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February 2013 Market Commentary

Markets take a roller-coaster ride

After a strong January, the markets started February in much the same way but ran into trouble in the middle of the month. In the end, U.S. markets still finished in the black, although international markets were not as lucky. The S&P 500 Index rose 1.36 percent, closing at 1,514, somewhat below its mid-month high of 1,530 but well above its low of 1,487. The wide swings reflected investor recognition of the continuing risks in Europe and in Washington, DC. The results of the Italian elections, pending sequester spending cuts, and uncertainty surrounding the recent Federal Open Market Committee (FOMC) meeting minutes all contributed to the volatility. 

U.S. corporate earnings remained strong, with about two-thirds of S&P 500 companies beating expectations and about one-fourth of them missing the mark, which was in line with previous quarters. Valuations continued high based on longer-term metrics, but they also appeared fair based on shorter-term metrics. Given the rise in valuations, investors will likely begin to look to earnings growth rather than multiple expansions as a source for continued stock gains.

Technically, the S&P 500 remained above its 50- and 200-day moving averages, and, despite the dips in the middle of the month, there doesn't seem to be any technical reason to expect a decline. There does, however, appear to be a resistance level at 1,565, the index's high-water mark, which it reached in 2007, suggesting that future gains might be challenging. As of month-end, the S&P 500 was only 3.4 percent below its 2007 high.

International markets got hit harder than U.S. markets, reflecting their greater exposure to European political and economic problems. The MSCI EAFE Index posted a loss of 0.95 percent for the month, while the MSCI Emerging Markets Index declined even more, losing 1.35 percent. Among the factors affecting foreign markets were the results of the Italian elections, which were interpreted as a vote against the country's austerity-based economic stabilization plan. This raised the possibility that the eurozone might face another political crisis.

Events in Asia also contributed to weak performance in the international markets. The Japanese plan to boost inflation and weaken its currency pushed the Nikkei average higher. China, however, led emerging markets downward, as manufacturing slowed and investors worried about central government efforts to contain property prices. Temporarily, both the MSCI EAFE and the Emerging Markets indices fell below their 50-day moving averages. Although both bounced back, this suggests that further weakness is possible.


January 2013 Market Commentary

Off to a great start

January got the year off to a great start. The S&P 500 Index was up 5.18 percent, and the Dow Jones Industrial Average climbed 5.91 percent. The perceived successful resolution of the fiscal cliff sparked the best January market performance since 1997. The beaten-down energy sector led markets upward, while the technology sector lagged. The S&P 500 ended the month only about 2 percent below its 2007 peak, having posted double-digit returns in three of the past four years.

The strong market action continued on good corporate earnings data and in spite of mildly disappointing revenue results. As of the most recent data, 71 percent of S&P 500 companies beat earnings expectations in the fourth quarter of 2012, but only 43 percent beat on revenues. Since late 2009, when nearly 80 percent of companies beat earnings estimates, the trend has been downward. According to Bloomberg, only 64 percent of companies beat in the third quarter. So the possible rebound to 71 percent may be another reason why investors have been optimistic.
Technically, equity markets show signs of continued strength. The S&P 500 remains above both its 50- and 200-day moving averages and briefly crossed a key price level of 1,500. Other technical market factors are also positive. The strong performance of the Dow Jones Transportation Average and the breadth of stock price appreciation suggest that bullish investors are enjoying significant momentum.
Developed international markets beat U.S. markets, but emerging markets lagged. The MSCI EAFE Index rose 5.27 percent, and the MSCI Emerging Markets Index returned 1.31 percent on a price basis for the month. Given the diversity of markets and economies included in these indices, it is difficult to draw general conclusions. It does appear, however, that continued economic recovery and the reduction in political uncertainty have made the U.S. and developed markets relatively more attractive.
Value stocks outperformed growth stocks across the globe, and European peripheral countries such as Italy and Portugal were top performers. Analysts expect European gross domestic product (GDP) to contract 0.1 percent in 2013, but investor spirits continue to be buoyed by the European Central Bank’s pledge to buy sovereign debt if necessary.
Technically, the MSCI EAFE and Emerging Markets indices remain above their 50- and 200-day moving averages, though the emerging markets benchmark is getting close to its 50-day, suggesting an erosion of investor confidence.

The Grinch has Already Stolen Christmas

Just as shoppers are putting away Christmas decorations and paying the credit card bills from last year’s holiday gifts, they have less money in the bank to pay their bills.  According to a recent Gallup poll, most consumers planned to spend $770 during the holiday season, slightly more than they spent in 2011.

In 2009, President Obama advocated for a two percent reduction in employee payroll taxes to ease the economic burden on working families.  Workers have enjoyed the extra take-home pay since Congress passed that tax cut into law.  But as folks opened their pay stubs in the first weeks of this year, they noticed their checks were smaller.  Although Congress voted and the President signed the bill to keep many tax cuts in place for middle-class Americans, they actually raised taxes on the majority of workers by allowing the payroll tax cut to expire.

By raising the payroll tax withholding from 4.2 to 6.2 percent, a worker making $50,000 a year will pay an additional $1,000 in taxes.  That’s $83 a month that will go to the government instead of putting that money into their gas tank or saving it for next Christmas. The Grinch has shown up well before Christmas Eve 2013, and will most likely have a significant impact on consumer’s ability to spend money.   Take a moment to assess what your family spent on holiday gifts, meals and travel last year.  Will your plans this December be different after you’ve looked at your January paycheck?

This month-long tax hike began in January and affects all wage earning workers regardless of their incomes. The financial pain isn’t as immediate, but having 2 percent less in each paycheck may force consumers to make choices and forgo purchases.   It has the potential to significantly constrict economic growth.  With the debt ceiling debate in Washington in a matter of weeks, tepid corporate earnings and fragile economic data, these tax increases could lead the economy back into recession.


The product of a nation overburdened by welfare entitlements

This is from the Congressional Budget Office

What Caused Total Spending on Means-Tested Programs and Tax Credits to Rise Over the Past 40 Years?

Two broad factors were responsible for the growth of spending on means-tested programs and tax credits between 1972 and 2011: increases in the number of people participating in those programs and increases in spending per participant. (This discussion focuses on the 40-year period ending in 2011 because that is the most recent year for which data on the number of participants are available for those programs.) Both of those increases were themselves the result of multiple factors. For example, the rise in participation stemmed from three important causes:

  • Population growth (the U.S. population increased by almost 50 percent during that period),
  • Changes in economic conditions (particularly the recession that occurred from 2007 to 2009 and the weak recovery that followed it), and
  • Actions by lawmakers to create new means-tested programs and tax credits and to expand eligibility for some existing ones.

Increases in spending per participant resulted mainly from two factors:

  • Growth in the cost of providing assistance (such as rising costs for medical care), and
  • Actions by lawmakers to provide more generous benefits (such as increases in SNAP benefits).


In their recent research piece, 3D Hurricane, Research Affiliates calculates Structural GDP which factors in unsustainable growth derived from debt.



And compares our debt to other countries:



Facing the Fiscal Cliff

We all have a higher authority to answer to. While voters spoke in November by reaffirming divided leadership, the government must ultimately answer to whoever finances our debt and deficits.

In August 2010, Joint Chiefs of Staff Chairman Admiral Mike Mullen declared that our debt is our largest national threat. Standard and Poor’s brought the issue back into focus when they downgraded the country’s credit rating in August of 2011. But with the cost to borrow money for 10 years at 1.65 percent, the market doesn’t appear worried about our national debt.

Eventually, the market may force the government to a workable solution by increasing interest rates on our debt.

We owe 1.6 trillion dollars to China, 1.1 trillion to Japan, 242 billion to Brazil, 191 billion to Taiwan, and 165 billion to Switzerland. For now, these countries are eager to own a large amount of our debt paying nearly zero interest. While lawmakers have legal and moral obligations to citizens, they have a financial obligation to debt holders.

These countries are the bull elephants that could easily start a Greek-like stampede out of Treasury debt. Stampedes are irrational, binary events. They happen fast and are unpredictable. Lawmakers must act rationally now to prevent an irrational market force.

Aging demographics in Japan and China will eventually force them to dip into their respective reserves (3 trillion dollars in China). As their citizenry ages, Japan and China will likely need to offer some sort of social safety net to their citizens. In 10 years, Japan will move from a net saver to a net spender, forcing them to sell their U.S. Government debt to finance these expenditures.

We need a plan to pay off our debt ahead of these massive demographic shifts.

What will work? Our one-trillion dollar annual deficit cannot be closed by higher taxes alone. We have to cut discretionary spending, which accounts for around 35 percent of the Federal budget. The rest is defense and entitlements. The right solution is one that shares the burden on both the spending and tax side.  

Healthcare advances are extending our longevity, and the work we typically do is more service-based than the back-breaking manual labor jobs of the industrial revolution. Our long-term debt solution will likely mean we work until 70 or longer before receiving government benefits.

As the largest economy on the planet, we have more time to find a solution than Greece or Spain, but we need to do so quickly. Without compromise by both parties, we will not fix the debt problem.



There Goes the Neighborhood

After the recession, homeownership has declined to near 50-year lows. Multi-family (i.e. apartments) housing starts jumped dramatically in October while single family starts declined. This can create a variety of difficult-to-solve problems for the dwindling group of owners. These problems stem from the same basic element—rental occupants aren’t making a long-term commitment which allows them to save money in the short run.

What motivation would a short-term renter have in repainting their rented space or keeping their yard in tip-top shape? If you found out that a used car you are considering was part of a rental fleet you would mark it off your buyers list because of the likelihood of abuse.

Owners have committed more time and financial resources to their purchases and therefore have more at stake. They have an incentive to exercise greater care for their purchase than a renter.  

Unfortunately, the same dynamics have surged into investment markets since 2008. The current crop of brokerage advertisements displays a similar theme. Everyone has tools to help you be a better trader. One ad even shows a guy trading on his phone while waiting to pick his kid up from the school bus stop. 

Trading isn’t ownership, it is renting. Traders place short-term bets on the table and are ready to close them out in days, if not minutes. In their quest for short-term profits, traders can bet on price increases or price decreases (short selling). Traders who use leverage in its various forms are trying to gain the benefits of ownership without the financial commitment of a long-term investor.

If you are the latter, consider how this impacts your investing “neighborhood.”  As you patiently build your investment account or 401K around reliable long-term holdings, these short-term renters are undermining your efforts by creating price uncertainty. They thrive on market volatility because it gives them more opportunities to profitably trade in and out of a position.

Long-term investors need to acknowledge the effects of short-term trading on their long-term holdings and adapt their investment philosophy to accommodate higher volatility. At LeConte Wealth Management, we use broad market exposure, sector valuation analysis and economic trend analysis to reduce risk and rebalance our client portfolios.

The notion of “buy and hold” turns a blind eye to the risks inherent in today’s trader-driven markets.


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