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Maintaining Your Investing Discipline (When Others Aren’t)


The June swoon is upon us. In late May the Federal Reserve warned investors that they would begin to unwind the financial stimulus that they have added over the past five years at the end of 2013. Amid a new European recession, Chinese growth stagnation, suspect employment trends domestically and flat corporate earnings, investors view the quantitative easing measures by the Fed as a necessity for higher prices.

Against this backdrop, the Fed’s unwind announcement was equivalent to yelling “fire” in a crowded theater. Investors panicked at the thought of life without artificially inflated prices. As the panic spread Interest rates increased at a historically unprecedented pace, gold lost more than 20 percent and the stock market dropped close to 10 percent. As you check your accounts online or wait for the mail to come, you’ll feel it this month.

Even the most disciplined investment approach won’t completely insulate you from widespread market disruption like we have seen recently. Operating from a clearly defined investment process, though, should give you the opportunity to take advantage of other investors’ lack of discipline. Our investment process begins with a thorough analysis of the steady stream of economic and financial indicators. This analysis led us to reallocate our bond holdings from long maturity bonds to shorter maturity and adjustable rate bonds this spring. We also pared our exposure to stocks as earnings and profit margins came under pressure. In late June we reallocated money into some bond sectors that were down more than 10 percent. We remain very cautious on stocks until we see better news on earnings and profit margins.

We share our investment techniques in this column to help you define your own process. Our previous columns addressed many of the issues that investors panicked about in June. Being early isn’t fun or easy. You will second guess yourself, and, worse still, have to endure the talking heads on television telling you how wrong you are until you are proven right. At that point, you get the pleasure of using your discipline to make money from investors who lack it.

Panic is the moment disciplined investors wait for. Warren Buffet has become an investing legend this way. At the end of March his company had amassed more than $44 billion dollars in cash and his insurance (the majority of Berkshire Hathaway’s assets) subsidiary’s investment portfolio was 57 percent stock and 43 percent bonds and cash. It is safe to say that Warren was waiting for a day when prices were lower before he put that cash to work.


July 2013 Q2 Market Commentary

As the Federal Reserve considers its exit . . .

The key news events for June were the Federal Reserve (Fed) meeting and news conference, where Fed Chairman Ben Bernanke announced that he believed the real economy was improving. He also stated that members of the Fed Board of Governors had begun to consider the circumstances under which it would slow the pace of the central bank’s bond purchasing program.

Markets interpreted this as an announcement that the Fed would be no longer be supporting the economy, and they reacted accordingly. Interest rates rose, and stock prices fell. Subsequent announcements that a reduction in stimulus would not occur in the near-term were reassuring to investors. Both interest rates and markets recovered, though rates remained higher and markets lower by month-end.

The downward adjustment and subsequent partial recovery may reflect a growing understanding that the real economy is normalizing and that interest rate policies must do so as well. At the same time, the gradual withdrawal of the Fed from fixed income markets may require further pricing adjustments as overall demand drops.

. . . Volatility returns to markets . . .

The volatility that started in May continued in June. Equity markets ended the month down across the board, with the Dow Jones Industrial Average losing 1.25 percent, the S&P 500 Index losing 1.34 percent, and the Nasdaq losing 1.52 percent. Volatility persisted throughout the month, with multiple moves of more than 1 percent, both up and down. Price movements were particularly high at the end of the month, with a more than 5-percent drop in five days followed by an almost 3-percent recovery.

Even as stock prices have fluctuated recently, investors should feel good about returns this year. This has been the strongest first half for U.S. equity markets since 1998, with the S&P 500 returning 13.82 percent. In the second quarter, it rose 2.91 percent.


June 2013 Market Commentary

Strong May marred by volatility at the end

May was another strong month for the equity markets, with a total gain of 2.34 percent for the S&P 500 Index, 2.24 percent for the Dow Jones Industrial Average, and 3.82 percent for the Nasdaq. Both the S&P 500 and the Dow notched new all-time highs, but the positive results masked a great deal of intra-month volatility. The first weeks of the month showed almost uninterrupted increases, while the last week was quite volatile, with multiple daily gains and losses of more than 1 percent, in addition to a noteworthy sell-off on the final day of May.

Fundamentals were unchanged for the month, with no new earnings announcements. Valuations crept higher with the market itself, extending further above historical levels on a long-term basis and starting to rise above those levels on a short-term basis. Technicals remained relatively strong despite the month-end turbulence, with all indices well above their 50- and 200-day moving averages.

Equity market volatility was driven largely by comments from Federal Reserve (Fed) Chairman Ben Bernanke, who seemed to suggest in a May 22 appearance before Congress that the Fed might start to reduce its asset bond purchases much sooner than had been anticipated. This unexpected information led investors to reconsider future growth expectations.

Chairman Bernanke’s comments also caused volatility in the fixed income markets. The Barclays Capital Aggregate Bond Index lost 1.78 percent for the month, and 10-year U.S. Treasury yields rose from 1.66 percent to 2.16 percent (as referenced in Figure 1). The floating-rate bank loan sector was the only fixed income sector to post positive returns, and long-duration Treasuries and TIPS were hardest hit. International bonds, particularly emerging market debt, also underperformed.

Figure 1: 10-Year U.S. Treasury Yields, January 2013–May 2013

International stock markets significantly underperformed U.S. markets for the month, on both a relative and an absolute basis. Representing developed markets, the MSCI EAFE Index was down 2.41 percent. The MSCI Emerging Markets Index was down even more, losing 2.94 percent. Volatility came largely from Asia. Japan experienced very wide swings, with large gains in the first half of the month erased and turned into losses in the second half. Of the major emerging market stock markets, Brazilian equities in particular struggled, losing 7.11 percent of their value.


Proof that Financial Planning is at least 90% Behavioral Science

Despite an annual salary of $232,735 each year that he was Mayor of Los Angeles, Antonio Villaraigosa will be broke when he leaves his position at the end of June. Apparently he spent more time escorting Hollywood starlets down the red carpet than planning his future without a taxpayer funded bank account.

CBSLA.com reports that after earning more than 1.6 million dollars, the mayor has no savings. To maintain his current lifestyle when he leaves office, he will need to earn a salary of $750,000.

As you ponder Villaraigosa’s plight, consider your own efforts at becoming financial independent. It bears repeating, It’s not what you earn. It’s what you keep. Being smart of hard working is only part of the equation to financial independence. “Earning” and “keeping” require good decision making skills which bring us to behavioral science.

In our planning relationships, we spent the majority of our effort addressing, modifying and supplementing the behavioral tendencies of clients. This is an individualized and ongoing process that develops as clients learn successful behavior.

Villaraigosa was more focused on building relationships with political allies than with his financial planning fiduciary who could have steered him down a less stressful path. As Mayor, he holds fiduciary responsibility for the city’s finances. After examining his personal financial shortcomings, it shouldn’t surprise anyone that Villaraigosa’s Los Angeles budgets haven’t been any better. His stewardship of Los Angeles taxpayers funds created deficits every year despite tax revenues increasing from 6.6 billion dollars in 2006 to 7.2 billion in 2013.


Estate Taxes: Review, Revise, Rejoice, Regret, What to do?

In the flurry of fiscal cliff drama of early 2013, the estate tax situation became clearer, so we thought.  In short, estates under $5 million would escape federal estate taxation, and lifetime gifting limits remained at that same amount.  It was a surprisingly positive outcome on a tax issue which I was afraid would not escape scrutiny.  As with all else in Washington, it remained only to wait until the winds changed to dash those hopes.

President Obama’s new budget proposal seeks a return to previous limits and tax rates.  Specifically, the exemption limit would revert to $3.5 million, the top estate tax rate would increase to 45%, and lifetime gift limits would be reduced to $1 million.  But what could all of this mean for you?

If you remember further back to the early 2000’s, you may recall a time when the federal estate tax was triggered for estates over $675,000.  This quite often necessitated a complex series of trust planning to ensure that the maximum amount was sheltered for married couples, with adjustments for inheritance taxes imposed by states.  In 2012, the exemption amount of $5 million, along with the ability to preserve a spouse’s exemption made much of that earlier trust work unnecessary.

But with the estate and gift taxes “back on the table” in budget negotiations, it can be difficult to know what, if anything, should be done to update your specific estate plan.  Here are some considerations.

  1. If your estate plan ever included the various trust instruments necessary to minimize state and federal estate taxation, undoing them in favor of simpler instruments may be a mistake.
  2. If you have, or have been advised to consider gifting a portion of your estate to your heirs during your lifetime, you should revisit that now.
  3. Your annual financial checklist should always include a review of beneficiary designations for retirement accounts, insurance policies, and other investments.  They should be updated not just to reflect changes in your family, but also to correspond with the latest versions of your estate documents.

As with investments, taxes, and retirement; estate planning strategies should be part of a larger perspective that brings all of the financial aspects of your life together.

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