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Transcript
Seaton Financial Advisors, LLC
Seaton Financial Advisors, LLC
E-Newsletter
2011 Year-End Review
It was a difficult year for US Stock investors, a horrible year for foreign stock investors and a good year for bond
investors. The Natural Resource category was a mixed bag with gold notching its 11th straight year of positive returns
and energy squeezing out a modest gain. However, silver, industrial materials and agriculture all suffered losses as
investors feared recession on a global scale. Europe’s debt crisis was the overwhelming factor driving market prices in
2011 with political corruption/incompetence a close, and important, second. Volatility was very high as investors
reacted to headline political news every time a European bureaucrat made a new pronouncement. The following chart
gives a visual idea of the U S stock volatility by plotting the S&P500 (blue line) against a diversified bond fund (yellow
line):
You can see it was late summer when the wheels fell off of the stock market and it took the rest of the year to struggle
back to “even”. This chart is also a good illustration of the value of bonds in a portfolio to dampen volatility.
Following is a brief review of each of the 5 major asset categories:
US Equity
Although the US economy was terrible on an absolute basis, relative to the rest of the world our economy did quite well
(like being the best looking horse in the glue factory). Coupled with the success our multi-national companies (think
Coke, Exxon, JNJ, etc) enjoyed in foreign markets, the US equity market managed to squeak out a small gain for the year
(S&P500 total return was 1.9%, almost all due to dividends). Large companies did better than mid and small sized
companies which isn’t unusual in a slow growth economy. The mid-sized company index fund (VO) lost 2% while the
small company index fund (VB) lost 2.8%.
Another way to seek understanding of the US stock market is by looking at “sectors”. Following is the 2011 total return
performance of the 9 sectors that comprise the S&P500:
% Return
19.5
14.1
12.4
6.0
2.9
Symbol
XLU
XLP
XLV
XLY
XLE
Sector Description
Utilities
Consumer Staples (food, clothing, etc)
Health Care
Consumer Discretionary (automobiles, restaurants, retail)
Energy (oil and natural gas)
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2.6
-1.1
-10.7
-17.1
XLK
XLI
XLB
XLF
Information Technology (computers and internet services)
Industrials (manufacturing, transportation, construction)
Materials (industrial metals, chemicals and forestry products)
Financials (banks, insurance, brokerage companies)
The out-performance of the “safe” sectors is an indication that investors think we are in a recession or that one is
imminent. Not surprisingly, the financial sector performed the worst as investors fear the coming effects of sovereign
country defaults (Greece, Spain, Portugal, Italy, et.al.). Within the financial sector, Bank of America lost an incredible
58% which is a good example of why it’s not good to place too much of your money in any single stock.
Finally, the stocks of companies with strong dividend track records performed well in 2011 as investors sought safety
and strength. Returns in the 6 to 10% range were generated by the most widely held exchange traded funds that focus
on dividend-paying companies.
Foreign Equity
2011 was a painful year for investors in the stocks of foreign companies. The stocks of companies in foreign developed
markets (Europe, Australia, Japan, etc.) declined 12.2% as measured by the EFA fund. This abysmal performance was
heavily influenced by the debt problems in Europe. The stocks of companies in emerging markets (China, Russia, India,
Brazil, etc.) fared even worse, declining 18.8% as measured by the EEM fund. Even though the economic growth in
most of these emerging markets was excellent, investors feared that the forecasted economic slowdown in the
industrialized nations would soon hurt the export businesses of the emerging economies. Also, China has a huge local
debt and housing bubble problem that could constrain future growth. The Chinese stock market lost 17.5% in 2011 in
spite of a “reported” GDP growth over 9%. By comparison, the US GDP growth rate for 2011 will be under 2%.
Natural Resources
There is no widely accepted common definition of which particular assets comprise this category. Following are the
assets that I include in this category along with their 2011 performance numbers:
% Return
9.6
-10.7
2.8
-9.5
-11.4
Symbol
GLD
SLV
VDE
VAW
MOO
Description
Precious Metals (gold bullion)
Precious Metals (silver bullion)
Energy (companies engaged in energy exploration, extraction, and refining)
Industrial Materials (companies in the chemicals and metals industry)
Agriculture (companies that support farming)
Gold continued to perform well as investors worried about the sovereign debt problem and the devaluation of
currencies.
Silver is actually a “hybrid” metal because it has value as a precious metal (similar to gold) and as an industrial metal
(heavy usage in solar panels, electronics and medical devices). The decline in silver was due to the concern that
continuing worldwide recession will reduce the demand for silver from the industrial sector. Also, the price of silver is
heavily manipulated by a handful of large institutions (large banks) which contribute to the very high price volatility.
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Agriculture and Industrial Materials declines, similar to silver, were driven by recession concerns.
Energy managed a positive return in spite of recession concerns primarily due to the continuing unrest in the Middle
East.
Bonds
The bond market out-performed equities again as investors continued to seek protection from the possibility of a
calamity in Europe. The bond market is diverse and more complicated than the stock market. Although bonds usually
provide greater protection of principal than stocks, bond prices are vulnerable to interest rate spikes, particularly when
interest rates are at historic lows, as they are today. Also, if yields are lower than inflation, bond investors may lose
purchasing power. Following is the 2011 performance of the major bond categories:
US Treasury
Municipals
Corporates
Short term
1.4%
1.6%
1.7%
Inflation Protected
Medium term
8.2%
12.7%
5.5%
13.3%
The three short-term bond funds all achieved about the same return which is slightly less than the rate of inflation.
Medium term treasuries and corporate bonds produced returns well above inflation as medium term interest rates
moved sideways or down (which increases the value of bonds). US Treasury out-performed corporate bonds due to the
“safe haven” status treasuries still enjoy in the marketplace (particularly globally).
Municipal bonds did extremely well because they had over-corrected to the downside at the end of 2010 based on
widespread fears of State and local government defaults. When those fears subsided in 2011, the bond prices
responded accordingly.
“Inflation protected” bonds also performed very well as investors sought a hedge against future inflation.
Cash
Short term interest rates were kept artificially low by the Fed in order to assist banks in earning profits to shore up their
balance sheets (the bailouts are never-ending). This resulted in interest rates on savings accounts, CDs and money
market accounts being very close to zero. While these low rates were painful for investors, cash can still play an
important role in a diversified portfolio strategy primarily as a risk reduction tool.
Looking Ahead
The world’s biggest problem continues to be excessive debt followed closely by government incompetence/corruption.
Neither of these will be solved in 2012 and there’s a good chance they will both worsen. However, if Europe can
postpone a massive debt re-structure for another year, China’s debt- fueled growth doesn’t grind to a halt and we avoid
a war in the Middle East, then the US Stock market could have a much better year than in 2011. Just as in 2011, I think
the downside risks in 2012 are greater than the upside potential so I still recommend emphasizing safety over growth.
The issue is the heavyweight fight between the forces that lead to deflation (high unemployment, sovereign and
consumer debt, government policies that stifle growth) and the force that leads to inflation (printing money to mask and
postpone the pain of too much debt). My view is that the inflationary forces will ultimately win the battle but it may
take a while. In the interim, it’s important to preserve sufficient capital so that you can take advantage of the future
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opportunities after the dust has settled. For US equities, this means maintaining an allocation on the lower end of your
strategic allocation range and favoring large companies with strong cash flows and a history of growing dividends. I
continue to believe foreign equities remain too risky at least for the near term. At some point, selected emerging
markets will be attractive again, especially for long term investors. Natural resources continue to be a mixed bag.
Because I believe currency devaluation is the end game, it’s important to have a meaningful allocation to precious
metals even though they may continue to be volatile. Energy is also important due to the instability of the world’s
suppliers and the constraints of domestic environmental regulations. Agriculture is still a good long term play but is
affected by so many variables that conservative investors may wish to tread lightly.
Bonds present perhaps the biggest investment challenge. With no way to know where interest rates are headed, at
least in the near term, it’s difficult to craft a strategy that carefully balances yield and risk. I think the recipe includes
three ingredients: short term bonds, intermediate bonds and inflation protected bonds. The precise mix of these three
bond categories will vary depending on each investor’s time horizon and appetite for risk.
Cash plays a very important role in any investment strategy even though it often has a negative return after inflation.
Cash provides an important buffer against potential losses in the equity and/or bond markets and allows investors to be
positioned to take advantage of investment opportunities after major market declines. Given the current level of
uncertainty in global economies and financial markets, a meaningful allocation to cash is probably prudent.
I hope you have a happy and prosperous 2012! Let me know if I can be of any assistance.
Terry