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.