An article in the September 28, 2009 issue of the London Financial Times caught our eye http://tiny.cc/lNKSn . The writer, Marko Dimitrijevic of Everest Capital was discussing the significant role that so-called "emerging markets" play in the world economy. He notes that emerging markets represent 30 percent of the world's stock market value and 50% of the world's economy. More telling was his calculation that for the period 2003 to 2009 while sales of the developed world grew at a growth rate of 5% annually, emerging markets grew at 11% annually.
Investors tend to look at the emerging markets as the volatile little brother to the more stable and much larger developed world big brother. Those roles may well be changing.
Tuesday, September 29, 2009
Friday, September 18, 2009
Guarantee Program for Money Market Funds ends today
Little noticed today was the U.S. government step to end the program under which they guaranteed money market funds. One year ago, the Reserve Primary Fund (a large money market fund) who held significant positions in commercial paper issued by the recently bankrupt Lehman Brothers was forced to "break the buck"-- meaning their money market positions were no longer worth the customary $1 for each $1 invested.
As a result of the unusual step by Reserve Primary Fund, money market holders began a massive withdrawal of funds as they fled into US T-Bills. Business felt this very quickly, as money market funds are a chief purchaser of commercial paper issued by US industry to fund short-term cash needs. To stop money from continuing to flee money market funds, and attempt to stabilize the commercial paper market, the US Treasury pledged $50 billion from the Exchange Stabilization Fund to back their guarantee of money market funds.
We can remember many conversations with clients as to why their money market fund investments were safe given this government guarantee.
What a difference a year makes! The expiration of the government guarantee for money market funds is about a page 3 story at best. Government has concluded (and we would concur) that holders of money market funds no longer feel the need for a government guarantee to protect their investment.
We can only hope that as other government support for markets is withdrawn it will be the non-event that this was. We still have significant concern that may not be the case.
As a result of the unusual step by Reserve Primary Fund, money market holders began a massive withdrawal of funds as they fled into US T-Bills. Business felt this very quickly, as money market funds are a chief purchaser of commercial paper issued by US industry to fund short-term cash needs. To stop money from continuing to flee money market funds, and attempt to stabilize the commercial paper market, the US Treasury pledged $50 billion from the Exchange Stabilization Fund to back their guarantee of money market funds.
We can remember many conversations with clients as to why their money market fund investments were safe given this government guarantee.
What a difference a year makes! The expiration of the government guarantee for money market funds is about a page 3 story at best. Government has concluded (and we would concur) that holders of money market funds no longer feel the need for a government guarantee to protect their investment.
We can only hope that as other government support for markets is withdrawn it will be the non-event that this was. We still have significant concern that may not be the case.
Tuesday, September 15, 2009
August 2009 Market Update (Posted to our blog two weeks after sending to clients.)
“Common sense tells us that consumer spending growth comes from highly employed, well-compensated labor, and we are far-far from even approaching that elemental condition. The fact is that near double-digit unemployment has resulted from numerous business models that are now broken: autos, home construction, commercial real estate development, finance, and retail sales.” Bill Gross, PIMCO
August closes another month of gains in stocks, but stocks would require still more gains to offset the losses of last fall. Stock price gains have been very strong in the emerging markets, as investors bet those markets will continue to “decouple” from slow growth developed economies. Below is a schedule of returns (as of August 28, 2009) for selected mutual funds to assist in understanding market returns:
August closes another month of gains in stocks, but stocks would require still more gains to offset the losses of last fall. Stock price gains have been very strong in the emerging markets, as investors bet those markets will continue to “decouple” from slow growth developed economies. Below is a schedule of returns (as of August 28, 2009) for selected mutual funds to assist in understanding market returns:
After such a run in prices from the market lows of March, many market experts are expecting a pause or even a pullback. Beyond this, at Payne Wealth Partners we are concerned about the economy, particularly in the U.S. and other developed countries. This is a theme we have developed in prior writings and the facts continue to support this thinking.
High levels of unemployment (with no expectations of relief anytime soon), wealth effects of house price and market declines over the past two years, and constricting credit are resulting in reduced consumer purchases. Consumer confidence as measured by the University of Michigan Consumer Sentiment Survey Index is at about 65 and has been range bound this year between 55 and 70. Compare this to an index in August of 2007 of 83 and in August of 2004 at 96.
Corporate revenues also reflect consumer concerns as, per Goldman Sachs, the sales of the S&P 500 companies in the 2nd quarter were down 16% from a year earlier, after a similar decline of 14% in the 1st quarter. Overall profits for the S&P 500 companies beat expectations because of reductions in expenses as evidenced by selling, general and administrative (SG&A) expenses that were down 6.4% in the 2nd quarter (also per Goldman Sachs) versus a year earlier. Expenses can only be reduced so much, and it will take true revenue growth to push stock prices higher over the long-term.
The monetary actions of the Fed and other central banks around the world coupled with government spending programs have worked to slow economic declines (U.S. 2nd quarter GDP down only 1% annualized) or in cases like France and Germany (each up about 1% annualized in 2nd quarter) return to economic growth. But government supported growth is not the same as sustainable growth and we have yet to see how economies worldwide will perform without the significant public sector subsidies. Although risks of deflation remain due to excess capacity as companies operate at reduced levels due to reduced customer demand, the high levels of government involvement seem to point to higher inflation in the long-term (another theme we have discussed for some time). Given our concern about sustained economic growth we presently have targeted the stock position in our portfolios near the low end of our allowed ranges.
There is a part of the world with true economic growth and that is the emerging countries. Most of these countries have below-average levels of government debt and are not running the high budget deficits of the U.S. and other developed countries. They don’t have expensive programs like Medicare and Social Security that further threaten already strained budgets. And their citizens are emerging consumers, as opposed to the developed country consumers whose excessive past consumption has left them with high levels of personal debt. To us this means capital invested in emerging countries will generally have a better opportunity for good return than that in developed countries. Additionally, currencies of these emerging countries should reflect their better balance sheets and perform better than that of the U.S. and other developed countries.
With the emerging country advantages in mind we have for some time targeted ½ of our international stock positions to be in emerging markets. The table above shows the return advantage emerging markets have experienced as compared to U.S. stocks. We are now establishing a targeted 5% position in emerging country bonds in all portfolios to reflect the long-term currency advantage we expect. This will be funded by a shared reduction in U.S. investment grade bonds and in high yield bonds.
To conclude, we are pleased with the significant recovery experienced in stock prices but at the same time we are concerned that conditions may not exist for sustained real economic growth. Given our concerns, we have our portfolios positioned to underweight stocks (as compared to neutral positions). We do continue to believe in the story of emerging countries and see their economic advantages as favoring both their stocks and their currencies over the long-term.
High levels of unemployment (with no expectations of relief anytime soon), wealth effects of house price and market declines over the past two years, and constricting credit are resulting in reduced consumer purchases. Consumer confidence as measured by the University of Michigan Consumer Sentiment Survey Index is at about 65 and has been range bound this year between 55 and 70. Compare this to an index in August of 2007 of 83 and in August of 2004 at 96.
Corporate revenues also reflect consumer concerns as, per Goldman Sachs, the sales of the S&P 500 companies in the 2nd quarter were down 16% from a year earlier, after a similar decline of 14% in the 1st quarter. Overall profits for the S&P 500 companies beat expectations because of reductions in expenses as evidenced by selling, general and administrative (SG&A) expenses that were down 6.4% in the 2nd quarter (also per Goldman Sachs) versus a year earlier. Expenses can only be reduced so much, and it will take true revenue growth to push stock prices higher over the long-term.
The monetary actions of the Fed and other central banks around the world coupled with government spending programs have worked to slow economic declines (U.S. 2nd quarter GDP down only 1% annualized) or in cases like France and Germany (each up about 1% annualized in 2nd quarter) return to economic growth. But government supported growth is not the same as sustainable growth and we have yet to see how economies worldwide will perform without the significant public sector subsidies. Although risks of deflation remain due to excess capacity as companies operate at reduced levels due to reduced customer demand, the high levels of government involvement seem to point to higher inflation in the long-term (another theme we have discussed for some time). Given our concern about sustained economic growth we presently have targeted the stock position in our portfolios near the low end of our allowed ranges.
There is a part of the world with true economic growth and that is the emerging countries. Most of these countries have below-average levels of government debt and are not running the high budget deficits of the U.S. and other developed countries. They don’t have expensive programs like Medicare and Social Security that further threaten already strained budgets. And their citizens are emerging consumers, as opposed to the developed country consumers whose excessive past consumption has left them with high levels of personal debt. To us this means capital invested in emerging countries will generally have a better opportunity for good return than that in developed countries. Additionally, currencies of these emerging countries should reflect their better balance sheets and perform better than that of the U.S. and other developed countries.
With the emerging country advantages in mind we have for some time targeted ½ of our international stock positions to be in emerging markets. The table above shows the return advantage emerging markets have experienced as compared to U.S. stocks. We are now establishing a targeted 5% position in emerging country bonds in all portfolios to reflect the long-term currency advantage we expect. This will be funded by a shared reduction in U.S. investment grade bonds and in high yield bonds.
To conclude, we are pleased with the significant recovery experienced in stock prices but at the same time we are concerned that conditions may not exist for sustained real economic growth. Given our concerns, we have our portfolios positioned to underweight stocks (as compared to neutral positions). We do continue to believe in the story of emerging countries and see their economic advantages as favoring both their stocks and their currencies over the long-term.
Friday, September 11, 2009
Have Profit Margins Peaked?
Taylor Payne authored this blog. Taylor is President, Wealth Manager of Payne Wealth Partners. Please read more about Taylor here. The London Financial Times reports that as a percentage of corporate output, second-quarter profits before depreciation, interest and taxes was 35%. Compare this to the long-term average for such margin of 29%.
Common sense tells us that as companies see their revenues fall, they had to aggressively cut costs and this has provided a boost to margins. However, such a lift to profit margins seems only temporary.
Banks have had huge margins given their low costs of funds and a steep yield curve that permits them to lend out at large spreads. These bank margins are not sustainable as the yield curve flattens.
Also, non-financial companies have received a profit boost from shrinking costs associated with reducing inventories (e.g. sell items from inventory that went in at a lower cost than present), but that is largely over.
With profit margins looking toppy and US stocks at about 18 times earnings it is difficult to see stocks making major advances from these levels.
Common sense tells us that as companies see their revenues fall, they had to aggressively cut costs and this has provided a boost to margins. However, such a lift to profit margins seems only temporary.
Banks have had huge margins given their low costs of funds and a steep yield curve that permits them to lend out at large spreads. These bank margins are not sustainable as the yield curve flattens.
Also, non-financial companies have received a profit boost from shrinking costs associated with reducing inventories (e.g. sell items from inventory that went in at a lower cost than present), but that is largely over.
With profit margins looking toppy and US stocks at about 18 times earnings it is difficult to see stocks making major advances from these levels.
Friday, September 4, 2009
Mr. Know-it-all
We all know people that think they know it all, right? Usually the wisest of a group knows that to be truly successful in any endeavor you must surround yourself with those people that are known to be the most knowledgeable. Any effort to be a true “Mr. Know-it-all” ends in failure while becoming part of a network of intelligent people leads to success. Ed Slott, a leading IRA expert seems to agree. That’s why Ed started a group called the “Ed Slott Elite IRA Advisors”. The purpose of the group is to bring advisors together from across the country on a regular basis to discuss the ever-changing world of IRAs and Qualified Retirement Plans. Today there are trillions of dollars in tax-deferred accounts and the balances are a growing portion of individuals' net worth, making specialized training in this area crucial. Ed also has a team of technical experts available to the members of the group at all times to assist in complex client situations and in developing specific steps in implementing high-end strategies. This network of other experts is precisely why
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