Perspectives

In a matter of days, Coronavirus has grown from a modest concern to one that has impacted the day to day routine of almost every American. Schools are shutting, events canceled, weddings postponed, countries are closing their borders and the stock market, our economic barometer, has been under significant pressure. With the S&P officially entering Bear territory ending an 11 year expansion, the feeling is one of fear and pessimism.

The decision to retire is one of those milestone events that we work towards our entire life, but as that critical date draws near, questions begin to surface. Will I have enough money? Where will my income come from? Do I have a budget and do I know what it costs me to live? What about inflation? When do I draw Social Security and sign up for Medicare? Will I know what to do with my free time or do I risk becoming irrelevant? What if I become incapacitated and I can't handle my own affairs?

In what has been described as the least fun bull market in history, the market is taking a pause as we ricochet from one new Washington policy proposal to the next. I’m constantly asked how long it will last and whether the rally is for real? While I will distance myself from the third rail of political commentary I have no problem with watching account values increase. That’s as real as it gets! It also appears that the Fed is finally beginning to move in a more deliberate fashion towards a higher interest rate policy. The most recent rate increase which happened on March 15th was met with positive market response, up 112 points on the Dow. Maybe the fears of Fed tightening were unfounded, or maybe it’s the fact that Wall Street has been predicting these increases for the past four years in what we refer to as “the worst kept secret on Wall Street”. The bottom line is that the economy is improving, business optimism is high and interest rate increases are the response. So good news is bad news is good news… go figure!

Equity markets are stuck in a narrow trading band, with high volatility and a palatable degree of uncertainty. Bond yields across the globe have turned negative; in fact Switzerland bond yields are negative from the shortest maturity through thirty years. Imagine paying the government to hold your money for thirty years instead of them paying you! If this isn’t a sign of extreme overvaluation in the bond market then I’ve never seen one. US treasuries, even at the current anemic levels look like a bargain to global investors when you factor in security and a high degree of liquidity. It’s important to keep in mind that institutional investors have very different objectives than retail investors. Retail investors seldom have to be concerned with the problem of moving billions of dollars through the financial system and where negative rates might be acceptable for an institution looking to park funds short term, it is unlikely they will be acceptable to all but the most pessimistic retail investor. Retail buyers have been replacing low fixed income yields with dividends, one of the reasons why higher yielding dividend stocks like utilities and telecoms, as well as other dividend-oriented products, have been doing so well recently. While dividend stocks are expensive by historical measures, they look positively cheap when you compare the yields to fixed income.

Wall Street is abuzz with a plethora of new digital “Robo” solutions for the investing public. The aim of these new high-tech offerings is to eliminate the middleman and drive down cost with the ultimate objective of controlling the investment assets. Robo has significant appeal to Millennials who are just beginning to accumulate their own net worth. Robo solutions offer increased mobile access and “go anywhere” solutions; a millennial dream. But let’s take this discussion a bit deeper and ask ourselves what the Robo solution truly adds, and if this “revolutionary” new trend really is revolutionary.

If you are fortunate enough to have the financial capacity to gift, your generosity may not always be received in the manner in which it was intended. In the paragraphs that follow, I will discuss some of the intricacies of gifting and the challenges that may arise. The decision to gift may be prompted by a desire to help another individual;

On Thursday, May 6th at 8:27 a.m., friend and client Joe Harris, aboard his 40 foot sailboat the Gryphon Solo 2 crossed the finish line in Newport Rhode Island, completing his solo around the world sailing adventure. While Joe wasn’t able to set the world speed record of 137 days, this accomplishment puts Joe in the rarefied company of less than 100 individuals to ever complete a solo circumnavigation.

Next week I travel to California with my wife to celebrate our son Alan’s wedding. Yes, this is the same son about whom I’ve written over the years, the one who went to his first job interview in wrinkled cargo pants and Doc Martens (he didn’t get that job), graduated from the University of Virginia, went onto a successful career in finance, and most recently has co-founded a start-up company. It seems only yesterday that he and his sister were in the woods building forts or on the ski slopes racing me to the bottom of the slope. This is one of those defining moments in our life and surely his as well, and Martha and I are really looking forward to this gala event. He and his fiancée couldn’t be more perfect together, and I’m excited about their future.

I read an interesting article in the Wall Street Journal last week entitled "Upshot of Domestic Oil Boom: Fewer Shocks." The gist of the article was that due to advanced technologies such as hydraulic fracking, the United States has boosted US crude oil production by 47% since late 2010. 47%! Domestic oil production in October surpassed imports for the first time in two decades. Canada has also made significant gains in oil production, and now the US imports about as much oil from Canada as all of the OPEC exporting countries combined.

Cash flow and income-generating investments continue to draw capital, as evidenced by the rally in the bond market and significant outperformance of high-dividend-paying stocks. It only makes sense given the demographics and the increasing number of individuals and pension funds that depend on the income they produce. I’m particularly intrigued by the noticeable increase in interest in tax-exempt bonds due in no small part to the recent tax increases.

I just returned from a trip to Newport Beach, California, where I had the chance to spend three days at the PIMCO headquarters and listen to presentations from a dozen or so portfolio managers. As you may be aware, PIMCO has been front-page news recently due to the recent announcement of the departure of its co-CIO, Mohammed El-Erian. This comes on the heels of news that PIMCO had record outflows in 2013 (Reuters Jan 3, 2014). I thought that it was important for me to hear the message directly rather than through the eyes of the media. I wanted to share with you some of my observations and opinions that have resulted from this experience with PIMCO.

This morning my daughter sent me an email describing a strategy that one young mother devised for teaching her children to be responsible. The letter went something like this

2013 proved to be better than even the most optimistic of forecasts. The combination of increased consumer confidence, an improved housing market, support from the Fed, and outflows from the bond market focused cash flows squarely on the equity market. The United States is leading the global recovery, anemic as that recovery may be, and funds from all over the world are flowing in our direction. By all indications, these flows should continue into 2014 and with luck, continue boosting both the stock market and the US dollar. What gives me confidence is that valuations still appear to be reasonable, and optimism, while improving, is still tempered. Also, there are still plenty of skeptics as well as a significant amount of cash on the sidelines, and potentially more cash coming out of the bond market. The stock market may win by default (a phrase we never use when describing the bond market!).

Whispers of a Fed tapering sent the bond market into a tailspin. In what may have been the most anticipated sell-off in bond market history, many firms (including our own) predicted the move as much as two years ago. The takeaway is this: Bonds have benefited from a tailwind for the past 30 years. From the day I entered the business in 1981 and 30-year AAA tax-free bonds were yielding 13.5%, until May of this year, interest rates have been in a steady decline, virtually uninterrupted. When you begin with a high coupon and add declining interest rates, it makes long-term performance look pretty darn good. The opposite is now true; we’re starting with a low coupon, which means less cash flow, and when you add in rising interest rates, you can easily offset the income component with price depreciation. The bond party is over. Bonds, unlike stocks, are mathematical; they can’t go up forever. In fact, the 30-year US Treasury bond is down 15% since May; Treasuries were supposed to be perceived as safe, right? Wrong!

I’m just back from a professional investor conference at the Goldman Sachs headquarters in New York City. In my industry, this represents the center of the world for finance. Just a block from Ground Zero and in the shadow of the new World Trade Center building, we witnessed “the crowning” as cranes affixed the spire, making the building the highest in the western hemisphere at 1,776 feet, and the third tallest building in the world. I must say that witnessing the renaissance at Ground Zero as well as working in Boston during the lockdown in the aftermath of the Marathon bombing, I’m extremely proud of our country and what we represent to the world. Americans have an incredible strength of spirit and perseverance.

The March march continues. Many investment professionals are witnessing a migration of cash from the sidelines into the stock market, and combined with two other emerging trends, we have the making of what I like to refer to as “The Trifecta”: Cash moving into the market, improvement in the housing market (which makes people feel more wealthy and confident, prompting increased spending), and ultimately, money moving from the bond market. Phase one and two are in process, and the third is simply a matter of time.

The very essence of compromise was lost on both sides of the political debate as volume seemed to replace logic, leading to one of the most divisive elections of our lifetime. Lack of clarity in tax law, health care, and public policy created a vacuum. Add in a pinch of “eurozone,” a dash of “debt ceiling,” and a dollop of “fiscal cliff,” and you had a recipe for indecision. Yet markets proved resilient and ended the year firmly in positive territory. Good markets attract capital like Justin Bieber attracts teenage girls. Consider the $10 trillion dollars on the sidelines (M2 money supply); now contemplate what could happen if bond prices begin to waver due to upward pressure on interest rates—even more cash for investment. Housing markets are also improving as evidenced by the Advisory Services Group Economic & Market Forecast dated 1/18/2013, and with that, the mortgage bonds that were created by pooling loans, the very same bonds that make up a large percentage of banks’ capital. As prices rise, capital ratios improve and lending increases, reinforcing a cycle of purchasing that could increase housing values even more.

As we enter the final quarter of 2012, it’s only natural to reflect upon what’s transpired over the past nine, almost ten months. Rather than regurgitate financial highlights and the barrage of political ads that can only leave one wondering if anyone in politics is up for the task, I wanted to focus on an intriguing article in the Wall Street Journal on 10/26/12, "Taking Early Exits off Wall Street."

The second quarter ushered in a wave of pessimism prompted by renewed concern over the challenges in the eurozone. While the situation in Europe is not as dire as what we witnessed during the same period last year, significant risks exist, and the uncertainty has cast a pall over the global markets. Despite the constant barrage of negative news, we continue to believe that there is slow but steady progress towards resolution. The ECB has stepped in to purchase government bonds in the secondary market of debt-laden countries in an attempt to provide liquidity and drive rates lower, and European leaders last month proposed setting up what may be the beginning of a European banking union, quite a change from just a few months ago. While the cost of Spanish government debt financing continues to rise, the increase has had the effect of forcing the acknowledgement of the precarious situation, requiring difficult political decisions that had previously been ignored. Incremental progress is also evident in the U.S. economy, but you wouldn’t know it by reading the headlines, and it’s important to look beyond the sound bites for the real story. U.S. economic growth, while slow, is still expected to come in at 1.5% - 2% for the year, not great but still positive. As for equities, values continue to improve as earnings hit record levels, and stock price appreciation remains modest. We are watching for signs of slowing earnings growth but don’t expect material P/E compression from already low levels. Equities by most measures are inexpensive, but in the words of Warren Buffet, "Stocks are the only thing that people don’t like to buy on sale."

The stock market continued to rally, posting its strongest first quarter showing since 1998. The willingness to take more risk was evident as defensive, yield-oriented equities, which led the market in 2011, lagged the growth names. Economic indicators continued to improve, albeit slowly, and while we believe that corporate earnings will continue to make new record highs, the rate of earnings expansion will likely slow to mid-single digits (from double digits in 2010 and 2011). Price-to-earnings ratios continue to be well below normal levels despite the extent of the rally, which began in October. If confidence continues to improve, we foresee a continued recovery in stocks.

By all accounts, 2011 was a challenging year, financially as well as emotionally: the Japanese tsunami and near nuclear meltdown, U.S. debt ceiling debate as well as the subsequent credit-rating downgrade, and the uncertainty of the outcome of Arab Spring. The strong first half was ultimately derailed by the Greek debt crisis, putting the other European countries’ ability to refinance their own debt in question. As the long-term viability of the euro, the second largest currency in the world, was called into question, global capital flowed to the only remaining currency that could handle the volume: the U.S. dollar. U.S. Treasuries, which were thought to be overvalued a year ago, continued to post significant gains, much to the surprise of the majority of the investment community. At the final tally, the U.S. markets closed close to where they started in January, but the MSCI EAFE (Europe and Far East) was a different story, closing down -12.14%. Global portfolios also suffered due to the inclusion of the Eurozone and the almost-certain recession to follow.

Global markets went into sharp retreat in the third quarter, rattling the nerves of even the most seasoned investor. What I find most disconcerting is that the outcome was going to be determined by the Germans and the French agreeing on a solution, not something that happens often. Even the US was pulled into the frenzy as the European banks were now looking across the shore for the Fed to pump liquidity into the system. All of this has injected the question of a new recession into daily conversation.

The canyons of Wall Street looked more like Coney Island in the second quarter as the bulls and bears went on a roller coaster ride. Stocks advanced in April, supported by positive earnings reports, and M&A activity pushed equity indices to their best levels since June of 2008, rising against mounting uncertainties across the globe. But stocks slid from the April 29 highs as bears feasted on a steady diet of soft economic data, inflation fears over Eurozone sovereign debt issues and the end of the Fed’s second quantitative easing program. Stocks managed to catch their breath in the closing days of the quarter, helped by some positive economic data. In addition, the stay of execution for Greece, with the passing of austerity measures mandated by the EU and IMF, ushered in a second bailout package for the beleaguered nation and some investor appetite for risk assets.

Despite a number of global uncertainties and a temporary market setback early in the year, stocks were able to retain their positive momentum and post strong gains in the first quarter. Funds continued to flow out of bonds and into stocks as economic data improved and the recovery marched on at a moderate pace. The labor environment, always a critical factor at this point in the cycle, showed signs of improvement. In addition, companies continued to impress investors with good earnings results, high productivity growth and margin expansion. The Federal Reserve’s aggressive quantitative easing program also helped boost stocks, in our opinion. As we anticipated in our communications over the last year, a lack of attractive investment alternatives has also helped to make the stock market the beneficiary.