indices was dominated by U.S. markets: S&P 500 Index +13.9%; MSCI Europe Australasia and Far East Index; and +0.1%; MSCI Emerging Markets Index (1.6%). With a strong U.S. Dollar, gold and silver moved lower, at (1.5%) and (20.0%) respectively; and investment-grade bonds, as represented by the Barclays Aggregate Bond Index (price appreciation + interest), returned a solid +8.2%. Oil (Brent crude) fell and astounding (46.4%), and the Russian Rouble plummeted (54%) relative to the U.S. Dollar.
Antaeus is neutral to bullish on domestic stocks and the U.S. economy in 2015: investor sentiment is not euphoric (euphoria is typical of bubbles), U.S. manufacturing and industrial companies are gaining market share, America has a growing energy and labor cost advantage, interest rates are barely-there, and the U.S. is the vanguard of a disruptive digital revolution. Further, U.S. corporate balance sheets remain healthy: the average debt to equity of S&P 500 since 1994 is 169%, vs. 101% as of 09/30/14, according to J.P. Morgan Asset Management. Nevertheless, the yield curve – which plots interest rates for U.S. Treasury debt at various maturities – is less steep than a year ago, valuations are quite full – particularly for small-cap stocks and equity-income stocks, and potential rising interest rates pose a headwind for valuations. The keys to returns are old-fashioned earnings growth and dividends.
We like discretionary stocks and technology stocks on a growth/valuation basis relative to other sectors.
While Antaeus sees opportunities in emerging markets’ stocks, commodity producing countries face significant headwinds including weaker commodities prices and a stronger U.S. Dollar, with Russia, Brazil, Venezuela and South Africa especially vulnerable. That said, bear markets tend to end before the bad news does because many know what the bad news is: and this may be the case for emerging markets stocks. Also note that a greater percentage of Asian debt is in local currency than ever before, meaning that a stronger U.S. Dollar may not hit the prices of these securities as much as some expect (though some countries – like Brazil and Turkey – are susceptible with sliding currencies, low growth and large deficits).
Antaeus is concerned about Japan long-term, but in the short-term we like stocks there, due to valuations and growth rates, especially if one hedges away the currency risk of a falling Yen. Additionally Japan’s decision to allocate 25% of its $1.13 trillion Government Pension Investment Fund to Japanese stocks and 25% to foreign stocks (up from 12% each) provides additional support for stocks in Asia. Indian stocks are rather attractive as well, especially with Modi in power, as are stocks in Vietnam, Cambodia, Thailand, Laos and Myanmar where wages are low, growth is robust, and multinational corporations are starting to locate their plants. China is a mixed bag as it continues to try to balance stable economic growth with the pace of credit expansion. As for Europe, it’s hard to be excited: without structural reform, its slow economic and population growth ultimately may lead to a partial breakup of the European Union. In short, with secular stagnation firmly in place, downside risks in Europe appear to be higher than elsewhere.
Antaeus anticipates inflationary pressure to pick up in the U.S later this year, but not in Europe and Japan where governments continue to battle the risk of deflation. Overall we expect higher volatility in the markets in 2015 as the Fed exits quantitative easing and perhaps raises rates, thus reducing liquidity – which may spark bouts of panic spelling. In general, we like large caps over small caps; and expect some stock pickers to shine vs. indexing strategies because low oil prices benefit some companies while crushing others.
With the yield on the 10-year U.S. Treasury at just 1.80% as of 01/23/15, realistically we expect low single digit returns from investment grade bonds over the next decade. Today such bonds are more appropriate for shock absorption and mitigating portfolio volatility than for providing coupon income. Oppositely, while some bonds with credit risk offer compelling yields, many high-yield bonds have limited liquidity and could struggle if markets become volatile and investors start to dump these securities.
Driven by lower demand, the growth of U.S. shale production, and Saudi Arabia’s decision to not restrain output – arguably to push out some marginal players, Brent crude oil prices ended 2014 at $57.33/barrel, and stood at $48.72 on 01/23/15. These low prices help consumers and transportation companies; but, for those in the business of extracting and producing oil – and for some “clean” energy companies whose products become less financially attractive – low oil prices pose a significant challenge. Further, while oil Master Limited Partnerships (MLPs) trade at a reasonable price to distributable cash flow, plenty of shale producers may slide into bankruptcy this year. As the head of Occidental Petroleum, Stephen Chazen, said recently: “the oil and gas industry is not healthy” with oil prices below $70/barrel. (The Economist, 12/06/14)
Threats always exist to the markets and thus to our base case. Since the U.S. has not experienced – in modern times – anything like what an Ebola outbreak could become, it certainly is a tail risk. More likely, deflation may be the only way out for Europe, which has major potential investment implications. A deterioration in China’s credit markets also could be painful, as could a bankruptcy in Ukraine, a major war in the Middle East or a deep recession in Russia. Last, Illinois, with the most underfunded retirement system, lowest bond rating and largest pension burden relative to state revenue in the United States, is a potential black swan for the municipal bond market.
“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”
While we doubt that the current U.S. bull market is over, we expect more volatility as this bull market matures. Diversification works over time, but that also means it takes time to work, particularly if one compares a portfolio to the S&P 500 after two years of strong performance by that index. Remember that while it is human nature to focus on returns in up markets, it also is human nature to obsess about risk in down markets.
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Antaeus Wealth Advisors, LLC
January 23, 2015
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 solely 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.
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