De-Facto Dollar
We were early in calling the breakdown of the U.S. dollar last year and its importance to equity and commodity markets. We changed our stance at the end of 2009. We have been positioned for the rally in the dollar. The dollar has been the short-term beneficiary of a flock to safety from foreign governments with debt problems. Greece has stolen the headlines with its cash crunch and a possible downgrade by the rating agencies. Greece's problems have hurt the euro and strengthened the dollar. As a result, the dollar is now trading at a high for the year. The outcome of the European Union’s decision regarding Greece will worry the market. All the talk regarding a Greek bailout tells us that the EU will print, borrow and spend in an attempt to fix its members’ problems. We are now looking at a situation in which the fate of the euro hangs in the balance. As the year plays out, we believe we will see further weakness in the euro as debt problems emerge in Spain, Italy and Portugal which will expect the same favorable treatment as Greece. The weakness in the euro will translate into dollar strength which will hurt U.S. exports and multinational companies who have enjoyed the benefits of a weaker dollar over the past year.
First Floor, Going Up
We believe that evidence continues to mount that the Fed will need to change its policy statement at the next meeting. The Federal Reserve has hinted at an increase in the key short term Fed Funds rate. We have already seen the Fed raise the discount rate (the rate at which banks borrow from the Fed.) Recent testimony by Fed Chairman Ben Bernanke indicates we may see a bump in rates as the employment picture begins to improve. Higher interest rates in the U.S. will instill confidence that the administration and the Federal Reserve have the power to do what is right for the country, while helping put wealth back into the pockets of people that save. Corporate America just might believe we have turned the corner and start hiring again. This in turn will cause investors to have confidence in the dollar to sustain the rally. The direction and price of the U.S. dollar is critical for determining the health of the U.S. economy and the financial markets.
Digging a Hole
 The Treasury Department announced that the U.S. budget deficit in February rose 14% (vs February 2009) to $220.9 billion. The federal government spent over three times more than it took in, spending $328.4 billion on shockingly low tax revenues of just $107.5 billion. For the current fiscal year the U.S. budget deficit is up 10.5% to $651.6 billion, on pace to exceed $1.5 trillion for any fiscal year, a new record in red ink. The Treasury is starting to have difficulty selling bonds as indicated with the drop in the value of Treasuries across the maturity spectrum at the end of March. The auction for the 5 year treasury was not well received and so yields spiked on 5 and 10 year bonds. The yield on the 10 yr treasury is the highest since July of last year. Moreover, indirect bidders, a group which includes foreign central banks, bought only 39.6%, the lowest level since July 2009. Over the years we have highlighted the growth of Chinese ownership of U.S.  government debt. China is the United States' single largest foreign creditor. Click here for the red ink. The market is sensing a change in Washington after the healthcare bill was signed by the President. We are seeing a trend given that the healthcare and the financial reform bills will add billions to the deficit. Our legislators are looking to spend more money we don’t have. If this continues, interest rates will rise whether the Fed raises the Fed Funds rate or not. The Fed is definitely aware of the predicament of the government. If the Fed was truly data driven they would be raising rates sooner rather than later. The Federal Reserve is being politicized instead of being data dependent on setting interest rate policy.
On the Fence
 The phrase “extended period” was the highlight of the Federal Reserve’s statement following the latest Open Market Committee meeting. Investors reacted enthusiastically and Wall Street had the green light to move the stock markets higher. To many, the words imply that the policymakers will not be hiking the Fed Funds rate for at least another six months. The Fed also issued a more upbeat report on the economy, noting that the labor market is stabilizing and business spending has grown substantially. The Fed began unwinding stimuli and ended one of its key liquidity moves by stopping the purchase of mortgage-backed securities at the end of March. The fear is the Fed action will negatively impact housing and prompt a significant increase in mortgage rates. Because of the Fed’s enormous role over the economy and the past economic downturn, the Senate remains skeptical. An atmosphere of distrust among legislators and the Federal Reserve prevails. In the eyes of the Fed the recent economic data has confirmed that the Fed has a little more leeway in keeping rates low. Inflation seems to be contained. Producer prices experienced its largest drop in seven months and consumer prices were virtually unchanged from last month’s levels.
A Difference of Opinion
China and the U.S. continue their attacks on each other’s respective trade policies. The U.S. equates the weak Chinese currency (the yuan) with a form of protectionism. China’s comfort level holding U.S. Government debt in the form of Treasuries continues to wane. While China remains the largest foreign holder of treasury securities, its overall position continues to decline. Analysts are becoming more concerned that domestic rates must rise soon to continue attracting the foreign demand that will be needed to help finance the ballooning deficit. In late March President Obama initially delayed and then subsequently canceled his Asian trip, which was intended to strengthen U.S. ties in a region where China has become the dominant influence. Frankly, the U.S. is looking like the antagonist to most of the world. Meanwhile, China continued with its strong-arm tactics as it forced Google to withdraw from the fast growing internet market. Google is just another pawn in the continuing struggle between China and the U.S. over global economic leadership. Investors will benefit most from stability and predictability in the relationship between these two countries, arguably the most important two economies in the world.
On the Back Burner
If recovery of the housing market is not working with significant government support in place, when is it going to work? Regardless of volatility, existing home sales have stagnated and the supply of new homes is starting to grow again. The number of previously-owned homes on the market jumped 9.5% to 3.59 million. At the current rate, the month’s supply moved to 8.6 months from 7.8 months last month. Given the recent lack of consumer acceptance for the current housing incentive program it is hard to see a light at the end of the housing tunnel. Recently any downside has been blamed on the weather and upside will be viewed as a huge positive. As the number of adjustable rate mortgages reset, will the number of homes on the market increase? (click here)
Investment Climate
 A year after the stock market hit bottom, the panic has been replaced by indifference and distrust. This makes it harder to extend a tired rally. Only three out of every ten people have seen the value of their portfolios increase despite the S&P 500 rising more than 70% since its low last year. Perhaps most of the cash is being used to meet living expenses and not wealth creation. Change has occurred exponentially over the last year. The uncertainty is constant. From uncertainty, trends emerge. Sentiment changes, true believers begin to buy into the new rally, and another trend is born. We believe the markets are at a cross road. During 2009, investors were rewarded almost indiscriminately for taking on more risk in lower quality, more volatile investments. In our view this is not likely to be the case in 2010. We believe a greater emphasis will be placed on earnings and sector and security selection in order to achieve desired results. The markets have been moving higher on lighter volume. This could be an indicator of impending change. Data continues to paint a picture of a recovering global economy. As Americans pay down loans, U.S. household debt shrank 1.7% in 2009 -- the first yearly drop since 1945. Consumer sentiment is virtually unchanged from a year ago as most consumers are concerned about their personal finances. It's important to watch what consumers do, not what they say. This is crucial given consumers make up 70% of Gross Domestic Product. The acceleration of global debt issuances appears to be leading to a bubble in sovereign debt. As more nations try to plug holes in their budgets more money will come to the U.S. as investors look for relative safety.
Buying Equities
In the U.S., investors should focus on companies that export consumer products, raw material producers, iron manufacturers, oil, coal and technology. We are looking for companies that export to countries where the local currency is strengthening in relation to the dollar. Overseas we are looking for companies that can export to fast growing areas such as India, China and Southeast Asia. Even U.S. financial stocks are enjoying a rally as uncertainty wanes. The new White House mortgage plan has provided support for the real estate investment trust and financial sectors. Investors may want to acquire the Gold Exchange Traded Funds (ETF) as gold breaks out of its trading range. The decision by the Fed to keep interest rates at a record low has buoyed and supported gold prices. Sovereign debt problems in developed economies will continue to be a problem as pensions and health care costs rise. This supports our case for investing in gold.
Sector Focus - Oil
 U.S. drilling rates have been picking up this year. Oil and gas rig activity is approaching the impressive highs of 2008. Oil drilling has been even more robust and has in fact surpassed all time highs. There has been a change in the relationship between the price of oil and the U.S. dollar. Last year, the key driver for the price of oil was the weakness in the U.S. dollar. As the dollar declined, the price of oil soared. Over the last 3 months, the inverse relationship has clearly broken down. Despite oil becoming more expensive in U.S. dollar terms, it keeps going up in price. This is a bullish indicator. We are taking advantage of this trend by buying the oil drilling sector for our growth portfolios. (click here for proposed oil exploration)
International
Japan has announced a stimulus package to jump start domestic growth after 10 years of deflation. Japanese companies have a competitive advantage now. The Japanese yen continues to slide and is at a 2-1/2 month low against the dollar. This makes Japan an attractive investment. Bank of Japan board member Kamezaki said that the BOJ is prepared to consider further monetary easing to combat deflation. This in turn will pump money into the economy to stimulate growth. Additionally, Japanese exports continue to rise. February exports rose 45% year over year. Japan has been steadily increasing exports to China. Japanese and American exports are fast becoming the most significant source of renewed activity. On the other hand we are reducing our portfolio exposure to the Brazilian market for now. That market has absorbed a wave of new debt and equity offerings. In addition, the index has so far failed to record a new recovery high since the January sell-off (suggesting it no longer represents global leadership.) We don’t want to wait around until the talking heads on CNBC tell us something that the market has made clear.
Action Plan – Let’s Talk
Taking inventory of your financial life is tedious yet important. No one likes to sift through mounds of paperwork to see the potential pitfall in their financial plan or lack of a plan. Avoiding the problem does not make it go away. Your assets, financial needs and lifestyle change over time. If people do focus on their finances it is usually on the investment side. After many meetings over the years we have concluded that clients want to review insurance policies and coverage last…if at all. Given the current low interest rate environment, clients can get the same coverage or more coverage for less money. New bids should be sought for all non-life policies every three to four years. The insurance business is always changing with new products, services and strategies that can help you protect your net worth while being tax advantaged. The focus should not be the dollar amount of coverage you have. We urge you to go through the process to make sure you have the right coverage for your needs. The first step is to complete a Risk Management Questionnaire. (Click here to stop guessing whether or not you are properly insured)
Higher Taxes are Coming
 Our clients have expressed concern over the mound of debt piling up in Washington. How are we going to pay down the deficit? Chances are tax rates will be going up on both the state and federal level. The concern for investors is…how do we save more and reduce the tax bite? The goal is to retire in a lifestyle that is consistent with one’s current standard of living. This is the challenge. It will be increasingly difficult to accumulate real wealth for retirement. The key is generating retirement income that is tax advantaged. How would you like to set up a retirement plan that looks like a ROTH IRA with no income limitations? The features include:
- Funding with after-tax dollars
- Assets accumulate tax deferred
- Retirement income can be accessed tax free
We consider this program a separate investment asset class that has no correlation to the stock and bond markets. Request a proposal to learn more about investing in today’s uncertain income tax environment.
More to the Roth...
Would you like to give more money to your children and your favorite cause at the same time? A Roth IRA conversion allows retirees to leave their IRAs largely untouched as an inheritance for their kids and grandkids. Retirees can avoid mandatory withdrawals each year by converting to a Roth IRA. Additionally beneficiary withdrawals are income-tax free. With these benefits there is a draw back. When you convert to a Roth, you have to pay income tax on assets you are moving from the traditional IRA. At financial planning forums we have heard many lively discussions on why the Roth conversion does not make sense. Paying taxes now is a definite while future growth is not guaranteed. Taxes should be paid from a separate taxable account. A strategy that swings the pendulum toward conversion is making an offsetting charitable contribution. You want income-tax deductions in the year you do the Roth conversion. If done correctly, the donation can reduce your tax bill. For more information on how to structure the trust or donor fund give us a call. (click here for Roth IRA conversion information.)
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 karpcapital.com.
If you have any questions on the analysis above, or would like to review your portfolio¹s performance, please call me at 877 900 Karp. Working with Karp Capital, there is only one boss, YOU!
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Peter Karp
Karp Capital Management Corporation
Registered Investment Advisor
2269 Chestnut St #308
San Francisco, CA 94123
P: (415) 345-8185 (F:(415) 869-2832
peter@karpcapital.com
karpcapital.com
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. Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of this report and are subject to change without notice. Such options and estimates, including forecast returns involve a number of assumptions that may not prove valid. Further, investments in international markets can be affected by a host of factors, including political or social conditions, diplomatic relations, limitations or removal of funds or assets or imposition of (or change in) exchange control or tax regulation in such markets. The past performance of securities or other investments does not necessarily indicate or predict future performance, and the value of investments and income arising there from can fall as well as rise; the investor may get back less than what was invested; and no assurance can be given that any portfolio or investment described herein would yield favorable investment results. We or our associated persons may act upon or use material in this report prior to publication. This document may not be reproduced or circulated without our written authority. |
