Looking back over 2009- Stocks

Wow!  Stock returns for 2009 were superb, particularly that part of the year from the lows reach March 9 of this year.  With a return of 28% year-to-date and 69% from March 9th to present, the S&P 500 demonstrates how well stocks did.

Stocks of developed international markets did even better, in part due to currency gains from a weak dollar.  The index known as MSCI EAFE is the generally accepted benchmark for these markets, and has a year-to-date return of 31%.

Leading the pack in stock returns were the emerging markets of countries like China, India and Brazil.  The return for the MSCI index for emerging markets year-to-date is 78%.  These stocks went down quite a bit more than developed markets in 2008, so they were coming from lower levels.  Also, they benefited from investor sentiment that sees these countries as the primary driver of worldwide economic growth for years to come.

So 2009 taught us that there are recoveries after the stock lows brought about by forced selling of those who must deleverage and emotional selling of those who got scared and followed.  Investors who really prospered maintained their discipline, followed their allocation plan, and even better identified opportunities that the tidal waves of selling created.  There was much to learn from 2009 and those who tried to time the market or who reacted emotionally and sold at the lows paid a big price for the lesson.  Let's hope investors can remember these lessons for a while.

Looking back over 2009- Bonds

2009 was for bonds a year where risk paid big rewards, while the safety of places such as U.S. Treasurys (which protected so well in 2008) meant losses.  First let's look at what happened with Treasury yields-- remember that when yields go up, prices go down.  The interest rate paid on the 10-year Treasury note went from 2.25% at 12-31-08 to 3.75% currently while the interest rate on the 30-year Treasury bond went from 2.6% at 12-31-08 to 4.6% presently.  To assess the effect on investors in these instruments, consider the 21% loss for year-to-date return on the iShares 20-year Bond Fund (symbol TLT).

While rising rates hurt investors in Treasurys, the improving economy meant big gains for investors in bonds with some credit risk (meaning some risk of default).  In fact, more risk generally meant more return (just the opposite of 2008).  The iShares Investment Grade Corporate Bond (LQD) has returned about 9% year-to-date.  The Barclays High Yield Bond Fund (JNK) has earned 37% year-to-date.

Is there a lesson in all of this?  To us the dramatic change from 2008 to 2009 for bond investors simply reinforces the importance of not simply following the crowd or reacting to what all of the TV "experts" or cable talk show hosts say.  As always, successful bond investors in 2010 and beyond will be those who perform the hard work of constantly evaluating the risk/return opportunities of different bond sectors, maturities and issuers, and then have the courage to act in a manner that is at times contrary to popular opinion.

Could the 2010 Estate Tax Rate be Zero?

Little noticed in the Washington furor over healthcare legislation is the scheduled reduction to zero of the estate tax effective January 1, 2010.   Presently the first $3.5 million of an estate is not subject to tax, with the maximum rate of 45% for amounts in excess of this exemption.  Under the terms of present federal statute (brought about by the 2001 Tax Act commonly known by its acronym EGTRRA) the estate tax will automatically be repealed effective January 1, 2010 unless Congress acts very soon (note the House of Representatives is scheduled to start it's holiday break after session today, Friday December 18th and not return until after the first of the year).

Most estate planners, including this writer, were of the opinion that Congress would not allow the repeal to occur.  Since EGTRRA has only 2010 as a year of no estate tax with a "sunset" provision that provides for reinstatement of estate tax effective January 1, 2011 with exemption of $1 million and maximum rate of 55% (60% counting surtax on estates over $10 million up to about $17 million), having one year with zero estate tax is unbelievably bad social policy.  Wealthy families would benefit tremendously from a death and resultant inheritance in 2010 only.  Gallows humor has described this environment as "Throw Mama from the Train".

We are at the precipice of such a 2010 with no estate tax and all that comes with that.  Sad that our political "leaders" have allowed it to come to this.  What happens (or doesn't happen) with estate tax legislation now bears extremely close scrutiny.

November 2009 Market Update (Posted to our blog two weeks after sending to clients.)

“When I started counting my blessings, my whole life turned around.”

Willie Nelson

In this season of Thanksgiving, we are mindful of our many blessings. What we will do here is to simply list, in no particular order, a few of those things for which we are thankful.

• The sense of team and purpose we feel as all of us at Payne Wealth Partners work together to serve our clients’ needs in wealth planning, investment management and life.

• The trust our clients place in each of us as professionals, and in our firm and the 99%+ of our clients that have stayed with us in these most challenging times.

• A Federal Reserve led by a scholar (Ben Bernanke formerly a Princeton professor) who specialized in the Great Depression and knew the steps to avoid a reoccurrence.

o Bernanke is highly intelligent having scored a 1590 out of 1600 on his SAT going on to graduate summa cum laude in economics from Harvard and earn a PhD in economics from MIT.

o After having been appointed to chair the Federal Reserve in 2006, one of Bernanke’s first speeches was titled “Deflation: Making Sure it Doesn’t Happen Again.”

• The system of capitalism that was sorely tested over the past 18 months, but has surely survived. In capitalism the search for profits ensures the market will produce those goods and services that the consumer desires to purchase. Although excesses can result in this system, this is still the most efficient system for allocation of capital and human resources. This system will reward most those individuals that work hard and remain responsible to their family, community and self.

As we examine the month of November (where the S&P 500 return month-to-date through Friday, November 27 is 5 1/2%, and year-to-date return is 24%), we are of the opinion that the period of rapid investment recovery from the lows of this March has come to an end, and we now must look forward to what type of economic growth we can expect to drive returns in the future. At Payne Wealth Partners, we see more economic challenge than opportunity over the next several quarters. Although some cyclic recovery is to be expected after any recession, the challenges going forward are significant, including:

• A US stock market that is presently trading at a PE ratio of approximately 20x future 12 month earnings and therefore has already priced in substantial profit recovery.

• Stock and bond markets worldwide that still are counting on government support for much of their current pricing. Policy makers are now beginning to publicly discuss how and when to remove this stimulus and to no one’s surprise there is some disagreement.

o Just this week the European Central Bank was discussing some possible tightening in the near term while the World Bank was promoting the continued presence of stimulus to assure not dipping back into recession

• A US home mortgage market where almost 11 million (about 1 in 4) mortgage holders are “underwater” (mortgage in excess of home value) with areas like Nevada, Arizona and Florida where the percentage of those with negative equity ranges from 45% to 60%. Notably in Indiana less than 9% of mortgages are underwater.

• A worldwide banking system that is still undercapitalized, including China where the Banking Regulatory Commission this week is reported to have said the banks must increase capital from 10% to 13% of risk-weighted assets.

• Unemployment in the US of 10.2% (or 17.5% if we include those underemployed and who have just given up looking) and still on the rise. Such high levels of unemployment have historically weighed on consumption and resulting economic growth.

For our client portfolios, we continue to maintain equity positions at the low end of our target ranges to account for the above concerns. Additionally, we continue to emphasize emerging market positions in both equities and bonds (to enjoy economic growth of emerging markets while benefiting from anticipated future dollar weakness against these currencies), and build some positions in alternative assets that can provide returns which are somewhat uncorrelated with the overall stock market. We are making no changes to client portfolios, other than to continue to move into alternative assets as described in last month’s investment commentary.

U.S. unemployment for November

Last week saw improvement in U.S. unemployment numbers, as the unemployment rate declined from 10.2% to 10%.  However there is still much with which to be concerned.  Key is that the rate which reflects both underemployed and those who have just given up looking for a job is still over 17% (17.2% for November vs. 17.5% for October). 

Other unemployment notable facts include a 28.5 week average length of time without work for all umemployed persons.  Also, 38.3% of those unemployed have been jobless for at least 27 weeks.  These measurements are at record levels since such recordkeeping began in the 1940's.

We think unemployment and its implications for consumers is still very concerning.  We may not see the full impact of unemployment until government stimulus for things like auto purchases, home purchases, possible job tax credits and the like have run their course.

U.S. Budget Deficits affect everything (including war)

Tonight President Obama will present the latest planned changes in the Afghanistan war strategy in a speech to be given at the U.S. Military Academy at West Point.  There will likely be few surprises in the speech as the contents have been widely published already, including an increased 30,000 additional troops.  Today's Wall Street Journal contains an interesting article http://tiny.cc/vVaR1 on the economics of such troop additions.

A few numbers according to the article:

• $1,000,000-  annual cost per soldier in Afghan theater (White House estimate)
• $500,000-  annual cost per soldier in Afghan theater (Pentagon estimate)
• $400 per gallon-  cost of fuel when delivered to certain Afghanistan locations
• $1 per gallon-  cost of same fuel in the United States
• $30 billion-  annual cost of 30,000 additional soldiers (per White House)
• $3.6 billion-  present monthly cost of U.S. military deployment in Afghanistan
• $65 billion and $61 billion-  Afghanistan and Iraq, respectively, Pentagon budget requests for fiscal year ending September 2010 (prior to tonight's announced troop additions) 

Expect these costs and the affect they will have on the already outsized U.S. budget deficit to be front and center in the debate over the U.S. strategy in Afghanistan.