Download May 1, 2013

May 1, 2013
BLBB Quick Tip: Do you still have retirement accounts in your prior employers’ retirement plan? If so,
consider rolling these accounts into an IRA account. You will likely find it much easier to manage these
assets in one consolidated account and you should end up paying far lower annual fees. We can help you
with your rollover(s)!
DJIA 14700***NASDAQ 3299***S&P 500 1582
US equity markets continued their unrelenting upward trek this month – a move that began in November 2012. The S&P 500
and the Dow Jones Industrial Average both reached new all-time highs while the NASDAQ achieved heights not seen since
November 2000. As you can see in the below table, a number of the major US equity indices are now significantly higher than
the lows they recorded in March 2009.
S&P 500
DJIA
Nasdaq
March 2009 low
666
6469
1265
April 2013 high
1597
14887
3327
% change
+140%
+130%
+163%
While the positive momentum in US equity markets is greatly appreciated by investors, it is also somewhat unnerving as recent
US economic data does not appear to warrant or support the lofty levels where US equity indices currently trade. For example,
the first estimate of the US GDP growth for 1Q2013 was 2.5% – well above 4Q21012’s -0.1% growth rate but below the 3%
figure expected by economists. Also, much of the GDP growth in the 1st quarter was directly attributable to inventory
rebuilding following a drawdown in the 4th quarter of last year. If the temporary impact of inventory rebuilding is removed
from the equation, then 1st quarter US GDP growth was closer to just 1.5%.
To further compound matters, it looks like the US economy is now beginning to feel the effects of higher taxes ($259 billion+)
and government spending cuts ($85 billion). Construction spending fell again in March by 1.7% (following a 4% drop in
January). Although private residential construction rose by 0.4% in March, government construction fell by a whopping 4.1%
– the largest drop in eleven years. Recent job creation data has also been weaker than originally expected, causing some
economists to speculate whether the onset of onerous Obamacare costs is causing smaller employers to purposefully stay small
and encouraging larger employers to reduce full-time employee headcounts and rely instead on more part-time labor and
independent contractors. Retail sales also fell by 0.4% in March; suggesting US consumers are beginning to cut back on
spending due, in part, to the end of the Social Security tax holiday which resulted in smaller paychecks starting at the beginning of
the year. Finally, April’s US manufacturing data revealed only a modest level of expansion.
Overseas, economic data has also been somewhat disappointing. China recently reported slower than expected GDP growth
along with slower export and manufacturing growth. The German economy now appears to be feeling both the recession that
has been plaguing southern Europe and the sluggish demand for goods and services from China. Germany’s forecast for 2013
GDP growth is a paltry 0.5%.
In short, it looks like there may be a disconnect between US equity market performance and the realities of what looks to be
another year of sluggish economic growth. US economic data is not terrible by any means but it also is not great. It is simply
“ok”. Equity market performance, on the other hand, is far better than just “ok”. Year to date, the S&P 500 is up 11%, the
DJIA is up 12%, and the NASDAQ is up over 8%. As we see it, there are several likely reasons for this conundrum. First,
extremely accommodative central bank monetary policies around the globe are helping to fuel equity performance. The
Federal Reserve, for example, is currently purchasing $85 billion of fixed income securities each month and plans to do so for
an indefinite period of time. This quantitative easing effort is just one of several plans the Federal Reserve has employed over
the last six or so years to help stimulate economic activity in the US.
Each time the Federal Reserve has implemented quantitative easing efforts during this period, US equity markets have
responded positively. Thus, in a bizarre twist, every time disappointing US economic data is released US equity markets now
tend to respond positively because investors assume disappointing economic data means the Federal Reserve will continue to
pump money into the US economy. In early April, the Bank of Japan announced it will adopt policies similar to those used by
the US Federal Reserve in an attempt to jumpstart economic growth in Japan. In particular, the Bank of Japan plans to inject
$1.4 trillion into the Japanese economy over the next two years. This was also news US equity markets liked.
Of course, while accommodative monetary efforts around the globe are helping to support equity prices for now, this will not
always be the case. It is inevitable that at some point the Federal Reserve and other central banks will need to begin reigning in
their accommodative efforts and eventually even begin tightening monetary policy. While it is likely this process will not
begin before the end of this year, we remain mindful of how US equity markets performed over the last few years – the spring
swoons of 2011 and 2012 – when investors began to consider the possibility that this process might be underway in the not too
distant future.
Second, US equity markets are highly attractive to investors seeking yield in a mostly “yield-less” fixed income environment.
Many investors rely upon their investment portfolios for income generation. Traditionally, these investors looked to bonds,
CDs, and even money markets as a way to generate a steady stream of income into their portfolios. Over the last few years,
however, the flood of income once generated by these types of fixed-income securities has dwindled to a mere trickle thanks to
the Federal Reserve’s policy of maintaining the fed funds rate at 0% - 0.25%. As a result, investors are looking further afield for
income generation and many have settled upon dividend generating equities – particularly those in certain defensive sectors like
utilities and healthcare.
Third, for a long time, many investors have held relatively large amounts of money in cash, savings accounts, and money
market accounts. These were investors who experienced the dramatic plunge in US equity market values in 2008 – 2009 and
also possibly investors who experienced a similar equity downdraft in 2000 – 2002. Many of these investors were skittish and
not willing to put their money back into the equity markets for a long time – especially given all the political and regulatory
uncertainties that also plagued the country. However, as the US economy began to recover and then as the political
uncertainties began to ease, equity values improved. Investors began to breathe a little easier after the country made it through
a difficult presidential election, the expiration of the Bush tax cuts, a debt rating downgrade, the fiscal cliff, the debt ceiling
debate, and all the other “issues” of the last few years. We are now on the “other side” of many of these issues and investors
now appear willing to take on a little more risk in their investment portfolios. As a result, equities are back in favor.
As we look ahead to the remainder of this year, we are focused on how Congress will deal with the next debt ceiling limit
which will probably be hit at some point in the next 1 – 5 months depending upon federal government revenues and
expenditures. It is likely the debate surrounding this issue will center upon limiting federal spending and generating additional
revenues. We expect this debate could get heated. Also, we are mindful that additional taxes and/or further cuts in government
spending usually act as a drag on economic growth, at least in the short run.
We are also focused on US economic trends and what these may mean for Fed monetary policy going forward. It generally
takes about 3 – 6 months for a change in the Fed’s monetary policy to filter its way through and impact the US economy. Also,
because the Federal Reserve has no choice but to use backward looking economic data to ascertain future economic activity,
timing can be quite difficult. For now, inflation remains a non-issue thereby affording the Federal Reserve additional time to
employ accommodative monetary policies. However, if inflationary pressures return to the equation, the Federal Reserve will
have far less flexibility. It remains to be seen whether the highly accommodative policies will eventually result in excessive
inflation.
For now, we continue to focus on building well-diversified portfolios. For the equity portion of our portfolios, we look to wellseasoned companies with a long history of paying and increasing dividends. In terms of fixed-income, for now we prefer to
maintain a shorter duration stance and we are generally staying away from long-term (20-year plus) maturities.
NOTE: The information herein has been obtained from sources we believe to be reliable but is not guaranteed and does not purport to
be a complete statement of all material facts. This report is for informational purposes only.