Three Long Term Economic Themes Standout TodaySubmitted by Antaeus Wealth Advisors on October 27th, 2013
- Value of Temporary Assistance for Needy Families (TANF) – food stamps, Medicaid, housing assistance, utilities assistance, and emergency food aid available to an unemployed, single mother with two children living in Hawaii: $49,175. In Mississippi: $16,894. (Cato Institute)
- U.S. Dollar’s portion of the currency FX market’s turnover in April 2010: 87.0%. In April 2013: 84.9%. (The Economist, 09/21/13)
- 50 year average seasonally adjusted U.S. civilian unemployment rate: 5.1%. August 2013 rate: 7.3%. (Bureau of Labor Statistics)
- Amount borrowed for each U.S. Dollar that the U.S. Treasury spends: 19 cents. (The Economist, 09/21/13)
- U.S. households with credit card debt: 47%. Average balance: $15,257. (NerdWallet.com, September 2013)
- Vehicle sales recovery. Average annual light vehicle sales since 1993: 15.2 million. Trailing 12 months sales as of 09/30/13: 15.3 million. (JP Morgan Asset Management)
- Federal Reserve’s target interest rate: 0.13%. Brazil’s target rate: 9.0%. India’s target rate: 7.5%. (JP Morgan Asset Management, 09/30/13)
- Average U.S. core inflation rate (CPI) since 1953: 4.1%. August 2013: 1.8%. (JP Morgan Asset Management, 09/30/13)
- S&P 500’s Earnings Per Share (EPS) in 2000: $68.02. As of June 2013: $91.10. (Standard & Poor’s)
- Price per barrel of WTI crude oil on 09/30/03: $29.19. On 10/18/13: $100.87. (U.S. Department of Energy)
- If not covered by Medicare, Medicaid or a private plan, and not enrolled in the Affordable Care Act’s health insurance marketplaces (HIMs) by 12/15/13, the 2014 penalty is the greater of $95 or 1% of income. The 2016 fine is the greater of $695 or 2.5% of income.
- States with the lowest credit ratings: Illinois, California, Michigan, Arizona, New Jersey and Nevada. States with the highest credit ratings: Delaware, Missouri, Virginia, Maryland, North Carolina and Utah. (Eaton Vance, October 2013)
Antaeus believes that three long-term economic themes stand out today, all of which have investment implications: the domestic shale gas revolution (e.g. lower energy costs); breakthroughs in biotechnology (e.g. drugs that target genetic diagnostics); and a rapidly growing consumer class in emerging markets (e.g. smartphones and consumer durables).
In 2013, despite the debt ceiling debacle in Congress, the stock markets of developed countries have been buoyed by the massive liquidity provided by central banks such as the Bank of England, the Bank of Japan, the European Central Bank and the U.S Federal Reserve. Bonds, however, have struggled overall in anticipation of rising interest rates, and emerging markets have stalled together with commodities prices. As of 10/20/13, year to date returns included: S&P 500 Index +24.2%; MSCI Europe, Australasia and Far East (EAFE) Index +22.9%; Barclays Aggregate Bond Index +0.8%; MSCI Emerging Markets Index +0.6%; and Gold (21.7%). While momentum remains strong in the U.S. stock market, Antaeus is finding very few inexpensive stocks. Warren Buffett seems to agree, per his comments on 09/19 on CNBC: “we’re having a hard time finding things to buy.”
Implications of Congress and the Fed’s Policies
If your doctor prescribes an antibiotic every time you have a fever, eventually your body may develop a resistance to antibiotics. If the Federal Reserve (Fed) continues printing $85 billion per month via quantitative easing, while it may lift stock prices and keep mortgage rates low (at the expense of private market savers), eventually we all will face some consequences. Though it may be a few years away, Antaeus does believe that ultimately a “correction” will hit the U.S. stock market. A debasement of the U.S. dollar over time is within the realm of possibilities as well. In short, flooding the economy with money may be an effective crisis policy and help those drowning in debt, but it does not create demand or guarantee economic growth.
Nothing has been done about swelling entitlements (e.g. Social Security and Medicare), because Congress has not been forced to act, and thus continues to play Russian roulette. When mounting debt on the Fed’s balance sheet (approaching $4 trillion) is impacted by rising interest rates – causing perhaps $200 to $400 billion of increased annual debt servicing costs – the markets will force Congress to act. In our opinion, it’s a matter of time before the starting age to receive Social Security benefits increases, additional means testing is instituted, and/or more of Medicare’s costs are shouldered by its recipients. Further, with a smaller cohort of working-age people and less productivity, America’s golden age of annual GDP growth exceeding 3.5% may be ending (2% may be more realistic going forward), which has far reaching implications. Our advice: save more, and expect less financial support from the government in years ahead.
While there are exceptions, governments globally are highly leveraged and poorly managed as well. Europe’s debt problems continue to grow, and its banks have significantly thinner equity buffers than those of U.S. banks. It thus makes sense to hold a portion of one’s portfolio in the currencies and securities of countries with less levered balance sheets.
For 18 quarters, earnings have come in above expectations, and we now appear to be in the mid-cycle of a consolidating bull market. Stocks may continue to be an asset class leader over the next few years, but probably at a slower pace than as of late because multiples are fairly rich, and margins appear to be flattening. Antaeus believes that the key fuel for the current bull market is sales growth – which is fairly likely if the global economy continues to expand.
Some of you may feel like you left something on the table this year. While such sentiment is understandable, remember that investing is a marathon, not a sprint; and one does need to participate in every last percentage point of bull markets if one avoids a commensurate portion of bear markets. It also seems that the lost art of picking stocks is enjoying a renaissance with today’s higher valuations and lower correlations among stocks. Though indexing beta investments often is efficient, and expenses always are a consideration, we seem to be in the part of the market cycle where unlocking shareholder value is more case by case. For example, if Americans’ energy costs fall due to the explosion of natural gas, certain companies will benefit more than others from the commensurate increase in consumer spending.
Strategies for 2014
We continue to like emerging market bonds – both due to improving credit quality and competitive yields – though we are sticking with active management as we anticipate more dispersion in returns within this asset class going forward. Next, fear of China over-heating has sucked capital from developing markets overall, increasing our conviction to invest opposite the crowd and start increasing allocations to emerging markets’ stocks. That said, some countries are vulnerable to an end of capital inflows due to rapid credit growth – and thus should be avoided – such as Turkey, Columbia, South Africa and Argentina.
U.S. corporate credit is strong – indicating that defaults will stay relatively low for a few years – but today bonds generally trade at premiums, meaning their prices will fall as they approach maturity. Further, while we do not believe it is prudent to entirely avoid bonds during periods of rising in interest rates – as they are a vital component of a diversified portfolio – moving to shorter duration bonds is prudent at this point.
Antaeus is initiating a strategic allocation of roughly 3% to convertible bonds in our models for 2014. Convertibles are fixed income securities that included embedded options to convert to stock. There are a few reasons behind our decision: convertibles historically have performed well during period of rising interest rates, their prices are attractive, and these hybrid securities offer some downside protection along with much of the upside of the stock market. Further, while mindful of valuations, we also like investments that derive their revenue from the transportation of shale gas across the United States.
High quality real estate continues to be compelling, though we are monitoring the compression of capitalization rate spreads, or the difference between the average cap rate and the average interest rate on debt financing. For protection and diversification, Antaeus holds silver coins in some client portfolios in case the Fed’s money printing press harms the U.S. dollar, and managed futures strategies to defend from an unexpected black swan event.
Conclusion and Reminders
In a rising interest rate environment, it will be difficult for fixed-income to pull its weight; and our highly levered economy probably will struggle to get weaned off low rates and unsustainable entitlements. While the current bull market in equities appears to be sustainable, the easy money already may have been made.
Stocks are extremely unpredictable in the short-term, and thus should be treated as long-term investments. If you judge the performance of your stocks more frequently than every 5 years, you may want to re-consider your investment strategy. When we buy stocks, we are buying businesses, and thus stay disciplined regardless of Washington’s antics or the herd behavior of other investors. There are many investment opportunities driven by biotechnology, consumers in emerging markets, and shale gas; yet markets will continue to be volatile as the U.S. government seeks a path to long-term fiscal strength.
By focusing on risk, Antaeus believes that we will provide strong long-term returns by limiting the likelihood of permanent capital impairment. We also strive to take advantage of market extremes, as bubbles can and do exist (e.g. Japanese stocks in the late 1980s, technology stock in the late 1990s and U.S. real estate in 2005). If, for instance, the price-earnings ratio of the S&P 500 moves past 19x, Antaeus plans to reduce our clients’ allocation to U.S. stocks.
Keep your seatbelts fastened: the current continuing resolution only keeps the government open through January 15th, and the borrowing through February 7th. Also remember that biggest mistake most people make is not bad investment choices; it’s overspending.
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Antaeus Wealth Advisors, LLC
October 27, 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 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.
 The weighted average correlation of stocks in the Russell 1000 fell 0.37 at the end of July 2013 vs. 0.57 a year earlier, according to Deutsche Bank.
 Examples: 10/05/98 – 01/20/00: 10 Year Treasury yield +2.63%, Barclays U.S. Government/Credit Index -5.15%, and BofA Merrill Lynch All U.S. Convertibles Index +68.85%; 12/30/08 – 06/10/09: +1.89%, -2.08% and +24.68% respectively. (Calamos, March 2013).