Notice how TV news bulletins put finance next to the weather report? In each, talking heads point at charts and intone about intraday events that are quickly forgotten. Meanwhile, the long-term wealth building story gets overlooked.
Many investors feel that they are not properly informed about the financial world unless they have checked daily, or even hourly, on how the Dow, FTSE, or Nikkei have moved in the intervening period.
In most cases, it’s a pretty harmless activity. It at least provides a bland conversation starter in fleeting social encounters, just as keeping up to date with tomorrow’s weather forecasts can fill an awkward silence.
But our very human focus on the day-to-day can often encourage us to make bad decisions that affect our long-term interests.
That’s because while we live moment-to-moment, what often affects us most are imperceptible, gradual changes that occur over many years.
Look at the way markets have begun in 2015, as reflected in daily news headlines from Reuters:
- January 6: Wall St. in Longest Losing Streak in 13 Months
- January 8: Wall St. Jumps for Second Day, Helped by Economic Optimism
- January 14: US Stocks Fall Heavily on Growth Concerns
- January 20: China Seen Posting Weakest Growth in 24 Years
- January 20: UK Stocks Gain on China’s Growth
The China GDP story is a good example. The curtain-raisers announced it would be the weakest economic growth number for nearly a quarter century. And, sure enough, it was. But because the result was a fraction higher than what the market had priced, Asian stocks rallied.
As always, markets price expectations for events like this and then move if the outcome varies with what is in the price. It is hard enough for professional investors to keep track, never mind a layperson.
So, from minute to minute, market sentiment shifts in reaction to news—news about the economy, companies, governments and politics, and the wider world. Prices rise and fall in response to this news, which by definition is unpredictable.
To use an analogy, the market news is like the weather. One day it’s sunny. The next day it rains. It’s unseasonably warm one day but cool the next. The narrower is your frame of reference, the greater is the apparent variability.
Look at Exhibit 1 (in USD terms) above, showing monthly moves in a common barometer of the global share market. All you see are the monthly ups and downs—the regular changes in “the weather.”
Another way to look at this movement (see Exhibit 2) is to measure the growth of wealth. This way we are less focused on the day-to-day or month-to-month movements and more on how wealth accumulates through time.
For a long-term investor, this is the more important measure because it takes into account cumulative gains. The media, by virtue of its publication schedule, must focus on the short-term. They need a different story every day.
These two ways of looking at the market are like the difference between the weather and the climate. The former changes constantly, the latter more gradually. With long-term investment, it’s the climate you need to think about.
Diversification does not eliminate the risk of market loss. There is no guarantee investment strategies will be successful.
Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.
Human beings love stories. But this innate tendency can lead us to imagine connections between events where none really exist. For financial journalists, this is a virtual job requirement. For investors, it can be a disaster.
“The Australian dollar rose today after Westpac Bank dropped its forecast of further central bank interest rate cuts this year,” read a recent lead story on Bloomberg.
Needing to create order from chaos, journalists often stick the word “after” between two events to imply causation. In this case, the implication is the currency rose because a bank had changed its forecast for official interest rates.
Perhaps it did. Or perhaps the currency was boosted by a large order from an exporter converting US dollar receipts to Australia or by an adjustment from speculators covering short positions. Markets can move for many reasons.
Likewise from another news organization, we recently heard that “stocks on Wall Street retreated today after an escalation of tensions in the Ukraine.”
Again, how do we now that really was the cause? What might have happened is a trader answered a call from a journalist asking about the day’s business and tossed out Ukraine as the reason for the fall because he was watching it on the news.
Sometimes, journalists will throw forward to an imagined market reaction linked to an event which has yet to occur: “Stocks are expected to come under pressure this week as the US Federal Reserve meets to review monetary policy settings.”
For individual investors, financial news can be distracting. All this linking of news events to very short-term stock price movements can lead us to think that if we study the news closely enough we can work out which way the market will move.
But the jamming of often-unconnected events into a story can lead us to mix up causes and effects and focus on all the wrong things. The writer and academic Nassim Taleb came up with a name for this story-telling imperative: the narrative fallacy.1
The narrative fallacy, which is linked to another behavior called confirmation bias, refers to our tendency to seize on vaguely coherent explanations for complex events and then to interpret every development in that light.
These self-deceptions can make us construct flimsy, if superficially logical, stories around what has happened in the markets and project it into the future.
The financial media does this because it has to. Journalists are professionally inclined to extrapolate the incidental and specific to the systematic and general. They will often derive universal patterns from what are really just random events.
Building neat and tidy stories out of short-term price changes might be a good way to win ratings and readership, but it is not a good way to approach investment.
Of course, this is not to deny that markets can be noisy and imperfect. But trying to second-guess these changes by constructing stories around them is a haphazard affair and can incur significant cost. Essentially, you are counting on finding a mistake before anyone else. And in highly competitive markets with millions of participants, that’s a tall order.
There is a saner approach, one that doesn’t require you spending half your life watching CNBC and checking Bloomberg. This approach is methodical and research-based, a world away from the financial news circus.
The alternative consists of looking at data over long time periods and across different countries and multiple markets. The aim is to find factors that explain differences in returns. These return “dimensions” must be persistent and pervasive. Most of all, they must be cost-effective to capture in real-world portfolios.
This isn’t a traditionally active investment style where you focus on today’s “story” and seek to profit from mistakes in prices, nor is it a passive index approach where you seek to match the returns of a widely followed benchmark.
This is about building highly diversified portfolios around these dimensions of higher expected returns and implementing consistently and at low cost. It’s about focusing on elements within your control and disregarding the daily media noise.
Admittedly, this isn’t a story that’s going to grab headlines. Using the research-based method and imposing a very high burden of proof, this approach resists generalization, simplification, and using one-off events to jump to conclusions.
But for most investors, it’s the right story.
1. Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable, Penguin, 2008
Article by Jim Parker - Dimensional Fund Advisors LP
Dimensional Fund Advisors LP ("Dimensional") is an investment advisor registered with the Securities and Exchange Commission.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. This content is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services
The financial markets encountered strong headwinds but little turbulence on the way to a record-setting year. 2013 has been described as a “year about nothing.” In reality, a lot happened—but nothing could challenge the market’s profitable run. Investors shrugged off news of a sluggish US recovery, recessions in China and Japan, threats of a US government shutdown, lingering euro zone debt problems, climbing interest rates, worsening turmoil in the Middle East, and stock market glitches.
The US and most developed market indexes experienced double-digit gains for the year. Overall, US stocks were up for the fifth year in a row while daily volatility fell to its lowest level in seven years. The Dow Jones Industrial Average posted a gain of 26.50%, its largest advance in 18 years. The S&P 500 Index had its best year since 1997, returning 32.39%. In the non-US developed markets, the MSCI-EAFE Index returned 22.78%, and all developed country markets in the MSCI indexes had positive returns. Emerging markets were the exception to the worldwide equity advance, as returns in many emerging countries turned negative, with the MSCI Emerging Markets Index returning -2.60% for the year.
During 2013, the yield on the 10-year Treasury note climbed from 1.76% to 3.01%―its largest increase since 2009. Rising interest rates left US fixed income indexes with either flat or negative returns, with longer-term and higher-quality bonds declining the most. TIPS performance was notably poor. Returns in the international bond markets were mixed and emerging market bond index returns were negative.
The above graph highlights some of the year’s prominent headlines in context of broad US market performance, as measured by the Russell 3000 Index. These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a longer-term perspective and avoid making investment decisions based solely on the news.
The world stock market performance chart below offers a snapshot of global stock market performance, as measured by the MSCI All Country World Index. The global headlines show that despite an abundance of negative news during the year, global stocks had an exceptional year.
A Slow Recovery
The US economy quickened its pace slightly in 2013, overcoming the drag from higher payroll taxes and a slowdown in government spending due to sequestration cuts. Estimated GDP growth averaged 2.3% for the year, compared to 2.0% for the prior two calendar years. The improvement came in Q3, when growth jumped to 4.1%. Despite this recent spark, the recovery that began in 2009 is one of the weakest in the postwar era.
A few indicators pointed to gradually improving conditions during the second half of 2013. Positive signs included job market gains, lower inflation, rising wages, a revival in manufacturing, stronger auto sales, increased consumer spending, and improved corporate balance sheets and sustained business profits. The housing market also improved, although most of the gains in home prices and sales came earlier in the year. Rising stock prices and housing prices helped boost household net worth to a record level in Q3.
The US Federal Reserve and Bank of Japan continued their monetary efforts to drive down long-term rates, keep short-term rates close to zero, and fuel economic growth. In the US, markets were anticipating when the Fed would dial back its quantitative easing program. The central bank hinted in May that it would begin reducing—or “tapering”—its monthly bond purchases. The message drove up US bond yields and briefly squelched markets, although the effect was short-lived in developed markets. Emerging countries felt the sharpest sting.
During the year, the Japan’s central bank began an aggressive bond-buying campaign designed to fend off recession, and the European bank was forced to cut interest rates in an effort to counteract rising joblessness and a deflationary threat in the Eurozone. Another surprise rate cut in November brought European rates to historical lows in an attempt to further boost the region’s fragile recovery.
Strong Business Fundamentals
In 2012, US corporate profits reached their highest level (as a share of GDP) in the post-war era. Few analysts expected a repeat in 2013. But through Q3, US businesses were on track for another strong year. Observers attribute rising profitability in a sluggish economy to productivity gains, falling wages, and relentless cost cutting among businesses. Rising profits have helped drive stock prices, but companies have been stockpiling the cash rather than reinvesting or distributing it.
It was the busiest year for initial public offerings since the financial crisis began, with a 59% jump in the number of US offerings and a 31% increase in cash raised compared to 2012. Companies took advantage of low interest rates by issuing a record amount of investment grade debt in 2013. The estimated $1.4 trillion in issuance surpassed the previous year’s record.
2013 Investment Overview
During Q1, the US equity markets logged strong returns. The quarterly return of the broad US market, as measured by the Russell 3000 Index, was over 11%, and the market’s daily volatility, as measured by the CBOE Volatility Index (VIX), fell sharply. Developed non-US markets also had a good quarter as economic conditions appeared to be improving. Japan’s latest effort to reverse more than two decades of deflation and economic stagnation was showing positive results and financial conditions in the euro zone, while still serious, were stabilizing.
After reaching all-time highs in May, the broad US stock market lost ground in June but managed to end the quarter with a strong gain of about 3%. Combined with Q1 advances, the market had its best mid-year start since the late 1990s. Daily volatility jumped by almost 33% in the quarter, partially as a result of increased uncertainty about the Fed’s announced monetary policy changes in the coming months. Volatility increased in non-US developed markets, including Europe, where economic conditions began to weaken and the central bank was forced to cut interest rates to offset deflationary pressures.
During Q3, the broad US market rebounded with a 6% quarterly gain despite investor concerns over the timing of the Fed’s monetary pullback and the US government’s debt limit. Developed non-US markets also had strong returns, especially in September, and outperformed both the US and emerging markets. Performance in Europe was particularly strong with the euro zone showing signs of an end to recession.
In Q4, equity markets climbed more than 10% and showed little concern from the government shutdown and the Fed’s confirmation of plans to begin tapering bond purchases in 2014. The European Central Bank again cut its benchmark interest rate in November to a record low in response to a sudden drop in the inflation rate.
All major US market indices had substantial gains for 2013. The S&P 500 logged a 32.39% total return. The NASDAQ Composite Index gained 40.14% and the Russell 2000, a popular benchmark for small company US stocks, returned 38.82%, its biggest gain since 1993. The stock market’s strong performance came with lower volatility, as gauged by the VIX, which fell for the second straight year to reach its lowest level since 2006.
Non-US developed stock markets also experienced strong gains. The MSCI World ex USA Index, a benchmark for large cap stocks in developed markets outside the US, returned 21.02%. The small cap and value versions of the index gained 25.55% and 21.47%, respectively. Emerging markets were the exception to the global market advance. The MSCI Emerging Markets Index returned -2.60%, with the small cap and value sub-indices returning 1.04% and -5.11%, respectively.
Among the equity markets tracked by MSCI, all countries in the developed markets had positive total returns (gross dividends; local currency), although the range of returns was broad (0.25% to 47.35%). Ireland, Finland, and Spain were the highest performers; Singapore, Australia, and Canada were the lowest performers. In the emerging markets tracked by MSCI, most countries logged negative total returns and the dispersion of returns was broad, ranging from -30.70% to 25.98%. Greece1, Egypt, and Taiwan were the top performing countries, while Turkey, Peru, and Indonesia logged the most negative returns.
The major world currencies were mixed relative to the US dollar. The euro gained 4.3% against the dollar—reaching a two-year high. The British pound gained 2% against the dollar. The Japanese yen experienced the biggest loss against the US dollar (21%) due to a combination of aggressive monetary easing and increased government spending. The Australian dollar gave up about 14% of its value against the US dollar.
Small cap and large cap stocks had strong performance in US and non-US developed markets, with small cap outperforming large cap in both markets. In the emerging markets, small cap slightly outperformed large cap, which had a negative return. Across the style spectrum, growth stocks and value stocks performed similarly in the US and non-US developed markets, and in emerging markets, growth stocks beat value stocks, although both had negative returns. Returns of major fixed income indexes were either mixed or negative due to rising rates. One- year US Treasury Notes returned 0.25%; US government bonds -2.60%; world government bonds (1–5 years USD hedged) returned 0.62%; and US TIPS returned -8.61%. Real estate securities had a relatively lackluster year: The Dow Jones US Select REIT Index returned 1.22% and S&P Global ex US REIT Index 2.36%. Commodities were negative for the third straight year, with the Dow Jones-UBS Commodity Index returning -9.52%. Within the index, gold returned -28.65% and silver -36.63%.
1 On November 27, 2013, MSCI reclassified the MSCI Greece Index from Developed Markets to Emerging Markets. Consequently, Greece was not considered an emerging market for the entire 2013 calendar year.
Russell data © Russell Investment Group 1995-2014, all rights reserved. Dow Jones data provided by Dow Jones Indexes. MSCI data copyright MSCI 2014, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. The BofA Merrill Lynch Indices are used with permission; © 2013 Merrill Lynch, Pierce, Fenner & Smith Inc.; all rights reserved. Citigroup bond indices copyright 2014 by Citigroup. Barclays data provided by Barclays Bank PLC. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio.
Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. Investing risks include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. International investing involves special risks such as currency fluctuation and political instability. Investing in
emerging markets may accentuate these risks. Sector-specific investments can also increase these risks. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
Just when you thought you could stop worrying about taxes now that April 15 has passed, there’s another new income tax that took effect Jan. 1, 2013. To fund Obamacare, a new 3.8% tax on investment income applies to couples making more than $250,000 and singles making more than $200,000. Investment income such as dividends, capital gains and interest above the $250,000 threshold for couples is taxed at 3.8% — in addition to any other tax that might be owed.
The Wall Street Journal provides some tips on how to avoid the new tax, such as trying to minimize AMT by moving more assets into tax sheltered accounts like IRAs, harvesting losses, spreading gains over a number of years, converting assets to Roth accounts, holding investments until death and even going off-shore. The tax does not affect some investments like muni bonds, though it may affect hedge fund investments.
Welcome to the new world of higher taxes — with some nasty surprises around every corner.
Article printed from NAPA Net: http://www.napa-net.org
At its most basic level, a trade takes place when a buyer is willing to buy at a certain price and a seller is willing to sell at that price. Both parties could be smart, experienced, and looking at the same data, yet somehow one party thinks it's a good price to buy and the other thinks it's a good price to sell.
Last week, several news items represented good examples of how investors could look at the same data and draw different conclusions. Consider these:
1. Gross domestic product rose at a 2.8 percent pace in the October through December period.
Bullish investors say that's up from 1.8 percent the previous quarter and the fastest pace in a year and a half.
Bearish investors say it's less than the 3.0 percent growth expected by economists and most of the growth was due to inventory accumulation.
2. The International Monetary Fund (IMF) cut its forecast for global economic growth in 2012 and 2013.
Bullish investors say fears are overblown as private-sector economic activity in the 17-nation euro zone showed small, but unexpected, growth in January and durable-goods orders were up a strong 3.0 percent in December in the U.S. - the third straight increase.
Bearish investors say just heed the IMF's warning, "Global growth prospects dimmed and risks sharply escalated during the fourth quarter of 2011, as the euro-area crisis entered a perilous new phase."
3. Spanish and Italian bond yields dropped dramatically lately.
Bullish investors say the drop in yields and the strong demand in January's bond auctions suggest the euro zone crisis is easing.
Bearish investors say the Portuguese bond market is now imploding, the Greek restructuring could fall apart, and the European Central Bank's December offer of unlimited three-year loans to banks has simply delayed the inevitable day of reckoning.
Source: The Wall Street Journal
It's differences of opinion like this that make markets. Thanks to the free market, there always seems to be a buyer for every seller - at a price.
Like Joni Mitchell who sang, "I've looked at life from both sides now," we look at the markets from both the bullish and bearish sides and, ultimately, make decisions which we think will best position you to meet your long-term goals and objectives.
Do you remember the good ol’ days?
Yes, we’re talking about the four-year period between 1998 and 2001 when the U.S.government pocketed a budget surplus of $559 billion, according to the Congressional Budget Office. By contrast, in the four years between 2007 and 2010, our government racked up a budget deficit of $3.3 trillion. That’s no misprint – it’s trillions of dollars!
The multi-trillion dollar deficits we’ve incurred in the last few years have maxed out the government’s credit limit.
Just like you and I have a limit on our credit cards, the government, by law, has a maximum amount it can borrow. This maximum amount it can borrow is called the debt ceiling.
The U.S.is one of the few countries where the government imposes a debt ceiling. As a result, if we continue having annual budget deficits, then every few years, Congress has to authorize an increase in the debt ceiling so the government can pay its ongoing bills. As you can imagine, this is not a vote Congress likes to make.
If the government doesn’t pay its bills on time, this would be considered a “default.” And, just like humans, if the government stiffs its creditors, it will face consequences. Those consequences could include a reduction in the country’s credit rating and chaos in the financial markets.
This year, the vote to raise the debt ceiling became especially contentious partly because of the Tea Party’s influence. Some Tea Party politicians and others are trying to rein in government spending and are using the debt ceiling issue as a way to make their stand, according to The New York Times.
As the debt ceiling drama plays out, there’s only one way to ensure we don’t have to worry about this issue again – start running budget surpluses and then return the excess tax money to the public!
By: Gillian Tett, Financial Times/CNBC.com
May 9, 2011
Another week, another wave of dismal fiscal gridlock in Washington. But as U.S. politicians squabble about how to cut the debt, another concept with a catchy name is quietly starting to creep into the policy debate: "financial repression."
A few weeks ago, Carmen Reinhart, a U.S. economist who shot to fame two years ago by co-authoring a influential book on sovereign debt, This Time Is Different, produced a joint paper for the International Monetary Fund on the topic of "financial repression" in the west. And while this phrase is not yet mainstream news, it is starting to generate a buzz among the policy elite in Washington and in some European capitals.
The issue at stake revolves around the question of where investors "choose" to put their money. During the past three decades, western savers have generally assumed they could put their money wherever they wanted, since financial markets were organized according to the mantra of globalization and free market capitalism — and thus the price of money (or interest rates) was set largely by demand. But as Ms. Reinhart and Belen Sbrancia, her colleague, point out, this freedom was unusual. In the 1920s, global capital markets were also pretty free. But, from the 1940s to the 1980s, western governments operated capital controls and interest rate caps that restricted financial flows, limiting investor choice.
It is often assumed that these controls were driven by a wave of financial reforms after the 1929 stock market crash (just as governments are implementing financial reforms now). And that is partly true. However, Ms. Reinhart and Ms. Sbrancia argue that these controls also had a crucial fiscal impact. After the second world war, the debt of the advanced economies spiraled to about 90 percent of gross domestic product, roughly comparable to today, which meant western governments desperately needed to find investors to buy the bonds.
One consequence of the controls was they created a captive domestic audience for those bonds. Better still, because these bonds paid a yield lower than inflation, whenever those captive investors bought bonds, they effectively paid a hidden subsidy to the government, enabling them to reduce the debt.
Ms. Reinhart and Ms. Sbrancia argue the world has forgotten that the widespread system of financial repression "played an instrumental role in reducing or 'liquidating' the massive stocks of debt accumulated during World War II." Between 1945 and the 1980s, they say the U.S. and UK's "annual liquidation of debt via negative real interest rates" on average amounted to 3-4 percent of GDP per year, or 30-40 percent of GDP debt reduction over a decade.
These days nobody is talking about introducing overt capital controls or interest rate caps in the west. And central banks appear determined to curb inflation. But some influential investors fear eventually the temptation to let inflation jump above bond yields will reappear. "While the ancient Romans used to shave metal coins in an attempt to monetize debts, our evolving financial system has used more sophisticated techniques (to cut its debt)," says Bill Gross, head of Pimco investment fund. "Bond prices don't necessarily have to go down for investors to get skunked."
Central banks such as the Federal Reserve have already been buying bonds. And there are now some intriguing hints that private sector institutions are being urged to hold more bonds. In the UK, the introduction of financial reforms has forced banks to purchase more gilts. Similar steps are afoot in other parts of Europe and in Washington some policymakers are quietly mulling whether U.S. banks and pension funds could — or should — follow suit, especially if foreign buyers (who own half the U.S. debt) stop buying U.S. bonds.
Such moves horrify some free-market economists, who argue "repression" crimps private sector investments, thus undermining growth. But postwar politicians clearly decided this was a price worth paying to cut debt and avoid outright default or draconian spending cuts. And the longer the gridlock over fiscal reform rumbles on, the greater the chance that "repression" comes to be seen as the least of all evils; at least compared with others that may emerge from spiralling western debt.
The Price of Gasoline
High gas prices have probably been getting your attention as of late. While higher prices have definitely hit your pocketbook and may have altered your driving habits, on a broad level high gas prices are beginning to pose a threat to the current economic recovery. Most alleged experts estimate that the U.S. economy will not be truly threatened unless oil prices reach $140 to $150 per barrel, but whether we reach that point or not, people are still clearly being affected by prices that are nearly three times higher than in early 2009. If prices remain this high it’s inevitable we’ll also soon see higher prices of goods and services subject to transport.
Oil prices have historically risen from Winter into early Summer as demand increases into peak travel season, but this year’s increase has come a bit early and appears to be driven as much by price speculation as actual demand. Keep in mind current oil prices of $114 per barrel are still well off their all-time high of $147 per barrel in July 2008, but that obviously hasn’t kept gas prices from rising above $4 in most areas.
Hopefully, we’ll see some price relief down the road, but given historical patterns we may not get much help over the next 3 to 4 months.
April Market Recap
April was a good month for the investment markets, with the S&P 500 rising 2.85% to close at its highest levels of 2011. We’re having a good year so far in 2011, but it has not necessarily been a smooth ride. The S&P 500 previously peaked on Feb. 18, only to lose 6.86% over the next month. However, the market has since performed well to gain 8.49% since March’s trough.
You will notice that your respective accounts are currently trading at or near their high points for the year. I am currently over-weighting most portfolios in commodities and other asset classes that figure to capitalize on a continuously declining U.S. dollar, while I have largely moved away from “high-quality” bonds, such as U.S. Treasuries and highly rated corporate bonds.
The market is currently overbought, which means that the statistical likelihood of a market pull-back is higher than in a normal market. For those of you with more conservative investment allocations, I have already taken measures to protect your accounts in case of a pull-back. However, just because we’re due for a pull-back doesn’t mean it will occur, which is why we still own equities, commodities and higher yielding corporate bonds, at least for now.
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The Standard & Poor’s 500 Index is a capitalization-weighted index of stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
A McDonald’s Big Mac costs an average of $3.71 in the United States, according to an October 14 article from The Economist. Just across the border in Canada, that same burger costs $4.18 based on the October 13 exchange rate. In the Euro area, you’d have to shell out $4.79 to quench your Mac attack. But, if you’re really hungry, you should forget going to Switzerland because a Big Mac there will set you back a whopping $6.78 at the going exchange rate.
So, a dollar is not worth a dollar when its value declines relative to another country’s currency such as the ones above. The dollar is also weak against the Japanese yen, where it fell to a 15-year low last week, and the Australian dollar, where it fell to a nearly 30-year low, according to MarketWatch.
What’s going on here?
Essentially, the combination of economic weakness in the U.S., extremely low interest rates, and our country’s easy money policy, have conspired to reduce the value of our currency relative to some other countries. And, as our government knows, a weak currency can be a net positive -- as long as it doesn’t get too weak.
According to an October 1 weekly update from Linda Duessel at Federated Investors, “Currency depreciation is the most politically palatable way to deal with both deficits and slow growth. Unfortunately, history suggests depreciating the dollar is the worst possible way to deal with public debt. It spawns inflation, stifles growth and eats away at earnings.”
The relatively weak value of the dollar may not crimp your day-to-day lifestyle right now. However, as an advisor, it’s an important macro indicator that could impact the value of your portfolio -- and your pocketbook -- if it gets too far outside of historical norms. It bears watching.
WHILE THE PURCHASING POWER OF THE DOLLAR can be analyzed using a Big Mac, it can also be analyzed using something less edible -- gold. Gold has been considered a medium of exchange for several thousand years, according to the National Mining Association. And, for some people, it is the soundest “currency” in existence today because it is scarce, it can’t be printed (mined) freely, and it has a long history of being valuable and tradable.
Measuring the value of the dollar in terms of gold is quite simple. All you do is plot the dollar cost of one ounce of gold over time. Back in the early 1930s when our country was on the gold standard, gold was set at a fixed price of $20.67 per ounce, according to The Economist. In the early 1970s, the last vestiges of the gold standard were removed and the price of gold was allowed to reach a “market” price. As of last week, that market price was over $1,300 per ounce.
The rise of gold from $20 an ounce to over $1,300 an ounce was effectively a massive devaluation of the dollar, according to The Economist. Had you bought an ounce of gold in 1930 for $20 and held it to today, you could sell it for more than $1,300. Had you just sat on your $20, it would still be worth $20, but it would buy you less than 1/50th of an ounce of gold.
The funny thing about gold is that it’s not an “investment” in the traditional sense because it does not pay a dividend and it does not generate cash flow. It just sits there and looks really pretty.
Unlike most commodities, gold has no true economic value beyond niche products such as jewelry. So what really drives the price is what the next person is willing to pay- a concept that is theoretically sound, but literally impossible to predict. Gold certainly could climb higher in the shrot term, but histor suggests caution and as seen by the JP Morgan Chart of the Week - as gold prices can rise like a rocket, they can fall just as quickly.
Think About It
“More gold has been mined from the thoughts of men than has been taken from the earth.”
One cause of The Great Recession was the cumulative effect of consumers spending more money than they could afford. Eventually, they got tapped out, business slowed down, and massive layoffs ensued. Of course, simple math says you cannot indefinitely spend what you do not have and, by 2008, the math caught up with many Americans.
Last week, the Commerce Department said the personal savings rate (saving as a percentage of disposable personal income) rose to 6.2% in the second quarter. That’s up from 5.5% in the first quarter. In the heyday of conspicuous consumption back in 2007, the savings rate was a paltry 2.1%, according to CNNMoney.com.
Higher savings is a double-edged sword. On the positive side, it means consumers are acting more responsibly and, by beefing up savings, they are setting the stage for future sustainable economic growth. The downside to this thriftiness is slower economic growth in the short term.
It’s a fine balance between saving enough to get our personal balance sheet back in order, but not too much that the economy takes years to regain its footing. Remember, consumer spending still accounts for about 70% of economic activity, according to The Wall Street Journal. The trick is we still have to shop -- but just not till we drop!
DOUBLE DIP IS NOT JUST FOR ICE CREAM CONES. Over the past few months, concern has grown that the U.S. economy could experience a double-dip recession. Drooping bond yields, which may suggest slower economic growth, coupled with some soft economic data and weak consumer sentiment, have raised a red flag. However, from an international perspective, the International Monetary Fund has raised its 2010 world economic growth projection five times since April 2009 and it now stands at a forecasted rate of 4.6% -- which is rather healthy and certainly not double-dip territory.
Although the likelihood of a double-dip recession still seems small, a July 27 Financial Times article outlined four risks that could possibly derail the recovery:
- A decline in business and consumer confidence.
- An end to temporary boost to post-recession economies, e.g., economic growth emanating from inventory re-stocking.
- A new crisis or “black swan” event that throws the world for a loop.
- Overly austere government budgets that tighten too much too soon and snuff out the recovery before it gets a chance to become self-sustaining.
These risks are reasonable and bear watching. However, let’s face it. No matter how well the world is humming, we (advisors) can always find something to worry about. But, that’s our job. It’s not that we’re pessimists. It just comes with the territory. We worry about things -- large and small -- in an effort to be proactive and to try and help you stay ahead of the curve.
Focus – Think About It
Here’s a list of the happiest countries in the world, according to a recently released Gallup Poll based on data collected between 2005 and 2009. Survey participants were asked to rate their overall satisfaction with their lives and how they had felt the previous day (to gauge their happiness in daily activities).
14 United States
17 United Kingdom
Does this list surprise you?