The Market feels a bit… “Toppy.”

5 03 2012

Jonathan N. Castle, CFP®, ChFC®

Where does the time go?  It is already nearly the end of February and it seems like 2012 is speeding along faster than last year!  So far this year, the financial markets have been reasonably good to all of us, with the S&P 500 up about 8.5%, the Dow up 6.6%, and the NASDAQ up an eye-popping 13.9% as of this writing.

The Dow Jones Industrial Index has broken through the psychological barrier of 13,000 – the highest it has been since March of 2008 a few times now.  In fact, the markets have been remarkably – almost eerily – calm for the last 3 months, quietly marching upward, shrugging off the occasional bad news (such as the Greek bailout nearly unwinding last week and the ever increasing tension over oil in the mideast) with little more than an occasional flinch. 

As we have said for the past 8 months, we remain cautiously optimistic.  “Moderately Bullish” is a term that I have used in the past.  Based upon historical behavior of Secular Bear Markets, we expect that over the next 3 years or so, we will see substantial ups (and downs) in the markets with a slight overall uptrend.  

As it pertains to the current rally, we believe this leg of the rally is probably due for a drawback of some kind.  The next chart shows our reasoning for this.  When the market approaches a point where it had difficulty breaking through previously (such as the Dow’s 13,000 level), this is known as “resistance.”  Typically, as a market index approaches a resistance level, it generally will pause, draw back, and then, IF the level is to be broken, will punch through that level to achieve new highs.  Similar to a person drawing back before breaking through a door, the market will generally draw back before “breaking out” to a new level.  As we are at that resistance level now, a drawback would be a natural – even necessary – part of a normal market rally. 

Despite the recent market rally, we do not feel it is time to break out any party hats on a new sustained bull market just yet.  There are a number of reasons to remain cautious about the markets:

  • According to the Investment Company Institute – the total inflows (new money) going into equity (stock) mutual funds from February 1st through February 15th was a little over 4.6 Billion Dollars.  While this seems like a lot, compared to the inflows to bond funds, which netted 15.2 Billion – it was just a trickle.  Clearly, investors are not ready to assume lots of stock market risk just yet, and the recent rally did not have the market breadth that would indicate the start of a new bull market.
  • The price of oil is going up.  Part of the reason is that US refineries shut down every May to retool to EPA requirements, so oil nearly always rises during this part of the year.  However – increased tensions in the mideast are also driving oil prices higher.  Higher oil prices mean slower economic growth.  As businesses must pay more for energy, they spend less on payrolls and other things which drive growth.
  • Europe’s financial situation is still quite a mess.  While it seems that the European Union is working feverishly to keep from imploding – and they may well succeed – the fact is that Europe is already mired in what appears to be a deep recession.  This will have a global impact, slowing growth in emerging markets as well as within the United States.
  • Our National Debt is a significant problem – and only getting worse.
  • We are in an election year, so significant economic policy will likely not be passed until next year.  Given the uncertain outcome of the 2012 elections, it is anyone’s guess as to whether any new policies will be helpful or harmful.
  • The Bush tax cuts are set to expire this year.  This expectation is curbing business spending.
  • And the list goes on… given the recency of the 2008 market crash, investors are not yet hungry enough for returns to take additional risks and dive head first into the markets. 

However – there are numerous reasons to be bullish as well.  Institutional investors are slowly beginning to see the opportunity in stocks – and have publicly stated their plans to acquire more stocks in their portfolios over the next several years in preparation for a future bull market.  Some reasons to own stocks – and to expect the market will go up are: 

  • Stock valuations are more attractive than they have been in decades.  Based upon the price of stocks compared to company earnings, stocks are cheap.  In the past, investors who loaded up on stocks at current valuation levels were handsomely rewarded over the next 10 years.  Institutions know this – and their demand for stocks during this period may well keep the market afloat.
  • We are seeing a new “flurry” of IPO’s (Initial Public Offerings).  New companies – such as Facebook – offering publicly traded stock for the first time.  Historically, when there are a lot of IPO’s, the market does well.
  • We are seeing a significant increase in companies buying back their own stock.  Not only does this activity boost the stock market – but it is also an indication of what company insiders think of the future prospects of their companies.  Who would spend good money to buy their own company stock – unless they believed the company woud do well?
  • Corporations are hoarding more cash than ever.  While initially this might seem a bad sign – it is a an indicator of the huge potential that exists.  Eventually, this cash will be deployed.  When it is – there is enough of it to have an enormous impact upon virtually all parts of the economy.
  • Currently, the dividend yield on the Dow Jones is a very attractive 3.07%.  So, hypothetically if the market only goes up 5%, an investor who owned the Dow Jones would reap over 8% in total return.  It is only a matter of time before return-starved pension funds, institutions, and corporations currently investing in Treasuries earning less than 3% begin to move money to other assets to seek greater returns.  When this begins, the market has the potential to move up very quickly.

This balance between bullish and bearish factors is a normal part of the recovery process, but makes for a challenging investment environment. In summary, we remain cautiously bullish, with an expectation for occasional market corrections which may exceed 20% or more.  Likely, it will feel like taking three steps forward, only to take two steps back.  However, we feel that reasonable gains are available with the correct strategy.  The most successful investors that we have worked with have carefully chosen their risk tolerance, and then invested in portfolios scientifically designed around that risk tolerance – and remained focused on the long term.  

This blog post is not personal investment, financial, or tax advice.  Please consult your financial professional for personal, specific information.  Indexes mentioned are a general barometer of the stock or bond market they represent.  You cannot invest directly in an index.  Past performance is no guarantee of future results.   

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services offered by Paragon Wealth Strategies LLC, a registered investment adviser.  http://www.WealthGuards.com 

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Our Expectations for 2012

19 01 2012

Jonathan N. Castle, CFP, ChFC

2011 has come and gone and we are rapidly working our way through 2012.  It seems that so far, a general sense of cautious optimism has taken over where only a few months ago, all we heard was gloom and doom.  We applaud what appears to be slightly more balanced reporting on the economic front.  While not all of the news is good, neither is it all bad as it seemed to be several months ago.  A sense of doom and gloom serves no good purpose for our economy, and we are pleased the mood appears to be lifting somewhat.

After reviewing a great deal of economic analysis and often conflicting opinions from our research providers, we have come to some general conclusions about what to expect for performance in the financial markets in 2012.  We have stated over the last several months that we are “cautiously optimistic,” or “moderately bullish.”  There is no substantive data that suggests we should change this outlook (details at the end of the article) – but that does not mean that we believe the road ahead to be easy, particularly for investors.  Nor does it mean that we are wearing rose-colored glasses, or our cups are always “half full.”  It simply means that we believe we will continue to improve – with occasional interruptions – from where we currently are NOW.  We also believe that it will take years for the economy to fully recover – but recover it will.

Our Major Concerns at this time are:

European Debt Crisis and Likely European Recession – Some experts believe that the European recession has already begun. Recent data points indicate that Germany’s economy contracted slightly last quarter, and it is likely that other economies will soon follow.  As we enjoy a globally integrated economy, European recession likely means slowing economic growth in the US and difficulty in achieving meaningful returns in international markets.

Rising Dollar – As the Euro weakens, other currencies, (including ours) strengthen against it.  A strengthening dollar makes it more difficult for US companies to export goods and may make it more attractive for US companies to outsource jobs overseas.  However, a strong dollar does have the benefit of making US debt more attractive to foreign investors looking for security.

Political Stagnation – The past 2 years have been a display of an embarrassingly dysfunctional government. Unfortunately, with 2012 being an election year, we believe it unlikely that any real policy change will occur until 2013 or beyond.

Overwhelming US Debt – this may be the most dangerous long-term economic issue we have to face. At some point, we must face the inevitable belt-tightening that will be necessary to keep the US afloat.  Either government spending must decrease, or taxes must increase – or both.  Neither option is good for the economy or financial markets.

The Fed is Out of Bullets – The Fed has reduced interest rates to the lowest that we have ever seen, and pumped trillions of dollars into our economy trying to stimulate economic growth.  However, the damage done to the economy during the Great Recession was so severe that most of the Fed’s actions served only to limit damage – not to create the opportunity for recovery that we were hoping for.  At this time, it appears that the Fed is nearly out of ammo and has few options left.  Fortunately, inflation has not been severe; if it were, the Fed would be forced to raise interest rates again, which would slow economic growth even more and investors holding bonds would see the market values of their bonds decrease.

US Consumer Belt-Tightening – A large part of our economy is based upon the American consumer.  While it is a bit embarrassing to say that our economy runs on us buying things we don’t really need – it is partly true.  As more Americans learn that they can, in fact, live without many of these luxuries, these dollars no longer stimulate the economy.  On a personal level, a reversion to thrift is positive and one that we wholeheartedly support.  On an economic level, however – especially as a service based economy, consumer thrift forebodes even slower growth than previously hoped for.

Rays of Hope and Sunshine

Receding Unemployment – ever so slowly, and certainly not in a straight line, unemployment figures are receding. This is a fact; there are jobs out there to be had.  Many are in small businesses where people are hired one at a time.  Some disbelievers say that unemployment is dropping “only because discouraged workers have given up looking for jobs.”  This argument is hogwash – new workers enter the job market on a daily basis, which offsets discouraged workers leaving or retiring early.  While the jobs may not be the premium top paying jobs that were available before – they ARE indicators of economic expansion from where we were two years ago.

Increased Home Sales – According to the most recent National Association of Realtors (NAR), housing sales appear to have stabilized.  Total housing inventory fell from an 11 month supply to a 7 month supply during 2011. Housing starts and permits are increasing, albeit slowly.  As the housing sector directly impacts over 17% of the entire US economy, this news – however tepid – is hopeful.

US Corporate Profits – US corporate profits are at a high not seen since before the tech-bubble crash.  While much of the profit results from cost-cutting, it is still meaningful. Increasing profits mean that most of the major US firms are on a solid fiscal footing, and are in a much better position to pay attractive dividends to shareholders and fund future expansions.  From a yield perspective – high quality stocks are now more attractive than bonds at current levels.

Improving Manufacturing Data – The December Manufacturing Institute for Supply Management (ISM) Report topped expectations with the factory sector barometer (known as the PMI) increasing to the best level in six months. The raw data of the PMI also indicates that the manufacturing sector has grown for 29 consecutive months, which is generally a good indicator of the future direction of the economy. ALL 3 major US automakers reported profits for 2011.

What to do?

“Buy Low, Sell High.”  We all know this.  Yet, many people are only comfortable investing when the economy is humming along smoothly and all the news is positive.  Unfortunately for these emotionally driven investors, periods of economic boom are often the most dangerous times to invest, because by then, markets are usually overvalued. (Buy High, Sell Low).  Remember – when everyone is already invested, there are no new investors to bid prices up further.  Being invested in portfolios designed to your personal risk tolerance – especially when markets are undervalued – has been proven to be a key to long term investor success.

Typical Bear Market Behavior

For the last 100 years, based upon a study done by Morgan Stanley in 2009 called “The Aftermath of Secular Bear Markets,” major bear markets typically behave as follows.  (Dates for our current bear market in parentheses).

  • Market Crash/Bear Market: -56% for 29 Months, on average (Oct 2007 – Mar 2009)
  • Rebound Rally: +70% for 17 Months, on average (Mar 2009 – Apr 2010)
  • Mid Cycle Correction: -25% for 13 Months on average (Apr 2010 – Aug 2011)
  • Trading Range: Sideways (but slightly UP) with 15-20% whipsaw behavior for 5.6 years, on average (Aug 2011 – ?)

Our current bear market appears to be slightly shortening the cycles, but, in light of current political dysfunction and the European Debt Crisis, we believe the “trading range” portion of the market cycle will likely last several years at a minimum.

For 2012, we believe the following:

  • Markets will continue to be choppy, sometimes uncomfortably so
  • We DO expect to see some growth out of stocks, but not particularly impressive growth
  • Larger, dividend paying stocks should play a large role in the equity portions of portfolios (as compared to mid- or small-cap stocks)
  • US markets will be less volatile, and return more, than developed international markets. Emerging Markets will suffer from the European recession.
  • Interest rates (and bond prices) will remain relatively stable
  • The US Dollar will strengthen compared to the Euro

Our suggestion is that investors focus on other issues over which they have control:

  • Maximize IRA, 401(k), Roth, and other retirement plan contributions.
  • Reduce debt wherever possible.
  • Cut back on unnecessary luxuries (cook at home more, examine utility bills, etc).
  • Examine opportunities for mortgage refinance or other strategies to lock in low interest rates.
  • Closely examine your tax strategies (Roth Conversions, capital gains realization, business sales, etc) to include the expectation that taxes will be higher in future years.

While this list is certainly not exhaustive, it is a good place to start.  If we can offer you assistance in making the decisions necessary to maximize your odds of success during these uncertain times, please don’t hesitate to give us a call.

This blog article is for informational purposes only and does not constitute legal, tax, or personal financial advice.  Please consult your own financial professional for personal, specific information.  PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.  http://www.WealthGuards.com






Should I Still Invest in a Crappy Economy?

20 09 2011

By Jon Castle, CFP®, ChFC®

It does not seem to matter who the potential investor is – whether they are already retired, are nearing retirement, or are a younger person with quite a bit of time until retirement… the question is often the same.  With interest rates being so low… with the markets unpredictible and volatile – what should I do?  The questions aren’t even really so straight forward as, “why should I invest my money now,” or “should I pay off debt first,” or even any of the other questions that, as a financial advisor for more than 15 years now, I’m used to getting.  The questions I am hearing now seem to have taken on the tone of confusion, despair, and a lack of direction, versus the questions I used to get such as “how should I invest,” or”what type of account – a Roth or a traditional IRA – should I have?”

Yesterday, when talking to a rather successful, nearly retired client on the telephone, she mentioned that she feels that she always has to take two steps backward for every three steps forward, and ideally, she would rather not see her account fluctuate at all once she retires next year.  “Isn’t there just something we can do with our money to earn a steady 6-8% or so with no risk?”  Unfortunately, the answer is NO.  While there might be many product salesmen out there who will try to convince you otherwise – the answer is still NO.   If there were -then all the institutions and large organizations in the world, who spend millions and millions of dollars trying to find or design such assets would have already found them.  A classic example of people and institutions trying to get outsized returns with no perceived risk is the recent mortgage debacle, and we saw how that turned out.

So – back to the original question – With the Economy on shaky footing (to say the least) and with the markets being… unusually volatile, to put it lightly – what should I do?

To answer this question, I had to turn to the history books, tenured academic research, and even some new research – but I think I found the answer.  Do EXACTLY what you have been told to do throughout the years.  Live below your means – save a portion of your income (assuming you are working and saving for retirement) and invest in a fully diversified portfolio designed specifically for your risk tolerance.  In fact – it is having the GUTS to invest during times like these that separate the winners from the… folks who wish they had as much money as the winners.

Last year, Dimensional Fund Advisors tapped into the database held at the Center for Research in Security Prices (CRSP) at the University of Chicago – the nexus of more Nobel-Prize winning research in economics than any other institution on the planet – to identify IF there was a direct correlation between a poor economy (as defined by low GDP) and poor investor returns.  In other words – SHOULD I STILL INVEST IN A CRAPPY ECONOMY?”

The Dimensional Study started by taking all of the world’s developed economies, examining their annual GDP growth from 1971 – 2008, and dividing them into two groups – High Growth, or Low Growth – for each year.  Clearly, much of what we hear on the news is about GDP growth – is our economy growing or not?  The higher the economic growth, the better – as this means reductions in unemployment, increases in personal wages, and, generally, a feeling of well-being, versus the cloud of general malaise that seems to have decended upon the world as of late.

Once the economies were divided into High Growth and Low Growth – the performance of their stock market indices was compared to their GDP Growth.  The question:  Does a poor economy (low GDP Growth) accurately predict poor investor returns?  The question was not – can an investor perform poorly during low-growth times (of course, we know that is possible) – but is there a clear and determinable correlation between a bad economy and a bad investor experience?

Oddly enough – the answer is NO.

                              AVG GDP                      AVG RETURN              Risk (Std Dev)

High Growth               0.92                             12.90%                          23.07

Low Growth               -4.02                            13.52%                          23.04

The data for Emerging Markets was similar, but quite honestly, the data for Emerging Markets only went back to 2001, and I felt this was just too short a time period to draw any reasonable conclusions.

When I first saw the data, I thought… well… this might be a sales pitch just to keep investors invested… we are still looking back only as far as 1971.  What about other periods of lousy growth?  And what about for the US in particular?  I wanted to check the data myself.  So, I delved into the CRSP database myself, using the French and Fama indices that go back as far as 1926, and to the Bureau of Economic Analysis (BEA.GOV) and compared hypothetical investor returns to the GDP growth (or lack thereof) during the 1970’s and during the Great Depression.

One particular period of interest to me was the years from 1972 to 1982.  Yes, this was after 1971, but I wanted to look at it further and in more depth from a portfolio manager perspective instead of just looking at the stock market.  How did it feel?  Remember the oil embargo?  Our defeat in Vietnam? The Cold War?  Carter’s “Misery Index?”  Double Digit Inflation?  During this period of time, the average GDP Growth was only 2.7% – well below the historical average of 3.4%.

The second period of interest was the period of the Great Depression.  Now the Great Depression itself lasted from 1929 to 1941 – but for this particular exercise, I wanted to look at the period starting about 2 and a half years AFTER the crash – starting with the summer of 1932 until the attack on Pearl Harbor, or December 1941 – the long, grinding years of the Depression.  During that period of time, our average GDP Growth was only 2.0% – the longest and weakest period of below-average growth on record for the United States.

My question was – how could today’s investors, using a properly designed, diversified portfolio,  have done during that time?  Were these two periods of time – arguably the worst periods (economically) in the past hundred years – a bad time to be invested?

Assume a relatively simple, domestic portfolio:  T-Bills (15%), 5-Year Treasuries (15%), US Large Stocks (11%), US Large Value, or underpriced, dividend paying stocks (21%), US Small Value Stocks (18%), US Small Stocks (10%), and Very Small, or Micro-Cap Stocks (10%).

Looking at the indices only (remember – there were VERY few mutual funds at the time of the Depression, and certainly no ETF’s,) we can get an idea of how an investor might have done.  The following numbers do NOT account for any fees, commissions, taxes, etc – but we can still draw conclusions.

From the period of 1932 – 1941, the above, simple, diversified portfolio (indices only) would have achieved an AVERAGE ANNUAL return of… wait for it… 19.29%!!  In fact one dollar invested as described above in the summer of 1932 would have grown to about $4.50 by December of 1941.  During the Great Depression!!

From the period of 1972 to 1982, the above, simple, diversified portfolio (indices only) would have achieve an AVERAGE ANNUAL return of… 14.82%!!  One dollar invested as described above in December of 1972 would have grown to about $3.49 by December of 1982.  During the Carter Years and the Misery Index!!

Were there periods of volatility, market corrections, and even stagnation in the investor’s portfolio?  Absolutely – in particular, a sharp market correction in 1936 would have scared out many undisciplined investors, and a particularly unpleasant 18 month bear market from 1973-1974 would have tested investor mettle.  But the facts remain – a fully diversified, properly balanced investor would have been able to achieve significant returns during those times.  In fact – there are a number of economic theories that suggest that investors who have the GUTS to invest (and remain invested) during these uncertain times are the ones who enjoy the GREATEST rewards.  These are the riskiest, most emotionally draining times to invest – as a result, the Capital Markets reward those investors more readily and more predictibly than the comparatively “timid” investors who only remain invested during the “good” times.

Today, the Fed and the International Monetary Fund (IMF) are projecting the US economy’s GDP growth to be about 2.7% for the next two years.  The media harps daily on the miserable shape of our economy, and politicians are using the economy as opportunities to further their agendas.  These are things that we must endure as a people, or change with our votes.

However – it is critical to SEPARATE our concerns about the economy – from our own INVESTMENT POLICY.  The two are NOT necessarily correlated.  A miserable economy – historically – does NOT mean miserable returns for an investor who is disciplined, creates a sound, diversified, low-cost investment STRATEGY with strict risk controls, and then implements it with courage and discipline.  In fact – it is EXACTLY these types of investors who have historically been the winners over the long term.

___________________________________________________________________________

This blog article does not constitute legal, tax, or personal financial advice.  Please consult your own financial professional for personal, specific information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.





Why has everyone suddenly become fearful?

29 06 2011

Jonathan N. Castle, CFP®, ChFC

The economy was in recovery; the bulls were stampeding through Wall Street, and for a few short months we had a general feeling that maybe – just maybe – all would be well with the economic world.  Then things seemed to fall apart – first we had a Tsunami and a potential nuclear disaster in Japan; then President Mubarek of Egypt was ousted, and then we started dropping bombs on Lybia.  To top it off, Greece will probably go bankrupt – if not soon, then certainly at some point in the future, and everyone in the US is wondering if that will be our own future if our brilliant congressional leaders can’t quit their squabbling and decide one way or another on our own budget deficit.  Do we simply raise our own debt ceiling, allowing our government to put us deeper in debt, do we default on some of our debt, or do we cut deeply into some highly sensitive entitlement programs to try and balance the budget?  QE2 is ending, so the Federal gravy train of free money is coming to an end, right?  To top it off, the market has been floundering around – falling one day and rising the next with no clear direction, reminding us of the ever present danger of a sustained bear market that may push all of our retirements back a few more years.

So what happened?  What should you do?

Well – since everyone’s situation is different, I’ll start off with some assumptions.  In my experience, individuals who are generally successful investors have the following characteristics, so I am going to assume that if you are reading this – then you have met the following criteria.  If not – then disregard anything and everything I say.

1)  You have an investment PHILOSOPHY (i.e., set of guiding beliefs and a repeatable strategy) that you believe in enough to stick to through the long term.  You are aware that events that effect financial markets continually happen and are often unpredictible – therefore, your investment PHILOSOPHY provides you guidance on how you build your investment portfolio, and does not change from day to day.  You are also aware that, contrary to what Wall Street and the mass media (which is in their pocket, by the way) constantly advocate – “buy when the market is going to go up, sell when it is going to go down,” is NOT an investment PHILOSOPHY.  It is an investment FANTASY.

2)  You have carefully measured your risk tolerance.  This means that you know EXACTLY how much your portfolio can drop before you even THINK about making any changes to your overall strategy.

3)  You have carefully designed your portfolio to match your risk tolerance.  In other words – if your risk tolerance is such that you can bear a drop of up to 10% in your portfolio – but no more – then you are aware that the market typically will drop 20% or more every 3.5 years, on average.  Therefore – you have designed your portfolio so that 50% or less of your account would be effected by such a drop.  So- if the overall stock market drops 20% – but only about half of your portfolio is in the stock market – with the rest of the portfolio in cash, CD’s, and perhaps short-term bonds  – then you can reasonably assume that a 10% drop in your portfolio would be a likely outcome of such a correction – and would be bearable.  Keep in mind that during extended recessions or financial crises (such as occurred in 2008) that these parameters are often exceeded.  The 2001 crash, on the other hand – did not effect properly diversified portfolios as much.  Point being – you have structured YOUR portfolio to match YOUR risk tolerance.

Assuming all of the above – then my general advice, assuming that you have some time until you need ALL of your portfolio – would be to do nothing.  Nonthing at all!  Sometimes we have to scream out, “Don’t just DO SOMETHING – Stand there!!”

As far as all the other stuff going on, here is my take on current events.  Granted – I cannot foresee the future – no one can – but from looking into things and trying to keep everything within a historical perspective, here’s what I think is going on.

1)  The market first.  The markets are quite efficient.  With probably more than 100 million investors, analysts, gurus, institutions, etc. all playing in the market and trying to get the most profit for the least amount of risk – the markets as a whole factor in a great deal of information in a short period of time.  I believe that the potential outcomes of both a default by Greece, and the end of QE2 are already factored into the current prices of stocks and bonds – for the most part.  None of this information was kept a secret; markets have known for nearly a year about the end of QE2, and honestly – Greece’s entire economy is about the size of Rhode Island’s.  The threat to the EU is certainly there – but more on a political front than as a potential for a global financial meltdown.  I expect very little response from the overall market to either the end of QE2 or a Greek default.  In fact, I believe that Greece WILL default – but in stages.

2)  Again, on the markets.  The economy is in recovery, but this occurs in stages.  Honestly I don’t understand all the wailing and gnashing of teeth – but I suppose that’s what drives in the revenue to the squawkers in the Media.  Remember those old rocket ships that had multiple stages – first the big rocket engine with all the fire shooting out of it, then a smaller booster rocket, and then another, and finally the little spaceship on the top of the rocket fires its engines and it goes off into outer space or to the moon?  Well, every time the rocket ended one stage, the engine would quit – there would be a pause – and then when the next engine would kick on the rocket would continue on its way.  We didn’t see all the media freaking out at every pause… squawking about how the rocket was going to fall back to the ground just because the first engine quit.  We don’t all jump out of our cars and start worrying that our car is broken everytime we shift from one gear to another… a marathon runner knows he can’t sprint for the full 26 miles… so why all the wailing and chicken littling every time there is a bit of bad news or a new report that wasn’t quite as good as the last one?  Economic recoveries take time.  This was the GREAT RECESSION, after all – over a decade in the making, so it stands to reason that it will likely take a decade or more to fix.

3)  There are a ton of reasons to believe that the stock market – and the economy – will continue to head in the right direction – upward.  First – the general index of leading economic indicators is still positive.  Yes, some of the coincident indicators have slowed down, but generally, they are still well ahead of recession territory.  Secondly, employment is still growing.  Yes, we’ve had a slow month or two of new hiring numbers – but employment is still growing.  And the number of temporary workers that have been hired is up to levels not seen since 2009, and companies typically hire temps before perms.

4)  Economic slowdowns (operational pauses) are absolutely normal after a run-up like we saw since last year.  This “pause” gives corporations time to think about their next moves – expansions, hiring, starting new projects, new marketing campaigns, etc.  Corporations have also been hoarding cash; it is only a matter of time before these corporate reserves are put to work in new growth opportunities and innovations.

5)  Stock buybacks are at an historic high right now.  Based upon P/E ratios, stocks are the cheapest they’ve been in 26 years (this from Bloomberg).  The Bush tax cuts are still in effect, corporate profits are higher than ever – and there is currently approximately 2 trillion dollars sitting in cash and on the sidelines ready to be deployed into the markets.  This all makes for a powder keg of bullish opportunity.

Ultimately, no one can see the future.  But I do believe that we as humans typically worry too much.  Supposedly about 95% of the things that we worry about never happen.  So, in this case – assuming all the above – my suggestion is that we just stand back and see where the markets take us.  I’m betting that place is up significantly from where we are now.

Disclaimers:

This blog post is for informational purposes only.  All investing involves the potential of loss – including invested principal.  Indices quoted are general barometers of security price movement.  You cannot invest directly in an index.  Past performance is not a guarantee of future performance.  This message is NOT personal investment advice and should not be taken as such, nor is it a recommendation to buy or sell any security.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services offered by Paragon Wealth Strategies LLC, a registered investment advisor.





High Unemployment… Debt Crisis… Inflation… Tsunami… why does the market keep going up?

5 05 2011

By Jon Castle, CFP®, ChFC®

Many times, while working with clients, we get the question,  “WHY are you generally bullish on the market?  All the news I hear is BAD.  How can you possibly think the market is going to keep going up?”

I will get around to answering this question – but bear with me a moment as I wax philosophical.  It has been my experience in working with individual investors saving and working toward retirement – that the most successful investors develop an investment philosophy – a set of guiding principles and beliefs that shape an investor’s decision making process.  This set of principles essentially guides the investor during the darkest times so they can remain disciplined during times of economic and market volatility.

“I think the market is going to go up – so I want to be invested NOW – but not if it goes down,” is NOT an investment philosophy!  An investment philosophy guides an investor’s decisions consistently, based upon their fundamental beliefs about the way markets work.  For example, MY own investment philosophy (not necessarily the right one – just what I happen to believe) can be summed up as follows:

1)  Capitalism – perhaps best described as “Pay Upon Results,” ultimately drives the financial markets.  It creates the impetus for new developments and for entrepreneurs to take risks, to create new businesses or opportunities, to hire people to do work, to think up new goods and services that people will buy.  Without capitalism, there is no opportunity for reward, so no one will take undue risk – and the economy will languish as it did in the old Soviet Union.  Sometimes capitalism gets a little out of control… and can be cruel… thus the need for prudent regulation.  However, it is the best economic system invented so far and is amazingly efficient.

2)  Capital Markets work.  With all of the competition to outdo the other guy – millions upon millions of investors seeking the highest reward for the lowest possible risk creates an environment of extreme efficiency in our Capital Markets.  Just about all known information – and the probabilities of all imagined outcomes- about any particular stock or bond – is very quickly factored into that security’s price.  Any “surprise” information that can significantly give one investor an advantage over another is factored into the price very quickly – usually within seconds of that information becoming public knowledge.  Therefore – most of the time – doing tons of research about any particular stock or bond is a waste of time because the market prices the information faster than you (or a mutual fund manager, hedge fund manager, or other money managers) can do the research.

3)  I do believe that there are those few who have the “gift” and have been able to outperform the general market by some margin.  However, this “gift” is usually fleeting  – numerous studies show if someone has outperformed the market in the past – the odds of them continuing to outperform in the future are miniscule.  More often than not, managers who outperformed merely increased the risk within the portfolio, and pay for that risk later in under-performance.  Picking a money manager (or a mutual fund) who will outperform the market – in advance – is extremely unlikely.

4)  Successful investors focus on what they CAN control instead of what they cannot.  We cannot control fund manager performance.  We cannot control the Fed’s actions, nor can we control the markets.  However, we CAN control costs, the structure of our portfolio, and our own behavior.  So, in general, better and more predictable performance can be achieved by capturing the movement of the entire market and its various sectors – through the use of lower-cost ETF’s, index funds, and institutional “total market” funds – than through individual stock picking, trying to hop in and out of the market based upon tips or media input –  or by using more expensive mutual funds where managers try to beat the market while enduring higher risks, tax inefficiencies, and trading costs.

5)  Above all – manage risk.  If the market gets bumpy and shakes you loose from your philosophy – you have failed.  Likely, you took too much risk and will probably never recoup that risk by reaping the rewards the market has historically given those who structure their portfolios so they can ride out the market’s bumps.  Risk tolerance is best described as the amount of money in your account you can watch disappear (through market fluctuation) without changing your philosophy.  If the market drops 20% – but you freak out if your account drops 10% – then you need to structure your account so it will most likely only drop 9% when the market drops 20%, instead of gambling on when the market will go up and when it won’t.  More often than not your gamble will be wrong.

OK, so that was my investment philosophy in a nutshell.  Now – back to the original question.

With all the bad news – why does the market keep going up?  Aren’t we just setting ourselves up for another disaster?   Personally, I think not.  I could be wrong, but I believe my logic is sound.

First – much of the “bad” news is sensationalized.  Right now, as I write this, the media is just about going bonkers trying to get the Obama administration to release photos of the dead Osama Bin Laden.  Now let’s think about this for a minute.  What real purpose would that serve?  Suppose the photos ARE released:

1)  He isn’t any less dead with the pictures than without.

2)  Pictures can be faked.  People (and countries) who don’t believe he is dead, will believe the pictures are faked.

3)  People who believe he is dead will still believe he is dead.

4)  If the photos are released, the media would get more people either watching their shows, reading their magazines, or logging into their websites to see the pictures.  This would sell more magazines (with the photos), and allow them to charge more money for advertising in those magazines, sell more web banners, and charge higher rates for their commercials!

AHA!  The net worldwide effect of the administration releasing the photos would likely be – the MEDIA MAKES MORE MONEY!!!!  Hmm…

So… let’s apply this logic to the stock market and the economy.  What if the media were absolutely unbiased and did not sensationalize anything?

Responsible Media:  “The preponderance of the data shows that the economy is slowly recovering.  Unemployment is slowly going down.  Generally, economic activity is increasing while housing still continues to lag.  Corporate earnings are healthy and corporations are sitting on mountains of cash which they will likely continue to invest over the next 5 years in new production, jobs, advertising, commerce, or in the stock market.  The Federal Reserve will likely, very slowly, reduce the amount of stimulus in the economy to try to control inflation – but must do it carefully in order not to derail the economic recovery.  (They know this, by the way, since they all have PhD’s in economics and finance).  The dollar is weakening a bit – but a weakening dollar can be good for America because it creates jobs at home (versus being sent overseas) and it allows us to sell American goods overseas more competitively.”  (REPEAT EVERY DAY OVER AND OVER with tiny adjustments… )

BOOOOORRRRRIIINNNNGGGG!  After about the third day, no one would watch that show anymore!  And of course, that show and its network would make no money in advertising.

Now – compare that with OUR MEDIA:

1) “Tsumani causes Nuclear Disaster!!!!  Will this cause a global stock market crash?!?”

2)  “Osama Bin Laden Killed.  EXPECT TERRORIST ATTACKS which may cause a global stock market crash!!!!”

3)  “Initial unemployment claims increased by 0.005% last month!!! Is the economic recovery DOOMED?”

4)  Fed to reduce Quantitative Easing.  Is the economic recovery DOOMED?!?!

5)  Fed did Quantitative Easing which boosted the economy.  Oh, No, we’ve got DEBT!  Is the economic recovery DOOMED?!?!

You get the picture.

 The simple reason the market keeps going up is this:  Investors seek investments which give the highest reward for every unit of risk.  Currently, cash is paying virtually nothing.  Bonds are trading at the highest prices (and lowest yields) in most of our lifetimes – so very little new money is moving into bonds.  There is a TON of cash sitting on the sidelines – and it has to go somewhere.  Slowly, it is making its way to the stock market.  The stock “Market” is driven by supply and demand.  As demand increases, the prices go up to reflect that demand.  Expect occasional bumps as unforeseen events unfold – but in general, our economy is expanding and is likely to continue to recover over the next several years.  The stock market is a “leading” indicator of the economy (investors invest for the future, not for the now), so it will generally rise BEFORE recoveries and will generally fall BEFORE recessions.  This is not new – it is basic economics.

It can be helpful to remember that the stock market NEEDS some uncertainty to do well.  Only when there is cash sitting on the sidelines (as a result of worry or uncertainty) can the markets continue to go up.  It is this very “worry cash” that gets the fed into the markets over time, which, in turn, drives the markets up.  OF COURSE investing is risky – why in the world would there be any significant reward without any risk??  The problem is – once everyone FEELS great about the market – once the last investor FEELS great about the economy and goes “ALL IN,” – then there is no additional cash left on the sidelines.  Thus – there is no further demand to continue to drive the market up.  THAT is when we need to really worry… that event occurred in March of 2000 – at the very height of the tech bubble… when all was well, the economy was booming… monkeys with dart boards could outperform professional money managers… and we all know what happened next.

Disclaimer:  This blog article is not personal tax advice.  Please consult your tax professional for personal, specific tax information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.