5 Year Total Return Performance by Asset Class

Courtesy of Deutsche Bank, we see the 5 Year Total Return Performance of stocks, bonds, precious metals, etc. As noted here, Gold, Silver, and Bonds have significantly outperformed equities. On a side note, somewhat surprising to me was how well High Yield bonds have performed, and how poorly the Shanghai Index as performed over the last 5 years. China's GDP continues to grow, and the China bulls continue to point out that China will be the leading economic powerhouse in the 21st Century, but whether this is true or not, we won't know yet, but what we can note is that the market is weary of China and its rate of "real" growth (not nominal).

My concluding point is that everyone says that gold/silver will continue to go up, stocks will trade range bound and bonds have to be approaching their own bear market.......but, if this run-up in Gold/Silver doesn't scream there's some type of bubble, then I don't know what does. Gold and Silver are typically a good hedge against a currency being debased (which, we all can agree is occurring in Europe and the US), but at these types of levels, do you really think the reward outweighs the risk?

Economic Musings - 2.23.12

The market appears to be trading range bound, as jobless claims hold steady in the US, however the investment community is hearing more talk of a moderate recession in Europe. According to the EU's latest projections, they expect the 17-nation Euro economy to experience a moderate recession and contract 0.3% in 2012, with Greece expected to contract 4.4% due to austerity measures and Portugal expected to decline 3.3% as they try not to fall into the "Greece" category (ie the worst of the PIIGS). This is something to watch because China's economy is still dependent on exports, and a significant amount of their exports go to Europe. To put this perspective, the US GDP is comprised of 67% consumer goods consumption, whereas China's GDP is only comprised of 30% goods consumption. Therefore, if Europe's banks continue to shrink and GDP does contract, Europeans will not have as much access to liquidity, and could reduce their spending, further impacting their economic output.

In addition, in the U.S., there appears to be some technical resistance at play, as US equities, as measured by the S&P 500, have been up 8.3% to begin the year, with last year's "losers" (ie Financial Services) performing the best and last year's "winners" (ie utilities), performing the worst.

Why the Market is More Weary of the ISDA than the Actual Greek Bailout

For today's comment, in honor of Greece's 54% "voluntary" hair cut from its creditors, I rehash my comment from early December (http://webbpicks.blogspot.com/2011/12/tues-12611.html) on the importance of whether the International Swaps and Derivatives Association or "ISDA" deems Greece's "voluntary" hair cut as a "credit event", thus triggering credit default swaps or "CDS". If the ISDA doesn't recognize these CDS as being triggered for Greece's bailout, then investors are going to call into question the value of all credit default swaps on every country/companies and whether these investors have actually "hedged" their exposure. If these CDS don't pay out when bonds have technically defaulted (through a 'voluntary' hair cut), then what's the point of even hedging these in the first place. Investors are now going to reprice "risk", thus leading to a higher risk premium, thereby requiring a higher return for their investments, and could cause volatility in the markets to rise.

On a side note, as to how different the markets have been behaving since September through November last year, when 1-3% dives/rises in the market were becoming common place. Courtesy of Jeff Staut, Raymond James, the S&P 500 has now gone 35 trading sessions in 2012 without suffering a 1% down day. There have been 12 other years since 1928 whether the S&P 500 has traded higher for 30 sessions or more without a 1% down day. In all but one of those occurrences, the S&P 500 was higher at year's end, with a median gain of more than 15%.

Why Should We Care About Greece?

For today's comment I am going to discuss why investors care about Greece, and then end with why investors shouldn't care about Greece.

The market today is going to be very volatile as Europe is weighing on investors minds, but fortunately the news out of the US is good, and bullish. To begin, the markets in Europe were spooked after concern has begun to weigh that Greece will miss a debt payment next month as the latest Greek bailout aid was postponed to February 20th. In addition, Moody's warned it could downgrade the long-term credit ratings of the 17 of the largest banks, and in particular, the banks with the most Euro exposure. But, over the pond, weekly jobless claims fell to a near 4-year low to 348,000, and housing data was strong with housing starts rising 1.5%.

Now to begin why we should care about Greece....although Greece seems to be a small cog in the Euro, it's seen by investors as a proxy for the bond markets, given the fiscal debt deficits and debt of many countries and is also a proxy as to how the European leaders will deal with its other weaker countries. Greece is by far the weakest of the countries, but the other PIIGS countries, and in particular Portugal, are very weak and without aid very well could end up like Greece. Will the stronger Euro countries request so much austerity for their aid that it's impossible for those countries to pay back the stronger, creditor countries? Or will the stronger creditor countries devalue the Euro, and essentially help pay for the weaker countries debt problems? This is not an easy resolution, and I wouldn't expect to see a definitive resolution in the near term.

Now, courtesy of Jim O'Neill from Goldman Sachs Asset Management as to why the "world" shouldn't care as much about Greece.

"This past week, the 6th in the year 2012, has displayed a slightly different character to the previous 5 weeks with the equity markets losing their strong upward momentum. There have been some understandable reasons for this, not the least of which is the never-ending saga of Greece, which I shall discuss a bit more below, and the related challenges about resurrecting a credible and permanent European Monetary Union (EMU) from this mess. Despite this, my main message is – once again – to please keep this in perspective. Greece’s economy is somewhere between $300 to $350 billion. Last year alone, China’s GDP increased by $1.4 trillion, to $7.3 trillion. I reckon that means China has created the economic equivalent of another ½ of Greece in the 6 weeks of 2012 to-date. It is also the case that the evidence about a self-sustaining recovery in the US continues to build after yet another decline in weekly job claims, a rather reliable indicator."

As you can see, China is much more important to the world GDP, and in the end, will have a much bigger impact on the markets then Greece. And, as long as economic indicators continue to be solid in US, we will focus on our own growth, and push aside all this "PIIGS" talk.

Obama's Proposed Tax Policy

Today's softness in the equities market is just a pull back due to today's economic #s, and I also believe due to political bipartisanship due to Obama's new proposed tax policy, which I have included some bullet points below. Now, most of this will not get passed as is, but some of this will be very popular with the masses, including the carried interest being taxed as ordinary income. I will go out on a limb and note that there's no way that Congress could pass dividends being taxed as ordinary income. As many know, once a company has paid out a dividend, it's already been taxed at the corporation's tax rate, so by taxing it again to an individual in the highest tax bracket, you will in effect have taxed that company's profit at close to 50%, which makes dividends not and economical use of capital deployment for corporations. This unintended consequence could ultimately result in a decline in dividends from corporations.
• Top individual income tax rate of 39.6%, starting in 2013 (up from 35%)
• Long- term capital gains top rate of 20%, up from 15%.

• 3.8% tax on unearned income of couples earning $250,000 or more; individuals making$200,000 — is to take effect in 2013 to pay for the 2010 health- care reform law.

• Dividends are treated like ordinary income. Top Federal bracket for some taxpayers = 43.4% (including dividends). Top dividend tax rate is now 15%

• The AMT is replaced with a 30% minimum tax for individuals with annual incomes of at least $1 million.

• The Carried Interest option benefiting hedge fund managers and private equity managers moves to ordinary income rates instead of a preferential 15%

Equities vs. Government bonds

Today's comment I look at the long-term and recent performance of equities vs. government bonds (ie US Treasuries). Courtesy of BASML, these charts below, which are based on a rolling 10-year annualized return, illustrate that in the last decade, government bonds have outperformed equities. With that being said, with the Federal Reserve supporting the market by keeping rates low for an extended period, I would currently allocate more to equities. Although government bonds did outperform equities last year, I believe equities will outperform US Treasuries this year. As I have previously noted, equity valuations are attractive, macroeconomic factors are trending positively, government policy is supportive and S&P dividend is yielding more than 10-year US Treasuries. I would still favor allocating some of your portfolio with corporate bonds, but would not be a buyer of US Treasuries.

The reason to be bullish for US Treasuries is if you believe there will be a major banking and debt crisis that spills over into US and China. And, as we have seen so far this year, that has not been the case. Earlier today, Greece's government approved austerity measures necessary to receive its next round of bailout package. The market has digested this positive news, and the S&P 500 is trading in the black to begin the day (up about 0.5% right now)

Fri 2.10.12

Today, the market is looking to pull back. The market has been on a nice run lately, and I would look for some profit taking today. If you remember last year, I harped on the fact that the market was becoming used to huge, wild swings of 2-3% or more a day. Well, lately volatility has declined and we have enjoyed a nice, steady rise. In fact, so far in 2012, there's only been one day of a decline of 0.5% or more and we haven't had a decline of 1% or more since late December. However, the news out of Europe and Greece is gloom and doom, as the European finance minister is basically saying there should be no Greek bailout, and it appears that other Euro countries are looking to push Greece out of the Euro.

The other point I would like to make about this rally we have enjoyed, is that too many investors have become bullish. Stocks, like McDonald's, are hitting their multi-year highs, even though we are in a sub 3% GDP environment. Furthermore, this is all happening while volume has been significantly lower than historical norms.
But, to leave on a positive note, courtesy of Sam Stovall, from S&P, when stocks are in the "black" in January (note the S&P was up 4.4%), then 86% of the time since 1945, the market has been in the black for that year.