Sovereign Debt and the Equity Investor

By Weston Wellington, Vice President, DFA

Last week we came across an “Economic and Policy Watch” update prepared by a major investment bank that reviewed recent government proposals to address the nation’s funding crisis. Titled “It Just Gets Worse,” the report chided policymakers for actions that “look like a poor cover for loose money, rising inflation, and fiscal problems,” and warned that “government financing needs are corrupting monetary policy.” As a result of these ill-advised tactics, the bank had turned “more negative” on the outlook for financial stability and saw “little hope of improvement in the inflation/currency mix.”

Amidst the barrage of news coverage from dozens of sources probing the US debt/default/downgrade issue, such a conclusion might seem unremarkable. We found it of interest because the focus of the report was not the US Treasury but the government of Indonesia, and it appeared over a decade ago, on July 16, 2001.

Indonesia’s sovereign debt rating at that time placed it firmly in the “junk” (non-investment grade) category: B3 from Moody’s and single-B from Standard & Poor’s. Although Moody’s upgraded Indonesia to a B2 rating in 2003 and to Ba1 in early 2011, at no time over the past decade was Indonesia deemed to merit an investment grade rating.

What has been the experience of equity investors in Indonesia since this report was published? The Jakarta Composite Index closed at 415.09 on January 16, 2001, while the Dow Jones Industrial Average finished that day at 10,652.66. On Wednesday, the Jakarta Composite closed at 4,087.09 and the Dow at 12,592.80. If the Dow Jones Average had kept pace with Indonesian stocks over the past decade, it would be over 104,000 today.

Investors in Indonesia have had their share of ups and downs over the years, and markets fell even harder than the US during the financial crisis, with a peak-to-trough loss of nearly 60%. But the recovery was sharper as well: The Jakarta Composite recouped all of its losses by April 2010, and the all-time high on July 22 this year was 45% above the high-water mark of early 2008.

For the ten-year period ending June 30, 2011, total return as computed by MSCI was 29% per year in local currency and 33% in US dollar terms. At no point throughout this period did Indonesia have an investment grade rating for its sovereign debt, and outside observers continue to find fault with the country’s troublesome level of corruption, primitive infrastructure, and unpredictable regulatory apparatus.

We are not suggesting that investors should dismiss the effects of a US government credit downgrade. US Treasury securities are so widely held around the world that any potentially destabilizing event is worrisome. Nor are we suggesting that investors focus solely on countries with low credit ratings. Just as a broadly diversified portfolio includes companies with high and low credit quality, investing in countries with both high and low ratings is equally sensible.

Some might say the strong performance of Indonesian stocks over the past decade was at least partly attributable to the nation’s improving credit profile, even if it remained at a relatively low level. The US, in contrast, appears to be deteriorating. Our point is that a low credit rating in and of itself is not necessarily a death sentence for equity investors. Citizens of triple-A countries behave much like those living in single-B territory—they eat, drink, shop, get stuck in traffic jams, chatter on mobile phones, and check their Facebook pages. (Indonesia claims the second-largest number of members in the world.) Companies doing business in either location generate cash flows, and investors do their best to evaluate what those cash flows are worth. A triple-A sovereign debt rating is no guarantee of superior equity market returns, and a “junk” rating is no assurance of failure. A diversified strategy will have exposure to both. •

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

Securities offered through Triad Advisors, Member FINRA/SIPC. Investment Advisory Services offered through LJCooper Capital Management, LLC., a Registered Investment Advisor.

Seven Headlines to Beat the Gloom

By Jim Parker, Vice President, DFA

Debt crises, sovereign risks, double dips and banking strains: Page One headlines can make for depressing reading these days. But being a smart news consumer—and smart investor—means keeping an eye on the lesser headlines. Here are seven you may not have seen:

• Robust Growth in Germany Pushes Prices—Analysts see a strong chance that German inflation will head towards 3 per cent by the end of the year against a backdrop of robust growth in Europe's biggest economy. (Reuters, July, 27, 2011)
• Brazil Domestic Demand Still Strong—The Economist Intelligence Unit says economic growth in Brazil surprisingly picked up speed in the first quarter, challenging the government’s efforts to cool the expansion. (EIU, July 6, 2011)
• Japan Retail Sales Top Estimates—Japan's retail sales rose 1.1 per cent in June, exceeding all economists' forecasts and adding to signs the economy is bouncing back from an initial post-disaster plunge. (Bloomberg, July 28, 2011)
• No Fear in China—Traders betting on gains in China's biggest companies are pushing options prices to the most bullish level in two years. The Chinese economy is projected to grow by 9.4 per cent in 2011. (Bloomberg, July 28, 2011)
• Southeast Asia Booms—Southeast Asian markets are the world's top performers in 2011 thanks to strong economic and corporate fundamentals. Thailand's index hit a 15-year high in July and Indonesia's a record high. (Reuters, July 22, 2011)
• Australian Boom Keeps Rate Rise on the Agenda—The Australian dollar hit its highest level in 30 years in late July as traders looked to the prospect of another rise in interest rates on the back of a resource investment boom. (WSJ, July 27, 2011)
• NZ Bounces Back—The New Zealand economy has grown more strongly than expected after the Christchurch earthquake, helped by improving terms of trade. The Reserve Bank signals it may raise interest rates soon. (Bloomberg, July 28, 2011)

Standing back from all this, the picture that emerges of the world outside North America and southern Europe is of robust economic conditions. If anything, policymakers in many parts of the world, particularly in Asia, are seeking to pull back demand, rather than stoke it.

Australia, for instance, is enjoying its best terms of trade in more than 50 years. An unprecedented investment boom in mining is injecting extraordinary wealth into the economy and has helped to push the Australian dollar to levels not seen since it was floated in the early 1980s.

Likewise, China, India and much of South-East Asia are seeing strong investment flows and worrying more about over-heating than anything.

This is not to say that all is right with the world. The aftermath of the global financial crisis has created severe problems, particularly in terms of public sector debt and deficits. But we know that that news is in the price. Meanwhile, economic activity in much of the world is thriving.

For equity investors, that means opportunities for wealth building are increasing, not decreasing. Moreover, the global economy is becoming multi-polar, rather than overly dependent on the US, which means the potential benefits from broad diversification are even greater.

That's why focusing too much on the day-to-day headlines with the US debt ceiling or European sovereign issues risks missing many of the good stories out there.

Sometimes, the best advice is to read the newspaper from the inside out.

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

Securities offered through Triad Advisors, Member FINRA/SIPC. Investment Advisory Services offered through LJCooper Capital Management, LLC., a Registered Investment Advisor.

Should We Even HAVE a Debt Ceiling?

Until recently, the U.S. government’s debt ceiling didn’t get a lot of publicity; it has been raised without fanfare 70 times in the last 50 years. Now that it’s front page news, some analysts are wondering why we have such a thing in the first place. An article in the August 1 issue of The New Yorker notes that there is no provision for a debt limit in the U.S. Constitution, and among democratic nations, only the U.S. and Denmark have a mandated debt limit that has to be raised by their legislative bodies.

The debt ceiling was adopted in 1917, at a time when the government budget was created and controlled by the U.S. President. The ceiling gave Congress a small measure of control over the President’s spending habits, but in the years since, we have evolved to a system where Congress authorizes government spending in line item detail. The New Yorker article notes that the only reason we need to lift the debt ceiling, after all, is to pay for spending that Congress has already authorized. If the debt ceiling is not raised at the last moment, the President, ironically, would have greater authority; President Obama would be the one to decide which bills get paid and which do not, with no input from Congress.

The irony of the debate, lost in the screaming headlines and press coverage that always seems to focus on the politics rather than the merits of each proposal, is that the U.S. nearly defaulted--and actually did lose its pristine credit rating―at a time when investors were happily lending it money at some of the lowest interest rates in history. This is a crisis entirely of our own making. At a time when the U.S. economy is still recovering from the subprime meltdown, skyrocketing oil prices, the Eurozone debt crisis and ripples from the Tohoku earthquake, it was entirely unnecessary to bring on the federal debt downgrade, the market panics and the reckless brinksmanship--what the New Yorker economist (evidently a soccer fan) says might be the biggest own goal in history. •

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

Securities offered through Triad Advisors, Member FINRA/SIPC. Investment Advisory Services offered through LJCooper Capital Management, LLC., a Registered Investment Advisor.

America's Tarnished Credit Rating

By now, you’ve probably heard that the Standard & Poor’s debt rating agency has downgraded all U.S. government debt with more than a year of maturity, from the top AAA rating down to AA+. To put that in perspective, now only 17 countries enjoy the AAA rating on their government bonds. Typically, that means that they are considered the safest havens for cash, and therefore are able to pay the lowest interests rates on their borrowing.

Here’s the list, and we’ve included the current yields on each country’s 10-year government bonds in parentheses. This lets you see what the top-rated countries pay on their debt, compared with the 2.34% interest our government has to pay on its 10-year U.S. Treasuries:

France (3.41%), Germany (2.83%), Canada (2.93%), Australia (5.75%), Finland (3.19%), Norway (3.29%), Sweden (2.82%), Denmark (3.06%), Austria (3.30%), Switzerland (1.53%), Luxembourg (NA), Guernsey (NA), Hong Kong (2.29%), the Isle of Man (NA), Liechtenstein (NA), the Netherlands (3.17%), and Great Britain (3.11%).

The first thing to notice is that our U.S. government is still borrowing at very attractive rates compared with the triple-A nations, and Treasury rates actually got better during the angry debate in Washington, as investors continued to beat down our doors to lend money to our government. Why? The downgrade and recent weakness in the stock market have made bond investors nervous, which usually causes them to buy the safest paper they can find. As an Associated Press report notes, the U.S. still offers the deepest and most liquid bond market in the world.

The second thing to understand is that, despite the high levels of government debt, there is really no crisis in the government finances or in the economy. S&P officials made it clear that they were more influenced by the recent messy debate in Congress than the fundamentals of government finance. They may have been particularly rattled by public statements by key members of Congress that it might not be a bad thing if the U.S. government defaulted on its sovereign obligations to its global lenders--sort of like one of us telling the bank that we’re thinking seriously about not making any more mortgage payments. David Beers, global head of ratings at S&P, said in a supporting statement that the agency was concerned about “the degree of uncertainty around the political policy process.” A separate statement by the rating agency said that policymaking and political institutional control had weakened “to a degree more than we envisioned.”

Long-term, our government faces some difficult choices. The question now is whether we’ll get action from Congress or more political posturing. We’ll get an early look between now and Tuesday, as a new Congressional committee, made up of Democrats and Republicans, will be looking for $1.5 trillion in deficit cuts that have not yet been specified through the debt ceiling compromise.  (A total of $917 billion in cost reductions has already been earmarked).

What does all this mean for investors? The investment markets were clearly rattled by the tone and uncertainty of the debt ceiling debate, with the S&P 500 losing 10.8% of its value over the ten trading days of the Congressional standoff. But a Money magazine report points out that when a country loses its AAA rating, that is not always terrible news for the nation’s stock market. Canada, for example, was downgraded from AAA status in April of 1993, but the country’s stocks gained more than 15% the following year. The Japanese government’s bonds were downgraded in 1998, and the Tokyo stock market climbed more than 25% in the next 12 months.

The awful nature of the debt ceiling debate, plus the downgrade, has clearly added fear and uncertainty to an already sluggish economic recovery. The Treasury debt downgrade is a blow to U.S. pride, and a warning to Congress--particularly those representatives who think the U.S. can simply walk away from its obligations without consequences.

However, as the decline in Treasury rates made clear, the downgrade is largely symbolic. Congressional gridlock and partisan posturing could leave us with a long 15 months until the next time we have a chance to vote on their job security. But it might be helpful to think back to last Summer, when concerns about a double-dip recession and mild panic sent the S&P 500 down a long unhappy slide to a low of 1022.58 on July 2, with a few additional bounces along the bottom until a September rally. Investors who sold out of the markets at that time missed significant--and largely unexpected--gains through the Fall, Winter and Spring, as people gradually realized that the world was not coming to an end.

In the short term, emotions rule the market, and they are visibly tilting toward panic right now. Longer-term, the market prices always tend to return to fundamentals, and it’s helpful to remember that corporate profits remain strong, new jobs are being added and the economy is still growing. The U.S. markets weathered much worse than this in 2008, in 2000, during the first and second world wars and a lot of panic-stricken times in between. Without the ability to see the future, our best prediction is that the Sun will continue to rise each morning and the U.S. will emerge from this crisis like it has all the others--and reward those who managed not to succumb to the panic like so many did last Summer and so many other inevitable periods of anxiety when things don’t go exactly as we’d hoped. •

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

Securities offered through Triad Advisors, Member FINRA/SIPC. Investment Advisory Services offered through LJCooper Capital Management, LLC., a Registered Investment Advisor.

Two Steps Forward, One Step Back

The U.S. and many world market indices were looking at modest gains until they ran headlong into the month of June, when a variety of concerns came together to drive prices lower pretty much everywhere in the world. If you look at the MSCI Developed Markets report, you see the column representing the month of June showing basically a vertical line of red numbers in North America, Europe, Asia and Africa. But the losses of the second quarter were generally not enough to overcome the gains of the first three months of the year, so many indices are still ahead for the first six months of 2011.

In the U.S., the Wilshire 5000 was up 1.71% for the two months heading into the June swoon, and it seemed as if we would experience another quarter of modestly positive returns. Instead, the index dropped 2.63% during the month, finishing down 1.05% for the three months ending June 30. Even so, the broadest indicator of U.S. stock activity is up 4.90% for the first half of the year. The comparable Russell 3000 index of U.S. stocks fell an almost imperceptible 0.03% during the second quarter, finishing the first half of the year up 6.35%.

The Wilshire U.S. Large Cap index was down 0.90% for the second quarter; up 4.95% for the first half of 2011. The Russell 1000 large cap index was essentially flat, rising just 0.12% for the second quarter; it finished the first half of the year up 6.37%. The S&P 500 fell 0.39% for the quarter, but is up 5.01% so far this year. Among the sectors, the biggest losers were financial services companies (down an aggregate 6.27% for the second quarter of 2011) and energy stocks (down 5.07%). Publicly-traded health care companies were up an aggregate 7.29% and utilities rose 5.01%.

The Wilshire U.S. Mid-Cap index fell 0.86% for the second quarter, but is still up 8.70% for the year. The Russell Midcap index was up 0.42% for the second quarter; up 8.08% for the first six months of 2011.

The Wilshire U.S. Small Cap index declined 2.01% during the second quarter; but is up 6.31% for the year. The comparable Russell 2000 fell 1.61% in the second quarter; it was up 6.21% for the first half of the year.

The technology-heavy NASDAQ Composite Index was down 0.59% in the second quarter, but is up 3.30% so far this year.

Looking abroad, the MSCI EAFE index, which tracks a basket of developed-economy indices, was up 0.33% for the second quarter, up 3.00% for the year so far. There are always lessons in the returns; the MSCI Europe index was up 0.78% for the quarter, and is up 6.71% in the first half of the year, when many analysts were betting on a decline due to the widely-publicized debt woes in Greece, and less dire sovereign debt issues in Ireland, Portugal and Spain. The EAFE Emerging Markets Index, which measures the overall performance of less-developed nations, was down 2.11% for the second quarter, down 0.45% for the first half of the year.

Among the notable countries, England's FTSE 100 index fell 1.07% for the first quarter; down 1.13% for first six months of 2011, while Germany's DAX index rose 2.74% for the second quarter; up 5.53% for the six months ending June 30. Japan's Nikkei average is up 1.11% in the second quarter, but in the first half of the year it has lost 5.6% overall. Chinese shares fell 6.92% on the Shanghai stock exchange; down 3.18% over the past six months. The Hong Kong Hang Seng index fell a similar 5.90% in the second quarter, and has so far posted a 4.43% loss for the year. India's Mumbai Sensex index was down 2.96% in the first three months of the year, down 8.34% in the first half of 2011, while Brazil's Bovespa Stock Index was one of the biggest losers internationally, down 9.91% for the second quarter; down 10.80% for the year so far.

In real estate, the Wilshire REIT index rose 3.64% for the second quarter of 2011, and is now up 10.62% for the year.

Bond yields continue to scrape along the floor; you can get a 0.02% yield on 3-month Treasuries currently, 0.10% on 6-month government bonds, and the two-year (0.45%), three-year (0.79%) and 5-year (1.75%) are not dramatically higher. The benchmark 30-year Treasury is currently yielding 4.36% a year. The Bloomberg web site shows 1-year muni bonds yielding an average of 0.211%; if you go out to ten year maturities, you can get an average yield of 2.729%.

Where do we go from here? The U.S. Bureau of Economic Analysis reports that America's economy--the gross domestic product (GDP)--rose 1.9% in the first quarter of 2011, which is significantly less robust than the 3.1% growth rate reported for the fourth quarter of 2010. If you've taken a trip to the gas pump, you are probably not surprised that the inflation rate reached 3.9% in the first quarter.

As you've no doubt read elsewhere, we are experiencing an unusual recovery from an unusual recession; in past economic downturns, the economy has come roaring back during the recovery, but today we are dealing with a more deliberate climb out of the hole. A quarterly survey by the Associated Press suggests that the U.S. economic recovery will be slow and deep, held back by shoppers reluctant to spend and employers hesitant to hire. A poll of 42 economists has concluded that economic growth will probably stay below 3% for the rest of this year and early next year, and their crystal balls say that the U.S. unemployment rate will end the year about where it is now: between 9.0% and 9.5%. GDP growth would have to reach 5% for a full year to drive the unemployment rate down by one percentage point; 125,000 jobs must be added each month just to keep up with population growth. In May, the latest month where we have statistics, 54,000 net jobs were added, down from 194,000 in March and 232,000 in April.

The other headline-grabbing issue is housing. A series of charts created by the web site NumberNomics.com makes clear that existing home sales, new home sales, and median new home prices have all been essentially flat since January of 2009. But with interest rates at record lows, a new house is far more affordable today than it was in 2007; the site notes that the cost of purchasing a home is now actually lower in many sections of the country than what it costs to rent. Distressed sales represented 31% of total sales in May, down from 37% in April--which is progress of sorts.

None of this is bad news for investors, who prefer the recovery to continue, slow or otherwise. But the rocky month of June, which started with six straight days of losses in the U.S. markets, is further evidence that even positive growth and positive returns don't guarantee a smooth ride. The returns of the first half of the year have come with a certain share of anxiety, but it may be helpful to remember that the great returns of 2009 came at a time when many investors were living in a state of fear bordering on terror. Let's count our blessings; the mild reversal of the past three months wasn't enough to offset the gains in the first quarter of the year for most of the elements in a diversified investment portfolio.

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

Securities offered through Triad Advisors, Member FINRA/SIPC. Investment Advisory Services offered through LJCooper Capital Management, LLC., a Registered Investment Advisor.

Inflation Fears

Recently, we've been hearing a lot about inflation, and the government statistics released on April 15 didn't do a lot to quiet the chatter.  The government reported that the Consumer Price Index for All Urban Consumers rose to an annualized 2.7% in March, up from 1.6% in February.  Troll through the latest batch of YouTube videos, and you see pundits and other observers suggesting (sometimes screaming) that the Federal Reserve Board is printing money, leading the U.S. to become another Zimbabwe or Weimar Republic.

The March jump is eye-catching, although the raw numbers are hardly alarming.  Since 1914, the inflation rate has averaged 3.38% in the U.S., so the current rate is still below average.  Moreover, a closer look at the various components of the U.S. inflation rate suggests that prices in general are not rising (as you would expect if a drunken Fed were printing money); most of the price rise is taking place in the energy sector.   The gasoline index is up 27.5% over the past 12 months, which most of us probably suspected based on our last visit to our favorite gas station.  The index for all items less food and energy rose just 1.2%--a rate one would hardly compare with the multi-million percent inflation experienced by the unfortunate citizens of Zimbabwe.

In fact, if you look at two charts created by the St. Louis Bank of the Federal Reserve Board, you see something interesting.  The first chart is the inflation rate since 2006.  The second chart is the price of West Texas Intermediate Crude oil, which can be used as a proxy for global oil prices.  Notice that the two charts look virtually identical.  When oil prices have risen--over the past five years, at least--so too has inflation, and in roughly the same proportion.  Oil prices go down, and so too does the inflation rate.  Price changes elsewhere, while not perfectly stable, have been moderate enough that this one factor has tended to control changes in the overall cost of living.

Is there a lesson from this?  First, we don't know what oil prices will do in the future, but even if they stabilize at the current higher rates, the inflation rate--which measures changes in cost of living--will moderate.  If the various uprisings in North Africa and the Middle East ever calm down--and an optimist might anticipate that they eventually will--then oil prices could fall.  Then, suddenly, you might be reading about how the Fed has somehow engineered a disastrous round of deflation.

Sources:

Average historical inflation rate: http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=USD

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

Securities offered through Triad Advisors, member FINRA/SIPC. Investment Advisory Services offered through LJCooper Capital Management, LLC, a Registered Investment Advisor.

Balmy Market Weather

In percentage terms, the first quarter of 2011 provided the best gains for U.S. stocks in more than a decade--the best quarter since 1999. We experienced positive--albeit modest--returns across almost the entire spectrum of investments for the first three months of the year.

The Wilshire 5000, which is a proxy for all the stocks in the U.S. market, gained 6.27% for the quarter, and has been up 17.43 over the past 12 months. The comparable Russell 3000 rose 6.38% in the first three months of the year.

Large cap stocks provided single-digit gains, with the widely-followed S&P 500 up 5.42% in the first quarter, 5.92% on a total return (including dividends) basis. Every component sector showed gains, ranging from a 16.29% rise in energy stocks to a 1.62% return in utilities. Industrials were up 8.2% and health care rose 4.99%. Meanwhile, the Wilshire U.S. large cap index was up 6.06% for the first three months of the year, while the Russell 1000 large cap index rose 6.24%.

The Wilshire U.S. Mid-Cap index gained 9.21% for the first quarter; the Russell Midcap was up 7.63% and the S&P 400 posted a 9.02% gain; up 9.36% on a total return basis.

The Wilshire U.S. Small Cap 250 index rose 10.06% in the first quarter, while the broader-based Russell 2000 small cap index was up 7.94%. The S&P Small Cap 600 rose 7.43% for the quarter, up 7.71% on a total return basis.

The widely-followed NASDAQ Composite Index finished the quarter up 4.83%, close to its 10-year average of 4.22% a year.

International stocks gained modestly as well. The broad Europe, Australia and Far East (EAFE) index was up 2.67% for the first three months of the year. The European component of the index rose 5.88% despite continuing worries about sovereign debt issues in Greece, Ireland, Portugal and Spain. In contrast, Pacific region stocks were down 2.96%, largely because of a drop in the Nikkei stock market.

Bond rates continue at historic lows. According to Bloomberg, 3-Month Treasuries yield just 0.09%, while 12-Month T-Bonds are yielding just 0.27%. Five-Year bonds yield 2.28%, 10-Year issues yield 3.47% and 30-Year bonds offer 4.50% interest. Bloomberg lists composite yields on 2-Year Municipal Bonds at 0.63%, while 30-year Munis offer 4.82% interest.

In real estate, the Wilshire REIT index rose 5.84% in the first three months of the year. The S&P U.S. REIT index was up 5.49%; up 6.39% on a total return basis. The S&P Global REIT index, which tracks changes in real estate across developed and emerging markets, rose 4.62% for the quarter.

The balmy economic weather and sunny market returns (in striking contrast to the actual Winter climate experienced in so much of the country) must have been a surprise to the economic "weathermen" who, only last July, were predicting a "bleak" 2011 economy. An Associated Press Economy Survey, gathering the opinions of private, corporate and academic economists published July 29 of last year found a consensus of weaker growth, higher unemployment and generally cloudy skies for the economy. In particular, the economists were expecting job growth to remain weak. As it happens, U.S. private employers added 216,000 jobs in March, and a revised 194,000 in February, reflecting what David Katz, chief investment officer at Matrix Asset Advisors in NY describes a reasonably-paced labor recovery.

Meanwhile, the stock market recovery has highlighted one of the peculiarities of investment math. Prior to March of 2009, the S&P 500 had, in round numbers, fallen 54% since its 2007 peak. The recovery, again in round numbers, has achieved a (quite remarkable) 100% gain since the March 2009 low point. Yet the market has not yet fully recovered to its former heights.  

The recovery...has achieved a (quite remarkable) 100% gain since the March 2009 low point. Yet the market has not yet fully recovered to its former heights. 

The reason, obviously, is that investment math tends to understate losses and overstate gains. After a 20% decline in the your investment portfolio, you need a 25% gain before the portfolio is made whole again. As the declines get bigger, the disparity grows dramatically; a 50% drop requires a 100% gain to repair the damage, and an 80% drop would require 500% subsequent rise before you climbed back to where you started from.

In terms of building wealth, that means that the smoothest ride, everything else being equal, is also the most rewarding, which is why we attend industry conference sessions on how to achieve better diversification in our managed portfolios, which asset classes tend to zig when others zag and what new investment opportunities exist which are less likely to follow the same return patterns as U.S. and international stocks.

Achieving this diversification is not always easy, as evidenced when virtually every asset class fell in lock step during the Great Recession downturn; indeed that was when many investors--including some professionals--learned all over again the value of having a bond and cash cushion in their portfolios. We were fortunate in this first quarter of the year that nearly every one of the traditional asset classes offered positive returns; we do not anticipate that being the case forever. Your investment eggs are in many baskets as a precaution against choppier markets whenever they decide to manifest.

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

Up, Up and Away...

2010 was another year of vindication--for the markets and for those investors and financial planners who were willing to put their heads down and stay invested when the ride turned bumpy.  Buy-and-hold stay-the-course investors have now been rewarded with two solid years of portfolio recovery, as the Wilshire 5000 (total market) index rose 11.59% in the 4th quarter of 2010 to put it up 17.16% for the year.  The Russell 3000 (total market) index posted similar gains: up 11.59% in the fourth quarter and up 16.93% for all of 2010.

In fact, no matter what sector you look at in the U.S. market, you see double-digit returns.  The Wilshire U.S. Large-Cap index was up 11.01% for the last quarter of the year, and gained 15.83% in 2010.  The Russell 1000 index, which also tracks large cap issues, gained 11.19% in the 4th quarter to finish up 16.10% for the year.  The Standard & Poors 500 rose 10.76% for the quarter and 15.06% for the year.

The Wilshire U.S. Mid-Cap index rose 13.89% in the last three months of the year, and gained 25.11% for the full 12 months.  The comparable Russell Mid-Cap index was up 13.07% in the 4th quarter and gained 25.48% in 2010

Small caps fared even better.  The Wilshire U.S. Small-Cap index rose 16.32% for the quarter and 28.94% for the year.  Russell's 2000 small cap index was up 16.25% for the 4th quarter and 26.85% for the year.  The tech-heavy Nasdaq Composite Index rose 12.00% in the last three months of the year, finishing up 16.91% for 2010.

International stocks posted less robust gains, as questions swirled throughout the year about the soundness of European debt and the European banks that own it.  The MSCI EAFE index of developed country stock markets rose 6.23% in the 4th quarter, pushing the international composite share prices into positive territory with a gain of 4.90% for 2010.  The developing world fared better than the mature Western economies. The MSCI index of emerging and frontier markets rose a somewhat more robust 11.85% for 2010's final quarter, and finished up 28.70% for the year. 

Among the biggest laggards were, predictably, Greece (its Athex Composite Share Price Index fell 35.1% for the year), Spain (the IBEX 35 was down 17.4%), Italy (the FTSE MIB Index down 13.2%) and Portugal (the PSI 20 Index down 10.3%).  Japanese stocks didn't do much to boost the wealth of their investors; Japan's TOPIX Index fell 1% in 2010, and Hong Kong's Hang Seng Index (one of several proxies for Chinese stocks) was up just 5.3% for the year.  The UK's FTSE 100 Index rose 9%.  Of the largest economies, only Germany and India posted investment performance comparable to the U.S. indices.   Germany's DAX Index was up 16.1%, and India's Sensex Index rose 18.5% in 2010. 

Alas, once again we were not astute enough to position your entire portfolio in the country with the world's highest market growth; the 96% rise in Sri Lanka's ASPI Index did little to enrich our clients overall, and we also managed to miss the runnerup--Bangladesh, whose All-Shares Price Index rose 83.5%.  However, we feel fortunate to have avoided concentrating our portfolios in Bermuda, whose BASX Index was the international laggard, falling 44.4% in 2010.

Despite widespread publicity about housing and real estate woes, the Wilshire REIT index--which tracks real estate investment trust that invest in commercial and residential property--gained 7.87% in the 4th quarter and was up 28.60% for the year. 

The bond markets saw yields fall and bond values, which move in the opposite direction of yields, go up.  The Bank of America Merrill Lynch index of Treasury Bonds rose 5.9% in 2010 as the yield on 10-year notes fell to 3.29%.  The two-year note fell to 0.59%.  Both had touched near-record lows earlier this year; the 10-year note yielding 2.33% on October 8, and the two-year note was yielding 0.31% on November 4.

The numbers are not in yet on the economy's growth overall in 2010, but what we can see so far suggests that a double-dip recession is less likely than it seemed at the middle of the year.  The U.S. Government's Bureau of Economic Analysis reported on December 22 that the U.S. Gross Domestic Product (GDP) rose at an annual rate of 2.6% in the third quarter of 2010, which means growth accelerated a bit from a 1.7% increase in the second quarter.  Among the highlights: real exports of goods and services rose 6.8% in the third quarter, after a 9.1% increase in the second. 

This is the time of year when you hear a lot of market predictions similar to those which predicted gloom and doom in 2009, and caution in 2010.  It would be helpful if those who were offering market predictions wore wizard hats and gypsy shawls instead of business suits, and were required to peer into a crystal ball before uttering their pronouncements about the future. 

As it is, all we can do is point to some of the forecasts which came from respected or widely-followed analysts, which provide evidence that the future--and that includes next year's market gains--is essentially unknowable.  At the end of 2009, author Dan Solin provided an entertaining look at what would have happened if you'd followed the advice of various famous market analysts.  He notes that Jeremy Siegel, the professor of finance at the Wharton School and author of Stocks for the Long Run, predicted that the U.S. would avoid a recession in 2008 and that financial stocks would outperform the S&P 500.  In fact, financial stocks underperformed all market sectors, and the recession brought back memories of the 1930s.

Meanwhile, Professor Nouriel Roubini told investors to avoid the stock markets in 2009, warning of a further loss of 50% of your wealth.  Investors who followed this sage advice would have missed a 24% surge in the S&P 500 and a 37% rise in the Nasdaq index. 

It gets worse.  Jim Cramer, the guy who screams at you on TV, predicted that Goldman Sachs would finish 2008 at $300 a share and Google's share price would reach $1,000.  Goldman Sachs finished 2008 at $84, and Google ended the year at $307.  Better still, Elaine Garzarelli, president of Garzarelli Capital, advised her investors to buy Lehman Brothers, Bear Stearns and Merrill Lynch, noting their attractive share prices.  Two of those firms no longer exist, and the other was sold in a shotgun marriage to a large banking institution.

What about 2010's early predictions?  The web site BusinessInsider.com checked out the forecasts of legendary Wall Street strategist, Blackstone Group economist Byron Wien.  He forecast that in 2010, the U.S. economy would grow at a real 5% rate and the unemployment level would fall below 9%; the Fed would hike short-term interest rates above 2%, 10-year Treasuries would be yielding 5.5% by year-end, there would be zero gains in the S&P 500 and Japan would finish 2010 as the best-performing major industrialized market in the world

The lesson here is to be extremely cautious about pundits, anybody who can predict the future and conventional wisdom about the markets.  If we could predict the future with any accuracy, everybody would buy the stocks that were going up, raising the prices to the point where the returns would be essentially zero.

But...  If you're feeling adventurous, you can turn to the Rollins College web site (http://web.rollins.edu/~wseyfried/forecast.htm), where the predictions of professional forecasters, the Federal Reserve Board, economists selected by the Wall Street Journal, the Office of Management & the Budget, the Congressional Budget Office and the Wells Fargo organization are all laid out in a grid.  They all expect economic growth for the next two years, gradually falling unemployment and low inflation.  Let's hope they're right for a change.

The articles and opinions expressed in this document were gathered from a variety of sources, but are reviewed by LJCooper Wealth Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices. Any articles written by specific LJCooper advisors will include a ‘by line’ indicating the author.

A Bright Quarter

2010 Quarter 3 Market Commentary

PDF Version

By Kenneth G. Bown, MBA CFP®

Investors entered the month of September fearful of past downturns, still haunted by the catastrophic decline in 2008. But yet again, the markets moved the opposite of what many were expecting, posting the highest returns for the month since 1939, and the third best single monthly return in 10 years, according to the Associated Press. The Russell 3000 rose 9.44% in September, putting it up 11.53% in the third quarter, and in positive territory — up 4.78% — for the year. The Wilshire 5000 index was up 9.43% in September, registering a third-quarter return of 11.50%, and bringing the year-to-date return up to a positive 5.57%.

The good news could be seen in all sectors of the U.S. stock market. After dipping to its yearly low on the first day of the third quarter — 1,011 — the large cap S&P 500 eventually rose 11.29% for the three months ending September 30, putting it in positive territory for the year, with a gain of 3.89%. During the month of September, the index rose 8.92% — which more than made up for the losses registered throughout the rest of the year. Similarly, the Russell 1000 large cap index rose 11.55% for the quarter, putting it up 4.41% for the first three quarters of the year.

Interestingly, for all the gloomy news about industrial unemployment in the U.S. economy, the largest yearly gainer was the Industrials sector of the S&P 500, up 11.45% for the first three quarters of the year. The worst-performing sector: energy, down 2.48% going into the last quarter.

Among the various categories of U.S. equities, mid-cap stocks have enjoyed the best returns: the Russell Midcap index was up 13.31% in the third quarter, putting it up 10.97% for the first three quarters of the year. Meanwhile, the Russell 2000 small cap index rose 11.29% in the third quarter, and was up 9.12% for the year. The Nasdaq Composite Index rose 11.30% for the quarter, putting it up 11.89% going into the last three months of trading days.

Some of the stock market gains appear to reflect good news in the economy. The Bureau of Economic Analysis reported on September 30 that it was revising its estimate of second-quarter growth in the economy: up 1.7%, after an increase of 3.7% in the first three months of the year. Corporate profits increased $47.5 billion in the second quarter after rising $148.4 billion in the first quarter.

International investors are beginning to recover some of the losses from earlier in the year. The MSCI EAFE index, which measures the composite returns of the developed nations (although it excludes Canada, for some reason) was up 15.79% for the quarter, but the index is down overall 1.25% heading into the fourth quarter. European stocks rose 18.87%, but were still down 2.98% for the year. The MSCI Far East index rose 7.05% for the quarter, up 3.10% for the year as of September 30.

Meanwhile, the emerging markets are still booming. The MSCI Emerging plus Frontier Markets index was up 21.53% for the quarter, putting it up 15.07% for the first three-quarters of the year.

Alas, our crystal ball wasn’t quite good enough to bet your entire portfolio on the Sri Lanka ASPI Index (up 50.3% for the quarter), or Peru’s Indice Selectivo Peru-15 (up 25.4%). But we were also fortunate enough not to have bet heavily on Iceland’s OMX FO Price Index (down 22.8% for the quarter), or Nepal, whose NEPSE Index fell 14.4% these last three months.

Real Estate investment trusts, portfolios of real estate property that trade on exchanges, also posted aggregate gains. The Dow Jones All Equity REIT index, which tracks 155 real estate investment trusts, was up 12.5% for the third quarter, helped by perceptions that credit may be becoming more available to commercial real estate, which depends more than most industries on credit supplies to refinance debt payments and fund new acquisitions. The NAREIT index rose 7.46% for the quarter, from 2,862.01 to 3,075.61, up from 2,711.15 at the start of the year.

Treasury Bond prices rose slightly as the yield on 10-year maturities fell from 2.95% on June 30 to 2.51% at the end of the quarter. Remarkably, the yield on 6-month Treasury notes is still hovering at 0.19%, and returns on shorter-term paper are even lower. Yield to maturity on 20-year Treasuries stand at 3.38%, and the longer 30-year maturity issues were yielding 3.69% as the quarter ended.

It should be noted that the U.S. markets are close to finally climbing out of the deep holes they fell into in 2008 and early 2009. The 3-year performance of various indices, for the period ending September 30, is within striking distance of positive territory. The Russell 3000 broad market index is still down 6.59% from the end of September 2007, and the large cap Russell 1000 is down 6.79% over the same three years. Over the same three-year time period, the Russell Midcap index is down 4.16%, and the Russell 2000 smallcap index is down 4.29%. If the markets offer gains in the last quarter similar to what we experienced in the third, investors who managed to stay in the market through the turmoil might be able to celebrate a full recovery of their portfolio value.

Meanwhile, it’s helpful to remember that at the start of the quarter, people were questioning the viability of U.S. and global markets after the near-meltdown of Greece, Portugal, Spain and other Southern European economies. Each quarter, each year, seems to bring a new thing to worry about. But looking longer term, the U.S. equities markets have managed to post long-term gains despite some fairly serious disruptions, including World War II, the Cold War, the conflict in Vietnam, stagflation and the oil shocks of the 1970s, the market crash of 1987, the bursting of the tech stock bubble, and the subprime mortgage meltdown and collapse of Bear Stearns, Lehman Brothers and AIG in 2008.

Indeed, if you look at the long-term movements in the stock market since the Great Depression, all of those events, which seemed pretty dire at the time, look like blips on the screen, small dips in the long-term growth of value in American and global publicly-traded enterprises.

There is no doubt that there will be other events in the future which will seem to endanger — or at least derail — the long-term growth of capitalism. But based on the history of the past two centuries, one might feel confident that whatever challenges await us, people in all sectors of the U.S. economy will find ways to build additional value.

The final three months of the year may bring the market indices back up to pre-meltdown levels, or they may disappoint. We simply cannot predict the short-term movements in stock prices. Despite all of our attention on protecting client portfolios, and the complex work of identifying risks and opportunities, the primary focus is still on a long-term bet that risk assets will be up more often than they are down, regardless of what dire thing you will read in the paper between now and the end of the year.

Disclosures
Past performance is not a guarantee of future results. As with any investment strategy, there is potential for profit as well as the possibility of loss. LJCooper does not guarantee any minimum level of investment performance or the success of any investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. This is not a solicitation or an offer to sell securities or investment advisory services except where applicable, in states where LJCooper is registered, or where an exemption for such registration exists. Returns data are sourced from DFA Returns Program, are net of DFA’s management fees, and assume monthly rebalancing. LJCooper’s management fees vary by client and are not reflected in returns shown. Custodial transaction fees are not reflected in returns shown. Performance information presented in the charts or tables in this brochure represents back tested performance for the asset class funds indicated and not the experience of any one individual client. Actual performance of client accounts may differ from the asset class portfolios. Direct investment cannot be made into an index.

1DFA Equity Portfolio is comprised of 15% DFA US Large Company Portfolio, 15% DFA US Large Cap Value Portfolio, 10% DFA US Micro Cap Portfolio, 10% DFA US Small Cap Value Portfolio, 10% DFA Real Estate Securities Portfolio, 14% DFA International Value Portfolio, 8% DFA International Small Company Portfolio, 8% DFA International Small Cap Value Portfolio, 4% DFA Emerging Markets Small Cap Portfolio, 3% DFA Emerging Markets Portfolio, 3% DFA Emerging Markets Value Portfolio. Diversified Equity Index is comprised of 15% S&P 500 Index, 15% Russell 1000 Value Index, 10% Russell 2000 Index, 10% Russell 2000 Value Index, 10% Dow Jones US Select REIT Index, 30% MSCI EAFE Index, 10% MSCI Emerging Markets Index.

2DFA 60/40 Portfolio is comprised of 60% equity funds in the same proportions as the DFA Equity Portfolio plus 40% DFA Five-Year Global Fixed Income Portfolio. Diversified 60/40 Index is comprised of 60% equity indexes in the same proportions as the Diversified Equity Index plus 40% Merrill Lynch US Corporate and Govt. 1-3 Years Index.