Almost exactly as expected in the last edition of Worth Considering, Washington reached a last minute deal to avoid the fiscal cliff. The markets have reacted positively, and recent economic data continues to improve at a tepid pace. Attention now shifts to the debt ceiling.
I can save a lot of space and time by simply saying that I expect a similar outcome to this debate as we had with the fiscal cliff. Drama and rhetoric will pour from Washington and the various news and internet outlets will fill your eyes and ears with as many exaggerated and skewed half-facts as they can.
I’ve commented in the past that I’ve expected the financial markets to pause and then resume their rising trend. I believe that pause was seen throughout the fall and the next uptrend is taking shape. But understand – it won’t be without volatility and corrections along the way. It is a trend, not a one way street. I continue to see the path of least resistance being higher due to such loose monetary policy around the world. As much as I would prefer the markets move higher based purely on economic recovery and expansion, instead I think the stronger fuel for the upward markets is more likely to be cheap money that needs a reasonable home rather than robust corporate earnings growth. I’m not expecting corporate profits to get stuck or even shrink. I do believe they’ll continue to meander higher albeit more slowly than in recent years. The combination of modest earnings and cheap money will most likely put the global markets on an upward glide path – complete with fits and starts that surround the debates about everything from the debt ceiling to the hard/soft landing in China, not to mention the European debt issues that have temporarily left the headlines.
Real Estate and Jobs
As I look ahead to all of 2013 and not just the current topics, I continue to believe that a recovery in real estate will stay a positive theme. A previous issue suggested that housing may come to the rescue of the slow economy. It isn’t just housing, but really all facets of real estate that appear to be adding to economic growth going forward. There are huge numbers of jobs related to the real estate markets, so continued improvement in that space would be very welcome.
On the topic of jobs, we need to remember how things are different in today’s job market when compared to a few decades past. I was reminded of a stark example of this as I was watching 60 Minutes recently. The story revolved around innovations in the technology world and it delved a bit into the job opportunities, or lack thereof, as a result. The researchers used the following data to support their claim.
Apple, Amazon, Google, and Facebook are now four titans of industry with a combined market capitalization of roughly $1 trillion. All four combined employ roughly 150,000 employees. To put this into perspective, that’s less than the number of new entrants into the American workforce every month. And, it is roughly half the number of people who work for GE.
Long ago I adopted the notion set forth by Bill Gross from Pimco that there is a “New Normal” taking shape around the world. At least as it pertains to job growth and specific skill sets needed for the future, this is surely a new normal. As investors, we need to keep in mind that employment data isn’t as directly reflective of economic growth and efficiency as it once was.
The Plow Horse Chugs On
I’ve also adopted the notion of the “Plow Horse” economy set forth by Brian Westbury at First Trust. I’ve highlighted Brian’s research in these pieces in the past. He has argued for a while now that the glass is half full with respect to the economy. He has flown in the face of most conventional wisdom, which has expected a double-dip recession for the past 3 ½ years. He, like me, continues to see the Plow Horse slowly chugging ahead in the New Year.
This slow growth will continue not just here in America, but overseas as well. Looking through all of 2013 I would expect the foreign markets will have a good opportunity to post stronger gains than those in the US. This hasn’t been the case in recent years. As I’ve said in previous writings, the US has been the global performance leader for a while now. It has just been in recent months that the relative performance of financial markets has favored non-US markets; and that hasn’t been by much. They still have plenty of catch-up to play to make up for particularly weak years not long ago. Look for the US to still do decently, but for global markets to perhaps make 2013 the first year in a long time that they outpace America.
Corrections and Bonds
What else to possibly expect from the New Year? A scary market correction, of course! There is still no shortage of potential “headline risk” in the world. Candidates for the catalyst of a correction would include, but not be limited to, the debt ceiling debate and a reminder of the financial stress in Europe. It is not likely, however, that a catalyst would be excessive market valuations or genuine economic data.
I wouldn’t anticipate that a normal, healthy correction at some point during the year would give way to a new downward trend across the board. Remember, corrections of 10-15% or so are what keep the longer term trend intact and keep dangerous excesses from building. There is no such thing as a calm correction. Not with “news” flowing as it does. But remember that while they aren’t calm, they are normal and healthy. They can come at any time and for nearly any reason. Try not to get swept up in the emotional aspects of them. And remember the insights of Peter Lynch who would rightly state that more money has been lost anticipating corrections than has ever been lost during them.
Perhaps 2013 will finally be the year when the bloom comes off the bond market rose. According to research from Blackrock, for the first time in history one category has seen the greatest amount of investment inflows for five consecutive years – the intermediate term fixed income (bond) category. Does this strike you as a streak that can, or even should, continue? As we continue to hover around historically low interest rates, this seems to me to be high risk looming exactly in places where most investors go to seek low risk. Watch out.
Understand that this doesn’t mean I am fearful of all bonds. I most certainly am not. I continue to believe corporate bonds will fare well relative to other income alternatives; but I do caution against holding long maturities even within the corporate space. I wouldn’t find, however, an attractive risk/reward relationship in the treasury markets at the moment.
The Conundrum of Confidence
Money flows indicate where investors feel the most confident – not necessarily the most accurate. I’ve heard it said that confidence is that nice warm feeling you get right before you fall on your backside. This is a crass way of pointing out the old wisdom of wanting to be on the other side of the crowd when looking for better investment success – both in terms of safety and returns.
With this in mind, it is very interesting to note that as we move through January, we are seeing an initial shift in these money flows. Bank of America Merrill Lynch recently reported that just over $22 billion flowed into long-term equity mutual funds and exchange traded funds in the week ending January 9th. That was the second-highest amount on record. This isn’t a comforting fact in and of itself. But I tend to believe this was much more an indication of pent up assets on the sidelines waiting out the fiscal cliff resolution than a greedy mob trying to buy high in the hopes of selling higher.
The point I want to make here is that, overall, confidence is only slowly returning to the markets. Other than this one recent week, there is still scant evidence of the public warming up to the idea of investing in any meaningful way. This is a positive sign for the longer term. I spent a fair amount of time in the first issue of Worth Considering last year trying to make the case that the market spent 2011 getting cheaper even though it really went nowhere, and that would be something that sets the stage for better results in the future. We aren’t in all too much different of a place today. The markets are not as inexpensive as they were at that time, but they are still far from overvalued. In fact, most measures still show them modestly undervalued from a historical perspective.
Given all of the following:
• Housing data has been very strong lately
• Retail sales around the Holidays met expectations
• Greece isn’t a daily headline
• Year-end manufacturing reports all show continued expansion – both here as well as in China
• The American Bankers Association released data last week showing that credit card delinquencies fell to an 18 year low according to their most recent data
You’d expect investor confidence to be a little higher. The fact that it isn’t should be encouraging to longer-term investors.
Checking In On Ben
Finally, some other potentially good news as we look to the future comes in the form of the Federal Reserve apparently beginning discussions on how to exit their Quantitative Easing (stimulus) programs, possibly even by the end of the year. I mentioned earlier in this piece that very cheap money is a key reason why I think markets will rise. Therefore, it would stand to reason that I would be less optimistic if the Fed changes gears. This is true, but there is no indication that their moves would be swift, and there is also no assurance they will actually end their stimulus programs prior to 2015.
I would be completely in favor of the Fed ending their activities sooner rather than later, provided it is an organized and phased plan, which is what they are considering. Specifically speaking, if they end their programs it would reduce the amount of upside potential financial markets have for the near term, but they would still have upside probabilities. More important is the idea that they might avoid creating an extremely dangerous bubble if they stop acting sooner than originally planned. This would mean the markets have the potential to rise for a longer period of time rather than rising sharply in a short period only to be left much more vulnerable to a problem down the road.
As someone whose primary job is to intelligently position assets to help clients achieve financial peace and security, I would wholeheartedly endorse a path that leads to more genuine growth rather than liquidity tricks to spur the short term outlook only.
The Takeaways:
The global financial markets are likely to have a respectable year ahead. Do not get depressed or otherwise emotionally swayed by the headlines on the horizon about the debt ceiling. Expect yet another Washington standoff that looks and ends much like the fiscal cliff did.
While I am optimistic, I would not fall squarely in the camp of the bulls. I don’t think there is enough upside potential in stocks alone to warrant above average risk taking. Instead, I highly encourage everyone to maintain a balanced approach in their portfolios.
Watch the news coming from the real estate markets on a countrywide level to gauge the state of the recovery in the overall economy. Don’t just look out your own window and think you’re seeing the whole story. There are pockets of the country that are well ahead of others and vice versa.
Don’t be alarmed or surprised if we have a period of correction at some point in the year. There are simply too many potential trouble spots to think none of them would raise their heads at some point. But that doesn’t mean there’s trouble afoot. If a portfolio is properly balanced, the effects of a correction shouldn’t be substantial and certainly wouldn’t permanently impair anyone’s financial future.
Happy New Year! I wish you and your family health and happiness!
Jeff Winn – Financial Planning Orlando FL
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