The Land of Opportunity?

By:  Douglas Schwartz

A few weeks ago, I had the privilege of hearing the co-founder of Home Depot, Bernie Marcus, speak.  There was one thing that Mr. Marcus said that I have been unable to get out of my head.  He said that if he were trying to create Home Depot today, he would simply not be able to do so.  He went on to add that in the 1970's, Washington was your friend.  They used to help and encourage free markets, business and entrepreneurship. Today, making money and becoming wealthy is demonized.  Washington is increasingly becoming your foe.

All of the outrageous legislation and regulations are hindering the ability for Americans to start and grow businesses, which obviously has a negative impact on job creation.  For example, let's talk about the Dodd-Frank Act which greatly increases regulation in the financial services industry.  It was passed in July of 2010 yet bureaucrats are still adding regulations to that bill to this day.  As of April 1 of this year, only 52% of the rules mandated by the legislation were completed. Yes, you read that correctly.  All this red tape is making it more difficult to start a business in the so called land of opportunity than other countries. For example, it takes six months to start a bank in England.  It takes three years to start a bank here in America.  It is easier for someone to come out of poverty in China (Jack Ma) and create a thriving business, than it is to here in the USA.   What's wrong with that picture?  I can think of at least one thing.

The problem stems from our citizens, most of us are simply not informed.  As a country, most people vote for the party their parents align with, for selfish reasons, or maybe even for whoever has the best one-liners.  This is another subject Mr. Marcus is outspoken on.  He says it's time for voters to get their emotions under control and look at the facts.  Frankly, most people care about themselves more than their country.  But in their defense, it is hard for people to truly understand the bigger picture.  In terms of economic policy and global economics, just last month, the International Monetary Fund basically admitted that they are out of ideas on how to get the global growth engine running.  More specifically, IMF Chief Economist Olivier Blanchard was quoted in a WSJ article earlier this month saying, "There are two forces at work weighing down prospects: the legacy of high debt and falling growth potential in the future."  All this big government fiscal policy is not working. We have had an accommodative monetary policy (near zero interest rates and quantitative easing) for far too long that has masked the true problems and allowed crushing fiscal policy to take root.

We simply cannot afford to stay on this current trajectory.  Our national debt is out of control.  Mr. Marcus has stated that if we stay on this path of government spending, we'll be in no better shape than Greece, Spain and France, but with no one to bail us out.  We will not see all the consequences of our current government's actions for decades to come.   It is easy for politicians to make promises that feel good, or for them to borrow money now and spend the borrowed dime to push their agenda.  But make no mistake.  We will pay for these crimes one day.  Our leaders are stealing from the next generation.  $17,898,691,021,355.14 and counting in national debt is a big problem.  This number doesn't even come close to including the government's unfunded obligations to Social Security and Medicare.

We have a very important election coming up. Before you go to the polls on November 4th, take the time to educate yourself on the candidates and how each of them stands on important issues.  It is time that we the people take a stand and let our politicians know that this out of control spending and blame game has got to stop.  I want to live in a country where our government encourages entrepreneurs like Bernie Marcus, not hinders them.

A Map Would Be Helpful - Part 2

By Charles Webb

For those who have been paying attention to the stock market the last few weeks, there’s little doubt that it’s been a little nerve racking.  Our clients will have or soon get our latest market commentary in their quarterly reports (see previous post).   In that commentary, we’ve addressed some of the reasons that we feel the market has sold off this month.  However, since then, we’ve seen even more volatility and a further selloff in the global stock market.  We wanted to send out this brief note to address the last few days’ activity.

As of this writing, stocks have had more days of triple digit declines, including an intraday move of -350 points on the Dow Industrial Average.  This has essentially put all the indices in negative territory year-to-date.  While the international concerns mentioned in our commentary are still the primary drivers, other news seems to have amplified this negative sentiment, the Ebola scare being the primary headline. 

Experience tells us that this piling on effect is fairly common.  When stocks top out, such as what we saw this summer, investors get nervous and begin looking for reasons to sell.  Initially, you’ll see the various parts of the market diverge from each other as investors naturally pull away from the more richly valued sectors.  We saw this trading pattern in September as the small and midcap sectors underperformed large caps. 

News concerning fundamental factors such as GDP and earnings drive most of this initial selling, but from there things tend to get irrational.  Once again, the Ebola news would fall into this category.  This is what you’d call “headline risk”.  There’s no reasonable explanation at this point to link stock market performance to something like a few people in the U.S. contracting a virus.  What it does, though, is create a catalyst for those looking for a reason to sell.  The trading jargon for this is “capitulation” and the financial news loves to report on it.

Whenever stocks reach historic highs, it’s necessary to have a periodic retreat to consolidate those gains.  Investors are never comfortable when things go straight up.  They always expect there to be a selloff.  Once that occurs, the feeling is that it’s now behind us and it’s safe to get back in.  You’ll hear a lot of talk of “10% corrections” and technical terms such as “200 day moving averages” being thrown around.  This is all just an effort to figure out when the sellers are done.

We never felt that 2014 was going to be a particularly good year, but we do believe it will finish positive for the year.  The good news is that bonds continue to rally.  For those who like to frequently look at their account balances, that will help. 

A Map Would Be Helpful

By Charles Webb

The title of this quarter’s commentary is derived from what seems like a complete lack of direction in both the stock and bond markets.  There certainly has been no shortage of news for the financial markets to respond to, but much of it has been conflicting and of questionable importance.  Weeding through the headlines of the last quarter, the larger drivers of the U.S. market performance have been shifting Fed policies, U.S. dollar valuation and foreign growth trends.   

After years of unprecedented market intervention, the Federal Reserve appears to be ready to end its bond buying program, known as quantitative easing, and eventually raise interest rates.  We’ve just started to see the technical details of how they plan on accomplishing this, but there’s still little consensus among board members of when these policy changes should take place.  The primary task at hand is to raise short-term rates from essentially zero to a preferred 2% without adversely impacting the economy.

The Fed has announced that it will end its six year experiment in long-term rate manipulation this month.  Through QE 1-3 and Operation Twist, the Fed has successfully propped up asset values, such as the housing market, by buying Treasury and mortgage-backed bonds in the open market.  The Fed now holds roughly four and a half trillion dollars of these bonds in its portfolio.  We’ve seen relatively little volatility over the last number of years and that has been largely attributed to the Fed’s market interventions. Now the principal question is how the markets will respond to the various economic uncertainties in the world without the Fed’s safety net. 

The answer to that question, we may need to look no further than the last few weeks of market volatility.  The past two weeks in particular have seen a reemergence of back to back days of the Dow Jones Industrial Average whipsawing hundreds of points in either direction.  Driving these swings are economic concerns abroad.  While slow growth in Europe is nothing new, what is new is the absence of a response from our central bank – the Fed.

The European Central Bank cut interest rates in June and September, when it also announced a bond-purchase program. These measures are designed to combat anemic growth and low inflation in their economies. Meanwhile, the Bank of Japan, too, is considering whether to enhance its bond-buying program to raise consumer prices and boost growth.

These moves and others have led to a reduction in the value of the foreign currencies relative to the U.S. dollar.  The stronger dollar in turn has put pressure on corporate earnings as our exports become less price competitive.  In previous years, these moves would have been offset by the monetary expansion that comes with quantitative easing.  Absent that, the markets are unsure as to where the dollar will stabilize and what the ultimate impact on corporate earnings will be.

As of now, the recent selloff has erased this year’s modest gains and actually pushed most indices into the red.  Large cap stocks have fared the best from a total return standpoint at near or just above breakeven.  The small cap sector, on the other hand, performed the worst, losing around 7% thus far.

The bright spot has been in the bond market.  The benchmark 10 year Treasury bond has rallied considerably since the spring.  We’ve seen the yield drop from as high as 3% at the end of last year to its current level of 2.2%.  While this has been good for bond prices, it hasn’t been good for those seeking income. 

We view all of this as temporary, as the markets attempt to find the right trading levels in a world without the Federal Reserve market interventions.  We’ve been stating since last year that we felt this was going to be a mediocre year for stocks.  For most of the year that has been true.  We still hold out hope that this recent selloff will be temporary and that we’ll see values pick back up by the end of the fourth quarter. 

Income is still king in our book.  Our total return focus has taken our portfolios into more diverse areas of the market.  These include the addition of convertible bonds, expanded use of Master Limited Partnerships (MLPs) and preferred stocks. 

Generating cash flow continues to be a challenge for investors and we look forward to higher interest rates in the near future.  Investors need a break from the Fed’s easy money policies.  We’ve been concerned for years about the credit risk average investors have to expose themselves to in order to meet their income needs.  Although higher rates typically put pressure on the stock market, we feel this is necessary in the long run to achieve a more balanced and risk appropriate investment strategy.