Sovereign Debt Update and Stocks vs. Bonds & GoldSubmitted by Antaeus Wealth Advisors on March 17th, 2012
- Percentage of profits American corporations paid in taxes in 2010: 10.5. In 1961: 40.6. (Institute for Policy Studies)
- Percentage of the expenses of the U.S. Postal Service represented by labors costs: 80. Percentage at FedEx: 32. (USPS, Fed Ex)
- Size of the United States economy as a percentage of global GDP: 19.1. Size of China’s: 19.1. (J.P. Morgan, December 2011).
- National median Monthly Rent vs. Monthly Mortgage Payment as of December 2011: $709 and $521. (Census Bureau, J.P. Morgan)
- Federal Gov’t debt at a percentage of GDP in 1980: 24. In December 2011: 72. (Federal Reserve)
- Americans’ household debt to-income ratio in 1990: In 2007: 130%. In March 2012: 113%. (Federal Reserve).
Sovereign Debt Update
The long-term challenge for Europe is that a large portion of its economy is not competitive in a global society. Unfortunately it is a real possibility that certain countries with weak balance sheets (e.g. Greece) eventually will leave the Euro. The primary risk of such departures is rapid capital flight as investors anticipate a redenomination into a local currency. In short: de-valuations and losses for investors. Redenomination from the Euro would create economic deleveraging pressures, increase the likelihood of a deep recession in Europe and have negative implications for global stocks.
Here in the United States, our 2011 Federal Deficit as a percentage of GDP was an alarming -8.7%. This bleeding will stop only if the underlying cause is addressed: spending more money than the U.S. government receives from tax revenue. With our debt approaching 80% of Gross Domestic Product (GDP), the Keynesian spend our way out of trouble strategy in not only impractical; but now, unfeasible as well. Antaeus’ concern is that America’s leaders will continue to kick the can until we are knee deep in a crisis.
With the above background, we have been adding positions to emerging markets bonds within clients’ portfolios, both in dollar denominated and local currency bonds. While historically developing countries defaulted often and had high inflation, today the finances of many developing countries are better than those of the developed world: accumulating reserves, stronger economic growth rates, and roughly 60% less debt to GDP. Further, 10 year U.S. Treasury bonds yielded just 2.28% as of 03/15/12, vs. average emerging markets’ sovereign debt yields over 6%. Of course, low yields may be the idea of developed countries, as this trick worked after World War II: keeping real rates negative so that inflation eliminates their debts.
The million dollar question is whether the U.S. government really pulls it off; or becomes stuck like Japan with deflation and piles of debt, or like Germany after World War I, where runaway inflation resulted from an excessive printing of money to pay off war debt. Case in point: Germany did not finish payment of reparations for World War I debt until in October 2010. Bill Gross, managing director of PIMCO, clearly is concerned by the Fed’s
commitment to low interest rates: “when the return on money becomes close to zero in nominal terms and substantially negative in real terms, then normal functionality may breakdown.”
Stocks vs. Bonds and Gold
Buoyed by stronger than expected economic data, less noise from Europe, and a rise in investors’ appetite for risk, the stock market has soared in the first quarter: year to date (03/16/12) the S&P 500 had returned +11.7%. Despite this momentum, and while we do expect a pull back at some point this year, for the long-term investor, stocks do appear to be more attractive than bonds. Remember: for long-term investors, the stock market is not about trading, but about linking their savings to business profits.
Today’s bond valuations, driven by several years of fear and decades of falling interest rates, are reminders of the prices of technology stocks in 1999. After posting 8.2% average annual total returns from 1970 – 2011, compared to just 5.6% from 1926 – 2011 , the odds are stacked against strong returns from the U.S. bond market over the coming decade. Oppositely, after just 2.4% average annual total returns from the U.S. stock market from 2001 – 2011, versus 9.8% total returns from 1926 – 2011 , we expect investors to capture a positive equity risk premium over the next ten years (not guaranteed of course). Antaeus also prefers U.S. stocks to international stocks. Leverage in U.S. corporations continues to decrease, versus, for example, the proliferation of debt in Chinese companies. Today U.S. companies have cash, cash flow and profits.
While stocks do not offer any guarantees, consider Warren Buffett’s comparison of bonds and gold to stocks in a 02/09/12 article appearing in Fortune magazine: “my own preference…is our third category: investment in productive assets, whether businesses, farms or real estate…Whether the currency a century from now is based on gold, seashells, shark teeth or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or See’s peanut brittle.”
Antaeus continues to consider active management in this volatile environment. For example, if the recent momentum stalls, we will consider taking profits on equities in some of your accounts. Alternatively, if a showdown develops in Iran, pushing oil over $140 barrel and significantly spooking the equities markets, Antaeus is ready to put some cash to work. We also continue to favor quality and defensive securities because of several ongoing risks: European debt crisis, leveraged U.S. consumers, the U.S. presidential election, a potential budget showdown this summer, a slowing Chinese economy and negative real interest rates.
Gold’s chart is eerily similar to various bubbles of the past: tulips, .com stocks, and real estate, to name a few. If you seriously agree with Ron Paul that paper currencies will go up in smoke, we silver prices appear to be more attractive than gold prices. In fact, Antaeus is able to purchase Silver Eagles in your accounts, which avoids some of the issues of using ETFs to invest in metals – such as contango and roll yield – though we certainly do not recommend investing in gold or silver at current prices.
For those of you excited by the recent rally in the capital markets, remember that higher prices bring more risk going forward. A good analogy is the cliff divers in Acapulco – they dive when they see rocks, confident they will hit ocean at the top of a swell – as opposed to diving when they see blue ocean! Finally, today Antaeus does see investment opportunities in private senior lien loans and in quality multi-family real estate.
I would like to remind you of a few of Antaeus’ core tenets in managing your assets:
- Year to year returns are much different than long-term returns.
- Utilize a risk-driven approach, not just a return-driven one.
- Avoid bubbles and herd investing. Antaeus is not afraid to act if our metrics build a strong conviction for employing tactical changes.
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.