TEETER-TOTTER TIME
Since our most recent letter that we distributed shortly after the third quarter ended, we have observed continued volatility in the equity markets and in most risk assets. This will be a much shorter letter and is intended to bring our clients up to date and to accompany our third quarter performance reports… click here to view the pdf article.
Let’s be clear. This is not a case of Chicken Little crying “the sky is falling.” Pieces of the sky have, in fact, been falling.
We at Silver Oak have been using every metaphor that we could think of since October 2008 to draw attention to the economic factors that have been affecting the investment world. We have used the Emperor’s New Clothes to illustrate the fact that it was illusory to believe that the economy was in a strong recovery and could support strong stock market performance going forward. We tried the history of the construction of the Great Wall of China to talk about the need for both political parties to agree on a viable jobs program based on infrastructure development. And we even threw in The Search for Red October with an “up periscope” metaphor for the need to safely look around at the global economic landscape to “see” if it is safe to surface and buy stocks again.
There is a very effective television ad for a credit card that asked, “What’s In Your Wallet?” We will turn that around by asking, “What’s In Your Portfolio?” Do you know how much risk you have loaded into your portfolio? You can answer that question yourself fairly simply by comparing your portfolio return for the third quarter with the broad market index, the S&P 500, and identifying how much of the portfolio has been exposed to stock market risk.
I eagerly brought in my L.A. Times and Wall Street Journal to see what the headlines were going to be on this Saturday morning. There were no headlines in the Times proclaiming the disastrous quarter we just experienced, not even in the business section. Tom Petruno, Senior Markets Analyst for the Times, penned an article entitled, “A Quarter to Forget, If Only We Could.”
We at Silver Oak know Tom pretty well. We have been fortunate to have been quoted by Tom numerous times over the years. We’ve been suggesting to Tom to write more about the need for investors to protect their portfolios and take less risk since 2008. Yet being the balanced reporter that he is, Tom continues to prefer to lay out the competing cases for either buying or selling stocks.
We have not vacillated because, unlike Tom who apparently must focus on writing impartial stories, we must focus first and foremost on protecting the wealth of real people. If that sounds a bit harsh, we are sorry but this is no time for pulling punches. We would prefer that Tom use his bully pulpit by standing up and shouting to Angelinos, THE WORLD IS A SCARY and UNCERTAIN PLACE – CONTROL THE RISK IN YOUR PORTFOLIOS!
Tom’s article contained the stock market results for the quarter, which we don’t mind quoting. The 30-stock Dow Jones industrial average lost 12.1% in the quarter and the broader S&P 500 lost 14.3%. Tom pointed out that this was the biggest decline since the fourth quarter of 2008. Even worse, the average European blue-chip stock tumbled 17.4% in the quarter. Tom also correctly mentioned that the asset many people (including us) had viewed as a haven – gold – was pummeled in the final few weeks of the quarter amid a steep decline in commodities.
But here’s the rub. Tom quoted a nationwide August survey by Russell Investments of “big money managers” that found 79% did not believe the U.S. economy was entering a recession. My guess is that these same money managers are continuing to promote buying stocks. Have you ever seen headlines from Smith Barney, Bernstein, RBC Capital, Wells Fargo Private Wealth division, or any of the other major money managers advising their clients to exit the stock market? I suspect that such an occurrence would be difficult for them to do since, on aggregate, they represent the stock market. They can’t exit the stock market; there would not be much of a stock market without them.
The good news for our clients is that Silver Oak is not a “big money manager.” We are an independent and objective money manager and as such, we have the independence to call a spade a spade. We observed many market anomalies in 2008 that lead us to conclude that the markets were dysfunctional and the global financial system was broken. We proceeded to adopt a more conservative, risk-oriented approach to asset allocation. That approach has caused us to focus on controlling risk as the key factor in designing portfolios that can withstand this “new normal” environment, as PIMCO calls it. With the expectation of continuing global geo-political financial fissures disrupting the investment world for years to come, risk-based asset allocation as a methodology is an approach that we will continue to implement and refine.
Last month, I stood up at a meeting of professionals called Provisors and offered to do what I call a stress test of their portfolios – an analysis of how much risk was in their portfolios. I don’t know if no one believed the market could go down further, but no one asked me to look at his or her portfolio. I plan on revisiting that offer this month because I still think we could go down further and that our economic malaise could last many more years. We will gladly make the same offer to any of your friends who would like to better understand their portfolio risk level.
As we look around the world, we at Silver Oak are focusing on a number of factors that lead us to our conclusions. At the top of our list are the following items:
- Equity prices over a reasonable period of time should be driven by the fundamental health of corporate America. In other words, if companies increase their profitability, their earnings will grow. The price/earnings ratio should then increase, driving the prices of stock higher. It is quite apparent today that such fundamental factors are not driving stock performance as we have witnessed the market declining even as companies meet their earnings expectations.
- Technical factors and global macro-economic events have been in the driver’s seat with respect to equity prices. Wild market volatility, up and down, occurs every time a European central banker gets quoted about whether Greece will default. And, we are greatly concerned about what may follow after an imminent Greek default.
- The problems emanating from the Great Recession of 2008 are a result of what is being called a balance sheet recession in contrast to routine business cycle recessions. Until there has been sufficient worldwide deleveraging (and this will not be complete until we have experienced much more financial pain, we will have a difficult time pulling out of the tailspin we have been experiencing.
- Our own domestic political climate has been contributing to the climate of apprehension being felt by our business community. There is too much uncertainty in issues relating to taxes and regulations, to name just two, for corporate America to be willing to take the risks associated with hiring more people and building more plants. So, they have been content to sit on the cash in their coffers. We would love to be wrong, but we don’t see this political climate becoming more conducive to business growth in the near future.
- A number of key commodities have been driven down to bear market territory. This is an indication of a worldwide slowdown in growth. The Thomson Reuters/Jefferies CRB index of 19 major commodities tumbled almost 12% in the third quarter according to Petruno’s article. Copper is another leading indicator of such a slowdown. Often referred to as Dr. Copper for its ability to diagnose the health of the world economy, its current value is indicating a prognosis that puts economic growth on life support.
Conclusion
I was a Boy Scout. In fact, I am an Eagle Scout. What does that have to do with concluding this letter, you might ask. Well, I have this “thing” about helping little old ladies across the street – an image from some Norman Rockwell painting I suspect.
The point is that our role is to first protect our client’s wealth and secondly to help them grow their portfolios. We help our clients get “across the street” – a phrase that we can use to mean successfully moving from a working lifestyle to a retired lifestyle. To cross that street requires having built an amount of wealth that translates into financial security. We want to make sure that we do everything in our power to keep people on that side of the street, comfortable with the financial security they have achieved and able to sleep well at night with the knowledge that we at Silver Oak are focused on their goals.
For clients who are not yet retired, we want to create a financial plan that continually moves them forward, toward their goal. We see too many prospective clients who have been taking steps backward because their portfolios have been steadily losing money. This is completely unnecessary.
If you are still in an asset allocation and an equities-oriented investment strategy that has not been working during the last three years, and possibly for the last ten years, you might ask yourself “why?” We know that changing investment strategies is difficult. At some point, however, when you realize that you are not getting to the other side of the street, you had better start watching out for the oncoming traffic!
Since we don’t see any business headlines that are screaming this message, we decided to create this early fourth quarter newsletter to create the headline ourselves. “OUT OF STOCKS” does not literally signify that we will never own a stock. It does, however, mean that we do not currently own stocks because the uncertainty around the world has elevated the risk level to the degree that we don’t think an investor can be properly compensated for the risks.
We want to encourage investors, and that includes nonprofit entities and private foundations, to reduce the level of risk in their portfolios. There are still strategies and methodologies to make money in this environment, but it is not possible by sticking to an outdated methodology of asset allocation that has worked in more stable times.
To our current clients, we again thank you for the confidence that you have expressed in Silver Oak and in our investment approach. It makes that Boy Scout in us leap for joy when we can help you stay on the good side of the street.
Markets are again exhibiting extreme volatility on the downside. With today’s bounce, responding to hopeful news coming out of Europe, we thought we would share some observations with you. We will use a question and answer format to try to focus on the questions that may be the most interesting and important to you.
1. Is the (investment) world coming to an end?
This is a natural question when we see the stock market decline as it did last week. As you know, if you have read our other communications throughout this year, we have virtually no U.S. equities in our portfolio models at present – haven’t since late May. We do have allocations to other asset classes that have been negatively affected by various economic factors, and we will discuss a number of those asset classes separately.
While Silver Oak has been very defensive and conservative in our asset allocations, even the most conservative holdings have given back some of the gains we experienced earlier in the year.
However, even with those pullbacks, we are pleased to say that each of our portfolio models is in positive territory for the year. While not every client portfolio is exactly the same in composition and has performed exactly the same, we can say that as we look at the S&P 500 results (as of Friday September 23rd they were negative by over 10%), having positive portfolios means that we are substantially ahead of that index.
2. Do our portfolios still own gold and silver?
We certainly have looked upon these precious metals as tools to help us protect portfolios against a number of dire economic scenarios, and especially as a “no confidence” vote against the dollar. Silver has exhibited quite a bit more volatility than has gold, which has been a bit troubling. We therefore bought and sold silver twice so far this year. The following chart reflects where we bought and sold the silver ETF during 2011 for many portfolios, depending on the specific model and allocation to the higher risk bucket.
We continue to hold our allocation to Gold. There are many factors that will affect the price of gold. Aside from jewelry demand and large purchases by central banks, gold has tended to rise this year due to a number of crises including the Greek debt crisis and the political stalemate in Washington, D.C. over raising the debt limit.
This week, we are experiencing a countervailing factor that has caused the metal to lose some of its luster, specifically the strength of the U.S. Dollar versus the perception of the Euro. Should the situation in Europe stabilize soon, we expect the dollar to continue to weaken, having a positive influence on the price of gold. Should stabilization not be in the cards for Europe in the short term, thus keeping the dollar strong, we will be watching gold closely in its relationship to the dollar and in absolute terms to see how it performs.
3. Why do we see some of the bond investments declining?
Our portfolios contain many different types of bond investments for diversification purposes. Some of our bond mutual funds are internationally diversified and are denominated in foreign currencies. The recent strength of our dollar also has a negative impact on these bond funds. While we continue to like international and emerging market bonds as part of our long-term strategy, we are in the process of trimming some of those positions due to near-term weakness.
Our investment philosophy places most of our bond holdings in the lower risk bucket. Certain bond funds with more volatility due to wider currency swings are placed in our higher risk bucket. Our goal is to maintain a target rate of return of 5-6% in the lower risk bucket. While we have generally been on track with meeting this target, periods in which significant actions are taken by both our Federal Reserve and by central banks in foreign markets certainly make this goal more difficult. We will continue to monitor the global macro economic factors that impact bond prices and plan to adjust portfolio holdings as needed to maintain our return target.
4. What is going to happen next?
That is certainly the $64,000 question. If our crystal ball was working, answering this question would be a lot easier. All we can do is to continue to monitor the economic fundamentals and events as they unfold, and translate economic policy into portfolio holdings which offer investment opportunities at a reasonable level of risk.
As our Fed Chairman noted last week in his prepared remarks, there are “significant downside risks” to the economy of the U.S. At the same time, some say that a recession in Europe is likely and that the demise of the Euro cannot be ruled out. There are too many structural issues at play for us to feel optimistic relating to many higher risk assets. However, at some point, with faith in the continuing recovery of our economy and in our free-market system, we will eventually conclude that the prices of equities have reached fair valuations and that expected returns justify their inherent volatility. At such time, we will add equities again to our higher risk bucket.
As always, we welcome your questions, emails, and telephone calls. This is a very unsettling period, and we are here to answer any questions you might have regarding our “take” on the current and future investment climate.
Question: What do the Great Wall of China and our House of Representatives Have In Common?
But first, let’s talk about the President’s speech to both houses of Congress last week. We will start by forgiving him for interrupting the opening football game of the season. At least he didn’t interrupt a debate by the Republican candidates for President. Of course, to be perfectly honest, it is quite unprecedented for the Speaker of the House to refuse a President’s request to address both houses of Congress.
Those may seem like small issues. They are, just as the tip of a small iceberg was enough to sink the Titanic. Perhaps somewhat like the rather small hordes of Genghis Khan. Old Genghis was a small thorn in the side of a number of Chinese Emperors. History tells us that the Chinese called a joint session of their feudal lords and decided on a major public works project to put people to work and save the kingdom by building the Great Wall of China.
Even if building a Great Wall here would put millions of Americans to work, it is quite apparent that our leaders would find ideological reasons to dismantle the project. It may be that we need that Great Wall. Not to keep out Genghis’ thundering hordes, of course, but as a symbol of action that could lead to at least a partial solution of our protracted unemployment challenge. Estimates are that the proposals might lower the unemployment rate by 1%.
Let’s be clear: there are no easy cures for the ailments that plague our economy. At the same time, let us be completely candid and recognize that we are facing systemic modifications to our way of doing business. By systemic we mean that many of the pillars of our political system and the structure of our economy are being disassembled and retooled based on a structurally different architectural rendering.
This is significant. Yet we are not hearing this kind of candor from anyone in positions of power. Think about the fact that it is quite unusual for the President of the United States to ask to address a joint session of Congress. The Constitution sanctions the joint session to permit the President to discuss the State of the Union, and also during times of crisis. With the fabric of our economic system fraying and facing entrenched unemployment which will threaten the well-being of the middle class, we should be inferring from the President’s appearance on Capitol Hill this past week that we are indeed facing a crisis.
Investment techniques during periods of crises must change to reflect the nature of the risks we face. At Silver Oak, we are convinced that the critical element of investing in today’s world is controlling risk. During normal times, designing portfolios with numerous asset classes that move in somewhat opposite directions to market stimuli and that create textbook diversification is smart. However, using those techniques when it is obvious that they are not keeping portfolios safe in this new paradigm is not smart.
Risk-controlled investing is a systematic methodology to investing during periods when black swans and other unusual but potentially catastrophic financial crises occur with more regularity than could ever be predicted. Silver Oak has been a leading proponent of this technique since 2008 and with great success.
We are eager to share our approach with anyone who has concerns about their own portfolio management. There is an excellent article written by a prominent money manager on creating portfolios by focusing on controlling risk that we would like to share with you. Please contact us to request a copy of this article.
In an interview on Bloomberg TV last week, Harvard University Professor William Sahlman made a statement that struck us as profound.
Answering Tom Keene’s question as to whether tax increases should have been part of the so-called “Grand Bargain” which capped the debt negotiations on Capitol Hill, Professor Sahlman noted that we have just been levied with the largest tax increase in U.S. history: he called it the “Uncertainty Tax.”
Fear and uncertainty are a pervasive undercurrent now, and markets (investors) hate uncertainty. No wonder markets are gyrating all over the world. Down 600 points + on Monday; up 430 points on Tuesday, down another 500+ on Wednesday and up 400+ on Thursday … this feels like the “Tornado” at Magic Mountain, without safety belts.
The recent downgrade of our national credit rating by S&P served as a trigger for the recent global markets volatility that we experienced last week. However, it is already largely being ignored as the world continues to grapple with the European debt crises and mixed signals from our own economic data.
It is clear that raising taxes during a weak economic recovery would cause a train wreck, potentially pushing our economy back into recession. Most of our politicians are trying to steer clear of that course. Yet the inability of our government to rise above ideological extremism has frozen our political system and rendered policy-making bankrupt. Meanwhile, the Eurozone is experimenting with economic policy to avoid potential national bankruptcies while inventing responses to overcome the economic slowdown which is plaguing the contintent.
These issues represent only the more obvious examples of uncertainty and instability. And so, as with other imposed taxes, this de facto “uncertainty tax” continues to suck value and peace of mind from our global wellness. Although our politicians will be loathe to acknowledge this climate they have helped create as having fostered a new tax, when their actions negatively impact our wealth and leave us without recourse, we must recognize that our collective pockets are being picked once again.
In 2008, we at Silver Oak recognized and wrote about the fact that the global financial marketplace had suffered serious structural damage. We then turned our macro-economic research and investment focus toward lessening the uncertainty impacting our portfolios by modifying our investment selection criteria. The success of our decision and methodology has been consistently reflected in our investment results. By choosing to build portfolios on a strong foundation of diverse income producing assets, we have created stability and steady growth in a period marked by extreme volatility.
We expect the US market to continue its almost daily wild gyrations during this period. Our market’s blue chip companies are now awash in liquidity, with little intention to invest in growth; investor and business confidence is sinking. High unemployment will persist for the foreseeable future, causing consumers to further cut back the discretionary spending that is needed to resume a healthy level of corporate growth. By and large, we do not expect our portfolio gains to arise from U.S. stocks.
Our skepticism and cautious, outside the box approach has served our clients well. We have striven hard to reduce the tax toll levied by uncertainty; our strategies have worked well and continue to do so. We are happy to share details of our successful approach. Please feel free to call us to learn more.
As always, we welcome your questions and comments.
THE WORLD ECONOMY & THE CASE OF THE DOG THAT DID NOT BARK
I have always liked detective stories. Judging by the popularity of the character and series “Columbo” starring the late Peter Falk, I’m certainly not in the minority.
Sherlock Holmes was one of my favorite sleuths. I wonder how he would have approached solving the enigmas that currently perplex our global financial leaders.
One of the most memorable of the Sherlock Holmes short stories was “Silver Blaze”, a tale about the disappearance of a race horse. The most important clue in solving the mystery came not from the obvious clues, including the events leading up to the crime, but from a dog that did not bark… Click here to view the pdf article.
Welcome to Silver Oak Wealth Advisor, LLC’s quarterly letter covering the first quarter of 2011. This quarter, we will address a couple of themes that will impact our portfolio allocation decisions over the rest of 2011 and, perhaps, over the next few years.
1. Global and emerging market investments should receive higher portfolio allocations.
2. The U.S. equity markets, if not currently overvalued, could produce significantly lower returns than the long-term averages would suggest.
Our goal is to share with you pertinent financial information and timely economic data that shapes the investment decisions we make on your behalf. While there is a science involved in portfolio design, a significant amount of artistry is also involved. As a sculptor works with clay to create a pot, we utilize the type of financial data we will share with you in this letter to mold our asset allocation decisions… Click here to view the pdf article.
Is the Economic Cup Half Empty or Half Full?
Part 1: Perception = Reality
PERCEPTION IS REALITY
Albert Einstein once famously said, “Reality is merely an illusion, albeit a very persistent one.”
Wikipedia, on the other hand, defines reality to the contrary: “Reality is the state of things as they actually exist, rather than as they may appear or may be thought to be.”
As we monitor the domestic economic data and stock market activity, we find ourselves appreciating the concept that perception is reality. Depending on your perspective, we are either in very good shape and getting better or on the verge of having the other shoe drop.
If you are unemployed, your perception of reality is quite bleak. If your house was foreclosed upon, or even if it merely dropped significantly in value, your perception of this economic recovery probably is severely jaded. If you were about to retire and your portfolio dropped in 2008 by 40-50%, you had better love what you do because you will be doing it for a lot longer.
When we look at the stock prices of various companies selling luxury goods, it looks and feels like a bull market. However companies selling their products to people who are struggling economically are looking less robust.
Let’s consider the chart of two companies to help paint a picture.
The first company is Coach Incorporated (COH). Coach sells high-end luxury leather products and has stores in the toniest of malls. For our foil, we will choose Walmart (WMT). They are not in luxury malls. Once famous for creating a profitable brand known for cutting prices to the bone, their growth has faltered and their customers do not appear to be spending. Here is the two-year (2009-2010) chart, with the dark line representing Coach and the yellow line showing the stock price of Walmart.
We wonder if the reported “increase in consumer spending” (and sentiment) isn’t mostly weighted on the side of the higher-end consumers who a relatively small percentage of the consumer base which has been the engine of our past economic growth.
ECONOMIC PROGRESS, NOT PERFECTION
We believe there is sufficient economic data to justify cautious optimism. As a nation, we clearly avoided falling into the precipice of a second, perhaps Greater, Depression. The feared double-dip recession has not materialized. The dreaded deflation that Japan experienced, causing what is referred to as the Lost Decade, has not materialized here, either.
Much of the credit goes to Federal Reserve Chairman Bernanke who both created and steered monetary policy. While still a politically sensitive subject, we think some of the credit also has to go to government policies that, among other outcomes, created a powerful perception of a country on the road to recovery. Perception can be reality.
Our economy has gone through a three year regimen of extreme physical therapy, but is still not yet ready to run a marathon. Many unanswerable questions remain. Some believe that a jobless recovery is not a recovery at all. Others are convinced that the recent QE2 government stimulus and an ever-increasing burden of debt are leading us into another crisis. As the economy finally shows signs of standing on its own two feet, there is a fear that the Federal Reserve will withdraw the stimuli and interest rates will rise. After all, there is no more room for rates to fall further.
Imagine refinancing your home at an interest rate 2-3% higher than it is now. Rising rates will mean that the government will pay out a significantly higher portion of our economic output just to pay the interest on our national debt. Corporations, currently enjoying cheap borrowing rates to spark their growth, will find higher interest rates to be an impediment. They could perhaps delay even further the hiring back of the currently unemployed or recent college graduates, and creating worse structural unemployment in the process.
We have clearly made some progress. However, there continues to be major global and domestic challenges to sustaining this recovery and moving to expansion.
Part 2: Our 2010 Year in Review
SILVER OAK’S 2010 YEAR IN REVIEW
Beginning with our successful avoidance of the extreme declines of 2008, Silver Oak’s investment approach has been twofold. First, we want to create solid, sustainable portfolio growth based on each client’s required rate of return. Secondly, yet certainly as important, we want to achieve that rate of return at the lowest possible level of risk.
We define the required rate of return as the combination of income and appreciation that is shown to make each client’s financial plan successful. It is a growth rate that we believe is realistic based on reasonable expected returns of the various investment vehicles from which we can choose.
Thanks to a spectacular 4th quarter, which was largely attributable to Ben Bernanke announcing a new round of “quantitative easing” and to the renewed Bush tax cuts, the stock market as measured by the S&P 500 rose about 15%. Yet for those who do not recall, the picture for the full year looked like a roller coaster ride. Through August, the S&P 500 had experienced a loss of 5% year-to-date. Meanwhile, Silver Oak’s typical portfolio advanced in a very different pattern.
The following graph reflects the volatility of the stock market during 2010 as measured by both the S&P 500 and Dow Jones Industrial Average. The yellow line is a bond index and includes components that formed part of Silver Oak portfolios. The lighter blue line is representative of many of our portfolios which contained a high allocation to fixed income as well as a lesser allocation to our “higher risk bucket.”
2010 Index Returns: Barclays Capital U.S. Aggregate Index: 6.55%; DJIA: 14.06%; S&P 500: 15.07%
It is clear that while the stock market (dark blue and red lines) ended higher than the light blue line (Silver Oak portfolio), it did so with terrific volatility, which we have observed is quite unsettling for most clients. It is our belief that building portfolios intentionally with a steady and gently upward sloping growth line (our light blue line) is preferable for most investors.
Part 3: The Year Ahead
SILVER OAK’S INVESTMENT PHILOSOPHY & OUTLOOK FOR 2011
We’ll now take this opportunity to review our investment approach and outlook at Silver Oak Wealth Advisors for 2011.
In these challenging economic times, we feel that the ability to make tactical changes to our portfolios is an invaluable component of delivering returns with less volatility. We always utilize the most advanced scientific, analytical tools and research available. We do not try to predict the stock market, and we do not consider our approach to be market timing; no one has shown that they can do that successfully.
What we can do to a significant extent is to estimate the risk that our clients are assuming and provide our guidance as to whether they are being fairly compensated for taking that amount of risk. By noting the relative likelihood of both positive and negative impactful macro-economic events, tactical portfolio decisions provide us with a tool to recalibrate the portfolio risk levels while identifying asset classes that are likely to help reach each client’s targeted or required rate of return.
As we contemplate 2011 and scrutinize the data, we see a different picture than we saw a year ago. The implications and potential effects on our existing client portfolios have caused us to make some modifications as we have entered this new year.
First, fixed income is unlikely to produce the substantial gains we experienced over the past two years. Various bond holdings and bond funds experienced double-digit returns annually over that period. This was possible due to a combination of factors including declining interest rates and a reduction in the perceived riskiness of the market in many individual bond categories; plus the perceived riskiness of the stock market.
Rates are now more likely to rise than decline, although we believe the government will continue to push for low short-term rates for an extended period of time. Longer-term rates are a function of various market forces that are out of the government’s control, including inflation. Therefore, we have sold a number of appreciated bonds and bond funds and have repositioned that money.
Due to our concern about the relative weakness of the U.S. dollar, we are continuing to hold and add new investments that will help maintain purchasing power.
The investment outlook for equities is obscured by continuing mixed messages. Because the economy has shown signs of improving, there is certainly cause for optimism that corporate earnings can continue to improve. As earnings improve, and as investors feel more optimistic, there is room for stock prices to also rise. However, we are aware that by some stock market measures the U.S. stock market is overvalued and vulnerable to a correction. This is NOT the time for a “Mission Accomplished” banner to be displayed over the U.S. economy.
There are any number of known risk factors around the country and globe that might derail this recovery and precipitate a market correction. Housing, unemployment, rising commodity prices, rising interest rates, an emerging market hiccup that may be caused by China slowing its economy, and sovereign debt issues in Europe, to name just a few, are all risks that would negatively impact stock markets globally. Again, these are known risks. In this unstable world, we continue to also be concerned about unknown risks.
We are currently witnessing both known and unknown risks case leading to an Egyptian regime change. The Dow Jones Industrial Index tumbled 166 points on the news in one day. As the regime change did occur peacefully, the market has resumed its steady climb. However, Egypt is not ready to raise its own version of George W. Bush’s “Mission Accomplished” banner quite yet, as more uncertainties and internal conflicts emerge. And the many other Arab countries caught in this contagion are raising new concerns. While it is impossible to ponder all the potential risks, we believe it is prudent to incorporate a certain level of sensitivity to presently unknown possibilities into our portfolio design.
When we look at various indicia of equity valuations we again see that some indicators suggest valuations are high and others suggest valuations are reasonable. After factoring in these conflicting views, we do believe that the level of risk in the U.S. equity markets is lower than in the past two years due to the present growth in our economy. Since we had previously minimized equity exposure, we are now recommending a slight increase in higher risk assets for most clients. We think that selectively adding about 10% more to our higher risk bucket will provide the potential for additional portfolio returns this year.
We are adding equity exposure in a couple of areas that will provide a good dividend or income component to our portfolios. Our objective is to augment the cash flow previously generated by our fixed income investments, which requires taking on greater risk to duplicate. To enhance our diversification, for example, we recently added an international energy-related holding with an almost 9% dividend. We expect that this addition will contribute both cash flow and a potential for good appreciation.
In many respects, 2011 represents to us the Chinese character for “dangerous opportunity.” We will not be taking these “better times” at face value or for granted, but, as always, remaining ever-vigilant over the safekeeping of our clients’ financial well being.
As always, we welcome your questions and comments.
Sincerely,
Joel H. Framson, CPA/PFS, CFP® Eric Bruck, CFP®
President Principal
If you’re shopping for life insurance, you’ll find myriad policies with innumerable options and riders. But individuals often face a choice between two common types of life insurance: whole life or term. While whole life provides permanent coverage and some cash value, it’s normally much more expensive than a term policy that merely promises a death benefit if you die within a specified length of time. After years of steadily declining, the premiums for some term insurance policies have recently started to creep up. That could lead you to rethink your options.
Consider these differences between the two types of policies.
Whole life insurance. This is the traditional form of permanent life insurance. (Variations include “universal” life insurance and other cash-value policies.) The annual premiums are generally fixed when you buy the policy, which remains in effect for as long as you live if you continue to pay the premiums. In addition to providing a death benefit, the policy builds up a cash value on a tax-free basis. Typically, you’re able to borrow against that value, or take the cash with you if you surrender the policy. If you decide to surrender the policy, you will receive the accumulated cash value less any surrender charges or fees. But the premiums for whole life insurance are sharply higher than those of a term policy, particularly when you’re younger and term insurance is relatively cheap.
Term life insurance. As the name implies, you can buy term insurance covering a specified term, usually 10 years or longer. You could tailor the length of a policy to the amount of time you project that you will need coverage, perhaps choosing to have it expire at your expected retirement date, when replacing your income becomes less of an issue. Most term policies let you continue coverage at a higher rate. One main reason why term premiums are lower than those for whole life policies with the same death benefit is that term insurance doesn’t have to divert part of what you pay to fund a cash build-up.
The bottom line. The standard financial advice on life insurance has been to buy a term policy and invest the difference between that cost and what you would pay for a whole life policy. Of course, every situation is different. For instance, with the cost of term insurance rising, you may prefer the peace of mind of having permanent insurance. But your choice doesn’t have to be either/or; you could combine both kinds of insurance as part of an overall financial plan.
Major life events such as the birth of a child or grandchild, the start of a new business venture, or a change in your personal health are important times to review your life insurance coverage. We are happy to help you evaluate the right mix of insurance for your unique situation. Please feel free to give us a call.
If you’ve seen one of the new $100 bills, it probably looked like a piece of play money. Ironically, that’s because counterfeiters have gotten so good at faking our real currency. The old bills were tastefully understated, but easy for any dictator, drug dealer, or common crook to duplicate with a scanner and high-end printer. Right now, there’s probably $70 million in fake U.S. legal tender out there, and 75% of it has Benjamin Franklin’s face on it.
The new money clamps down on counterfeiting by incorporating high-tech features that no commercial printer can duplicate. Older security features are still there, but now there’s also a blue ribbon running across the face of the bill that contains three-dimensional images of the Liberty Bell and the number “100.” Tilt it and the images move, thanks to about 650,000 tiny lenses imbedded in the paper.
It’s a pretty colorful design, with copper accents here and there to contrast with the familiar green ink. Those accents hide another trick—a second Liberty Bell in the little copper inkwell that turns green when you move the bill.
All of these new features may take a little getting used to, but they’re ultimately for our own good. Every counterfeit bill out there devalues real U.S. currency, and this is one form of inflation we can avoid.