U.S. manufacturing continues to gain market shareSubmitted by Antaeus Wealth Advisors on February 13th, 2014
- *Maximum retirement benefit paid by Social Security to an individual retiring in 2014 at normal retirement age of 66 is $2,642/month. 2014’s Social Security Wage Base is $117,000. (Social Security Administration)
- *Maximum amount that a deceased individual may pass onto heirs federally estate-tax free in 2014: $5,340,000. Maximum in 1984: $325,000. (Internal Revenue Service)
- *Since 1926, average annualized returns for stocks after inflation when the market’s Price/Earnings (P/E) ratio is between 15 and 19.9: 6%. (The Leuthold Group). S&P 500’s P/E as of 02/11/14: 16.1.
- *Percentage of the S&P 500’s total returns from capital appreciation since 1926: 59%. From dividends: 41%. (JP Morgan Asset Management)
- *If a child born in 2013 attends a private 4-year college between 2031 and 2035, and the annual price increases over the last 30 years (+5.7% per year) continue, the aggregate 4-year cost of the child’s college education (including tuition, fees, room & board) will total $483,238. (College Board)
- *In only 5 of the last 50 fiscal years has the U.S. had a budget surplus, where tax receipts exceeded outlays.
- *86% of the 53.7 million tax returns filed in 2011 did not pay any federal income tax and reported less than $30,000 of Adjusted Gross Income. (Internal Revenue Service)
- *The size of the U.S. economy was $16.9 trillion as of 09/30/13, a record. The size of the national debt was $16.7 trillion as of 09/30/13. (Commerce Department, Treasury Department)
- *More than 3 out of every 5 Americans surveyed between the ages of 44-75 fear running out of money during retirement more than they fear death. (Allianz, 05/27/13)
- *California and Illinois have the 2 lowest credit ratings of any U.S. states. (Standard & Poor’s)
- *12/31/13 P/E ratio as a percentage of 20 year average P/E for small-cap value stocks: 117.3%. For large-cap growth stocks: 85.7%. For telecom stocks: 177.8%. For technology stocks: 69.5%. (Russell Investment Group)
- *November 2013 unemployment rate of those with less than a high school degree: 10.8%. For those with a college degree: 3.4%. (JP Morgan Asset Management)
- *Annual salary needed to cover principal and interest payments on the average home in Cleveland: $22,348. On the average home in San Francisco: $125,072.
- *Years it took for the U.S. 10-Year Treasury yield to reach a sustained level above 4% following its bottoming in 1946: 18. Average annual return of corporate bonds during the 1950s: 1.64%. (Fidelity Investments)
In 2013, the macroeconomic backdrop to financial markets was generally positive with stable growth, low inflation, loose monetary policies by central banks, and well-functioning markets. Japanese stocks – juiced by Shinzo Abe’s policy of intentionally de-valuing the Yen – rallied with the Nikkei 225 index posting total returns (price change plus dividends) of +57.0%. U.S. stocks also were strong with the S&P 500 Index returning +32.4%. Other notable indices: MSCI Europe Australasia and Far East Index +25.3%; Barclays Aggregate Bond Index +0.3%; MSCI Emerging Markets Index -2.3%; and Gold -28.9%.
With relatively low earnings expectations, the U.S. stock market’s rally has been driven by improving outlooks for fiscal and monetary policies and by a strengthening economy. Going forward, Antaeus believes that stock prices will receive additional support from the crumbling of a dam of uncertainty that had kept retail investors out of risk assets. While we remain open-minded about how much longer the bond market can enjoy this period of relative calm, the likelihood of a happy ending for those who take this stillness for granted looks increasingly remote; and the hit to many investors’ portfolio returns coming off such low bond yields may be significant. We also anticipate that the Federal Reserve’s (Fed) quantitative easing program will conclude by the mid-2015. 
With the S&P 500 trading at an above average P/E ratio and sluggish earnings growth, today’s stock prices are somewhat dependent on the policies of the Fed. According to bubble-hunting Yale economist Robert Shiller, U.S. stocks are not yet in the “red zone” (when the 10 year cyclically adjusted P/E ratio exceeds 28.8), although they were getting close to that zone at a ratio of 25.2 as of 12/31/13. For this reason, we believe the market could run for 2 to 3 more years – partly due to momentum – but at some point, we may reach irrational exuberance with “shoe shiners giving stock tips.” Small-capitalization stocks, in particular, seem susceptible to a pull-back.
In term of municipal bonds, investors are now openly debating whether Puerto Rico will default on its $10.6 billion in general obligation bonds. This paper was downgraded to “junk” status by Standard & Poor’s on February 4th. We do believe, however, that overall municipal finances are getting stronger, not weaker, in the United States. Further, while Antaeus finds better alternatives outside of fixed-income from a potential return perspective going forward, high quality bonds still play the important role of providing diversification and liquidity in portfolios.
Antaeus expects that U.S manufacturing will gain market share, as wages in China have increased significantly, and because energy costs have fallen in the United States much due to the “shale gas revolution.” Additional bright spots in America’s economy include: accelerating U.S. Gross Domestic Product (GDP) growth, rising housing formations and light vehicle sales, rebounding consumer spending and continued low inflation. Corporations also continue to be flush with cash. In short, the economy is in relatively good shape for an environment of deleveraging.
We have concerns about the global economy, however. Though the risk of recession is lower in Europe now than in recent years, 80% of European debt still is held by its banks (vs. 20% of U.S. debt by U.S. banks). A risk of deflation in Europe remains – which is alarming – and last felt here in the United States during the great depression. As for China, growing debt levels, a shadow banking system, and slowing GDP growth are disconcerting; and in emerging markets overall, weakening commodity prices and currency declines, combined with political and social tensions have created a challenging environment.
Strategy Going Forward
Antaeus finds compelling valuations for many blue chip stocks outside of the United States – especially in Europe – though we are reluctant, particularly in emerging markets, to get too excited this early. While Europe may have bottomed, we expect emerging market stocks to fall even farther before they turn a corner. Country by country differentiation probably will remain essential for effective emerging-markets investing in 2014. We also continue to look for companies benefiting from the interaction of breakthroughs in human genomics with medical treatments, for those positioned to capitalize on the growth of smart phones, and for companies with products that resonate with the growing middle class in emerging markets.
Antaeus remains vigilant about the prominence of central bank policies and its global ripple effects, similar to the linkage between subprime mortgages, leverage and the global financial system. Tapering may be painful for several asset classes – so, as always, we advocate thorough portfolio diversification and keeping some defense in place. As an analogy, a generator gives people peace of mind by allowing them to stay in their homes and not worry if a storm knocks out power. In the context of a portfolio, cash and high quality short-term bonds provide that safety feature to help “keep the pipes from freezing” during times of crisis. An additional non-correlated asset class is managed futures, which while more speculative, potentially can provide greater return during a stock market correction.
As a final comment, for individuals still working and expecting their pensions to be rich, or those who believe that Medicare premiums will not continue to rise, we advocate being careful of such assumptions. Detroit and Illinois may turn out to be harbingers for municipalities that cut pension benefits to shore up their balance sheets; and, as a nation, we have barely scratched the surface of paying for the medical care that baby boomers will require.
Evan P. Welch, CFP®, AIF®
Chief Investment Officer
Antaeus Wealth Advisors, LLC
February 13, 2014
 With the Fed now holding 41% of Treasury bonds with maturities over 10 years, it seems doubtful that it will continue to expand its balance sheet much longer.