2012’s Strong Start

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In a recent edition of Worth Considering, I spent some time explaining that the equity markets here in the US and around the world were inexpensive by historical standards. I tried to show how the sideways movement of the markets in recent quarters was masking some positive developments in terms of valuation and might be setting the stage for eventual upward movement. It was my belief then, as it still is today, that 2012 isn’t likely to be a huge upside year, but that much better times – for the markets, anyway- are nearing.

Two important things have occurred since I made those comments. First is that Fed Chairman Ben Bernanke modified his views for how long he’d like to leave interest rates at zero, and second is that the markets have risen appreciably around the world.

On the first issue – Bernanke and the ongoing zero interest rate policy: This should underscore just how fragile the state of the economic recovery still is. I applaud the attempt at transparency because it no doubt helps business owners better gauge the cost of capital which allows them, hopefully, to better map their corporate plans for growth and job creation. It would be great if we could also provide them clarity on other costs of doing business, like healthcare costs and taxes, but that’s a different topic altogether. Of course, the ongoing zero interest rate policy is a sad reality for folks looking for income from their hard earned savings.

Bernanke’s comments serve the purpose of forcing people into assets they might not really like to own at this stage in their lives. Retirees are likely to shift more assets into the stock market and away from savings accounts and CDs. After all, when you can earn less than 2% on a ten year treasury, the 3-4% or so you can get from certain traditional blue chip stocks begins to look like a risk they must become willing to take.

The old saying of “don’t fight the Fed” comes into play. It is a theory that still holds water. Simply put, with interest rates on the floor the path of lesser resistance for financial markets historically has been up. It won’t be a straight line, but the probability of markets being higher in the future than what they are today is ever increasing. Still, investors shouldn’t get carried away and forget their risk tolerances; after all, these are probabilities we’re talking about, not guarantees.

On the second issue – the rising markets: With this rise in prices, the markets are no longer as undervalued as they were at the end of the year. But they haven’t lost all of their value by any measure. We’ve continued to see strong earnings growth which means the market’s price/earnings multiple hasn’t expanded by the full measure of the rise in the market. In short, we’re not as cheap as we used to be, but we’re still a bit undervalued by historical standards.

So what to expect now? I think we’ve gone up about as much as should be expected for the time being. Could we have a correction to validate this recent rise? Sure. But I think that is likely all we’d see; a simple correction that leads to a continuing plateau as we wait for more signals from the worldwide economy. If those signals continue to show more green lights than red, then we will likely meander higher. Again, this is the path of lesser resistance in a zero interest rate world. If those signals flash red, we’ll grind around somewhere near current levels I’d suspect.

Also of importance is the expansion of Europe’s LTRO (Long Term Refinancing Operation) operations. This is essentially their version of QE (Quantitative Easing). As far as I’m concerned, it is QE3 for the world – this time the machinations take place in Europe instead of America, but the same end is being sought. Down the road, it is nearly unimaginable that these events won’t cause inflation to pick up. For now, the deflationary pinch of all this credit being destroyed is holding down reported inflation numbers.

This won’t be how the story ends, I believe. As the years roll on, inflation will most likely be the central issue. Until that day, stocks, bonds, metals, commodities, and also real estate will likely begin to fare better.

Thank you, Oklahoma.

Last week we were introduced to the $25 billion mortgage settlement. I was torn between tears of sadness and stomach churns of nausea as I read about it in USA Today. It looks to me that nobody receives any truly valuable benefit from this settlement. If this deal moves along as described in their February 10th article, it is sheer lunacy. As a person raised around a hard working, Mid-Western, middle class mindset, I am offended by this deal. Please don’t misunderstand me, where there was fraud there needs to be restitution; who wouldn’t agree with that? And I certainly will not defend the banking industry when it comes to their role in the issue. It is simply my opinion that this deal is crafted very poorly. Something should be done, I agree; but I sure wish something more sensible could have been discovered.

As a financial advisor, I couldn’t possibly encourage clients to view the lottery as a financial strategy. So imagine the chill in my spine when the USA Today article begins with: “For almost 1 million homeowners, the $25 billion federal-state mortgage settlement announced Thursday may be like winning a lottery.”

I tend to agree with Jonathan Lieberman, managing director of New York investment firm Angelo, Gordon & Co., which oversees $22 billion, who said the following on a conference call held by the Association of Mortgage Investors: “I see a continued erosion of responsibility, community, standards of care, moral values, and fiduciary standards….there is no penalty.”

And I certainly agree with Oklahoma’s approach. As stated in the article: “Oklahoma is the only state that didn’t sign on to the settlement. Oklahoma Attorney General Scott Pruitt criticized the national deal, saying it goes too far and rewards homeowners who stopped paying their mortgages over those who continued to make payments.”

I understand that many Americans lost their homes or are currently delinquent on their mortgage due to natural forces of an economic recession. If someone loses their job I certainly understand the strain this puts on their ability to stay current on their bills. But this settlement – at least currently – doesn’t differentiate between genuine need for assistance as a result of either authentic distress or bank fraud and those that are choosing to game the system. This settlement appears to treat those that are being “strategic” in their choices to stop paying – people with jobs, savings, and ample opportunity – the same way as it treats a person in real need. How insulting… and dangerous.

I also wonder just how meaningful a $20,000 reduction in principal is to a homeowner who is underwater by $100,000 on their mortgage. Did this taxpayer funded “lottery” really positively impact the lucky lottery winner? Is his or her life or economic profile really any different now? Will their behavior change as a result? Can it? I don’t know.

I could write for pages about how bad I think this settlement is and how damaging it could be for our economy – financially and morally. But I’m hoping that there are more details to come about how this will be implemented. The concept of forging (or even forcing) an arrangement by which the housing/mortgage dilemma is addressed is sound. This particular approach, however, seems to be off target. It might actually serve to ironically further distress the housing market as was posited by a Zillow economist in the USA Today article.

I applaud Oklahoma for their approach to avoid broad sweeping gifts with little justification and instead opt for specifically targeted payments to those clearly victimized by deceptive foreclosure practices. Hopefully sanity can spread.

The takeaway:

  • 2012’s strong start is welcome, and justified to a certain extent. We might now stall around current levels for a while.
  • Let’s hope this latest mortgage settlement isn’t a done deal as much as a much needed work in progress.

Commentary by Jeff Winn, Financial Advisor Orlando FL


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