Rally in U.S. Stocks has LegsSubmitted by Antaeus Wealth Advisors on June 9th, 2013
- U.S Housing recovery: home ownership near historical norms at 63.5% vs. 69.1% between 1995 and 2005. Household debt-to-income is about 99% vs. 120% in 2005. (Goldman Sachs, March 2013)
- Percentage of those under 30 with student loans at least 90 days late in Q4 2012: 35. (NY Federal Reserve)
- Total U.S. household net worth in Q3 2007: $67.4 Billion. In Q1 2013: $69.2 Billion. (JP Morgan, April 2013)
- Approximate proposed cap permitted in tax-deferred retirement vehicles per person in President Obama’s 2014 budget: $3.4 Million. (Wall Street Journal, 04/13/13, estimated portfolio needed to generate a $205,000 annual annuity for a 62 year old)
- Importance of capturing dividends: growth of a $10,000 (12/31/60 – 12/31/12) investment in the S&P 500 including dividends: $1,241,459. Excluding dividends: $245,426. (Morningstar, 01/12/13)
- Unemployment rate in Spain: 27%. For Spaniards under age 25: 56%. (Wall Street Journal, 04/26/13)
- U.S. Dollar Index vs. major currencies in 2002: 112. In March 2013: 76. (Federal Reserve)
- Average debt level on S&P 500 corporations’ balance sheets in October 2007: 32.1%. In May 2013: 23.8%. (Ned Davis Research)
Positive Economic Themes: U.S. manufacturing renaissance driven by more competitive labor costs and lower-cost energy; housing recovery; healthy corporate balance sheets.
Negative Economic Themes: Pending fiscal-and-spending battle appears to be a protracted one; ongoing global de-leveraging; potential decade long recession in Europe.
Risk control is the best route to loss avoidance. Risk avoidance, on the other hand, is likely to lead to return avoidance as well.
As Marks eloquently said, investment programs based on fear tend to produce underwhelming results. America has faced the unknown since 1776, yet, as of 12/31/12, according to Warren Buffett, the Dow Jones Industrials had climbed 17,320% plus dividends during that time. Nevertheless, stocks are volatile securities, so risk control is an essential component of a well-managed portfolio: capital, once lost, remains lost.
Investors have been rewarded since the financial crisis for following the old adage “don’t fight the Fed.” The result of low interest rates, massive liquidity, and monetary easing by the Federal Reserve, the Bank of Japan, the Bank of England, the Swiss National Bank and, to a lesser extent, the European Central Bank, has been record breaking rallies in stocks and in junk bonds. Year to date, 1 year and 3 year total returns as of 06/07/13: S&P 500 Index +15.2%, +27.1% and +62.4%; MSCI Europe, Australasia and Far East Index +5.5%, +22.8% and +23.9%; and Barclays BA to B High Yield Index +2.7%, +12.9% and +35.0%.
Because of the “cash drag” effect on portfolios during most markets, clients sometimes ask: why keep a cash position? The reasons are several: one may need to make a large withdrawal from time to time (e.g. buy a car); bills still come due when markets crater; and cash is king during black swan events. Cash also provides ammunition to pounce when prices come down. With ongoing gridlock in Washington over the nation’s debt pile, we expect volatility to rear its ugly head at some point, providing buying opportunities for long-term investors. Further, we may need a stock market crash for lawmakers to act on much needed entitlement reform, and to address our ongoing deficits. It also seems like there always is another shoe to drop in Europe.
That said, longer-term, there is reason to believe the rally in U.S. stocks has legs:
- Investors continue to hold high levels of cash paying 0%, and bonds with the lowest yields since the 1940s. It is likely that more of this money will pour into stocks over the next few years.
- We expect U.S. equity markets to move beyond the trading range that has been in place since 2000 (estimated S&P 500 bottom up annual earnings are $101.70 today vs. $56.13 in 2000).
- Periods of lower than average returns tend to be followed by periods of average or better. As of 06/07/13, average annual total returns over the trailing 15 years for the S&P 500 were just 5.2% vs. an average of 9.0% since 1802.
- America’s business cycle is strong. Hours and productivity per worker are rising; pent up demand exists for cars and infrastructure (infrastructure – especially software – is the oldest since 1965); corporate profits are robust even as companies de-lever; relatively low wages and cheap energy have created an ideal environment for a U.S. manufacturing renaissance.
- We expect the gap between the 10 year Treasury yield and the S&P 500 earnings yield to close gradually over time. In short, bonds are expensive relative to stocks.
- Technology stocks are especially attractive: phenomenal cash flow, strong growth rates, relatively low valuations, minimal debt.
Still, make no mistake: this is hardly the boom like conditions of the 1990s or the credit-infused expansion of the last several decades.
Debt, the U.S. Dollar and Europe
While U.S. stocks are compelling for reasons explained above, the massive sovereign debt levels in the U.S., Europe and Japan are concerning. These debt loads can bring instability, volatile markets, inflation, and, of course, currency de-valuation. As well respected bond manager Jeffrey Gundlach points out, U.S. debt is “simply at the point where you can’t pay it back” and the U.S. government alone has more than $120 trillion in unfunded liabilities, including programs like Social Security and Medicare, which may slowly de-value the U.S. dollar: “the idea that you will pay that back with today’s valued currency stretches the imagination.” To address the potential decline in value of the U.S. dollar due to the Fed’s policies and America’s swollen deficits, Antaeus believes it is prudent for investors to have a small slice of their portfolios in silver and/or other currencies. We also believe that ultimately the loose monetary policies of the Fed will bring inflation.
Europe’s economic gloom is far from over; and additional debt restructuring and confiscation for bondholders in some parts of Europe is expected. Concerned that politicians are relying on the European Central Bank instead of addressing the root problems (labor costs and unfunded welfare states); Bundesbank President Jens Weidmann said in April that “the crisis effects will remain a challenge over the next decade.” His concerns do not mean that the Euro will implode, however. Although France’s woes are a threat to the long-term viability of the Eurozone; with 50% of its economy based on exports, the implications of Germany jettisoning the Euro are huge. If Germany returned to the Deutsche Mark, the value of its currency probably would shoot up much like the Swiss Franc has, making it near impossible to compete in a global economy. Who is going to buy BMWs if they double in price?
Bonds can provide critical diversification – and thus belong in most portfolios – but their returns look less promising going forward than in recent years. Bonds are at the tail end of a 32 year bull market, and we expect this “block of ice” to gradually melt away as interest rates rise. Further, in the short-term, low interest rates may lower the cost of government debt, but they also prevent savers from keeping up with the cost of living. As Bill Gross writes, current interest rates are “hidden forms of taxes that reduce an investor’s purchasing power as manipulated interest rates lag inflation.”
Antaeus likes emerging market stocks today, though we prefer active managers who “revenue map” over strategies focused on indexing or where companies are based. Companies that are able to sell effectively to the growing number of middle class consumers in emerging markets could make a fortune, regardless of domicile. The interaction of emerging market consumers and developed market companies has perhaps never been so interwoven. Not only are valuations sound, but growth opportunities are excellent: by 2025 it is estimated that emerging markets will account for about $30 trillion of spending (vs. $12 trillion in 2010), nearly half the total estimated global spending and almost twice the current U.S. Gross Domestic Product.
In summary, deflationary threats have lessened, and Antaeus see compelling opportunities in high quality U.S. stocks with growing earnings, and in emerging markets equities. At some point the hyperactive role of central banks will begin to dissipate, thus inflicting losses on bonds and stocks. Their easy money policies eventually could lead to tears and inflation, but probably not in the immediate future.
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Antaeus Wealth Advisors, LLC
June 8, 2013
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.
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.
 Morningstar. Note: These figures are total returns, including dividends, as opposed to average annual returns.
 Yahoo! Finance, Standard & Poor’s, Jeremy Siegel.
 Investment News, 04/15/13.
 Wall Street Journal, 04/18/13.
 PIMCO, “There Will be Haircuts,” May 2013.
 McKinsey and Company, March 2013.