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Keeping the Fed in Perspective

It’s been a big week! But don’t lose focus on the long term.

Too many people are making a big deal over the Fed’s announcement earlier this week, resulting in traders kicking up a lot of dust in the markets and the talking heads dissecting the meaning of the announcement.  Let’s keep a few things in perspective:

1) Nothing substantially new was stated except that the Fed’s bond buying may begin to taper off at the end of this year as opposed to early next year.

2) This was not unexpected news. This was already hinted at a few weeks prior. We already knew this.

3) The life support, QE3, or Fed’s efforts to help the economy must end someday.  Did everyone forget that it was bound to happen?

4) Bernanke even stated that any policy changes would be contingent upon the economy’s CONTINUED growth.  As the economy strengthens and can stand on its own, the Fed would reduce aid accordingly.  And at that time, shouldn’t it be celebrated rather than shunned?
There is some volatility in the markets as a result this announcement.  It may continue for a while. Is it a little speed bump or is it the sign of something more?  We will wait for the dust to settle to see where things stand. We may see opportunities as the market rebounds.

Why is my portfolio lagging the stock market?

We’ve fielded a few phone calls from clients in the past few weeks confused about why their statements are not reflecting the same rate of return of the S&P 500 which they’re hearing about in the news.

We’re not surprised by the observation.

The S&P 500 has been having a banner year so far! US equities have been our best performing asset class. Actually, it’s one of the few asset classes that has maintained a positive trend over the last few months. While almost all other asset classes have been struggling to show any gains, such as commodities, bonds, real estate, and some foreign holdings, the US equity market has been surging ahead.

It’s as if the US equities were the last ones at the party and didn’t notice that everyone else left the room until the music was shut off!

You are correct. Your portfolio is not reflective of what you see in the headlines, and has not surged ahead like the US equities as measured by the S&P 500. But, then again would you want a portfolio consisting only of US stocks? What if the Fed raised interest rates or stopped buying up bonds? Would you be fearful that a market correction could occur, wiping away all of your gains (or most of them)?

In effect, a portfolio consisting too much of any asset class would be, as a result, taking on excess risk. We work with our clients to diversify their portfolios to lower risk and volatility. In case some asset class declines, the other asset classes can support the ones in declines. We are maintaining diverse portfolios for our clients in order to spread risk out and try to minimize volatility.

Up is Up

The stock market is running. The economy … not so much. So what is going on?

A quote I wrote down months ago (but not the author). It sums it up:

“we expect robust flows … to dominate fundamentals.”

In a perfect world one invests in the stocks of well-managed companies that are growing sales and earnings in a sound and strong economy. However, this bull market is not that. Yes, well-managed companies are growing sales and earnings. Yes, the price of the stock market relative to its underlying earnings, although rich, is not excessive. However, it is not a sound and strong economy.

What is driving this market is: liquidity.

“Credit is super-abundant and stock market behavior is conditioned not so much by the fundamental performance of its underlying companies but by increasing doses of monetary Ritalin.” (link)

Our Federal Reserve is pushing a reported $85 billion of newly created cash in the banking system every month and dropping interest rates to near zero. Much of this new cash is buying stocks. Also, savers that are faced with near zero CD rates, are searching for some return and buying dividend stocks.

Furthermore, the European Central Bank appears to be no longer backstopping their citizen’s bank deposits. Money is moving out of Europe and finding a home here (Link). Japan with its aggressive yen devaluation plan is also a benefit to our stock market (Link).

Robust inflows of cash are driving this stock market higher without concern for the economic uncertainty all around us. The psychology of Birinyi’s bull market cycle is in full swing (see below). The stock market is running. Up is up.

Is There Growing Optimism in US Economy?

For the last few weeks, we’ve all been distracted with important issues. To name a few, completing tax returns, listening to the debate on guns, and following the news on the rising tensions in North Korea.

If you think back, you may have missed a headline about the Dow Jones Industrial Average breaking its all-time high. That happened on March 5th, a little less than 2 months ago. It’s a worthy milestone to reach. But what does that mean for your investments or the future?

Everyone has an opinion. When asked “What do you see happening next in the economy”, a well respected economist responded “If I had a crystal ball and knew the answer to that question, I wouldn’t be here. I’d be sitting on the beach.” Some look at this event and say that we’ve reached a high water mark and that we should expect to see the market decline. Others look at this and see it as an indication that the bull market is continuing along. Is the glass half empty or half full? Are you optimistic or pessimistic about the future?

We continue to be optimistic in our approach. We see the looming clouds as bumps and obstacles, but not significant enough to derail the recovery. We see issue after issue being wrestled with and slowly pushed down the road, resulting in near-term clarity, but few long-term solutions

If you’re on the fence, not sure what to make of this recovery, the following link offers a great case for being optimistic about the future.

The Case for Optimism


Recap of a Letter Written Before the Election

The following comment was included in the newsletter we sent to our clients at the end of September. It was written during a period where many were unsure how the election would affect their portfolio.

“It’s actually been a pretty good year for most investors. So here we are about 45 days away from the election, and it appears to me, with the recent surge (both US and global), that the markets are picking up steam.

What explains this improvement, considering the dark clouds apparently forming? Could it be possible that the markets would actually strengthen after the election, regardless of who wins it, simply because one huge uncertainty will have been removed? We’re already at the point where, here in the US, corporate earnings, cash flows, cash positions, and dividend yields are all near record levels.

How did this happen when the investor class is full of dread (a looming fiscal cliff or taxmageddon are being discussed by the talking heads all the time)? Can the gulf of relative value between the US bond market and the US stock market, which has been growing almost unabated for 30 years, grow still wider? Or, could it be that John Templeton is right again, and that it is exactly in times like these that bull markets are born?

I don’t discount the volatility that comes with the cyclic nature of the economy, especially one impacted by globalization. The tough months / quarters / years happen for all sorts of reasons and will probably continue. But there are great companies out there that will continue to sell mass quantities of cola, diapers, and the hottest cell phone, and sell those around the world, even if Greece leaves the Euro, or Spain defaults, or if the wrong person wins the presidential election.”