Risk: best defined as a permanent loss of capitalSubmitted by Antaeus Wealth Advisors on April 24th, 2014
- In 1994, it took a taxable income of $312,362 on a joint return to produce federal income taxes of $100,000. It will take a 2014 taxable income of $376,047 on a joint return to produce federal income taxes of $100,000. (Tax Foundation)
- The top 10% of U.S. taxpayers paid 68.3% of all federal income taxes paid in 2011. They paid 49.3% of all federal income taxes in 1980. (Internal Revenue Service)
- Percentage of the total $6.6 billion in long-term care benefits that were paid out to women in 2013: 67. (American Association for Long-Term Care Insurance)
- The U.S. economy grew by 1.9% in calendar year 2013 vs. a (0.4%) drop in the size of the collective economies of the 17 nations using the Euro. (Commerce Department)
- Personal savings rate, including employer contributions, for the average American in 2013: 4.5%. Average since 1959: 8.4%. (Bureau of Economic Analysis)
Likelihood of needing long-term care for a 75 year old American in 2012: 72%. Average age of first claim: 79. (American Association for Long-Term Care Insurance)
- Average annual portfolio performance improvement for investors using investment advisers, due to a combination of tax alpha, behavioral finance, reduced internal costs, re-balancing, and strategies for spending down assets: 3%. (Vanguard Group)
- Institutional reserve assets invested in U.S. dollar denominated assets in 1999: 75%. In 2013: 60%.
- Estimated decline in the value of a 30 year Treasury bond portfolio if interest rates rise 1%: (14%).
- Average quarterly return for convertible bonds in rising-rate quarters, 1993-2013: 3.97%.
- Increase in value of the average U.S. home from 12/31/11 to 12/31/13: 14%. (Office of Federal Housing Enterprise Oversight)
- As of 12/31/13, the six largest banks in the U.S. held $9.67 trillion of assets, or 66% of the assets of the entire banking industry. (FDIC)
- Average American’s mortgage debt in 2013: $149,925. (CNNmoney.com)
- Debt/assets for companies in the S&P 500 in March 2000: 36.7%. In October 2007: 32.1%. In March 2014: 23.9%. (Bloomberg)
- 10-year annualized return of the average mutual fund investor as of 12/31/13: 4.81%. Average return for all mutual funds: 7.30%. (Morningstar)
- The 75-year (1939-2013) average annual growth in the size of the US economy: 3.7%. Number of years since 2004 the U.S. economy has reached 3.7% growth or better: 0. (Commerce Department)
The essence of investment management is the management of risks, not returns.
Like Warren Buffett, and his mentor quoted above, at Antaeus we believe that risk is best defined as a permanent loss of capital. While we may have a good understanding as to why prices go up and down; it is very difficult to predict when they will go up and down.
With many investors feeling “performance envy” after not fully participating in the strong returns of U.S. equities in 2013, remember that performance chasing is a dangerous game. While a multi-asset portfolio will never outperform a particular year’s best asset class, historically the long-term performance has been comparable to the stock market, with less volatility. According to Lipper, the 44-year annualized return of the S&P 500 was 10.41% vs. 10.29% for a multi-asset portfolio from 1970 – 2013, with the average negative return for the former (15.2%) and for the latter just (8.7%).
Year to date
As of 04/24/2014, year to date, stocks have limped along with the following total returns (price appreciation + dividends): +2.4% S&P 500 Index; +1.7% MSCI Europe Australasia and Far East Index; and (0.4%) MSCI Emerging Markets Index. Gold has moved higher +5.9%; and bonds, as represented by the Barclays Aggregate Bond Index, have returned +2.9%.
Today U.S. inflation appears to be in Goldilocks territory, with increases too low to trigger consumer backlash and high enough to avoid painful deflation. Combined with low interest rates, a steep yield curve and strong corporate profits, this environment has elevated the Price-Earnings ratio (P/E) of the S&P 500 to roughly 16.3 as of 04/11/14. While not in “bubble territory” overall, U.S. blue chips are no longer inexpensive based on long-term history, and, of course, what one pays for an investment has a significant impact on the ultimate return one realizes. Further, with corporate profit margins at historic peaks, and insider selling increasing, Antaeus has become increasingly vigilant about the possibility of a correction.
Over the next several years, Antaeus expects gains, though smaller than 2013, to continue for U.S. stocks, with corrections along the way. Gains probably will be driven more by mergers & acquisitions, earnings growth, dividends and stock buy backs; as opposed to by rising valuations. We also anticipate that the unprecedented money printing since 2008 may lead to overshoots in some assets, such as in biotechnology stocks, floating rate debt and certain real estate sectors. It also does appears that U.S. interest rates will rise, albeit slowly, especially if unemployment continues to improve; posing a headwind for bonds overall.
Across the pond, the consensus is that after shrinking last year the Eurozone will see real GDP growth around 1% in 2014 (vs. 2.5% in the U.S. and 7% in China). Investors are now confident that the single currency in the Eurozone will survive. Antaeus sees European equities as attractive if the economic recovery continues, but the recovery is dependent on improvements in corporate earnings, which may be difficult given Europe’s high labor costs. If, however, Europe disappoints and falls back into deflation, European bonds are more attractive than European stocks overall.
We believe that the real estate market in China is closer and closer to a price correction – fueled by an opaque shadow banking system – and stories of financial excess seldom have happy endings. Total Chinese public and private debt rose from 125% of Gross Domestic Product (GDP) in 2008 to 215% in 2012. Further, while the valuations of emerging markets’ stocks are attractive compared to valuations in the developed world, the negative impact of slowing Chinese demand and currency declines in various countries needs time to run its course.
Risks and Opportunities
With 2013’s run-up, a lower margin of safety exists in stock prices today than a year ago. Companies are increasing stock buybacks – precisely as stocks have become more expensive – and, based on history, an indication that valuations are high. Social network stocks arguably trade at irrational prices, with analysts’ assertions based on their future profit potential, which is eerily similar to the dot-com bubble. Also note that analysts’ consensus is for 19% earnings growth in Japan, 17% in Europe and 10% in USA – because we are farther along in our macro-economic recovery than other parts of the developed world.
Antaeus’ opinion is that the pressures in emerging markets represent a cyclical rebalancing, not a structural decline. We wait patiently for the right time to buy emerging markets’ stocks for our clients. The trends just are not there yet. As for Japan, Abenomics is finally helping the Japanese economy get back on its feet, but the economy’s long-term sustainability is under question with high levels of debt and rising taxes.
As for bonds, spreads are tight – meaning junk bonds are expensive – so the juice is increasingly not worth the squeeze from a credit risk perspective. For instance, the spreads for publicly traded high yield bonds above U.S. Treasury bonds with similar maturities are just 3.63%, compared to an average of 5.63% over the last ten years. (Eaton Vance, March 2014) For investors concerned about principal preservation, consider short duration high quality bonds/bond funds or bond ladders – but don’t expect much yield. For investors looking for yield, we find the spreads provided by emerging markets bonds more compelling than those of U.S. high yield bonds.
Some believe that private equity is like the stock market with advantages. Today we see opportunities in the credit realm of private equity: private loans. Further, although a relatively small market with relatively low liquidity, we continue to like convertible bonds. Convertible bonds’ conversion feature (into the applicable company’s stock) historically has been helpful in rising interest rate environments, especially when accompanied by economic expansion.
Long-Term Themes to Ponder
- As quantitative easing ends, a compression of stock valuations is likely.
- With a large percentage of Americans retiring or retired, it may be difficult for the U.S. economy to provide average annual GDP growth above 2% over the next two decades.
- The U.S. economic recovery probably will continue to benefit wealthier households more than the general population. This divergence poses a risk from a demand perspective since upper income households have a smaller average propensity to consume – and a larger propensity to save than the overall population. It thus may be challenging to reach the 3% annual GDP growth that America seems to need to move standards of living higher.
- The U.S. Dollar probably will represent a smaller percentage of the world’s reserve currency in the future.
A climate of fear is your friend when investing; a euphoric world is your enemy.
With the Oracle of Omaha’s advice in mind, if the mess in Ukraine engenders enough fear to rattle the markets, Antaeus is ready to invest some of the cash siting in our clients’ accounts.
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Antaeus Wealth Advisors, LLC
April 24, 2014
 It is possible that inflation will rise, thus upsetting the proverbial apple cart. Potential sources of inflation include upward pressure on wages, more robust consumption from the wealth effect of higher home prices and stronger equity markets, an acceleration in the velocity of money (i.e. bank lending), and increased food prices due to a prolonged drought in California.
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.