Stocks are Dead; Long live Stocks!

The S&P 500 is setting multiyear highs right now. It’s the economy right? Not really, the U.S. economy grew 1.7 percent in the second quarter, creating about 140,000 jobs a month on average this year. That is less than half of the monthly hires needed to bring the unemployment rate back to pre-crisis levels by 2015. Well then, it’s due to our government averting the so-called fiscal cliff—the spending cuts and tax hikes that could stall the economy next year. Not so fasr, our government has not addressed that issue yet – hey, they still have 100 days. Europe’s financial crisis is resolved! That’s not it, Europe’s problems, while getting better, remain unresolved.

So how is it that the Standard & Poor’s 500-stock index is up 25 percent over the past 12 months? Stocks have reached levels not seen since Lehman Brothers and Bear Stearns existed.

Over the long term, through all the noise, stock prices actually move relative to corporate earnings. S&P 500 profits estimates (Bloomberg) suggest earnings growth of 11 percent next year, and 12 percent in 2014; this may send the S&P 500 to record levels if earnings come in at or near expected.
Corporate America is lean and mean - think of great comapnies like Apple and Wells Fargo. We are also counting on help from the Federal Reserve, which is widely expected to start a third round of bond purchases to boost the economy.

With that said, the threats to the market remain (actually they never quite go away). Chief among them is the fiscal cliff. Under a law passed last year the failure of lawmakers to agree on some combination of spending cuts and tax increases would result in $1.2 trillion of automatic cuts and accompanying tax hikes in January 2013. That combination could shave 2.9 percent off economic activity in the first half of 2013, according to the Congressional Budget Office. While many economists believe the impact to be good for the economy long-term, in the short-term the market would likely hiccup, frankly creating a chance to buy on the dips.

Europe also remains a potent threat, Greece has yet to ratify the spending cuts necessary to receive life saving bailout funds and there is no guarantee that Spain, which is suffering through an economic depression, will agree to more austerity in exchange for the European Central Bank’s financial aid.

Individual investors could also decide to get with the program. While prudent managers have been suggesting to add equities to portfolios where appropriate, do it yourself investors have pulled money from U.S. equity mutual funds for a fifth straight year in 2011, moving $75 billion out of stocks this year alone. If these dollars come back to stocks it could raise stock prices even further – as individual investors usually buy high.

As always, talk things over with an accreditied investment manager or financial planner to see what proportion of high-quality equities make sense for you.

CBlakely CFP®, CTFA     Sept. 2012

Sources: Bloomberg LP.

Stories Sell

Happy Ending?

The stories our leaders tell us matter, nearly as much as the stories our parents tell us as children, because they orient us to what is and to what could be. Our brains evolved to expect stories with a particular structure, with good guys and bad guys, a hill to be climbed or a battle to be won.  

 In that context, Americans needed their president to tell them a story that made sense of what they had just been through, what caused it, and how it was going to end. We are all scared and angry. Many have have lost their jobs, some their homes. This was a disaster made by Wall Street’s best educated, who speculated with our assets and therefore our futures. It was caused by politicians like Phil Gramm who told us that if we just deregulated we would be more competitive. Unabashed greed and recklessness were the unintended consequences.

We are suffering from the same ending we experienced 80 years ago, when the same people sold our grandparents the same bill of goods. Can we draw on their wisdom?

Like most Americans, at this point, I have no idea what the President believes on virtually any issue. The president tells us he prefers a “balanced” approach to deficit reduction, one that marries “revenue enhancements” (a weak way of describing popular taxes on the rich and big corporations that are evading them) with “entitlement cuts” (an equally poor choice of words that implies that people who’ve worked their whole lives are looking for handouts).

When 400 people control more of the wealth than 150 million of their fellow Americans, when the average middle-class family has seen its income stagnate over the last 30 years while the richest 1 percent has seen its income rise astronomically, it bodes ill for the U.S. economy. Now that Standard & Poor’s has downgraded the U.S.’s AAA credit rating, it is important to respond boldly and, at the same time, lower expectations.

The first step is for our political leaders to frankly acknowledge the problems at hand: The U.S. economy will face a hard slog for an extended period; the political system is polarized; and, under current policies, the budget deficit will remain large.

Expect Slow Growth
We can expect sluggish economic activity for years, not quarters, and we face the risk of another recession. Those who in January were predicting growth of 4 percent or more for 2011 did not sufficiently appreciate the evidence from economists that foretell what most often comes after a systemic financial collapse is a decade of weak growth. (Read “This Time is Different: A Panoramic View of Eight Centuries of Financial Crises.”) Two years ago Bill Gross of PIMCO called it the “new normal.” I sense he was right.

Government Opportunity

We should take this opportunity to reconsider what government should properly do. We need to invest more in roads, bridges, railroads and the like, and the best way to do this would be to create a new infrastructure bank in the same mold as the Tennessee Valley Authority.

The Executive branch needs to lead us again with a simple but strong narrative repeated over and over to keep our attention focused on the slog ahead and importantly the light at the end of the tunnel.

Our Opportunity

Rahm Emanuel, the former White House chief of staff, once famously remarked that one should never let a serious crisis go to waste. It may be time to make nuanced shifts in your portfolio.

This correction is likely near a bottom and therefore, valuations in the U.S. are now attractive on a long-term basis. Price to earnings ratios on forward (future) earnings for most major U.S. stock market averages are under ten. On an earnings yield basis, stocks look remarkably attractive relative to bonds.

On a relative basis, stocks are about as cheap as they have ever been compared with bonds.

 Hard Assets - It’s too late to buy gold and other precious metal safe havens for this cycle. In the long-run no one knows. But, a price drop would happen quickly, if at all.


 Bonds - Keep your powder dry. Shorten bond durations and look to corporate notes for a little yield, or Canadian or German government bonds if you must own sovereign debt. There is very little value left in the U.S. Treasury curve at this point.


 Equities - Financials have completely broken down, but have dropped to extremely attractive long-term values. Consumer staples and utilities act defensively during market downturns, but leadership usually shifts to other sectors at the bottom of the market. Consumer discretionary, industrials, materials and tech should lead as the economy finds stable footing.

CBlakely CFP, CTFA  08/2011

Sources: This Time is Different: A Panoramic View of Eight Centuries of Financial Crises, Reinhart, Rogoff: The New York Times Sunday Op-ed page July 2011, Bloomberg LP. PIMCO

A Huge Bust (economic)

How many books, articles, blogs, and news stories are out there attempting to explain why the economy can’t leave the Great Recession in the dust and start adding large numbers of jobs? The deficit is too big. The stimulus was flawed. China is crushing us. Businesses are overregulated. Wall Street is under-regulated. The list goes on.

My sense is these are all symptoms of something else, something bigger. The main culprit is a tremendous economic bust and we are still in the middle of it. It isn’t simply a housing bust. It’s a deflation of the great consumer bubble, decades in the making. (Only the very wealthy and very poor are unaffected.)

For example, the auto industry is on pace to sell 28 percent fewer new vehicles this year than it did 10 years ago — and 10 years ago was 2001, when the country was in recession! Sales of ovens and stoves are on pace to be at their lowest level since the early 90’s. Home sales over the past year have fallen back to their lowest point since the crisis began. And big-ticket items are hardly the only problem.

The Federal Reserve Bank of New York recently published a report on what it calls discretionary service spending, a category that excludes housing, food and health care and includes restaurant meals, entertainment, education and insurance among others. Going back decades, such spending had never fallen more than 3 percent per capita in a recession. In this slump, it is down almost 7 percent, and still has not really begun to recover.
Retail sales were weaker than expected, and consumer confidence fell, causing economists to downgrade their estimates for economic growth yet again. It’s a familiar routine. Forecasters in Washington and on Wall Street keep saying the recovery’s problems are temporary — 10 years is temporary if your time horizon is 500 years, mine is not.

If you’re looking a reasonable explanation for the terrible job market, it is this great consumer bust. Business executives are only rational to hold back on hiring if they do not know when customers will fully return. Consumers, for the most part, are coping with a loss of wealth and an uncertain future (pushing back durable goods purchases). Both consumers and executives are panicky given the latest economic problems.

We are feeling the deferred pain from 25 years of excess, as people try to rebuild their depleted savings. This pattern is a classic one. The definitive book about financial crises has become “This Time Is Different: Eight Centuries of Financial Folly,” Surveying hundreds of years of crises around the world the authors conclude that debt is the primary cause and that the aftermath is “deep and prolonged,” with “profound declines in output and employment.” On average, a modern financial crisis has caused the unemployment rate to rise for more than four years and by 7 percentage points. (We’re now at almost four years and 5 percentage points.) The recovery takes many years more.

The notion that the United States needs to begin moving away from its consumer economy — toward more of an investment and production economy, with rising exports, expanding factories and more good-paying service jobs — has become so commonplace that it’s a cliché. It’s also true. And the consumer bust shows why. The old consumer economy is gone, and it’s not coming back anytime soon.

Sure, house and car sales will eventually rebound, as the economy slowly recovers and the population continues expanding. But consumer spending will not soon return to the growth rates of the 1980s and ’90s. They depended on income people didn’t have. (I might suggest underweighting the consumer discretionary sector for the near term and not for the reasons you would think, with a P/E over 19X for the sector it’s a too expensive and may be overdue for a correction considering where we are in the business cycle.)

The choice, then, is between starting to make the transition to a different economy and enduring years of fits and starts in the economy.

The easy thing now might be to proclaim that debt is the devil and ask everyone to get thrifty. History, however, has a different verdict. If governments stop spending at the same time that consumers do, the economy can enter a vicious downward cycle (see the Great Depression for details).

But the debt-ceiling debate doesn’t have to be yet another problem for the economy. The right kind of agreement could help soften the consumer bust and also speed the transition to a different kind of economy.

Politics, of course, makes many of the current ideas being discussed unlikely to happen anytime soon. Unfortunately, though, these debt-ceiling talks won’t be the final chance for Washington to help the country recover from the great consumer bust. That’s the thing about consumer busts - they can last for a long time.

CBlakely CFP®, CTFA, CMFC 07-2011


Sources: New York Times, Federal Reserve Bank of New York, “This Time Is Different: Eight Centuries of Financial Folly” - Carmen M. Reinhart, and Kenneth S. Rogoff