January 24, 2013

Technically, the United States went over the fiscal cliff on January 1, and for those of you paying attention, the S&P 500 rallied 4.57% from 12/28/2012 to 1/4/2013.* What? Not what the financial media was predicting? The good news is that Congress was able to pass the American Taxpayer Relief Act before markets opened in 2013, thereby making permanent the Bush-era tax cuts for most Americans. The bad news is that Congress kicked the can down the road two months on $109 billion in painful spending cuts. While we wait, and endure two more months of headlines about partisan bickering, we’ll get some real news about how companies are doing with the fourth quarter 2012 corporate earnings.

Corporate earnings seasons provide a report card for how companies around the world are doing. Not only do we get a backward view at business activity and profitability, but corporate managers provide forecasts about how they expect their business to perform in the future. Wall Street plays a bit of a silly game with earnings. Wall Street analysts try to guess how much companies will earn. If the analysts guess too high, stocks tend to fall; if they guess too low, stocks tend to rise. Then, there is guessing about the guessing. Money managers we are talking to think that Wall Street analysts have set the bar for corporate earnings a bit low for the fourth quarter. So while economic activity may have been hampered by the uncertainty around the fiscal cliff and a mediocre holiday selling season, Wall Street may be too pessimistic relative to how companies performed, relative to the previous quarter. In fact, we have seen many analysts significantly reduce their estimates since last October. According to Thomson Reuters data, earnings were expected to grow by 2.7%. Now, those guessing about the guessers say that these lowered expectations leave room for companies to surprise investors, even if their results aren’t particularly strong.

While corporate earnings are interesting and can sometimes provide insights into important economic trends, we don’t care all that much about any one earnings season as we are long-term investors; in general, we don’t get too caught up in the events of any three-month period. While we don’t focus that much on a single earnings season, you can expect the financial press to be buzzing. Headlines from the financial media about which companies beat and which ones missed their projected earnings make great news; but, remember, the financial press isn’t in business to give you advice. They are in business to sell advertising and generate ratings. So while the news swirls about earnings, about the budget deficit, and just about anything else, the key is to stay focused on your financial goals and maintain a consistent strategy.


*Source: Bloomberg

Europe: The Rollercoaster that Doesn’t Seem to End

August 7, 2012

The jump in volatility recently has caught the interest of many investors and prompted thoughtful questions about the economy.  We have been tracking three primary subject areas on a daily basis through these unusual global financial events:  (1) the health of the U.S. financial recovery; (2) the European debt crisis; and, to a lesser degree, (3) the health of China and other Asian economies.  These first two issues are at the heart of the recent market volatility.

The European Union is in an unfortunate position of slow to declining growth combined with unmanageable levels of debt.  In most economic downturns, the cycle to reverse the decline is a decrease in interest rates by the Central Bank, which puts more cash into the system and creates a declining currency value.  As a result of low borrowing rates and attractive currency exchange rates, domestic and international spending slowly improves.  The 17-member Euro zone does not have this luxury because, while they share a Central Bank lending rate and currency exchange rate, they pay their own sovereign debt at a borrowing rate set by the market.  Countries that have very high levels of debt—like Greece, Spain, Ireland, Portugal and Italy—cannot muster the growth needed to raise revenue to pay their existing debt and cannot issue more debt at a cheap enough rate to make it financially viable for the long term.  It is a vicious cycle that has been a decade in the making.  While it seems to have been a slow-moving train wreck, we appear to be nearing the climax.  Ultimately, that should be good news because it would create some clarity in an uncertain world.  The hope is that the Euro zone will solve the current problems without an undue level of bank failures and defaulting loans, while also fixing the deficiencies in the system.  There have finally been some meaningful ideas offered, such as a rescue fund that can borrow from the European Central Bank, thus ensuring enough resources to bail out even a large participant like Spain.

In addition to news from Europe, every day we see some chart that compares the current financial recovery in the United States to recoveries in the past.  More often than not, the current recovery is shown to be very weak and fallible compared to others.  A strong recovery creates jobs, increases our standard of living, and ultimately increases personal net worth.  We want a strong recovery because we want all of the above, so it is disappointing when jobs growth or retail sales or home sales are reported to be unexpectedly weak.  Although it has been frustratingly slow, and may continue to be for awhile, the good news is that our economy is making progress.  The even better news is that when the rest of the world gets its act together, the United States seems poised for solid growth and a recovery.  Recent earnings reports show a very lean corporate America with little fat to trim.  A pickup in global sales should have a pronounced and immediate impact on the American economy.

The outcome of the European debt situation and the recovery path of the U.S. economic recovery will influence the financial models and the psyche of investors worldwide.  While the volatility causes us to pay extra close attention to world events, our outlook for a slow and steady recovery in the United States has not changed.  We have lived through many of these market “blips” over the past few years and will probably experience many more over time.

The Fiscal Cliff

July 3, 2012

Have you read about or heard about the “fiscal cliff” the U.S. is facing? In 2011 an agreement was reached in Congress to raise the amount of debt the government could issue so that the U.S. wouldn’t default on its obligations. There was a catch however, if Congress couldn’t come up with offsetting cuts by the beginning of 2013, $641 billion in spending cuts and tax hikes would automatically go into effect.  The impact of these cuts, which are equal to almost 5% of the US Gross Domestic Product (GDP), could be devastating, sending the U.S. back into recession. 

At the time these cuts were set in place, 2013 seemed like a long way away and the cuts that were laid out were so draconian, that an agreement seemed all but certain. Now 2013 is approaching, and a solution has not yet been proposed; the impending drastic spending cuts and tax hikes are the fiscal cliff you will be hearing more about in the media in the coming weeks and months.

Wealth Enhancement Group isn’t alone in worrying about the impacts of this fiscal cliff. Chairman Bernanke expressed his concern in a statement during a June meeting before the Joint Economic Committee of the U.S. Congress and said that if Congress failed to address the fiscal cliff, it would “pose a significant threat to the recovery.”  Former President Bill Clinton stated that we need to “find some way to avoid the fiscal cliff, to avoid doing anything that would contract the economy now” on a CNBC interview.  And, Treasury Secretary Larry Summers added that the top priority should be not taking “gasoline out of the tank at the end of this year.”  Federal Reserve Bank of Dallas President Richard Fisher added fuel to the fire, sharing his view that Congress has had “reckless fiscal policy.”  Making matters even more complicated, political observers don’t expect any action before the presidential election in November, which provides very limited time to actually address these important budget issues. 

So with these spending cuts and tax hikes our politicians have put a trigger in place that could lead to slower growth and even recession. At Wealth Enhancement Group, we have enough faith in the political system of the U.S. that we believe a deal will be reached that will avoid “yanking the rug out” from under what is already a fragile economy.

In the end, politicians are usually rational and if they don’t find a solution, they’ll be responsible for what may clearly be bad decisions and one that won’t help them win votes.  The best-case scenario for the economy and markets would be a grand bargain that maintains short-term spending, but reduces the country’s long-term, unfunded liabilities. While a grand bargain may still be out of reach, we believe that smaller compromises are more likely than not.  So while we’re concerned about the fiscal cliff, we ultimately think that the worst case scenario is unlikely.

Wealth Enhancement Group