Double Dare

When I was a kid, we use to taunt friends by saying, “I Double Dare YOU,” to do something. Since becoming an adult, I don’t think I’ve used this expression. What brought it to mind was the inability, last night, of the Speaker of the House, Boehner, to get consensus in the Republican Party, for “Plan B,” to avoid the “Fiscal Cliff.” It’s almost as though his colleagues were saying, “We Double Dare YOU to go over the ‘Fiscal Cliff’.” It appears that to move forward, Boehner will have to work with President Obama and Senate Majority Leader Reid, to develop a solution that a majority of House Republicans and Democrats can accept. The clock continues to tick, even as the House Republicans go home!

I feel very blessed to be working at Secure Planning. We don’t do double dares. The group has worked together for many years, has built a relationship with each other and with our clients. I wish each of you a peaceful holiday and a happy and healthy New Year.
Thank you!
Ed Mallon

Value Added

One of the major advantages of a capitalist system is the concept of “value added”. In practice, the concept is very easy to understand, but not likely to be taught in most schools. As I have watched the President and Congress work on the "Fiscal Cliff" (which they created), it has become clear to me that either they do not understand this concept or know about it. When land lies fallow, it has no economic value. When the farmer buys seed, for say $1,000, plants it in the fallow land and harvests a crop worth $10,000, that is added value. When a manufacturer buys steel costing $1,500 and converts it into a product that sells for $15,000, that is added value. Many Americans believe that a finite amount of money and wealth exist in this country and therefore it needs to be “redistributed”. This is nonsense! The amount of wealth that can be created is almost limitless. Manufacturing, agriculture and transportation are examples of value added businesses. The understanding of this concept is very important. Manufacturing adds wealth to the economy, so we need to develop more manufacturing to move the economy forward. The Institute for Supply Management announced earlier this week that their index had slipped to 49.5%. This is the lowest the index has gone since July of 2009. It means that, even though manufacturers have lots of money, they are not spending it, resulting in a sharp contraction of goods production and contraction in the number of related jobs. They are in effect saying, we don't trust the government to get their financial house in order! As manufacturing stalls, the economy stalls! The growth in GDP this quarter appears tepid and, without action on deficit reduction and tax increases, the economy could slide back into a recession. Long-term, I believe, manufacturing is going to be very important to the prosperity of the United States. As I keep reiterating, we have a stable government, high productivity, high quality, and low-cost natural gas. All of these could bring us back to being the most successful manufacturing country in the world. That means lots of value added, creating more jobs, more revenue for the government and higher interest rates for retirees.
Ed Mallon

Investment Falls Off a Cliff

The above was the headline in the Wall Street Journal this morning. The article goes on to discuss the curtailment of capital spending by many major corporations that are sitting on large amounts of cash. The companies are reducing their investments in equipment, buildings and software. Previously, these types of investments helped pull us out of the recent recession. The article indicates that these large corporations are worried about the fiscal and economic uncertainty they face. If large companies are worried, small companies must also be worried! How about consumers? It was reported on Saturday that retailers are seeing consumers cutting back, making retailers worry about sales during the holiday season. This all seems to be rather negative news. With this as a backdrop before the opening of Monday’s stock market, you might think the market would plummet. You would have been wrong. The S&P 500 went up over 1.5%! In any stock market correction, the price of stocks decrease to a point at which buying becomes stronger than selling. This can last for a short time, generally 2 to 7 days, followed by a resumption in a downward direction. The past couple of weeks have taken a toll on the stock market, putting it in a technical “oversold” position. This rebound has been expected. Sometimes the news is reporting facts that the stock market has previously built into pricing. The “big deal” is still the Fiscal Cliff. Late last week, when the president and congress were seen as working together on this issue, there was a sense of optimism that they might resolve the looming problem. As I noted in my blog “The Fiscal Cliff!”, the issues are difficult and will require a great deal of compromise to resolve. Compromise is not something that comes easily to Washington these days. We can continue to hope for the best but, as with the large corporations, keep our money secure!

I would like to take this opportunity to wish each of you and your families a very Happy Thanksgiving!

Ed Mallon

Three Month Market Topping Pattern

While we often tend to look at fundamental analysis to determine the direction of the stock market, such as heading for the “fiscal cliff” or problems in Greece, it is sometimes a good idea to check on technical analysis. This blog will give an overview of where I believe technical analysis appears to be pointing at this time. On average, a bull market lasts about 39 months, sometimes longer or shorter. The current bull market began in March 2009 and reached its 39 month point in June of this year. For three months, from August until recently, some of the equity indexes reached new highs, seeming to show a robust equity marketplace. During this same three-month period, signs indicated that all was not well with the majority of underlying equity issues. The S&P Mid Cap and Small Cap indexes did not significantly break out of the highs from 2011, and selective buying was occurring. Selective buying indicates that buyers have become picky, and is usually a harbinger of a downturn in the markets. The NASDAQ Composite was showing greater signs of weakness as it dropped steadily. All of this produced what technical analysts call a topping period, where some issues continue to rise while most have hit their peak and are headed downward. What some long-term investors like to look at are the 200-day moving averages of various indexes. The idea behind the 200 day moving average is that it gives a clearer picture of the long term patterns of the market represented in an index. The daily movement on the NASDAQ Composite broke well below its 200-day moving average in October. The Dow Jones (DJ) Utilities average, DJ Transportation average and DJ Industrial Average have all broken below their 200-day moving average. Increased selective demand, coupled with the drop of most averages below their 200-day moving average and the impact of the weakening European markets on the U. S. markets all point to an extended bull market. What we saw last week was likely a correction in the market and not the start of a bear market. Given the extended nature of this bull market, caution should be exercised.
Ed Mallon

The Financial Cliff!

The term “Financial Cliff” is being bantered about quite a bit lately, but not all Americans really understand what it is, let alone the implications. The “Financial Cliff” refers to two separate developments that will take place unless Congress acts to avoid one or both of them.
One of the automatic changes that will occur, without action by Congress, is that the tax structure currently in place will expire at the end of this year, to be replaced by the old tax structure that existed in 2001. This means substantial increases in taxes for most Americans. At the same time, the payroll tax, which has been reduced for the past two years, is due to rise to its previous level. These tax changes mean less take home pay for every American worker. A reduction in net earnings will mean that consumers will have less to spend (and save) and economic growth will decline.
The other automatic cut that will occur at the end of the year is in Federal spending, with one half coming from the defense budget and the other half coming from mandates such as Social Security, Medicare, Medicaid and other basic services. This cut will also have a negative impact on the economy, as federal government spending that goes into the economy will be reduced.
To put this all in perspective: the growth we have been experiencing this year is roughly 3.1% with expectations that it will be similarly slow next year. If these two automatic changes go through, it is possible that the economy in six months could be negative 3%. Following the downturn in economic growth, the economy would be expected to begin increasing, and by 2014 to 2015 it could be growing better than today.
Will Congress act to change or eliminate these two automatic actions? At this point, no one really knows, but what if they don’t? In that case, we are likely to see unemployment increase again, housing values decrease and everyone will feel the pinch! It has also been suggested that if this is allowed to happen, long term benefits to the economy could be better than if Congress were to attempt to blunt the initial pain. The reason is that if we had a reduction in government spending and an increase in taxes the national debt would begin to fall. The financial strength of the United States would grow, and ultimately it would be favorable to business and consumers.
Part of this hinges on what I have been saying for most of this year: the United States has the highest productivity in the world, the best quality in the world, a stable government, and cheap energy in the form of natural gas. But our financial strength is being sapped by overspending and under-taxation. When you couple these with a strengthening financial situation, we cannot be beat! Many parts of the world are implementing austerity measures, while we in the U.S. have continued to have low taxes and high government spending. At some point and in some way, we too will have to feel the pain. So will Congress now let things go without intervention? Do politicians understand economics? Does any politician want to take away benefits and increase taxes?
One last comment. If the tax changes take place, the capital gains tax will rise to 25% and the taxes on dividends will go from 15% to a maximum of 42.5% (almost triple) and everyone will be paying more taxes on income. Are we a country that thinks long term (take your pain now) or short term (send the pain to another generation)? The “Wealthiest 1%” are not going to get us out of our mess. We all have to participate to make it happen!
Ed Mallon

Will They or Won't They

Currently the big question is: Will the Federal Reserve step in with a stimulus package or won’t they? Given the sad state of job growth, as reported last Friday, and the number of people still out of work, it seems likely that the Fed will do something. The next questions are: what will they do and what will be the impact? It appears to me, from reading reports since late August, that the Fed is likely to begin a new bond buying program that will push down interest rates on bonds, which have been rising. This in turn will make borrowing cheaper, helping to stimulate the economy and driving equity prices higher. That at least is the theory. The reality may be that stock prices have already accounted for the Fed’s action since it became clear at the August Fed meeting they would do something to stimulate the economy. When the Fed does announce their plan, equity markets may be susceptible to disappointment. That in turn could drive equity prices down. Across the pond the question is: Will the Central European Bank buy more Greek bonds and will they give additional help to Spain and Italy? Based on reports late last week, the Spanish and Italian governments got a clear sign that what they were doing for austerity was sufficient, while the results in Greece were disappointing. Looking at Greece’s issues it seems more and more likely that they will leave the European Union. Many large companies are already preparing for such an event. The impact of such a move on Europe and the U.S. is unknown but will likely be negative in the short run. All of this is in part due to the aftershocks of the subprime mortgage fiasco of 2008. Have we learned anything? Today the Wall Street journal reported that the booming car sales of August were helped along significantly by lenders making significant subprime car loans. Ed

"Stocks are Dead!"

In section C of the Wall Street Journal on Wednesday, August 1st, the headline read: "Bill Gross: Stocks are Dead and Operate Like a 'Ponzi Scheme'”. It notes that Bill Gross is co-founder and co-chief investment officer of Pacific Investment Management Co., or PIMCO, the largest bond fund in America. His belief is that the rates of return seen with stocks cannot continue and in the long run will come down. At the time this was reported, the 10-year Treasury bond was yielding about 1.5%. As of today, the same bond is yielding 1.84%. While this may not seem like much of a change, it means that the 10-year Treasury bond has decreased in value in a matter of 17 days. With bonds, when the yield rises, the value of the bond declines. Putting it in dollar terms, if you hypothetically purchased $100,000 of 10-year Treasuries at the beginning of the month, the value of your money would have decreased about $2,800 by last night. Because Treasuries impact most bond yields, we have also seen similar drops in value for most bonds. During the same period, the S&P 500 has risen 36 points for a 2.6% increase. If you had hypothetically purchased $100,000 of the S&P 500 Index, your money might have increased by about $2,600. Trying to guess the direction of the stock market or bond market over short periods of time is futile. I do believe there are long term trends that need to be watched, as well as short term events that must be taken into consideration. For bonds, with the long term trend from 1981 until now, we have seen interest rates continue to fall and as they fell, the value of bonds increased. Will this hold for the future? I don’t think it will. I believe bonds must ultimately begin to have increasing interest rates and reductions in value. The reason for holding bonds now is because of the uncertainty in the U.S. and the world, and the long term stability of bonds is because of the priority in payment, both interest and principal, of bonds over preferred and common stock. As greater stabilization comes to the U.S., and the world situation plays out, the benefits of stocks, dividends and growth, will be more likely to outweigh the stability of bonds. The ultimate answer to our current situation and long term investing is diversification. Bonds go up and down, stocks go up and down, real estate goes up and down, currencies go up and down and commodities go up and down! These changes happen because of economic trends but also because of human emotion. The three rules of investing are: Diversify, Diversify, Diversify! Have a great weekend! Ed

A Perspective of Value

The stock market works primarily on the idea that equities and fixed income securities have value. As the perspective of value changes the pricing of each of these two types of securities changes. Recently Spain has been under a great deal of pressure because the perception is that their banking system and economy are in poor shape and are more risky than what they were before. With this in mind you can understand why the interest rates on Spanish bonds has increased dramatically. Early this morning Italy was downgraded by two levels with a statement indicating it could be downgraded more in the future. This undoubtedly will have a negative impact on Italian bonds in today’s market, especially as the government there is doing a major refinancing of debt. In the U.S. the Federal Reserve (FED) has been holding short term rates at about zero and 10 year Treasury rates at all time lows, as of this writing 1.479%. The FED is doing this in the hopes that it will stimulate the economy, particularly the housing market. Thus, we have seen the lowest mortgage rates in 70 years. All of this points to the real problem. Worldwide economic growth is stalled. This in turn has lead to very high unemployment worldwide. This decline has been going on for some time. In October of 2007 the S&P 500 reached a new high of 1549.38. By February of 2009 it was down to 735.09 a staggering drop of 814 points or 53%! A bear market is one where the drop is 20% or more. This one was a duzy! During the recovery over the next three plus years the S&P reached 1419.04 on April 2, 2012. This was still 8% below the high in 2007. Since then with fits and starts the S&P has drifted down and is currently about 6% below the high of April. As we wait to see what earnings will be for the second quarter of this year it appears that the economy grew at a lack luster pace and that earnings for companies will likely follow with less than original estimated earnings. This is likely not to have a positive impact on stocks. The worries about equities is likely to continue to have a positive impact on higher quality bonds, especially U.S. government and corporate bonds. Historically the market goes up before a Presidential election and this may be the case this year. Looking at the fundamentals of the economy and the long term trend in the supply and demand for stocks I think this will remain a hard period for stocks to show significant gains and more likely trend down. My guess is that we may have entered the beginning of a bear market on April 2nd and are now going thru the stages of reaching a bottom. If that is the case then we could see the stock market lose about another 14% from where we are currently. Ed Mallon

Wildfires in Colorado

I wanted to take this opportunity to let our friends and clients in Colorado know that you are in our thoughts and prayers as you go through the tragedy of the wildfires in Colorado and especially in the Colorado Springs area.
Ed Mallon

Position Clarification

Many of us are feeling ”overloaded” by what we read and see about the U.S. economy, as well as what is happening in Europe and many third world nations. To put it as succinctly as possible: I am bearish on where the world stands currently. Accordingly, I will be taking a more reserved position. I have begun to underweight--by a substantial amount--the equity positions in each of our four fundamental categories (Conservative, Moderate, Growth and Income, and Aggressive). To give you an example, the allocation for a Growth and Income portfolio would normally be about 60% equities and 40% fixed. With the changes we are currently making, that portfolio will only be about 20% equities, about one-third of what I would normally allocate. You might wonder why I wouldn’t just get rid of all the equities. The answer is, I could be wrong! In addition, I am moving away from indexing, such as the S&P 500, and small stocks, and am going with managed portfolios of large- and medium-sized companies. I believe that, in times like these, the actual management of large stocks will offer better performance. I also like dividend-paying stocks. In the portfolios for which I have discretion, I have allocated few or no international equity positions because I believe they are too risky. In the long run, I am very bullish on the U.S. as I believe that the U.S. has four major attributes that no other country can equal: a stable government, the highest productivity in the world, the best overall quality of goods produced in the world, and inexpensive and plentiful energy supplies (especially natural gas). My perspective is that, once we are past the upcoming U.S. elections, Europe quiets down, and a decision is made on federal taxes and spending, it will be time to re-enter the stock market in full force. I expect these issues will all be resolved by the early part of next year. In the meantime, I remain cautious. Ed Mallon

Facebook and the Stock Market

For the past several weeks Facebook has been dominant in the financial press. What would be the initial price ($38), how many shares would be sold (422 M) and how high would it go the first day ($45)? Facebook was the talk of everyone who used it and therefore thought it would be a great stock to own! Often when an IPO is issued it goes up dramatically, not everyone gets to participate (meaning the small investor is left out) and it makes the early investors wealthy. So far none of these is the case with Facebook. The stock at this writing, late in the day on Friday, is back to where it started after having risen briefly in early trading. Just about everyone who wanted stock got it, including the small investor. The early birds in the IPO did not get wealthy the first day! This is also the first time in years that I had clients calling us up wanting to buy this stock. Why wouldn’t you want to own Facebook (or why would you want to own Facebook)? The dominant reason to own Facebook is that you like the product and you want to be a part of it! This is not a logical way to buy stocks; but it is not all that unusual either. When Facebook is analyzed on a fundamental basis it does not hold up. It has virtually no earnings relative to price. It was acknowledged during the filing of the IPO that the most prevalent use of Facebook is on smart phones and they have not figured out how to place advertising on this medium that will result in significant revenues. In the case of the basic system their biggest advertiser, General Motors, announced earlier this week they would no longer advertise on Facebook because it was resulting in no additional sales. The CFO of Facebook also indicated earlier in the week that a significant portion of the funds raised would go to attempting to find a way to get ad revenue on smart phones and there was no certainty of success. For now the syndicates that offered the IPO are doing their best (as they should) to support the price of the stock at its initial public offering price of $38. What will happen after the support period ends is anyone’s guess. My guess is that many individuals who wanted the stock bought it because it was a product they liked and they will keep the stock. Institutions that acquired shares did so in many cases because after the cooling off period of 60 days, Facebook will become part of the NASDAQ index. If you do any indexing you will need to own Facebook. The institutions, too, are unlikely to sell Facebook. It will be interesting to watch how Facebook does even as the S&P 500, which started the year at 1277, reached a high on April 2nd of 1419, and has now receded to 1293, or a drop of 9%, having lost almost all of the gains since the beginning of the year. We may be headed into Bear Market territory (loss of 20% from the high). Facebook has made it interesting during this past month. Anticipation can really be fun!
Ed

Trading Range Blahs!

From mid-April 2011 through October 2011, we saw the S&P 500 index decline by more than 19%. It then rebounded to reach a peak of 1419 on April 2nd, 2012. Since that time, we have seen a steady erosion of prices, demand and follow through in the market. As I am writing this, the S&P 500 stands at 1397, which is a 1.6% loss for April. The market’s day-to-day volatility makes this statistic meaningless. It’s the fundamental and technical factors gripping the market now that are more concerning. The economy is still moving forward, but at a considerably slower rate than anticipated. The rate of growth for the first quarter was expected to show a gain of 3.5% but came in at 2.2%. This is well under the fourth quarter rate in 2011. Corporate earnings have been mixed, with some big winners but many companies failing to meet earnings expectations. The good news is that consumer spending is up. The markets have been looking for help from the Federal Reserve to further stimulate the economy. It seems increasingly unlikely that the Federal Reserve will step up with any stimulus because the economy is growing, although at a slower pace. Europe’s economy is stalled, with England now in a double dip recession and Spain back in recession. On a technical basis, short term demand has expanded but long term demand is falling off. This means that a question exists about the intermediate and longer term outlook of the market’s uptrend. The increasing number of stocks selling below their 30 day moving average indicates that investor demand is now focused on fewer companies. The NYSE’s Operating Companies’ advance/decline line failed to confirm the April 2nd highs. That failure was the first divergence since March of 2009. With all of this information, it seems likely that the stock market is headed downward in the future. Although May traditionally produces the peak of the stock market, last year it happened in April. A lack of supply appears to be holding this market together. Bad news could change that in a hurry. As I stated in a previous blog, an average bull market lasts 39 months. This market will be 39 months old in June.

Looking at the Bull

Trying to determine the status of the stock market at any point in time is difficult at best. When the market continues to rise for a sustained period, we call it a “Bull” market, and when it declines for a period of time, it is considered a “Bear” market. The determining factors in most cases are the interval and rate of movement. On average most “Bull” markets last about 39 months. During a bull market, a correction of more than 10% usually occurs once. The question is whether we are still in a bull market or if it has ended, and are we now entering a new one. This is rather important because it can give us a much better idea of what to expect. The bull market that began in March of 2009 has had two corrections of more than 10% (16% and 19%). This has not happened since 1940. Two indications that the bull market had ended were noticeably absent. The April high should have been preceded by a falling advance-decline line of the NYSE Composite. It wasn’t. At that point there should also have been a persistent rise in selling pressure. Again, there wasn’t. A bear market is one defined as a drop of 20% or more from the high of the bull market. The drop from April to October of 2011 was 19.3% (close but not enough). In light of other considerations, it appears that we are 36 months into the same bull market which began in March of 2009. Because it has aged this long, events in the bull market are beginning to indicate that we are coming to the end. Two major examples are a greater selectivity of stocks being purchased, and larger stocks dominating the increase in values while small and medium stocks tend to see a deterioration in value. We are seeing both of these happening now. Looking at all of the above, it appears to me that we are coming to the end of this bull market. Ed Mallon

Inflation on the Rise?

A report released today indicated that inflation is "rising." The report seems to say that the cost of gasoline, in particular, is causing the problem. On closer examination, I wonder about the reality of the rate of inflation. At the end of last year, the annual rate of inflation was 3% for the 12 months ending in December. For the 12 months ending in January, it was 2.9%. To me, it appears that, while inflation is a potential concern, especially to the bond market, it is not out of control and will likely result in no changes to Federal Reserve policies. Still, it bears watching. Ed Mallon

FRB Action

For the past two days, the Federal Reserve Board has generated a great deal of anticipation over its next action. The Chairman of the FRB, Ben Bernanke, has indicated a willingness to be more open with the thoughts shared by the members and will give a longer-term idea of where short term interest rates will be headed. Yesterday, he gave a clear message that the FRB is planning on keeping interest rates low into 2014, and that it does not see inflation as being the problem it was in 2011. This information is important for planning on how to position fixed income investments for the future. A shift from very short term to higher paying intermediate term fixed investments is now likely, as there will be less fear of an upward shift in interest rates that would reduce the value of bonds. The result will also be likely to mean that corporations will be better able to plan capital expenditures that require financing. Both of these should benefit the economy over time. The stock market is responding favorably to this information, which will be good for corporations, business expansion and profits. Ed Mallon