Are Happy Days Here Again?

The stock market is a leading indicator.  It gives the collective opinion of future economic growth on a global scale.  Now that it’s revisiting past highs, it’s presumably predicting a sound global economy with solid growth prospects, or is it?

The best reason for the stock market to rise is in anticipation of growing GDP:  For example, Apple is selling more gizmos and its revenues and profits are growing, or Exxon is producing more fuel for emerging market countries that have an expanding middle class.  Two factors that influence GDP growth are fiscal policy (Congress) and monetary policy (the Federal Reserve and global central banks). Washington is dysfunctional and it will be forever.  That doesn’t mean that we’re doomed to the economic doldrums from now on.  Dysfunction is a relative term.  If Congress were slightly less dysfunctional, it could get out of its own way, which would benefit the economy.  For example, small businesses are the primary driver of job creation in the United States.  Both companies noted above began in a garage with two people that had good ideas and hired people (creating jobs) to implement them.  Now they’re the biggest companies by market capitalization in the world, employing hundreds of thousands of people. Small business owners and the jobs they create are the main casualties of rising tax rates, which presently appears to be the primary goal of Congress in the name of “income equality”.

The Federal Reserve, the Bank of Japan, the European Central Bank and the Bank of England are all printing money.  That money is sitting on their balance sheets.  It’s not being lent out.  If it were being circulated through the economy via lending we would see inflation.  When banks are eager to lend we will see a lot of inflation.

Investors make decisions to allocate their life savings based on what they expect Congress and the Central Banks are going to do.  They have a bad taste in their mouth from the credit crisis in 2008.  Many are not aware of how much risk they are really taking in their portfolio.  Some are chasing stock market returns hoping to recoup what they lost in the Great Recession while others are piled into bonds thinking that they are being safe.

Cash has a negative real return due to inflation but it has to be a part of a portfolio to meet short-term goals and needs.  When interest rates go up cash will benefit but it will still be a drag on performance.

Bond prices go down when interest rates go up.  With interest rates at 0% it is safe to predict which direction they will eventually go. We are in the foothills of a rising interest rate environment.  Interest rates aren’t going up until the economy is really growing and banks are lending money.  Inflation also negatively impacts bond returns.  Nonetheless, they are a key component of managing risk.  We’re using solid bond managers with a global perspective.  In the immortal words of Johnny Cash, our bonds “are everywhere, man”.

Stocks are going to do better than bonds and cash, especially if the trend of an expanding middle class in emerging market countries continues.  The stock market has done well the past few years but investors don’t really see it that way, especially if they sold stocks in 2008 and 2009.   If Congress exhibits a lower level of dysfunction going forward stocks would do very well in the next decade.

Real estate is one of the more reviled asset classes the past few years but I think it’s headed in the right direction.  It should do relatively well in the coming decade especially if inflation kicks up.  Mortgagees will benefit from higher inflation as well.  Consumer confidence has taken a huge hit with the bursting of the real estate bubble. I don’t think there are many “deals” left in real estate other than getting lucky and picking up a short sale, which is still a tedious process.

The stock market is at five year highs.  The GDP growth rate for the United States in 2013 is questionable.  In the fourth quarter we contracted unexpectedly by a fraction.  I’m not optimistic about the growth of the economy in the first or second quarter of 2013 based on Congress’ ability to lead and get out of its own way (and ours).  I think the main reason the stock market is doing so well right now is that there is nowhere else to allocate capital.  Stocks are more fundamentally sound than cash and bonds, and they are liquid, unlike real estate.  But stocks are also more volatile than cash or bonds and we could see a big sell-off when we get unfavorable news.  Investors are quicker to pull the trigger on stocks than they used to be and that short-term mentality is detrimental to their long-term goals.

The key to protecting our life savings is fostering a long-term perspective and proper asset allocation.  We need a certain percentage of cash, bonds and stocks to reach our long-term goals.  That percentage varies from family to family.  Investing is not the same as trading or speculating.  No one knows the future, especially me.  We design our clients’ asset allocation to manage their risk and maximize the likelihood of success measured in decades, not days.  Populating that allocation with the best components is critical.  The equity index funds and actively managed bond funds we employ are among the best building blocks of wealth available. Happy days might be here again, or they might not, but our clients are positioned to weather either eventuality to the best extent possible.  That is the basis for private wealth management with charity, prudence and fortitude.

Planning for the Fiscal Cliff

The fiscal cliff will likely be averted but not artfully so.  Even if it was brilliantly navigated, GDP will  suffer in the first and second quarters of 2013.  Meanwhile the life savings of millions of investors around the world are going to be impacted.  The prudent thing to do is to focus on what we can control: our attitude and our behavior.

We can control our attitude by limiting our exposure to the white noise broadcast by the news media.   Often we see two brilliant people espousing opposite ideas that does nothing to help a family make good financial decisions.   For example, “Raising taxes on the families making more than $250,000 per year is the answer to our spending problems!”  I happen to the believe the counter-argument that “Raising taxes when the economy is growing at less than 2% and unemployment is at 8% is a recipe for recession.”  But all this noise is detrimental to our peace of mind and negatively impacts our ability to make good decisions. We can’t control the outcome of that debate but we can control the amount of risk that we take.

We manage risk by choosing the appropriate asset allocation to accomplish our goals and then populating that allocation with the best components available.  Most Americans have the bulk of their liquid wealth invested in 401ks and IRA accounts.  The key to navigating the fiscal cliff is to choose the proper percentage to be invested in stocks and in bonds and to give it time to work. There are a lot of risks in the financial markets, particularly in bonds.

Many investors believe they are investing conservatively by purchasing bond mutual funds.  Investors often choose bond funds because they have a higher yield than their peers.  What they don’t understand is that the higher yield probably reflects more risk in the underlying securities owned by the fund.  This is the next iceberg lurking below the surface of the water that is going to capsize retirement portfolios in the years ahead.

Your situation is unique and you deserve better than a “one size fit’s all” strategy.  I’ve read countless articles on what investors should do and my advice is to get advice.  Please discuss your situation with a Certified Financial Planner that you trust and get a customized asset allocation.  To learn more visit my website http://www.dogwoodcapital.com or http://www.napfa.org to find the appropriate advisor for your family.  The National Association of Personal Financial Advisors (NAPFA) is the country’s leading professional association of Fee-Only financial advisors—highly trained professionals who are committed to working in the best interests of those they serve.

Volatility is Coming

The main risks we are facing are slowing global economic growth and the European currency crisis.  Both of these are political risks driven by fiscal (i.e. Congress and European Union Bureaucracy) policies of taxing and spending, not monetary policy (Federal Reserve, ECB, etc).  Central bankers cannot solve our problems, only politicians can.  Unfortunately, that isn’t very inspiring with the leadership we’ve experienced.  I believe the euro will survive but it will have fewer countries in the currency block during the next decade.

Financial markets are going to be manic depressive for the next four months.

1. The elections this fall will set the tone for economic policy in the coming decade with two polarized camps with completely opposite and contradictory solutions to our problems.  The Bush Tax Cuts expire in 2013.  The Obamacare tax hike will arrive shortly thereafter.

2. Europeans have implemented another short-term fix to their long-term problems.  The currency zone will shrink with Greece being the template for expunging countries.

3. I recommend that you watch “Duck Dynasty” on A&E and avoid financial news channels. They don’t add value.  They just create unactionable noise that is detrimental to peace of mind.  I also like Forbes magazine and the weekend edition of the Wall Street Journal.

 

The Key to Prosperity is a Healthy Middle Class

Economies with a healthy, growing, middle class tend to expand.  This is exactly what is happening in emerging market countries.  It’s almost like they’re going through what the United States went through in the 1950’s but without the baby boom.  Families all over the planet want to replicate the middle class American lifestyle (as seen on TV) and now they can buy iPhones and Big Macs and drive cars, too.

Most small business owners are middle class families.  Policies that are friendly to small business bolsters the vitality of the middle class.  Most of the companies in the S&P 500 started in a middle class family garage with two guys and a pickup truck.  Even the most cherished company on the planet, Apple, went from three people in a garage to 60,000 employees.  It was not the result of a government program (i.e. Freddie Mac, Fannie Mae, or Solyndra).

The United States is in a unique position.  It has been the perfect environment for the middle class to grow and thrive since its inception.  Our middle class expanded through natural population growth and immigration.  I believe more people would rather immigrate here to live and work and raise a family than anywhere else in the world.  Immigrants are twice as likely to become millionaires than citizens that are born here. Policies that make it easier for small businesses to happen will ensure that the middle class remains vibrant. Policies that disincentivize small businesses (raising taxes and increasing regulation) will lead to further economic anemia.  We have been through all this before.

Economies do not boom or crash or stagnate forever.  I don’t know what the world will look like in 2022 but I can pretty much guarantee it isn’t what we’re envisioning now.  I don’t like some of the things that are happening around the world and in our country. But fundamentally, I have hope for the future and I believe we still have better days ahead of us.  There are a bunch of clever, hard-working people around the world that want to live the middle class American dream.  Hopefully good leaders and sound economic policies will enable them to do that.

Overcoming the Dignity Deficit

There are countless thousands of blogs on financial matters.  Most of them are just noise and trash.  I’m not interested in contributing to that.

There are numerous financial gurus.  I am a Certified Financial Planner (R) and I manage money for retired families.  I’m passionate about the people that entrust their financial futures to me  but I am not passionate about writing on financial topics.  I’m a big fan of Clark Howard and Dave Ramsey.  They’re doing an awesome job educating the general populace about good decision making and general, nonspecific issues pertaining to financial planning.  I’ll leave that to them.

What we are lacking is an honest discussion about human dignity and the issues and thinking that ennoble and destroy it.  Living with dignity and respecting the dignity of others are enormously practical and the fruits of this lead to functional families and societies.  I’m going to explore the affronts to dignity and the positive steps that can be taken to rectify them.  This sounds like serious business, and it is, but we’re also going to have a lot of fun with it.  My goal is that readers will come away encouraged and energized with practical steps that can be applied to improve themselves, their families and society.   One of the greatest tragedies is that we fail to recognize our own dignity and the attitudes and behavior that undermines it or strengthens it.  This is a critical step in cultivating the virtue of hope.  And hope is one of the most beautiful expressions of the human condition.

I Think It’s Going to Be Alright

The headwinds to the global economy are well-documented and financial markets are steeped in uncertainty.  Obviously, nobody knows what’s going to happen. Some people are apocalyptic, some are sanguine, expecting a prolonged low-growth malaise. Very few are optimistic about the future.

I think it will be better than most people predict it’s going to be partly because the feedback loop is so negative. A few years ago, economists were predicting 3% GDP growth and 3% inflation and 6% unemployment into perpetuity.  We mistakenly believed that we were in a “goldilocks” business cycle brought about by artful management of monetary policy. Everyone, including myself, bought into those assumptions because it was conventional wisdom, it resembled what we had experienced historically, and it was compelling. The deficiencies of those assumptions are glaringly obvious today but it made a ton of sense at the time.  It’s human nature to forecast our current situation (whether it is good or bad) into perpetuity. We think it will always be the same and in reality, it is always changing. We’ve always been in a cycle and we always will be. We don’t understand where we are in the cycle until we’re looking at it over our shoulder.  A decade ago we were too optimistic.  Now I think we’re too pessimistic.

Middle-class consumption drives the global economy.  The picture isn’t great for the developed countries. In the United States, we’re still recovering from the real estate crash but we’ve done a lot to heal our personal balance sheets (now it’s Congress’ turn).    Europe is going to be working through its currency woes for years.  In my opinion, the Euro as it is today will not exist in a decade.  It might be a four country currency zone.

I’m extremely optimistic about the rising middle class in the emerging market economies: Asia, India, Latin America and Africa.  I’d like to give the world a Coke… and some Kentucky Fried Chicken, and an iPhone and a Wal-Mart in every town.  Someday it will happen and our clients will benefit from it.

Growth, Inflation or Default? Oh My!

Sovereign debt is traditionally considered one of the least risky forms of debt  because governments can raise taxes (annoyingly referred to as “revenues”) through the political process.  Because of this unique benefit their borrowing costs are lower than non-sovereign (corporate) bonds.  But not all sovereigns are the same.  S&P  rates 19 out of 127 nations as AAA, which is its highest credit rating.  The United States is the only AAA rated country with a negative outlook.

The negative outlook doesn’t mean that we have lost our AAA rating yet.  In the ponderous credit analysis process, giving a negative outlook is announcing to the world that a downgrade is possible.  The wording of the S&P release was looking ahead two years to 2013 as a possible timeframe for the downgrade to occur (if it were to occur).  A lot could happen between now and then to change the outlook.  The purpose of the statement was to put the bond market and Congress on notice.  The stock market reacted with a 1% drop which is not that significant.  The bond market didn’t react at all.  Gold and silver spiked.  In essence, financial markets already know.

Where do we go from here? There are three ways to get out of sovereign debt: grow the economy, create inflation, and default.  The most desirable way to get out of debt is through economic growth which creates rising tax revenues.  This requires policies that are friendly to small businesses whose entrepreneurship creates the bulk of new jobs in an expanding economy.  Another option the United States has, that most countries do not,  is to devalue our currency.  Inflation robs all bondholders of real value because we’re paying back debt in dollars that aren’t worth what we borrowed them in. For the 23% of Americans that owe more on their houses than they are worth, this might be a small consolation. The United States is in the catbird seat because the dollar is the world’s reserve currency and we can “quantitatively ease” as much as we want, up until the point that foreign investors (especially China) stop buying U.S. Treasuries, which can happen rather abruptly.  The third way to handle debt is to default on it.  For most debt burdened countries that are not in control of their own currency, such as Greece, this is their only option.

We have known for thirty years that the federal budget is structurally flawed.  Tough choices will have to be made and it will impact the lives of all American citizens and many foreign interests as well.  More than ever, it is important that we vote intelligently and plan prudently.  It is a very good time to take a good look at our goals and to position our portfolios to maximize the likelihood of attaining them.  We’re in a different world today than we were five years ago.  Five years from now, things will be different again. I am hopeful that it will be for the better, but I am planning for less favorable outcomes as well.

Growing in Charity

I have much to be grateful for.  But so often I focus on the things that aren’t as I would have them to be rather than appreciating the countless things that are wonderful.  That is pride, which is human nature at its worst.  The way to overcome pride is to cultivate the virtues of humility and gratitude.  The way we cultivate humility and gratitude is by making sacrifices.

“Sacrifice” is a loaded word.  Often when I hear it I want to run the other way.  But we’re happiest when we are giving of ourselves and this is the essence of sacrifice.  All parents sitting around a Christmas tree sharing with their families understand this.

St. Therese of Lisieux was a Carmelite nun who is world-renowned for her charity. In her autobiography, A Story of a Soul, she shared how she grew in charity and gratitude.  She had what she called “sacrifice beads”.  Every day she wanted to make ten sacrifices for others and she used the beads to keep count.  Instead of making a negative comment or judgment about a person, she would say something nice about that person.  Then she would pray, “Lord, I make this sacrifice as an act of love for you.”

This is a habit I am cultivating.  I hope it works for you, too.

Merry Christmas and God bless you!

Rising Standard of Living in Emerging Markets

The global economy is growing but it doesn’t feel like it in the developed countries (the United States, Japan and the Eurozone).  Asia is booming.  India is growing at a healthy clip.  Africa and South America are exporting massive amounts of natural resources.  China has surpassed Japan to become the number two economy in the world, although they still lag the United States by far, which retains the number one position. 

There are 6.8 billion people in the world.  About 800 million of them live in the developed countries.  That leaves 6 billion people in emerging market countries who aspire to the American dream, which in essence, is a standard of living.  American exceptionalism is not elitism or nationalism.  It is the understanding that anyone can come here, work hard and provide a good life for their family.  Unfortunately it is not possible for every emerging market country to emulate the United States in our standard of living due to political instability (or corruption) and the lack of rule of law in their native countries.  As emerging market countries adopt policies that encourage the rise of a middle class, they are prospering.  When the Chinese started acting like capitalists their economy exploded.  Obviously they have a long way to go towards rule of law and an open society, but a little bit of freedom for 1.3 billion people goes a long way, and has had a profound impact on the global economy.

I believe the U.S. economy is healing but it has a long way to go.  High unemployment and the depressed real estate market will not go away without significant changes in public policy from Washington.  Hopefully the recent elections will bring us closer to the fruition of those policies.  It will not be pleasant for families that are depending on government entitlement programs or for the taxpayers that must sacrifice to pay for them.  It will take a lot of time to strike a balance between these two constituencies if our experience is anything like what we’ve seen in Greece and France.  It will require character and leadership from Washington which has not been evident thus far.

Managing Expectations

It’s human nature to take whatever scenario we are experiencing right now and extrapolate it into the future.  But life, and the global economy, are cyclical.  We go through seasons of growth, decline and recovery.  Usually investor sentiment is at it’s best or worst when we’re about to enter a new phase of the cycle.  When the stock market or real estate or tulip bulbs are booming, investors stumble all over each other to buy them.  Likewise, when these markets are crashing, investors scramble to dump them.

I don’t know if we are going into another recession or if we are just going to muddle through.  But there is opportunity to make money if one keeps a long-term perspective.  In the age of Facebook, Twitter and Linked-In, we are constantly updated and inundated with the status of the people we follow.  This has damaged our ability to keep ongoing events in perspective.  Investing (and life)  is a marathon not a sprint.   Some days are frustrating (or scary) but it’s part of the journey.  It doesn’t seem to work out the way we expect it to but it does work out.

I’m not suggesting that we take a Pollyanna attitude about our portfolios.  Quite the opposite, I’m suggesting we position ourselves to weather whatever might happen.  We have been rebalancing clients to weather these uncertainties.  Now is a very good time to review the risk in your portfolio.