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Don’t Worry, Be Happy
Here are the performance numbers for the major indices.
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The Dollar and the Great Currency Debate There have been strong statements both in support of and against the dollar. After the G8 summit meeting, Russia’s finance minister said the dollar’s role as the world’s main reserve currency was unlikely to change in the near future. Before the G8, Japan’s finance minister said the government’s trust in U.S. Treasuries was “absolutely unshakeable.” On the other hand, in a statement from the BRIC (Brazil, Russia, India and China) conference, there were calls for significant changes to the international economic system. “We believe there is a strong need for a stable, predictable and more diversified international monetary system”, a BRIC representative was quoted as saying. The BRIC’s statement lays the foundation for future calls to move away from the U.S. dollar as the preferred currency for exchange in the international market. While China holds the largest U.S. dollar reserves, it is not a member of the G8. Member countries Japan and Russia, on the other hand, hold the second and third largest dollar reserves of the G8, respectively, and want to prevent further erosion in the value of their holdings. They’re concerned a weaker dollar makes their exports less competitive. As a precautionary move, Japan and Russia have been reducing their holdings of treasuries. On the other side of the equation, China has made a stand and currently is not participating in treasury auctions. The Chinese are finding other places to diversify their reserves. Brazil’s oil giant Petrobras (PBR) and the China Development Bank (CDB) announced a loan deal whereby the CDB has agreed to loan Petrobras $10 billion over 10 years. A portion of this loan will go toward PBR’s investment expansion plans. Petrobras is Brazil’s largest company, and at the end of 2007, it was ranked as the world’s eighth largest oil company among those with publicly traded shares. It’s no secret that China is on a quest to access large pools of natural resources for the future. The problem is we have hundreds of billions of U.S Treasuries that are going to be auctioned in order to service our deficit spending. If buyers do not surface, long term yields will rise, weakening the dollar and forcing the Fed to push short term interest rates higher. This does not leave The Federal Reserve and the U.S. Treasury in an enviable spot.Business as Usual at The Fed The Federal Reserve, the U.S. Treasury and the administration should receive a thumbs-up for providing the means to help the banks through the current liquidity crisis. The Fed continues to buy treasuries to keep rates low. At the end of June, Federal Reserve policymakers ended a two day meeting by leaving interest rates unchanged and indicating that rates will stay low for some time to come. The Fed’s benchmark interest rate remains steady in a range of 0 percent to 0.25 percent. This quantitative easing (buying our own treasuries with government funds) is robbing Peter to pay Paul. The government numbers equate to The Fed purchasing approximately 16% of Uncle Sam’s debt over the next few months. It is important to gain some perspective as to where the United States stands relative to historical debt levels. (Click to see chart) The chart shows the total amount of government debt as a percentage of Gross Domestic Product (GDP). It is currently at a record 50 year high of about 100% of GDP. The debt is almost 50% higher than the historical average. The Fed has done virtually nothing to abate the housing downturn and credit is still hard to secure for consumers. Sadly, most banks are unwilling to work with homeowners until they are in default. The Fed has been silent about outlining an exit strategy to absorb the dollars out of the system at the appropriate time. This has ignited inflation concerns. We are starting to see commodity prices climb in the face of weak demand. The Fed has only one option and that is to raise rates slowly to thwart the drop in the dollar and the rise in costs of raw materials used in manufacturing. The big question is whether the government has created a false economy and a sense of safety by instilling a belief in investors’ minds that all crises can and will be solved by government actions. If this is true, it could skew investment decisions toward unnecessary risk taking. Isn’t that what got us into this mess in the first place?When Will the Recovery Come?
We are a long way from job growth, rising home prices and an upward trajectory of consumer spending. Fundamental underlying problems still remain. It’s hard to see any business sector whose prospects for employment aren’t either grim or dim. The unemployment rate traditionally peaks after the recession has already ended. We believe there are more problems lurking for consumers and banks. The latest statistics show about 12% of homeowners are behind on their mortgages or in foreclosure. The U.S. Bureau of Labor Statistics recently reported that some 27% of the nation's 12.5 million unemployed workers have been without a job for more than six months. This is a record rate. Soon, banks will be faced with looming troubles for commercial real estate, and the ongoing issue of toxic assets on the books of larger banks. This may continue to impede their ability to make the loans that would spur a recovery. We believe that the housing market must show signs of stabilization before economic recovery can be considered underway. Where is the Consumer?
With less money to spend, where is all the money going? The answer lies in food and energy. During the month of May, 17.9% of personal consumption expenditures were spent on these two categories alone. While this is a decrease from June and July 2008 readings of 20.2%, it is still quite high. We can’t forget the unemployment rate is 9.4% and expected to rise to 10%, or maybe even 11%. The good news for consumers is that their real pay rose yet again to an all-time high in May. Pre-tax earned income per worker, adjusted for inflation, is driven by productivity, which is also at a record high in the U.S. Borrowing has been curtailed by the inability to get credit. Fear of the recession sliding into a depression has stopped consumers from paying on their debt. This in turn creates a problem for the prospects of an economic recovery. Consumers may be changing their approach on building wealth. There is also a shift from relying on home equity as a way to save for retirement. Two years ago, we stated that it was a slippery slope to rely on your home as your retirement nest egg. The American people are now realizing that their home is above all a place to raise a family rather than a retirement savings vehicle. Don’t bet against consumers in Brazil, Russia, India, China and other emerging economies. In these economies we have evidence of a consumer that is rapidly coming to the forefront of the global financial community. The emerging consumers are living longer and looking to raise their standard of living through better diets, education and consumer goods. Many emerging consumers now want what the old world consumer has long taken for granted.Bond Market - Foretelling the Economic Recovery Since March 9th, the U.S. stock and corporate high yield-bond markets have enjoyed a rebound. With the market’s appetite for risk, high-yield bonds have been the top performing segment so far this year. To further us along in our quest for economic recovery, higher interest rates need to be avoided. If not, borrowing rates would climb higher, including mortgages, credit cards, auto loans, etc. We see this economic downturn as consumer and credit driven. Although government bailouts have improved liquidity and confidence in the financial sector, the real economy continues to struggle. There are sectors of the bond market that look attractive, though the treasury market is at the bottom of our list. Fear has played a role in the recent rise in the yield of treasury securities. Fear of inflation is at the heart of the sell off as well as concern that the bond rating agencies might downgrade the debt of the U.S. government and municipalities. In the past we have been positive on municipal bonds and they have performed well since the March 9th market lows. We are, however, disappointed with the response of the major municipality issuers to reduce expenses and balance the budget shortfalls. State income tax collections for the January- April period were down significantly compared to the same period last year. The decline averages 26% for states with a personal income tax. (Click here to see how your state ranks) California has been relying mostly on the federal government to bail out the state’s budget problems. This is cause for concern as the state heads toward insolvency. With the defeat of ballot measures designed to plug the gaps with increased state borrowing and higher taxes, Sacramento must work harder to reduce the $24 billion deficit. In the meantime, we are under-weighting muni bonds and limiting our exposure to the highest quality income streams for clients in the highest tax bracket. We continue to purchase inflation indexed securities (TIPS), government sponsored/guaranteed mortgage backed securities and high quality bonds of major corporations for income investors.Opportunities on the Horizon
Real Estate - Running Against the Wind Have existing home sales hit rock bottom? We might be seeing signs of stabilization. The actual supply of unsold homes is fluctuating around recent lows. May’s 9 month supply of unsold homes remains high, but is at the bottom of a recent flat trend. It peaked at 11 months last June. Buyers looking to move up market are waiting on the sidelines because they can’t sell their current home. Sellers looking to downsize are waiting if they can. A depressed home price cuts into their nest egg. The segment that is vibrant is the entry home market. With the combination of house prices coming down, and mortgage rates at historic lows, the housing affordability index is the best that it’s been in 30 or 40 years. With this backdrop, we believe now is the time to buy investment real estate at the entry level. Investor buying is subsiding and new buyers are apprehensive given the continued slide in prices. We suggest buying homes in the hardest hit home markets where the prospects for future job growth is strong. In addition, we want to purchase homes where the cash outlay on a monthly basis equates to the fixed cost of owning the home. We might be a little early, but our investment time horizon is 7 to 10 years. If you would like to review how investment property could fit into your financial plan please give us a call. Your Company’s Retirement Plan Today’s question is…. are you a fiduciary of your company’s retirement plan? If you're not sure, it's time to find out because if you are, it is important to know exactly what your responsibilities are. Many employers offering qualified plans to their employees are not fully aware of their fiduciary responsibilities and the potential personal liability. Because the stakes are so high, it is especially important during the current financial market turmoil that all fiduciaries understand their responsibilities to comply with ERISA. (Click here to see if you could be a fiduciary) If you are a fiduciary, you have duties to act solely in the interest of plan participants and beneficiaries and with the exclusive purpose of providing benefits to them. These duties include:
Please call us if your company has not had a retirement plan review in the last year. Preserving your Collectibles The collectible market has been strong relative to other investments. With market volatility and uncertainty, investors are looking for alternative investments. Rare documented collectibles from coins, to art, to cars and antiques have been attracting huge pools of cash. In September 2008, post banking crisis and amid the economic turmoil, Sotheby’s London sold $200m of Damien Hirst’s art. This was in excess of the pre-sale estimate of $177.6M. In January 2009, the legendary Gulf One Corvette was sold by Mecum Auctions amid cheers from the crowd at Kissimmee, Florida. The car sold for $1,050,000. Recent trends indicate the collector car market has stabilized and is returning to the levels seen in 2004 and 2005. Keep in mind; these are the highlights in the midst of a collectibles market that has seen declining sales volume but with strong pricing. With the dollar declining in value, we could see a pick up in prices if the global economy stabilizes. It is important to preserve the value of your collectibles. Some collectors have heard that auction sales and prices are going down and jump to lower their coverage. It is important to have the proper perspective before you make changes to your policy. First, you need to have an appraisal of your collectibles. Even though softness has entered the markets, prices are still high. Collectors are still buying art with money coming out of traditional investments. In addition, the auction price does not automatically determine the value. Just because an item does not sell at auction does not mean its value automatically drops. The auction market is a one-day sale with a limited audience of buyers. (Click here for more information on how to protect your collectibles) When economic times are rough and people have financial duress, there's a tendency to look the other way or believe what’s convenient. Start by taking an inventory of where you are financially. This includes all your assets and liabilities. Since it’s the end of the quarter, all your bank, credit, investment and retirement statements will be delivered in the next two weeks. We view today’s environment as an opportunity to upgrade your investments, recalculate your income streams and determine your true risk tolerance. These are times that test your commitment to your goals. It has been proven over the last two years that a standard buy and hold portfolio is not the strategy to use as your goals change and the fundamentals of the financial markets evolve. There are ways to transfer and reduce risk that are fairly new concepts to most investors. As you approach retirement or rely on your portfolio for income replacement, it is prudent to look not only at portfolio diversification (stocks, bonds, commodities, currencies and real estate) but also investment product diversification. Don't hide -- take an interest…. It is your money. Call us to review your portfolio or to address your financial concerns.
At Karp Capital we’re here to listen to the concerns of our clients, give sound advice, and execute their financial plan. If you appreciate this style of financial management and would like to work with an advisor who can satisfy your investment concerns, you have found a home at Karp Capital. Please remember that we appreciate your support and we're flattered when you refer your family and friends. If you know someone that would enjoy our commentary on the market, please share the newsletter with them. If they would like to receive our quarterly commentary please direct them to sign up for the email edition at www.karpcapital.com. If you have any questions on the analysis above, or would like to review your portfolio's performance, please call me at 877 900 Karp. Working with Karp Capital, there is only one boss, YOU!
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