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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.


May 2013 Market Commentary

Markets strong as real economy slows

April was another month of strong equity performance, with the S&P 500 Index notching an all-time high toward month-end and with both the Dow Jones Industrials Average and the Nasdaq showing strong gains as well. The S&P 500 was up 1.93 percent, trailed slightly by the Dow at 1.94 percent and the Nasdaq at 1.88 percent.

Although markets dipped twice during the month as a result of disappointing economic news, stronger-than-expected earnings reports drove the markets back up as the month closed. With more than half of companies reporting, operating earnings per share grew 2 percent, in line with expectations, and roughly 70 percent of companies beat earnings expectations.

Despite the healthy earnings, corporate revenues were less encouraging, as more than half of companies missed top-line revenue expectations. Should this trend continue, equity valuations could come under pressure. Technically, markets were robust, with all three indices well above their 50- and 200-day moving averages, and no resistance levels above.

International markets also had a good month. The MSCI EAFE Index was up 5.19 percent, slightly better than the U.S. indices, and the MSCI Emerging Markets Index gained 0.66 percent. Developed international markets were spurred higher in April as a result of good news from a variety of sources. After two months of uncertainty, Italian politicians came to a compromise, electing Enrico Letta as their prime minister. Letta is known as a centrist and supporter of the European Union; his ascent led investors to buy Italian bonds, pushing the Italian 10-year yield to its lowest level in 30 months. Shockingly, Italian yields are now lower than they were in 2007, before the global financial crisis began (see chart). Portugal also took steps to become more market-friendly, announcing a plan to reduce corporate taxes.

Yield for Italy’s 10-Year Bond, 2007–2013


Source: Bloomberg

On the other side of the world, Japan’s central bank announced an unprecedented plan to double that nation’s monetary base in two years and put an end to the deflationary spiral that has plagued Japan for more than a decade. Meanwhile, the European Central Bank was poised to cut rates in early May, a move supportive of stocks and risky bonds.

April was also positive for fixed income investors. The Barclays Capital Aggregate Bond Index returned 1.01 percent for the month. Longer-duration bonds performed quite well, as the 10-year U.S. Treasury yield fell, from 1.84 percent to 1.673 percent. Weaker-than-anticipated economic releases, combined with continued low inflation, reassured investors that the Federal Reserve is unlikely to discontinue its easing program in the near future. International bonds performed particularly well, as foreign currencies bounced back against the dollar.

Financial markets diverge from real economy

Although performance for the financial markets was hearty in April, the real economy showed signs of a slowdown. Only 88,000 jobs were added in the U.S., well below the 268,000 new jobs reported for the month before. Weak durable goods orders also signaled a spring slowdown, and the reported gross domestic product (GDP) growth of 2.5 percent for the first quarter was somewhat below expectations. Consumer spending and business investment were the primary drivers of growth, but reduced government spending slowed the expansion.

Despite the disappointing jobs report, total labor demand stayed strong. According to the Ned Davis Research Group, the number of hours worked has increased at a level equivalent with having added 328,000 more jobs to the workforce. This suggests that overall demand is healthy, but that companies are reluctant to hire new workers. This is also consistent with the lower confidence reported by business surveys.

Consumer demand was vigorous early in the first quarter but slowed significantly toward quarter-end, with a decline in retail sales for March offsetting strong gains in previous months. In addition, although the University of Michigan Consumer Sentiment Index fell early in April, the Conference Board Consumer Confidence Index rose later in the month. This reflected the fickle nature of consumers, whose net worth has risen because of home and stock market values, but whose short-term purchasing power has been affected by taxes and gas prices.

Housing has been particularly positive for consumers. The S&P/Case-Shiller 20-City Home Price Index most recently reported a 9.32-percent gain year-over-year, as prices climbed and demand outstripped supply.

The decline in government spending continued in April—and indeed likely accelerated. In fact, during the first quarter, government spending decreased roughly 4.2 percent on an annualized basis—or 0.8 percent of GDP—according to Capital Economics. This figure was not inclusive of the sequester cuts, which came fully into effect at the beginning of April.

The economic impact of the sequester cuts is not yet known, as it will take time for them to trickle into the economy. So far, however, markets have not reacted negatively to budget downsizing. The positive side of this is that the decrease in government spending is narrowing the deficit, which is projected to come close to stabilizing in 2014. On that note, at the end of April, the U.S. Department of the Treasury announced that it actually expects to pay down federal government debt in the second quarter. If this were to pan out, it would be the first quarter during which federal debt has fallen in six years.

Risks around the world persist

A variety of possible risks surfaced in April. Notwithstanding the good news from Italy and Portugal, the European economy continued to stagnate, as Slovenia and other countries struggled to stabilize their banking systems. North Korea kept on rattling its cage, and several countries confirmed that Syria had used chemical weapons. If such use is deemed to have been widespread, this could spur an intervention by the U.S. and its allies. None of these risks appears to pose an imminent threat to markets, but they should be followed carefully.

Recovery moves along but at a slower pace

The U.S. economy continues its recovery, although the pace looks likely to slow into the second quarter. U.S. corporations also keep posting impressive profits, but growth may not be as significant going forward. Markets appear to be pricing in an optimistic future, but, if this scenario does not play out as expected, equity market revaluation could lower levels. In short, although there are many reasons for optimism, investors should keep in mind their personal risk tolerance and allocate capital prudently, with an eye toward long-term goals.

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.
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