Client Letter, Fall 2012
Telos Wealth Management Posted on Friday, November 2, 2012 at 2:47PM The true theory of our Constitution is surely the wisest and best, that the States are independent as to everything within themselves, and united as to everything respecting foreign nations. Let the general government be reduced to foreign concerns only, and let our affairs be disentangled from those of all other nations, except as to commerce, which the merchants will manage the better the more they are left free to manage for themselves, and our general government may be reduced to a very simple organization and a very unexpensive one…” — Letter from Thomas Jefferson to Gideon Granger, August 13, 1800.
Current Market Environment
Our Market Environment Indicator (MEI) remains "bullish" (i.e., risk-on). As a result, in accounts employing our Market Leaders Model Portfolio (MLMP) investment strategy, we’re currently overweight equities and underweight bonds and cash. In spite of our rather pessimistic economic outlook, the market may have additional upside left: we are currently in the early stage of the historically best-performing period of market performance, October through April. While we do think there is another correction on the near to intermediate-term horizon, we are not yet “bearish”, and will continue to rely upon the MEI to signal when it’s time to position accounts employing our MLMP strategy more conservatively.
Unfortunately, we remain of the opinion that any near-term positive market performance is not likely to be based upon broad improvement in the macroeconomic picture, but rather upon expectations that “QE3” will be successful in inflating capital asset prices. Central bank activism can only postpone—not avoid—the ultimate day of reckoning for an economy trapped in a debt deleveraging cycle. Case in point: the Japanese central bank recently embarked on their eighth round of quantitative easing since 2000. In order to determine how effective their "QE" programs have been, one only need look at the Japanese stock market as measured by the Nikkei index: it was at 13,500 at the end of 2000 and it’s at 8,947 today—over 33% lower!
The path to higher risk-adjusted returns, and the ability to avoid large losses, is particularly difficult in the current market environment where zero-percent interest rates are grossly distorting the value of capital assets. Intermediate and longer-term risks will remain high until there is a fundamental change in how global governments and central banks deal with the unprecedented debt crisis they are facing. In the meantime, we believe there will continue to be cyclical investment opportunities which can be taken advantage of through both risk-on/risk-off and absolute return investment strategies.
Unintended Consequences?
We recently received this email from a business owner: “…last week I found our medical insurance rates will rise 50-75% next year to account for the changes required by the “Affordable Care Act.” My personal rate went up almost 100% this year as insurance companies are shifting policies in anticipation of losing younger participants. Furthermore, I heard from my Uncle and he found the “Affordable Care Act” has caused him to lose his Medicare Advantage coverage and will result in an additional $250 a month in costs.”
Whether or not you are a business owner, the broader financial impact of this real-life example should not be ignored. It goes without saying that if businesses have to spend more on health insurance it will have a negative impact on their revenue. If revenues go down, the amount of money companies have to pay for wages and other benefits will go down, as well, possibly putting further pressure on the unemployment rate.
While the unemployment rate recently fell to 7.8%, it is still almost 3% higher than what is typical for an economy heading into its fourth year of recovery—a recovery built primarily on unprecedented fiscal and monetary stimulus. On the fiscal stimulus side of the ledger, the objective of our government has been to replace private sector spending—which is depressed due to the stubbornly high unemployment rate—with public spending. On the monetary stimulus side of the ledger, the objective of our Central Bank has been to make money less expensive to borrow. However, there is little evidence to suggest that this type of stimulus and spending have been effective over longer periods.[i]
The Fiscal Cliff
There are multiple components to the so-called “fiscal cliff” which, combined together, present a very serious economic and political problem for the U.S. To help illustrate the personal income tax components of this complex issue, we have attached a fiscal cliff graphic summary provided by Principal Funds (also available here: https://secure02.principal.com/publicvsupply/GetFile?fm=MM5925&ty=VOP&EXT=.VOP). From a purely income tax standpoint, if Congress allows the Bush-era tax cuts to expire, personal income tax rates are scheduled to increase from 10 to 35% in 2013. For investors, capital gains rates are scheduled to increase from 15 to 20%. With this in mind, we strongly encourage you to discuss your personal situation with your tax professional and financial advisor.
U.S. Elections
I recently spoke to a young man who said to me, “I’m so fed-up with the bitterness of the presidential election that I’m not going to vote.” My encouragement to this young man was the same as I will humbly offer you, dear readers: “I completely understand your frustration, but elections have been like this since—at least—the presidential election of 1800 between John Adams and Thomas Jefferson[ii]. So, please don’t forfeit your right to freely vote, which was secured by the blood and toil of those who have gone before us.”
When it comes to actually predicting the winner of the election, we’re not sure that the often quoted polling data can be trusted. A better gauge may come from the Michigan Consumer Sentiment Index, which measures the attitudes of consumers (http://www.conference-board.org/). According to Bloomberg[iii], since the days of Richard Nixon every incumbent enjoying average reading of 95 or above have always been re-elected. Meanwhile, those with readings below 95 have never been re-elected. The Index now stands at 72.2, the highest since February 2008, and up from 68.4 in September.
Hurricane Sandy
This letter was completed just prior to the news regarding the devastating impact of Hurricane Sandy on the Eastern and Mid-Atlantic regions of U.S. We will address the potential economic impact of this disaster in a future letter. In the meantime, we are thankful that more lives were not lost, and we continue to pray for those who have been affected by this catastrophe.
[i] John H. Makin, The Limits of Monetary and Fiscal Policy http://www.aei.org/article/economics/fiscal-policy/the-limits-of-monetary-and-fiscal-policy/)
[ii] Richard J. Behn, The Election of 1800-1801 (http://www.lehrmaninstitute.org/history/1800.html#intro).
[iii] Michelle Jamrisko, Obama Second Term Would Defy Confidence Measure: BGOV Barometer
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