Expectations

We all have certain expectations and so does the market place. As each year progresses, expectations arise about the future inflation rate, the growth of the economy, consumer spending, and other such areas of interest. Based on these expectations, investors make decisions about what investments they want, when, and how. As real results come in, the expectation is compared to the result. Generally, if the result meets or exceeds expectations the response is good. If the result falls short of the expectation, the response is not good. Last week, a report was released showing that consumer spending, a key ingredient in moving the economy, did not meet expectations and the market dropped. The market moved lower due to fear that consumers had curtailed their overall discretionary spending for everything except automobiles. This week, a report was released indicating that consumer prices were rising and exceeding expectations, moving the market up. The market rose because higher prices are apparently taking hold, thus increasing the possibility of added profits for companies. Currently, we are at the end of a quarter, with a half year behind us and a half year to go. Earnings from various companies are very important to the market at this time as analysts attempt to figure out what will happen for the balance of the year. We closed the second quarter with both stocks and bonds down for the month of June. As of this writing, stocks have staged a dramatic recovery and bonds are moving into positive territory. This is all good news, but the markets are very susceptible to wide fluctuations, and earnings reports will continue to come in between now and early August. At this time, the economy appears to be growing stronger, the Federal Reserve will reduce purchases on bonds, and the U.S. deficit for the current fiscal year, which ends on September 31, will be substantially lower than expected. This is good news for the U.S. economy and the stock market. We as investors need to remember that short term shifts in investments will occur, and we must be patient and look at the long term. To me, the long term looks extremely good.
Ed Mallon

Double Down!

The month of June was unkind to both bonds and stocks, as both lost value during the month. From the beginning of May until last week, Barclays index, which tracks investment grade bonds, was down 3.77%. Some people are referring to this as a “blood bath”, which it certainly is not.
Back in 1994, we had what has come to be known as the “bond massacre” when bond values dropped 5.3%. Bonds, like stocks, do go up and down, but bonds pay interest, which helps offset losses. The reason for owning bonds is that, over the long-term, they are more stable and can offset significant losses in stocks. The portion of the bond market that was most adversely impacted was United States government notes with maturities of 10 years or longer. These bonds were down an average of 10.8% during that same period. The long-term investor knows that a knee-jerk reaction is not the best investment move. As occurs quite often with a big selloff, the pendulum swung back, with bond interest rates falling later in the month and the value of bonds beginning to grow, although not back to where they had been at the beginning of May.
While it is unusual, stocks and bonds can rise or fall at the same time. Such was the case in June as stocks also fell. Using the S&P 500 as our measurement, the index fell from 1666 on May 21st to 1573 on June 24th, a drop of 5.6%. It recovered to 1606 by the close of the stock market on June 28th. In many respects, the second quarter of the year returned the gains of the first quarter. What precipitated this selloff of both bonds and stocks was an assessment by the Federal Reserve Board that the economy was getting stronger and would be growing significantly in 2014 and 2015. In May, I indicated that I thought the market was ready for a 10% correction but not a bear market. Some bonds have produced that correction, as have some stocks. The long-term outlook seems bright.
Ed

The Fed Makes its Mark

On Wednesday June 19th, following a regular Federal Reserve Board (Fed) meeting, Chairman Ben Bernanke made an announcement composed essentially of two parts. Mr. Bernanke said the Fed would wind down the bond-buying program, in which they have been buying $85 billion in bonds monthly, and work towards a goal of ceasing the operation by mid-2014. His justification for the change is an optimistic assessment of the current state of the economy and its direction over the next two years. The Fed expects the jobless rate, which was 7.6% in May, to fall to 6.5% to 6.9% by the end of 2014. Mr. Bernanke commented on better fundamentals, saying, “In particular, the housing sector, which has been a drag on growth since the crisis, is now obviously a support to growth.” He was referring to rising home prices increasing household wealth and thereby strengthening consumer confidence and spending. Overall, the Fed expects the economy to grow by 3.0% to 3.5% in 2014, which would be a marked improvement. The Fed also expects inflation to remain low, between 1.5% and 2%. Other members of the Fed indicated that it is unlikely the Fed will begin pushing up short-term interest rates until 2015. Better economic growth, low short-term interest rates and a housing boom all seem very positive. The problem is, many in the financial community believe the result of the Fed reducing, then eliminating the bond program will bring higher mortgage interest rates, a slowdown in housing, reduced consumer confidence and a stalling of the economy. Fear of what might happen when Mr. Bernanke steps down in January of 2014 is an additional negative. Markets don’t like uncertainty!
The bond and stock markets’ response to this change was sudden and sharp! The value of bonds and the value of stocks both dropped. As interest rates on a bond rise, the value of the bond drops. A month ago, for example, the 10-year Treasury bond had about a 1.7% interest rate. Now, the rate is 2.59%, or a drop in value of about 8%. The stock market has also taken a big hit with the S&P 500 down 5.7% since May 28th, falling from 1661 to 1566. Gold, too, has fallen. The day of Bernanke’s announcement, the value of an ounce of gold was $1,373.60 and is now $1,276.90, a drop of over 7% in a matter of days. So much for the safety of gold. For the investor, this may be a good time to take a summer respite and come back in the fall. The next few months could show substantial market volatility. If Mr. Bernanke and the Fed are correct, we should see the economy continue to pick up as we move forward in 2013. That being the case, the stock market should recover, eventually, and the bond market will settle down. For now, we will wait and see.
Ed Mallon
(written Monday, June 24, 2013)

Mixed Market

When putting together an investment portfolio, you do not want your various investments to move up or down in tandem all the time. That is why one of the basic tenets in building a portfolio is to use non-correlated assets. Two broad categories of non-correlated assets are stocks and bonds. Stocks move separately from bonds and for this reason we like to have both in a portfolio. The current environment might appear to contradict this non-correlation of stocks and bonds, since both have lost value since May 9th. In fact, this does not disprove non-correlation; it just proves that current information has pushed both stocks and bonds downward. The question, therefore, must be “Why?” Looking at the bond market, we know that as interest rates rise, the value of bonds decreases. Lately, interest rates have begun to rise, in large part due to the uncertainty of the Federal Reserve Board (FRB) policy on buying $85 billion of bonds monthly, which has kept rates low until recently. The stock market moved down, reflecting the fear that a reduction in buying by the FRB would stall the economy, just as it was beginning to pick up momentum. My belief is that the FRB decided to test the markets by seeing what would happen if a reduction in buying bonds was to begin shortly (this summer or fall). The result has likely been to make them very concerned about such a possible change. The FRB meets next Tuesday and Wednesday, and will be discussing this issue and what they need to do. As the fears of reduction of bond purchases by the FRB have grown, the currencies of Japan and Europe have risen, which, if continued, would curtail any chance of growth for them. Emerging countries are seeing the value of their currencies decreasing, as investors avoid risk in favor of liquidity, creating a negative impact on their economies. The impact of a possible change in bond purchases by the FRB has already resulted in the bond, stock and currency markets preparing for the worst. It is my belief that the FRB is well aware of their role in leading the world out of an economic recession. With what has taken place in a very short period of time, the fragile recovery is headed in the wrong direction. For three years now, the FRB has been working to create momentum in the economy. I don’t think they are going to do anything to disrupt the goal at this time. Everyone wants to know, “What’s the deal?” The FRB must come out next week and say, with a great deal of certainty, that there will be no change in our buying of $85 billion each month until early next year at the earliest, or some similar indicator of their plans! A week from today we should have a pretty good idea of what they will be doing and for how long. If not, markets will continue to be volatile.
Ed Mallon

In the Name of National Security

How far should the federal government be allowed to go in reducing freedom and privacy to provide security for our nation? Since 9/11, the federal government, in the name of national security, has not only reduced certain freedoms and collected more data, but has also authorized holding assets and individuals without their normal rights under the Constitution. This secretive use of power has been building up for some time. With the NSA document leaks, reported in the Guardian newspaper last week, the massive level of surveillance over the public was revealed. This time we were made aware of how invasive the government is willing to be to “protect our rights.” Clearly, the genie is out of the bottle, recognizing that large volumes of data can be mined easily to find specific information. The time has come to take the shroud off the NSA and make them as accountable to the public as any other government agency. When we allow our government to keep secrets from our own citizens, it does not turn out well. An open discussion and evaluation is needed to decide the boundaries for information gathering on our own citizens before we lose this hard won democracy that we all cherish.
Ed Mallon

In Memorium

(written) May 27, 2013
Each year at this time I go back in my memory to visit a friend and mentor. I joined the Cub Scouts at age 8. The Pack had 160 boys, met on Wednesday and had one adult leader (that is another story). The assistant Den leader was Michael Thomas Glynn. He took me under his wing and became the big brother I never had. He helped me become a Wolf. Then he was promoted to Den Leader and I was chosen to be the assistant. Mike moved up again and I became Den Leader. When I joined the Boy Scouts, Mike was my Patrol leader. I just kept following in Mike's footsteps. Mike had all the merit badges to become an Eagle Scout, but hard as he tried, he couldn't earn the last two required badges, swimming and life saving. He was proud of me when, with his encouragement, I became the first Eagle in Troop 416. Mike went on to graduate 66th in a class of 596 from West Point in 1965. To this day, I remember Mike's enthusiasm on Christmas Eve 1965 when he met my fiancé, Fran. He spoke about the career he hoped to have in the State Department when he completed his military service. Mike went to Vietnam on January 3, 1966. He was a Platoon Leader in Pleiku Province, Vietnam, when he was killed on May 28, 1966. He was the second member of the West Point Class of '65 to die in Vietnam. What might have been? At this time of year, we should look with appreciation and gratitude to the men and woman who serve in our military, and especially to those who have given their lives.
Ed Mallon

Indexes

As the economy has gone through its many changes, I have continued to watch certain trends. One of the trends is new jobless claims each week. The number for the week is good to know, and we’d like to see it below 350,000, but the four-week average is the important number. We want to see that drop below 350,000. Last Friday, the Labor Department announced the jobless weekly number at 335,000 and the four-week number at 336,000. This was good news.
This information is available to everyone, so it is important to have some personal indexes that are not controlled by the government or media. The BK index is used to get some sense of the impact of inflation on the economy. You will recall that back on September 23, 2010, I discussed the BK index and the alarming 27% jump in the index, while the CPI only went up 3%. Since that time, the index has gone from 1.59 to 1.65, an increase of approximately 3.8% over almost three years. This would indicate that inflation is not rearing its ugly head in the consumer marketplace. (For those of you who have forgotten, this index measures the price of a Junior Whopper with cheese at Burger King over time).
Another index that I use to determine the direction of the economy is the FMAS Index. This index has been pretty reliable at determining the direction of the economy. It is also known as a leading indicator because it tends to decrease before consumer spending as a whole goes down, and tends to rise as consumers begin to spend again. I have been using this index since I realized the income of my wife, Fran Mallon (FM), an artist, and the number of Art Sales (AS), tend to move ahead of the economy. Thus I am pleased to announce that for the first quarter of this year the FMAS Index is up 400%, indicating that the economy is about to become robust!
Another very important index is the EROORES Index (Ed’s random observation of real estate sales). While this index turns out to be hard to quantify, casual observation of my own neighborhood revealed that three houses went on the market during a three-week period, and all were under contract in less than a week. Many of my clients in Denver have noted that housing sales are going like “hot cakes”, and with the help of their observations, I have gathered that the housing market is totally robust. Yes, the economy appears to be headed in the right direction, however slowly that may be.
Ed Mallon