Time for More Investment Risk?

Wednesday, August 8th, 2012

“An improvement in the global economic outlook is the key fundamental reason to take on more risk in an investment portfolio,” said BCA Research in a recent commentary. “The U.S. payroll report was positive relative to expectations, but rather weak in absolute terms. Moreover, last week’s Fed and ECB meetings did little to lift our optimism. Several indicators continue to suggest it is too early to add to pro-cyclical currency trades.

• For example, the global leading economic indicator is still pointing down. More importantly, with no new stimulus measures announced this week, it is difficult to see the global LEIs inflect upwards.
• In addition, gold is a real-time monetary indicator and the peak in March 2008 correctly warned that deflation risks were escalating. Gold’s recovery in early 2009 (ahead of the bottom in equities) then accurately indicated that reflationary policies were finally gaining traction. Gold prices slipped back below $1,600/oz following this week’s Fed and ECB meetings. This suggests that major central banks are still behind the curve.  As in early 2009, a sustained rally in gold will signal that the forces of reflation are starting to win out.
• Finally, an uptrend in Chinese stocks and an acceleration in Chinese money supply growth will be bullish signs for Chinese growth and the commodity complex.”

BCA concludes that “it will take further proof that the global economy is stabilizing before augmenting a pro-cyclical currency investment stance.”

Source: BCA Research, August 7, 2012.

Tags: Absolute Terms, Central Banks, Chinese Growth, Chinese Money, Chinese Stocks, Currency Investment, Currency Trades, ECB, Fundamental Reason, Global Economic Outlook, Global Economy, Gold Prices, Investment Portfolio, Investment Risk, Leading Economic Indicator, Monetary Indicator, Money Supply Growth, Payroll Report, Reflation, Uptrend
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Secular Outlook: Implications for Investors

Monday, July 30th, 2012

by William R. Benz, PIMCO

• For investors, the biggest challenge now is moving from a world of normal distributions, with expected occurrences around the mean, to one of bi-modal distributions where more extreme scenarios prevail.
• Key institutions, including governments and central banks, were previously stabilising forces but are now helping to accelerate underlying, destabilising trends in the global economy and financial markets.
• In this environment, investors need to invest for outcomes rather than simply for beta and diversification.

Perhaps the most important tradition at PIMCO is our annual Secular Forum in May. Since I joined 26 years ago and participated in my first forum with 16 other investment professionals, our forums have become much bigger and much more global. More than 300 of us descended on Newport Beach or tuned in via video in our most recent round. But the tradition continues, as does the intensity and excitement, with the output of our forum – our three- to five-year secular outlook – forming the cornerstone of both our longer-term investment strategy and our business positioning.

Mohamed El-Erian, our CEO and co-CIO, in his Secular Outlook commentary “Policy Confusions & Inflection Points,” summarized three themes that we expect to play out over the next few years: continued policy and political confusion, overly incremental public and private sector responses and, therefore, greater potential for inflection points. Mohamed also discussed the key investment implications of our outlook, noting that the strategies and guidelines that may have served investors in the past will likely be challenged in the context of inflection dynamics.

That point is worth revisiting and expanding upon because, in our view, investing is fundamentally changing. Previously, most investors simply aimed to beat their benchmarks and diversify among assets to mitigate risk. But today, as we face unusual uncertainty in the global economy and the financial markets, extreme events are not only possible but increasingly likely, and in this environment, we believe investors need to define their objectives and choose strategies that target specific outcomes.

Investors’ biggest challenge

The world is facing a number of very significant challenges for which there are no easy solutions. The eurozone faces high debt levels, a lack of structural growth and pressure to get the policy mix right to avoid contagion. The U.S. is suffering slow growth, high debt, a looming fiscal cliff and political polarisation. While enjoying higher relative growth, China and the developing world are also slowing and making difficult transitions from export-led to consumer-driven ‘emerged’ economies. And globally, a lack of policy coordination, increased income inequality and the growing use of social networks as communication tools also present long-term challenges.

Uncertainty is one common theme, and another is the potential for more extreme outcomes, good or bad. The eurozone, for instance, has to either find a path toward fiscal union or create a mechanism for orderly exit, with very little room to manoeuvre in between. Likewise, the U.S. needs to find a way to resolve its fiscal issues or face the consequences of a further downgrade and eventual loss of reserve currency status.

For investors, then, the biggest challenge is not continued volatility; that’s almost a given. The challenge is moving from a world of normal distributions, with expected occurrences around the mean, to one of bi-modal distributions where more extreme scenarios prevail.

Key institutions: once stabilisers, now accelerants

In the old normal, key institutions acted as stabilisers: They generally behaved in a counter-cyclical fashion to help enforce reversion to the mean. For example, governments and central banks enacted policies to stimulate growth and prevent deflation during economic downturns and did the opposite in upturns. Regulators tended to de-regulate during tough times and tighten the rules during times of excess, while financial institutions decreased and increased lending as interest rates rose and fell.

Their actions, individually and collectively, helped bring economic growth and the markets back to normal, back to long-term averages, back to the mean. They weren’t necessarily coordinated, but they were generally effective and helped create the Great Moderation of steady growth, strong returns and relatively low volatility that we witnessed from the mid-to-late 1980s until the global financial crisis in 2008.

But today, these institutions are acting as accelerants. Governments in Europe, the U.S. and Japan are under pressure to pursue fiscal austerity rather than stimulate growth, exacerbating the downturn. Central banks are largely going their own way, after a well-coordinated response to the financial crisis, and in some cases, are resisting stimulative measures, which is slowing, if not preventing, the healing process. Regulators, adopting a ‘never again’ mentality, are creating blunt instruments to solve complex problems, leading to unintended consequences, particularly in the banking sector, at a time when more rather than less lending should be the recommended medicine. And banks, especially in the eurozone, have been severely impacted by their holdings of sovereign debt, which, in turn, has led to a vicious cycle of falling share prices, credit rating downgrades, asset sales, reduced lending, slowing local economies, worsening government balance sheets and ultimately, an acceleration of, rather than a counterbalance to, the crisis.

Finally, investors are also acting as accelerants. Individual investors have always been more momentum-driven but had little aggregate impact on markets in the past due to their small size, lack of timely and direct access to information and lack of coordinated activity. But as they’ve grown in size and sophistication, accessing real-time information through their defined contribution plans, global platforms, multi-national distributors, private banks and independent financial advisors, their impact has become much more pronounced. When risk sectors outperform, flows into those sectors tend to increase; when they underperform, flows tend to diminish. In both cases, underlying trends are reinforced.

What’s even more interesting is how the behaviour of institutional investors has changed. This began in 2000-01, after the technology bubble burst. The perfect storm of plunging equity markets and falling interest rates turned corporate and public pension plan surpluses into deficits and created big challenges for foundations, endowments and others seeking income and targeting specific absolute returns. The movement toward solution-based investing was born as investors began to shift toward liability-driven investing (LDI), absolute return, income seeking and other, more specific strategies. The momentum increased following Lehman’s bankruptcy and again in response to recent events in Europe. But with this shift has come a more activist (or re-activist) approach, as investors make larger and more frequent changes to overall strategy, tactical weightings, benchmarks and guidelines. Some still prefer to rebalance around their longer-term, normal policy targets, but as a group – and we see this globally across our client base – institutional investors have indeed become more active.

Governments, central banks, regulators, financial institutions and investors – each group is responding to the challenges they are facing in a logical and well-intentioned fashion. Yet in the current secular environment, we believe their actions are adding to, rather than smoothing, volatility. And instead of acting as stabilising forces, we believe they are actually helping to accelerate the underlying destabilising trends. (See figure below.)

Significant implications for investors

Global challenges combined with these market accelerants have created an environment of unusual uncertainty in which ‘muddle-through’ is a temporary state. We believe this has significant implications for investors, particularly those who are still investing simply for beta and diversification rather than for specific outcomes.

First and foremost, the new normal is here, and investors need to embrace it. We coined the phrase a few years ago to describe a multi-speed world on a bumpy journey of deleveraging, reregulation and eventual reflation. We can argue whether we’re still on the journey or we’ve arrived at the final (though still very bumpy) destination. But what’s clear is that what felt like a ‘new’ normal back then now just feels normal. Gone are the days of the Great Moderation, reversion to the mean and normal-shaped distributions, in our view; instead, continued (high) volatility, acceleration in trends and bi-modal outcomes have become the new norm. In an era when muddle-through is no longer a viable option – for Europe, the U.S. and potentially others – investors need to rethink their overall approach and brace for more extreme economic and market events.

Second, there is no free lunch. There never really was, but investors are facing even more difficult trade-offs today. If the objective is to enhance yield or upside potential through credit, high yield, emerging markets, equities or other risk sectors, the likely trade-offs in a bi-modal world are higher volatility and greater downside. If the goal instead is to own ‘safe haven’ assets for downside risk mitigation, such as U.S. Treasuries, U.K. gilts or German bunds, the trade-off is currently negative real yields. And if the need is to maximise liquidity through cash instruments, the payoff is truly negative real yields (with negative nominal yields on occasion). Even when seeking inflation protection, whether through inflation-linked bonds or hard assets – like gold, real estate and commodities – we believe the trade-offs in terms of real yields, volatility and downside risk are much less attractive in this environment.

Third, investors need to think differently with respect to allocations, benchmarks and guidelines. We’ve highlighted this in the past, but it’s even more important today. In our view, asset allocation should be risk-factor-based as bi-modal distributions and accelerants are not friendly toward traditional mean-variance methodologies, which aim to maximize returns for given levels of risk. Benchmarks should be GDP- rather than market value-weighted, particularly in fixed income space, to reduce exposure to those countries, sectors and issuers with the highest or fastest growing debt. And guidelines should be flexible, with more rather than less discretion, so as to allow managers to play both offence and defence in a bi-modal world.

Fourth, investors should be confident in their managers’ ability to understand and measure risk. Global challenges, market accelerants and unusual uncertainty put a premium on risk management. This includes understanding how the credit sensitivity of fixed income investments can affect their duration – i.e., ‘hard’ versus ‘soft’ duration – and help determine what is considered a ‘safe haven’ and what isn’t. It means performing credit analysis of sovereigns knowing they have more than just interest rate risk. It necessitates analysing the entire spectrum of the capital structure to pinpoint exact needs in terms of collateral, covenants and other forms of defence. Derivatives continue to be useful tools, but being able to identify and control counterparty risk is increasingly important. And leverage, while appropriate in certain circumstances, needs to be well understood. Bottom line: we believe in developing multiple risk measures and stress testing often.

Finally, investors need to develop specific objectives and invest for outcomes rather than simply for beta and diversification. Many investors traditionally started with risk/return targets and used historical mean-variance analysis as a framework to determine asset allocations across multiple asset classes, with benchmarks for each asset class and sub-category, and then found managers that aimed to provide returns above their benchmarks. In the days of normal-shaped distributions and reversion to the mean, this was a widely accepted strategy: Long-term realised returns and volatility came in largely as expected, and further diversification – across asset classes, within asset classes and across different managers and styles – helped to smooth short-term swings. It was a beta-driven strategy, aided by diversification. But the world has changed, and we believe investors need to deepen their understanding of their objectives and invest for outcomes.

Setting objectives and investing for outcomes

Every investor has a unique set of needs and circumstances that should form the basis for setting investment objectives. Yet it’s important to consider the secular context as well, particularly given the challenges and trade-offs we’re likely to face:

• Prolonged period of low real yields on high-quality assets, with negative real yields on traditional ‘safe havens’
• Increased potential for low and even negative real returns
• Continued high volatility with increased likelihood of bi-modal outcomes
• Eventual, though uneven, inflation pressures

Income-oriented investors should consider emphasizing high-quality fixed income spread sectors, such as covered bonds, mortgage- and asset-backed securities, investment grade credit and, depending on risk tolerance, upper-tier emerging market and high yield issues and higher dividend-paying equities.

Investors with specific return objectives should consider focusing more on absolute return strategies, ranging from unlevered LIBOR-plus approaches – essentially seeking to outperform cash – to alternative strategies, depending on their risk/return targets and liquidity needs. Credit, emerging markets, equities and other asset classes can also play roles, individually or grouped into a multi-asset approach, as long as risk factors and exposures are well understood and investors consider ways to potentially limit downside risk under more extreme ‘left tail’ scenarios.

Investors concerned with volatility and ‘fat tail’ events should consider risk-mitigating strategies. If investors want to defend against downside, potential strategies would include positions in hard-duration, ‘safe-haven’ assets, explicit tail-risk hedges or a combination. Investors focused on liabilities may want a liability-matching or LDI program. Alternatively, if the goal is to maximise liquidity, cash and short-term strategies would likely play a significant role.

Lastly, for investors worried about reflation, the suggested focus is on potential inflation hedges, such as inflation-linked bonds, commodities and real estate.

In truth, many investors will likely want to employ more than one approach – income with an inflation-hedging component, absolute return with tail-risk hedges, LDI programs that include a combination of derivative-based overlays with LIBOR-plus strategies on the underlying collateral, or any of these with a cash buffer that can be used for liquidity or to invest tactically if the opportunity arises. And this makes sense. In our view, as long as investors focus on their objectives and their targeted outcomes, rather than fall into the old ‘invest for beta and diversification’ trap, they can navigate a world of secular challenges, accelerants and unusual uncertainty.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Covered bonds are generally affected by changing interest rates and credit spread; there is no guarantee that covered bonds will be free from counterparty default. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. Absolute return portfolios may not necessarily fully participate in strong (positive) market rallies. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Certain U.S. Government securities are backed by the full faith of the government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Dividends are not guaranteed and are subject to change and/or elimination. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Tail risk hedging may involve entering into financial derivatives that are expected to increase in value during the occurrence of tail events. Investing in a tail event instrument could lose all or a portion of its value even in a period of severe market stress. A tail event is unpredictable; therefore, investments in instruments tied to the occurrence of a tail event are speculative. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
LIBOR (London Interbank Offered Rate) is the rate banks charge each other for short-term Eurodollar loans. It is not possible to invest directly in an unmanaged index.

This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

©2012, PIMCO.

Tags: Benchmarks, Central Banks, Confusions, Cornerstone, Diversification, Financial Markets, First Forum, Global Economy, Inflection Points, Investment Implications, Investment Professionals, Investment Strategy, Mohamed, Newport Beach, Normal Distributions, Occurrences, PIMCO, Political Confusion, Private Sector, Term Investment
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Challenging the Paradigms of Investing

Sunday, July 29th, 2012

Challenging the Paradigms of Investing

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

It’s been an exciting and educational time this week. I’ve been in Vancouver at the Agora Financial Investment Symposium speaking to hundreds of investors who are eager to learn how to grow and protect their wealth. This year’s theme, “Innovate or Die,” fit well with my presentation, as the conference challenged attendees to adapt their investment strategies just as empires and enterprises adjust to changing circumstances.

When I wasn’t behind the podium, I was sitting with the audience, soaking up new ideas from speakers, including Gloom Boom & Doom Editor Marc Faber, historian Niall Ferguson and Editor of Outstanding Investments Byron King, who surprised me and challenged my current way of thinking.

Back at the office, our analysts and portfolio managers continue their daily meetings as always to discuss and digest the mountains of research that cross our desks each day. We question what we read, analyze statistics and hypothesize on what we see happening across the global economy. As much as emotions and biases take a role in investing, our goal is to make decisions not based on groupthink that discourages creativity, but founded on a collective wisdom that encourages critical evaluation of the economy and markets.

Global investors constantly need to be watchful of individual biases, impaired thinking and emotional reactions that can have an adverse effect on a portfolio. That’s why we created this weekly Investor Alert which thousands of readers have come to rely on. One of our values at U.S. Global Investors is to always be curious to learn and improve, and the Investor Alert was borne from a belief that shareholders want to understand the very subtle nuances of biases and misconceptions.

My presentation attempted to address a few cognitive dissonances I see in the markets these days and I was pleased to have several attendees approach me afterward, remarking how they thought differently after seeing the slides.

See previous presentations and be surprised.

As much as I’d love to share all of the visuals here, in the interest of space, I selected only a few that I believe challenge the paradigms of investing.

1. For all the hype over recent tech initial public offerings, did you know that investors have lost more money in Groupon and Facebook than the entire assets in all of the gold funds? With the endless coverage leading up to Groupon and Facebook’s IPO, the stocks appeared to be positioned to the public as a mainstream investment. However, I believe people were unaware of the risks involved when they purchased shares.

As you can see below, since its price peak on November 4 through July 26, Groupon has lost $15 billion in market capitalization. Facebook has lost even more in dollar value in a shorter amount of time: From its intraday high on May 18 through July 26, the market cap of the company has dropped $34 billion. These losses pale in comparison to all the money invested in gold funds in the U.S. combined.

2. Did you know that the overall market has historically been more volatile than gold? Take a look at the rolling 1-, 3- and 12-month volatility for the S&P 500 Index, Bank of America stock, gold bullion and gold equities. As with any investment, price action over the short term can rise and fall, but what surprises many investors is that gold has had less rolling volatility than the overall market, gold stocks and a big bank stock like Bank of America (BAC). In fact, looking over the past five years, BAC has seen more volatility than gold, the overall market and gold stocks!

3. While Warren Buffett bashed gold, did you know that Berkshire Hathaway has underperformed the metal over the last 10 years? Gold has been on an incredible bull run over the past decade, and while Berkshire Hathaway kept pace for the first six years, it has struggled to maintain gold’s rise since 2006. In his last shareholder letter, Buffett dismissed gold, comparing the rise of the yellow metal to the tulip mania in the 1600s and claiming that gold only “enjoys maximum popularity at peaks of fear.”

As long as I’ve been in this business, there have been naysayers who question the inclusion of gold in portfolios. However, because the precious metal typically is not highly correlated with other financial assets, holding a small allocation—5 to 10 percent—in a traditional portfolio of stocks and bonds has historically added diversification and reduced volatility.

4. In today’s low yield environment, did you know that inflation causes investors of Treasuries to lose money? Treasuries are seen as a “safe haven” investment, but as of the middle of July, the 10-Year Treasury had fallen to less than 1.5 percent. Yet inflation burns off at a rate of 1.7 percent. This leaves investors with a loss of about 0.2 percent. I believe better opportunities exist.

As I’ve discussed recently, there are plenty of dividend-paying resources stocks with yields much higher than the 10-year Treasury, as well as municipal bond funds that have a higher 30-day SEC yield on a tax-equivalent basis than long-term Treasuries.

Always Be Surprised
Among the millions of people around the world who will watch London’s Olympics, many will stay glued to their flat screens to see firsthand the element of surprise. We want to see the rising star who was considered the underdog, the athlete who takes a record number of gold medals or the team that pulls off an unexpected win. These are memorable moments in the making, like track and field star Jesse Owens, who changed history when he overcame adversity and infuriated the Nazis when he won four gold medals during the 1936 Games. Just like the Olympics, I encourage investors to always stay curious and watchful because you never know where the market’s opportunities will be.

Tags: Adverse Effect, Biases, Chief Investment Officer, Collective Wisdom, Critical Evaluation, Doom Editor, Educational Time, Emotional Reactions, Financial Investment, Frank Holmes, Global Economy, Groupthink, Investment Strategies, Investment Symposium, Investor Alert, Marc Faber, Outstanding Investments, Portfolio Managers, Subtle Nuances, U S Global Investors
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Why Invest Internationally?

Wednesday, July 25th, 2012

July 24, 2012
by Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research

Key points

• Some investors shy away from international investing believing it’s too risky or complicated.
• We’ll show you how it can lower your overall risk while potentially boosting your returns.
• ETFs and mutual funds can make international investing convenient.

A young, educated workforce in Singapore. Rising household income in Brazil. Export growth in China. Natural resources in Canada, Australia, Brazil and Norway.

These are some of the factors driving global growth. And if you’re only investing in US companies, they represent opportunities you may be missing. In fact, investing solely in the United States amounts to excluding three-fourths of the global economy¹ and over half of the world’s stock market value.²

We believe that allocating between 5% (conservative) to 25% (aggressive) of your total portfolio to international stocks can be a smart move for a number of reasons:

• Potential for higher rates of growth abroad.
• International stocks are becoming a larger share of the investment universe.
• Potential to lower overall risk in your portfolio.
• Multiple currencies can provide an added layer of diversification.

Let’s look closer at each of these.

High rates of growth abroad

International markets can offer growth opportunities that may not be available in the United States due to differences in household income, younger populations, availability of natural resources, export strength, and movement toward free-market economic policies. Many Asian countries, for example, benefit from exports to the Chinese economy.

Exposure to these unique growth areas, as well as emerging markets, can boost return potential. Emerging market countries typically have lower household incomes and lower debt levels relative to developed markets, giving them the ability to grow faster.

Economic growth in the United States is expected to be subdued in the near term. The International Monetary Fund (IMF) is forecasting growth in the United States to be below world growth over the next several years.³

Emerging-market economies in particular are expected to have high growth rates which the IMF estimates are two to three times faster than developed-market economies.⁴ Corporate revenues have the potential to grow faster when economic growth is higher. However, bottom-line profits depend on how expenses grow. For example, wages in China have continued to rise this year, despite the slowdown in revenue growth.

United States becoming a smaller share of the pie

In addition, while the United States boasts the world’s largest economy and stock market, the country’s importance and share of the world economy has been declining, particularly as emerging markets have grown in size. Remember, investing solely in US stocks means excluding nearly three-fourths of the global economy and over half of the world’s stock market value.

While it’s true that US companies can have international operations, investing in companies located overseas provides the potential to benefit from currency diversification (more below).

Potential to lower overall risk in your portfolio

Investors can potentially reduce portfolio risk by diversifying their investments across various asset classes—categories of investments—each tending to respond differently to various market cycles and events. International stocks are one of the five main asset classes, along with large-cap stocks, small-cap stocks, bonds and cash investments. While international investing has higher stand-alone risk, the power of diversification across asset classes can potentially lower your overall portfolio risk.

Put simply, by investing abroad you gain exposure to companies operating in other countries—with potentially unique products and customer sets—that may weather market downturns and upturns differently.

See the table below, which shows how performance in the United States has stacked up versus other developed markets in recent years.

The Best And Worst Performing Markets

Source: Schwab Center for Financial Research with data provided by Morningstar, Inc. Based on developed markets as designated by MSCI® as of 12/31/2011. Each market, except the U.S., is represented by annual total returns of the MSCI country index and is net of taxes. The S&P 500® Index represents the U.S. market’s annual total returns. Returns assume reinvestment of dividends and interest. All returns are in U.S. dollars. International investing may involve greater risk than U.S. investments due to currency fluctuations, unforeseen political and economic events, and legal and regulatory structures in foreign countries. Such circumstances can potentially result in a loss of principal. Indices are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no indication of future results.

Also, take a look at the graph below. It shows how a hypothetical portfolio of 75% domestic stocks and 25% international stocks delivered a higher return with lower risk than an investment in either market alone from 1971-2011.

International Investing Adds Diversification, Potentially Improving Overall Return and Risk

Source: Schwab Center for Financial Research with data from Morningstar Inc. United States represented by Dow Jones U.S. Total Stock Market Index. International represented by MSCI EAFE Index net of taxes. The 75/25 hypothetical portfolio is rebalanced monthly with dividends and capital gains reinvested, excluding transaction costs. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product. MSCI EAFE is the measure of the equity market performance of the developed markets of Europe, Australasia, and Far East. Time period is from January 1971 to December 2011. Risk is measured by the annualized standard deviation of monthly returns.

Currency: An added layer of diversification

An important benefit of international investing is exposure to currencies other than the US dollar, another way investors can diversify their portfolios.

One of the key factors affecting returns is how currencies behave in relation to other countries. And because currencies tend to move in different directions, when the US dollar is declining, investments in international companies can help boost returns. Of course, the reverse is also true—when the dollar goes up, international investments tend to underperform.

These relative currency moves are a significant reason the best-performing market varies from country to country each year (see table above).

Know the risks of international investing

Investing internationally also brings increased risks. However, the good news is that many of these risks are reduced if you hold a diversified (by country, sector and company) portfolio of international stocks, such as many international mutual funds and ETFs provide.

What to keep in mind:

• Political and regulatory risk. Foreign governments can be less stable and they can have restrictions on how freely businesses operate as well as their ability to earn profits. Also, a country’s financial condition can undercut growth prospects. For example, if a country is running large deficits, it may need to raise taxes and reduce spending, which could shrink corporate profits.
• Information risk. Finding timely and accurate information about your investments may be more difficult, and there can be differences in accounting standards. This can make comparisons to US companies challenging. An additional consideration is that news about international companies can occur at nearly anytime, impacting price movements during times that are inconvenient for US-based investors.
• Currency risk. There’s the possibility that the currency of your investment will fall relative to the US dollar, lowering the return after it’s translated back into dollars.
• Transaction risk. Some countries impose currency controls that restrict or delay currency conversion, prolonging the time until you are able to access your funds. Reporting, clearing and settlement of trades also may take longer.
• Higher volatility of returns. International markets can be more volatile and trading can be less liquid (fewer shares changing hands). Dollar-cost averaging—investing a fixed dollar amount at regular intervals—can be a good tactic to spread out risk and lower the average cost per share.
• Higher costs. Investing directly on foreign exchanges can bring additional fees, including higher commission costs, exchange fees, stamp duties, transaction levies and foreign currency fees. These fees are the reason most international mutual funds and ETFs cost investors a bit more (via higher expense ratios) than their domestic counterparts.

Bottom line

International markets are gaining in importance, and by investing solely in the United States, you may be passing over growth opportunities. While there are higher risks involved with international investing, by adding it to your other investments, your overall portfolio risk could decrease while experiencing potentially higher returns—making it well worth your time to add some international flavor to your portfolio.

1. The International Monetary Fund, December 2011.

2. S&P Global Broad Market Index, May 2012.

3. International Monetary Fund, April 2012.

4. International Monetary Fund, April 2012.

Important Disclosures

For funds, investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Some specialized funds can be subject to additional market risks. Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost.

International investments are subject to additional risks such as currency fluctuation, political instability and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Diversification strategies and dollar-cost averaging strategies do not assure a profit and do not protect against losses in declining markets.

Past performance is no guarantee of future results.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

Tags: Asian Countries, Brazil Export, Canada Australia, Chinese Economy, Debt Levels, Economic Policies, Emerging Market Countries, Global Economy, Global Growth, Growth Areas, Growth Opportunities, Half Of The World, Household Income, Household Incomes, International Markets, International Stocks, Investment Universe, Natural Resources In Canada, Smart Move, Stock Market Value
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The T Report: China & LIBOR: Spain, Messy & Messi

Wednesday, July 25th, 2012

by Peter Tchir, TF Market Advisors

PMI

Chinese PMI was better than feared, but if I had to bet on what number is less manipulated, Chinese data or LIBOR, I would have to bet on LIBOR. Since we don’t have much else to work with, I guess we are stuck looking at it, and it shows that the slowdown is slowing, but I can’t get very excited about that.

European manufacturing PMI came in at 44.1, worse than the already low expectations of 45.2. The situation in Europe is deteriorating and all the summits aren’t helping. The banks need to be recapitalized and “uncertainty” needs to be removed or else business will continue to grind to a halt.

Most interesting, I thought, was that German Manufacturing PMI came in at only 43.3 and even German service remained under 50. Germany is not immune to the woes in the rest of Europe or to the global economy. French manufacturing PMI was an equally dreadful 43.6. Maybe the growing weakness in the core will light a fire. It isn’t enough to have firewalls. They either have to spend that money and finally take serious default and currency risk off the table, or the economies will continue to slide deeper into recession or depression.

Pesetas and Real Madrid

Spain had a reasonable t-bill auction today. The yields were high compared to any of the core with 6 month t-bills coming in a 3.69%. In a normal world, that isn’t bad, but in a world where Germany and others get paid to issue money for 6 months, it doesn’t look great.

In any case, talk of redenomination continues. Many people argue that the only way out for Spain and others is to exit the Euro and create their own currency that they can devalue at will.

I continue to see several problems with that. Devaluation will be controlled by the markets and not the politicians making it uncertain where the exchange rate will settle in. If the bets are “too high”, “too low” or “just right”, I would certainly bet against “just right”.

The uncertainty created by a new currency will be immense. The confusion for banks and businesses will overwhelm any possible business. Who will want to do business in a country with a highly volatile currency where the end result remains highly uncertain? Who will do business in similar looking countries? Trade will grind to a halt and demand for non-essential goods will dry up as people wait to see the results.

Finally, in a country where much of the “daily essentials”, particularly energy have to be imported, it is far more difficult to see how the people or the country, prosper. In successful devaluations, the country has often been natural resource rich and been able to “harness” those resources for their domestic economy during the devaluation process.

But those arguments are confusing, so let’s look at Barcelona and Real Madrid. Will Barcelona be able to afford Messi? How much of the revenue of these clubs from domestic markets? The higher the percentage of domestic revenue, the more expensive players will be. And it wouldn’t just be foreign players. Spanish players would also be tempted to leave. The clubs would have to pay their players in Euros. That could become a huge burden for Spanish clubs. As the peseta plummets, how will they afford these top players? Will clubs in other countries be able to pay them?

What if the situation in Spain erodes where daily protests become a way of life? What if the devaluation causes domestic problems? If political tensions grow and civil unrest increases will players want to stay in Spain when they could demand the same money elsewhere, without the additional risk?

Maybe Germany is hoping to transform the Bundesliga into the best league through currency devaluation? Yes, this is largely tongue in cheek, but it may be worth thinking about what Liga BBVA would look like after devaluation. People may not be passionate or understanding of the economy, but they are passionate and informed about their football clubs. In a world where much of the talent is imported and the local talent is free to leave, the analysis may not be as fanciful as it sounds. M

any Canadians saw it happen to their teams when a combination of a weak Northern Peso (this was pre loonie) and high taxes made it hard for Canadian franchises to compete (the BlueJays have never recovered). It wasn’t just sports. There were big issues of “brain drain” as many top people and companies looked to move to the U.S.

A weak currency may not be as helpful as people think and in fact may cause far more problems than it fixes, especially since this wouldn’t merely be devaluing, it would be creating a new currency and leaving a union, adding to the confusion and complexity of the task. Any real “progress” towards a near term redenomination would cause me great concern for all risk.

Risk “Meh”

Markets really don’t seem to know what to do. The greed is saying sell-off because Europe is a mess, yet the fear is that enough government money and liquidity comes into the market that we ignite another rally.

Domestic credit continues to do okay. Spreads have widened in the past few days, but very calmly and with relatively little enthusiasm for any move wider. You can pick up some high yield bonds marginally cheaper, but that’s probably only until you engage an offer and find out they aren’t really selling.

My concern that Europe will mess this up is growing. They seemed to have been implementing small steps that could work, but they seemed to have slowed down, and the level of dangerous (and poorly thought out) rhetoric is growing. I will continue to keep a close watch on the situation and am continuing to lighten up risk, though will add when drops seem overdone.

The price action in Spanish bonds is chilling, but volumes are incredibly low.

Tags: Bets, chinese data, Currency Risk, Devaluation, Exchange Rate, German Service, Global Economy, Libor, Low Expectations, Madrid Spain, Politicians, Real Madrid, Recession, Redenomination, Slowdown, Summits, T Bills, Tf, Uncertainty, Woes
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David Rosenberg: Where to Go For Positive Returns

Monday, July 23rd, 2012

 

 
David Rosenberg discusses how the 3 D’s (Deleveraging, Deflation, and Demographics) are hurting markets, and where investors can go for positive returns, with Wealthtrack’s Consuelo Mack.

Here is the full transcript:

CONSUELO MACK: This week on WealthTrack, the influential economist whose projections have been right on target. Financial Thought Leader David Rosenberg shows how the 3 D’s of deleveraging, deflation and demographics are hurting economies and markets and where investors can go for positive returns, next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. This week, we are sitting down for an in-depth interview with one of the handful of prognosticators who has gotten it right going into and through the rolling global financial crisis we are experiencing to this day. He is Financial Thought Leader David Rosenberg, chief economist and strategist at Toronto-based wealth management firm Gluskin Sheff. Dave returned to his native Canada in 2009 after spending many years as Chief North American Economist at Merrill Lynch, where Institutional Investor magazine placed him on their coveted “All American All Star Team” from 2005-2008.

Rosenberg took on the bullish Wall Street herd as early as 2004, when he started warning about the developing housing and credit bubble which, as he predicted throughout, would wreak havoc on the financial system and many world economies. Well he hit the nail on the head again last year, forecasting the global economy would slow and that treasury bond yields would fall- another homerun. In his influential and widely read daily “Breakfast With Dave” reports, he ranges across the globe covering everything from Europe and how “it is rather incredible that this rolling crisis is now going on 2-1/2 years and policy makers have yet to find a viable solution”; to emerging markets and “why the once mighty BRIC currencies are depreciating of late at their fastest pace since the 1998 Asian crisis”; to the financial markets and “how the “pattern of the past three years is unmistakable as each spring, the equity market corrected as stimulus measures wore off, to only then prompt more incursions by the fall.”

What other patterns are unmistakable to Dave Rosenberg and why did he write in a recent report that “the future is brighter than you think”? I asked him all of the above and more, starting with what he thinks the most important patterns for the economy and markets.

DAVID ROSENBERG: I think the primary trend is still one of deleveraging. It hasn’t really changed much from the last time that the two of us spoke; it’s become much more global in nature. So it started off in the U.S. four or five years ago, in the American mortgage market, the housing market, consumer loans in general, but now we’re seeing how it’s morphed into the survival of the welfare state and all the debt finance to prop up these peripheral countries in Europe, and even now there’s questions about whether China is going to have a hard or soft landing because of a perceived property bubble there.

So we’re still in this deleveraging cycle, still dealing with the impact of too much debt relative to the size of the global economy, and this is what’s creating all this market angst and instability that we’re still living with; notwithstanding the fact that the economy, the U.S. economy is three years in a recovery, we’re still stuck in a very slow growth mode, but recurring financial market instability at the same time.

CONSUELO MACK: So is there any way of knowing whether the second half is going to be worse, better, or the same as the first half? Because, I mean, I’m thinking of my audience out there, and myself included, and saying, “I don’t want to live through another three or four years like this.” So what’s it going to look like, do you think the second half?

DAVID ROSENBERG: Well, I’m going to sound like a classic economist here and say it’s going to be somewhere in between, and this is what I mean. Are we going to get another gut wrenching, you know, 7% decline in GDP, and lose another 8 million jobs? I don’t think we’re going to go through anything close to what we endured in ’08 and ’09.

CONSUELO MACK: And to back-to-back kind of 50% decline in the stock market?

DAVID ROSENBERG: It’s not going to be that bad. But then again, you have to take a look at the contours of the recovery. I actually think the recovery tells you a lot more than the actual gut-wrenching recession did, because normally when you do this with the economy, you do that.

CONSUELO MACK: You get to a V, right?

DAVID ROSENBERG: Well, even in that 1933-’36 period, you got a huge recovery, much bigger than we had this time around, and this time around we had basically a checkmark of left-hand person, that’s what we had. It was not a V-shaped recovery; it was a very meager recovery, especially when you consider everything that the government threw at this thing. Consider the Fed took rates to 0 in December of ’08, they’ve tripled the size of their balance sheet $3 trillion. We’ve had, what, $4 trillion, four years of trillion-dollar deficits, and…

CONSUELO MACK: The fiscal stimulus…

DAVID ROSENBERG: …and more foreclosure moratoria. We’ve tried everything. So we’ve had modest economic growth, but very unacceptable. And now what’s happening is the Fed is left now with all these uncreative tools. Like Ben Bernanke certainly believes that he can do more but, you know, in Economics 101 you learn about the law of diminishing returns, and it’s basically that you end up getting less and less and less incremental impact from the same policies over time. And so that was the same with QE1, QE2, with the LTRO that we had out of Europe. We were getting just a smaller incremental impact on the economy with each individual policy proposal.

CONSUELO MACK: So therefore three years into a quote, unquote “recovery”, so are we on the cusp of another recession?

DAVID ROSENBERG: Cusp or precipice, I don’t know if I’m quite there yet. The economy is extremely fragile. The underlying trend in the economy is barely 2%, it’s barely 2%. So when you have a trade shock that can wipe out 2 percentage points of growth, you’re left with 0. Now, maybe that’s not a recession in the classical sense because we’re not actually going in reverse, but the unemployment rate is going up in a no-growth environment. And then you talk about this so-called fiscal drag, this fiscal cliff that we’re going to see next year- it’s because, you know, we’re probably not in as bad as shape as the Europeans, but here in America, we’ve kicked the can down the road a lot in terms of the Bush tax cuts getting extended, in terms of payroll tax relief, extended unemployment insurance benefits, all these provisions expire December 31st. So just by the government taking back the parking permit from everybody, we have a drag on the economy next year from fiscal restraint, 4 percentage points of GDP, percentage points.

CONSUELO MACK: Which we don’t have. So listening to you, Dave, quite honestly, I do want to kind of bury my head in the sand and I’m thinking to myself, you know, that I want to be in incredibly safe assets, that this is no time to put risk on. And yet, you know, one of the things that you follow, as well, is investor sentiment and the fact that there is a growing despair out there that people are very frightened and worried. And as we know traditionally, that’s in fact, the time when it’s actually best to buy risk.

DAVID ROSENBERG: I mean, there are always opportunities. In a fat-tail world, you’ve got to be very cognizant of the risks. So it’s as much not just focusing on the gross returns, but we have to – and this is what we’re doing every day at my shop at Gluskin Sheff- is we are assessing the risk, identifying it, managing it, and pricing it. And frankly it’s not about, you know, being risk averse. You know, people think that somehow, you know, when you talk about risk all the time you’re risk averse. It’s always important to make sure as an investor that you’re getting paid to take on the risk, that you’re not paying…

CONSUELO MACK: Right, so it’s price is really…

DAVID ROSENBERG: Right. Like, for example, I would say, you know, the high-yield bond market right now is actually, I would argue, priced for a bad economic outcome. You want to buy the assets that you think have already discounted. What’s embedded, what’s the story in this particular asset class, what’s it telling you? So I’m taking a look at the high-yield market right now. I think it’s actually very attractive. We have a core portfolio of high-yield bonds, and the reason I say that is because ultimately when you’re buying corporate bonds, you’re staking a claim in the corporate balance sheet. And the one thing that’s not changed, despite the fact that we’ve got all this angst overseas, the fact that the U.S. economy has hit stall speed, corporate default rates are barely more than 2%, you’ve got corporate balance sheets in great shape whether you look at debt equity ratios, or interest coverage ratios- the fact that treasurers companies both Canada in the U.S. have locked in their maturity schedules, 80% of corporate debt is locked in. In some sense, the corporate sector is in better financial shape than the government sector is. So I like corporate bonds.

CONSUELO MACK: One of the things that you’ve told clients is that reliance and deriving a stable income stream while preserving capital is paramount right now. So in these uncertain times, stability of income stream is one of your major investment focuses.

DAVID ROSENBERG: Right. And it comes down to what my overall theme is called: the macro and market outlook in 3D. So I’m talking about the 3Ds. What are the 3Ds? Well, they’re deflation, there’s demographics, and there is deleveraging and we talked about the deleveraging. There’s also this demographic overlay because the first of the Boomers are 55 going on 56, that’s the median age. The first of the Boomers are in their mid-60s, and so they control the wealth. They’re in a different part of their investment life cycle right now, and so accumulating cash flows as opposed to relying on strictly capital appreciation for the Boomer class, the life cycles as far as investments are concerned, that’s altered. And we’re seeing it in our own business in terms of what our clients are telling us, how they would like their money managed.

So you’ve got the demographics talking about the deleveraging, but the deflation. And so people will say to me, “Well, I thought in a deflation, cash is king in a deflation.” And the answer is well, you know, historically that’s true. That’s the ultimate capital preservation- cash is king in deflationary environment except when interest rates are 0. And so then it’s not cash is king, cash flow is king. So it’s imperative. It’s not just about preservation of capital, which of course in the fat-tail world, which is the deleveraging world, capital preservation is key; but you have to overlay that with preservation of cash flows. That’s why MLPs have been so popular.

CONSUELO MACK: Right, Master Limited Partnerships.

DAVID ROSENBERG: That’s why muni funds. That’s right, and that’s why REITs, and that’s why dividend growth, dividend yield have been so popular now. People come back and say to me, “But these things look so expensive.” Well, they look expensive because that’s what’s in demand, you know? And it doesn’t mean because it’s expensive you don’t want to buy it. You know, the perfume I bought is expensive, yeah, but is it good? Yes. Well, okay, that’s why it’s expensive because it’s a good thing to buy. These are good strategies right now, and that’s why their prices have been up as much as they have.

CONSUELO MACK: So as far as this pattern that we’ve seen for the past three years in the stock market, and where it rallies until the spring and then it basically sells off. That has been very disheartening for investors. Are we locked into that for the foreseeable future?

DAVID ROSENBERG: I think what we have is this battle going on, got this battle. We have the secular forces of deflation coming from all this deleveraging and the deleveraging, of course, takes demand out of the global economy, you’ve got the deflation, and then you’ve got these governments fighting it hard. So the secular forces of deflation in the market place, and then the tug-of-war as governments come in and reflate- whether it’s China, or whether it’s the U.S. government, or whether it’s the ECB. And so what this does is creates tremendous volatility, tremendous volatility.

But once again, the question is for an investor, what do I do with this volatility? How can I sleep at night? And that’s why in conjunction with say income equity over here, and corporate bonds over there, there should be a slice in the portfolio in hedge funds that really hedge long-short strategies that can actually be…

CONSUELO MACK: And they exist? There really are hedge funds that really hedge?

DAVID ROSENBERG: Well, you know, hedge funds have been around for 50 years. They got a bad name in the last cycle because they weren’t hedge funds, they were leverage long-only funds. But there are firms out there that are either hedge funds. You know, Gluskin Sheff is not a hedge fund, but 20% of our business is managing these long-short strategies, and it’s actually a very effective way to be nimble in the market place when you get these dislocations.

It’s really just taking sectors and companies that you think are bad businesses, are going to cut their dividends, and you put a short position on them, and you couple that with long position of the companies that you think are going to grow the dividends over time.

CONSUELO MACK: So let’s talk about earnings, because I know that you’ve said that the E in the price earnings ratio, the earnings, they are problematical. So what is your outlook for corporate earnings? And again, what does that mean for the stock market?

DAVID ROSENBERG: Well, corporate earnings right now have hit an inflection point, and it’s not just that they’re slowing, they’re actually starting to contract. Earnings are actually, after a three-year period of steady increases off those lows in 2009, corporate profits are actually now starting to decline outright.

CONSUELO MACK: And you’re talking about the S&P 500?

DAVID ROSENBERG: S&P 500 and even bigger picture. When we got the GDP numbers a couple of weeks ago- the GDP numbers give you corporate earnings for all of America, not just for the large-cap companies- and corporate earnings are coming down. And my sense is that the earnings estimates by the analysts on Wall Street is still far too high. Earnings estimates are important. I’m noticing that fewer companies are giving guidance. Fewer companies are giving guidance. What’s that telling you? That corporate CEOs, very similarly, they have a very clouded crystal ball right now. Fewer companies are giving guidance, and then the ones that are giving guidance, for every one that’s saying something positive about their business, two to three are saying something negative about what the outlook is. And on top of that, the estimates are starting to come down. I don’t think they’ve come down enough.

What does it mean for the stock market? You know, I think that if we were to go into a recession, normally the market corrects 20%. I’m not going to say that we’re going into a recession, but my sense is that the stock market is going to remain at best in the range that it’s been in for the past several months. We have to respect the range, but we’re going to be still in for a lot of volatility, which is why I was saying before that hedge funds, they really hedged, totally appropriate. On top of that, you have to be nimble and as tactical as you possibly can be, but if you’re going to ask me do I think that there’s more downside pressure given the risks out there, and especially to corporate earnings, the answer is yes. I think at this stage, without getting into, you know, what’s your call on where we can get to, I think the balance of risks is at that the market goes down over the near term and then goes up. And if it does, I think it will be a great buying opportunity down the road.

CONSUELO MACK: Let me ask you just about another macro issue, which is what about Europe? And you’ve said, you wrote recently that, you know, you’re two and a half years in, you know, these rolling problems keep coming up in Europe, and there are no viable solutions.

DAVID ROSENBERG: Well, I mean, there are solutions. I don’t know how viable they are. I think it’s a matter of just looking at it realistically. The European Union was working just fine. You know, the whole notion that we were going to try and avoid another World War, another European war at all costs. I don’t think that we needed to have a currency union to achieve that. You can’t have a monetary union and not have the fiscal union, and an integrated banking union. You can’t have it.

CONSUELO MACK: So realistically, I mean, are the 17 countries going to sacrifice their sovereignty?

DAVID ROSENBERG: Hardly likely. I had breakfast recently with a CEO of a major Canadian bank, and he told me that they have a Eurozone breakup committee. And he said this is happening around the world. Any major multinational corporation, any business that is doing business in Europe has one of these Eurozone breakup committees, not unlike the pre-Y2K committees that you had in the late 1990s. So you can bet your bottom Euro that if that’s what they’re doing, the Eurocrats in Brussels are trying to come up with some sort of… you talk about viable, what’s a viable exit strategy? Unless the ECB steps up en masse and rapidly expands its balance sheet, and starts buying the bonds of Italy and Spain en masse at auction, you know, that’s pretty radical. I don’t know what the quick fix is. So I think that the end game will ultimately be that the Eurozone breaks up.

CONSUELO MACK: One of your investment themes that we’ve talked about basically has been capital preservation and income orientation, as well, and one of the themes that you and I have talked about in the past is what you call “SIRP”, which is Safety and Income at a Reasonable Price. Are you looking for SIRP investments? Is that still a major strategy theme?

DAVID ROSENBERG: I would say that SIRP has its thumbprints across all the portfolios we’re running at Gluskin Sheff. In fact, what’s interesting is that we, for years, since 2001 we’re running this one particular strategy that’s called “premium income”, which it’s a hybrid, it’s got dividends, and it could have REITs, it could have preferred, convertible bonds; it’s really a portfolio aimed at distribution, a portfolio aimed at generating monthly cash flows for our clients.

CONSUELO MACK: And that’s Safety and Income at a Reasonable Price.

DAVID ROSENBERG: Right. Well, when we say… for example, when I talked about corporate bonds, and we’re talking about “safety” in quotes; I mean, safety, it’s relative. When talking about corporate bonds, it’s because of the quality of the balance sheets are very strong. Because that’s inherently when you’re buying corporate bonds, it’s mostly about default risk. You want to minimize that strong balance sheets. When I talk about on the equity side, we’re talking about running portfolios that have a low beta, which means low correlations with the overall market direction.

CONSUELO MACK: Right. The overall stock market direction.

DAVID ROSENBERG: The overall stock market direction, so we’re talking about, so it’s not just about, you know, does this company have a consistent history of paying off dividends, and we like the business. It’s also how does it move relative to the overall market? So in a period like this where it’s very tumultuous, and where the market is more prone to go down than up, you want to run your portfolios with very low betas. And so that’s the safety part, that’s the “S” part of the SIRP.

CONSUELO MACK: And the low correlations of the markets, in a highly correlated market, which is what we’ve been in for the last several years, so what are the areas that aren’t correlated that have low betas?

DAVID ROSENBERG: Well, for example, one of the themes that we liked has been the consumer frugality theme. So it means consignment stores, it means private label, it means do-it-yourselfers. I mean, for example, you could actually say, wow, because a Home Depot, does it fall under that category as an example. I’m not going to go sell my home, I’m not going to move, I’m underwater in my mortgage, but you know what? I still want to have a fun life, so instead of buying a new home, I’ll spruce up my existing home. And so home repair, a do-it-yourselfer, and so you can find…

CONSUELO MACK: So can you match a name or two to, you know, the frugality theme? So, for instance, frugality, what’s a–

DAVID ROSENBERG: Well, I’ll tell you one area where we have been long, and it’s worked out well has been the dollar stores. And they’ve been phenomenal investments, and by the way, it’s not just because low income households shop there, you’d find… and what the studies are showing is that a greater share of middle income households are actually going to dollar stores. And that’s an area where we have focused on in terms of our consumer exposure.

CONSUELO MACK: Let me run down a couple of the other investment themes, noncyclical. So give me, you know, what’s the theory behind the noncyclical emphasis? And give me an idea.

DAVID ROSENBERG: Well, it’s all about generating stable cash flows. In an uncertain environment, what do you want in an uncertain environment? You want stability. What about utilities, regulated utilities? Regulated utilities. They have regulated pricing power. What about telecom? And it might not just be the stock, you might want to buy the bonds of these companies. Once again, if you have a single A telecom company that’s giving you a triple B yield, you know, I will be happy to take that all day long in terms of looking at the risk and reward. So telecom, utilities, consumer staples, these are the areas that will tend to outperform in the environment that I’m describing right now.

CONSUELO MACK: And one other category that you had was hard assets. So what are we talking about when you’re emphasizing hard assets?

DAVID ROSENBERG: Resources are not a bad place to be. They’re already corrected quite a bit, so resources, whether it’s raw food, or whether it’s, I would say energy, which is corrected quite a bit. ]If you’re a long-term investor, these are complements. They’re not going to generate a yield for you, but they are what you want to own, things you can see, touch and feel in a very uncertain world, and these things have cheapened up quite a bit, as a hedge against the income part of the portfolio.

CONSUELO MACK: So one question is One Investment for long-term to diversify portfolio, what is it that you would recommend that we all own some of?

DAVID ROSENBERG: Well, I’m still a big advocate of corporate bonds. As I said, I think balance sheets are in great shape, default rates are low, there is too much default risk priced in, and so I would say I would focus on, let’s try and generate equity-like returns without taking on the equity risk. And there is a part of the capital structure that can accomplish that, and it’s called “corporate credit”. That is still to me a happy medium between 0 percent treasury bills and going out in the riskiest part of the equity structure. So corporate bonds to me are a solid investment.

CONSUELO MACK: And Dave Rosenberg, you know, you have a reputation of being a permabear, which is not fair, because you were also known as a permabull in the ‘80s and the ‘90s, and in a recent report you said” the future is brighter than you think.” Why when others are despairing are you getting enthusiastic about the future?

DAVID ROSENBERG: Well, I’m not going to say I’m getting enthusiastic about the future. What I am willing to do is put out some checkmarks as to what can cause me to turn more optimistic. And so I see a flicker of light, and it’s realization that politics will lead the financial markets, which will lead the economy, and what leads the politics is the grassroots level, and so what happened last month, for example, I think in Wisconsin with the recall in San Jose, San Diego, and there seems to be this growing realization at the grassroots level that we have to get our public sector balance sheets in better shape; that these underfunded liabilities have to come under control. So we’re starting to see more of a groundswell of support.

What I’m thinking about is how things will change politically on November the 6th, understanding, coming from Canada; Canada went through what Europe is going through right now. Canada is going through what the U.S. was going through back in the early 1990s. You could never have predicted that Canada ten years later would be the poster child for fiscal integrity globally. But it took tremendous political courage.

CONSUELO MACK: We’ll see what happens, and that’s what you’re going to be watching, Dave Rosenberg.

DAVID ROSENBERG: I’m more than willing to reclaim my status of a permabull that I had in the ‘80s and ‘90s if I see those clouds part come November.

CONSUELO MACK: All right, Dave Rosenberg, so great to have you here from Canada, Gluskin Sheff. It always a pleasure to have you on WealthTrack.

DAVID ROSENBERG: Thank you.

CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s reiterates one we just talked about- Dave Rosenberg’s long-time income generating strategies which is S.I.R.P.: safety and income at a reasonable price. So this week’s Action Point is: seek safety and income at a reasonable price, or S.I.R.P.!

Everything we know about the financial markets right now points to ongoing volatility and headwinds for stock price appreciation. Among the areas Rosenberg recommends where you can find reliable dividend growth and dividend yields are: Canadian and U.S. preferred stock shares, which are senior to common stocks; energy infrastructure investments, such as natural gas pipelines; and utilities. All S.I.R.P. vehicles.

And that concludes this edition of WealthTrack. I hope you can join us next week. We are going to sit down with an investment professional who combines two disciplines: overall investment strategy and actual fund management. BlackRock consultant Bob Doll will join us to discuss macro trends and micro strategies. Until then, to see this program again, or others and read my Action Points and our guests’ One Investment recommendations, please visit our website, wealthtrack.com Have a great weekend and make the week ahead a productive one.

Tags: American Economist, Chief Economist, Consuelo Mack, Credit Bubble, David Rosenberg, Deflation, Demographics, Depth Interview, Global Economy, Global Financial Crisis, Institutional Investor Magazine, Investors, Merrill Lynch, Native Canada, Prognosticators, Sheff, Target, Treasury Bond Yields, Viable Solution, Wealth Management Firm, Wealthtrack, World Economies
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We Are All Alone

Thursday, July 19th, 2012

by John Nyaradi, Wall Street Sector Selector

Investors are on their own and cannot count on the Federal Reserve to save their portfolios.

Global markets seem to be pricing in a new round of quantitative easing from the Federal Reserve.  Dr. Bernanke and his colleagues will likely comply sometime between now and December.  However, even with more quantitative easing, investors can’t count on the Federal Reserve to rescue the stock market and their portfolios.  We are on our own, and here’s why:

1. Europe’s Debt Crisis

Europe is the crisis that just won’t quit, with Spain, Italy, Greece, ad nauseam , all running out of money. There is simply no solution to this problem as there is simply not enough money in Europe to save Italy and Spain. When the piper finally demands to be paid, no central bank on earth will have the firepower to stop the global financial avalanche that this crisis could trigger.

2. Earnings

Second-quarter earnings season is shaping up as a weak affair with downgrades coming from most every sector. As we all know, stock prices eventually are based on earnings, and no amount of monetary policy, low interest rates or quantitative easing can add profits to corporate bottom lines. Monetary policy can set the stage for, but cannot create, demand.

3. Global Recession

This item is part and parcel of Items #1 and #2. Recession is quickly spreading across Europe. China’s economy, while still growing briskly by developed world standards, is rapidly slowing. The United States limps along with a 1.9% growth rate and recent GDP estimates have been sharply revised downwards. Like antibiotics for a sick person, Dr. Bernanke and his Fed can help but the disease must run its course and the patient must have the physical strength to survive on his own.

4. Diminishing Returns of Quantitative Easing

Each round of quantitative easing has smaller impact and brings greater risks for the global economy. Last week’s interest rate cuts by the European Central Bank, the People’s Bank of China and more quantitative easing from the Bank of England were largely ignored by global markets which, in the “good old days,” would have rallied hard on this sort of same-day global intervention.  Like antibiotics fighting a virus, quantitative easing is losing its effect as the virus grows immune and mutates to offset continued attacks.

5. The Dreaded Fiscal Cliff

Dr. Bernanke has made it quite clear in recent testimony to Congress that the “fiscal cliff” coming up in December is too big for him to manage and that it needs to be resolved to avoid a significant economic shock. The hit to GDP from the fiscal cliff would likely trigger another recession in the United States (See Item #3)

ETF strategies for difficult days

So what are we supposed to do as we try to protect capital, prepare for retirement and secure our financial futures? Several options come to mind:

A. Cash: Cash is king, particularly in deflationary, depression-like environments. The U.S. dollar, represented by PowerShares DB Bullish Dollar ETF (NYSEARCA:UUP) is up some 5% since early May as capital seeks the perceived safety of the U.S. dollar. Cash doesn’t have to be U.S. dollars, either, as Swiss francs have been on a roll, along with the Japanese yen (NYSEARCA:FXY)

B. U.S. Treasury Bonds: Like the dollar, the U.S. is still seen as the safest harbor in an uncertain world and U.S. Treasuries are near record low yields and high prices as money flocks to the perceived safety of Uncle Sam. The biggest moves will probably come in the long end of the curve and iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) is up some 14% since early April. iShares Barclays 7-10 Year ETF (NYSEARCA:IEF) has gained more than 5% in the same time frame. One day, the “short” bond trade will be the position of a lifetime, but that day does not look like today.

So now it’s summertime, but the living is not likely to be easy, at least for awhile. (apologies to George and Ira Gershwin, “Porgy and Bess”)   We can’t count on Dr. Bernanke and his Federal Reserve to save us from what lies ahead but we can use the power and versatility of exchange traded funds to navigate through these challenging times.  We are all alone.

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Tags: Ad Nauseam, Bernanke, Bottom Lines, Debt Crisis, Diminishing Returns, Downgrades, Earnings Season, Enough Money, Firepower, Gdp Estimates, Global Economy, Global Markets, Global Recession, Interest Rate Cuts, Italy Greece, Low Interest Rates, Physical Strength, Second Quarter Earnings, Sick Person, Stock Prices
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Case for US and Global Recession Right Here, Right Now; Recognizing the Limits of Madness; Permabears?

Wednesday, July 11th, 2012

There is a big difference between making a claim the economy is in recession from a claim the economy is headed for one.

Case for a Global Recession

I think the entire global economy is in recession and said so on July 6, 2012 in Plunging New Orders Suggest Global Recession Has Arrived

However, we need to define the term “recession”

Contrary to popular myth, recession does not mean two consecutive quarters of economic contraction. Rather, two consecutive quarters of economic contraction is a sufficient, but not necessary condition.

In the US, the NBER is the official designator of recession start and end points. Many recessions have started with GDP still growing.

The “Conditions for Global Recession” are even looser. “The International Monetary Fund (IMF) considers a global recession as a period where gross domestic product (GDP) growth is at 3% or less. In addition to that, the IMF looks at declines in real per-capita world GDP along with several global macroeconomic factors before confirming a global recession.”

Given current conditions are what one would expect from outright stagnation (if not worse), I am confident a global recession has begun.

What About a US Recession?

On June 21, I gave 12 Reasons US Recession Has Arrived (Or Will Shortly).

Tipping the Balance to Now (Not Shortly)

• The Third Consecutive Weak Payroll Report
• The pending Global Collapse In Auto Sales
• Plunge in China Import Growth (For discussion see China Import Growth Plunges, Trade Surplus Hits 3-Year High; Will US Response Be Protectionism? Is China Headed For a Deflationary Shock?)

That is enough for me. And I am not the only one to feel that way.

ECRI’s Achuthan: “I Think We’re in a Recession Already”

Link if video does not play: ECRI’s Achuthan Says U.S. Economy Is in Recession

Partial Transcript of Video

Achuthan on whether he can reaffirm his recession call from last year:

“Yeah…I think a lot of people forget what our call was. What we said back in December was that the most likely start date for the recession would be in Q1 and if not then, by the middle of 2012. I’m here to reaffirm that. I think we’re in a recession. I think we’re in a recession already. As I said back there, it is very rare that you know you’re going into recession when you’re going into recession. It often takes some big hit on top of the head. In the last recession, it took Lehman to wake people up and the recession before, it took 9/11.”

Those are exactly the kinds of things that irritate me about the ECRI. The fact of the matter is Achuthan was calling for a recession in September, not December, and not June.

For details, please see my September 30, 2011 post ECRI Calls Recession Based on “Contagion in Forward Indicators”; Just How Timely is the Call?

Tom Keen: “Single Sentence, why recession now”
ECRI’s Lakshman Achuthan: “Contagion in Forward-Looking Indicators”

That link clearly shows I thought a recession was imminent as well. Those are the facts. It is silly to try and hide them.

Yet, in December (after economic data firmed), Achuthan moved the date forward to June, wanting another 6 months to be proven correct.

My question in September “Just How Timely is the Call?” was a good one. The ECRI has been both very early and very late. Far from the perfect track record they claim.

That my friends is the nature of making predictions. No one is perfect, not me, not Achuthan, not anyone, and it is very foolish to pretend otherwise.

Actually, I have no problem at all with Achuthan moving the date forward. Conditions change. My problem, is revisionist history that makes it appear as if a recession call in September was a recession call for June (made in December).

All this nonsense goes away the moment Achuthan admits the ECRI does not have a perfect track record.

That said, I think Achuthan is now correct. However, I thought so in September. So be it. I was wrong. The solution when you were wrong is easy, simply say you were wrong.

The Other Extreme “Recession is Not Imminent”

Please consider the other extreme, Recession is Not Imminent by Dwaine van Vuuren.

Among the bearish voices I most respect is John Hussman, whose work I read regularly. He is thorough and quantitatively rigorous. Whenever I am convinced there will be no recession, I temper my enthusiasm by re-reading his articles to make sure I maintain a balanced view. One day he will be right and I will be wrong, but at least I won’t be blindsided.

But the data don’t show catastrophe. Looking at the Leading SuperIndex, we are a bit worse off than last summer and the summer before that. We just put in a leading SuperIndex peak on April 13 (10 days after the SP-500 peak) that is lower than the prior two peaks. This slowdown, if not checked in time, may well be the one that pushes us into recession. But even that worst-case scenario is still three to four months away, according to the SuperIndex recession-path projections in our regular weekly report.

Emphasis in italics added.

I disagree. The global data is an outright catastrophe. Moreover, the jobs reports in the US and the US ISM manufacturing numbers are  a catastrophe as well.

I am amused by van Vuuren’s statement “at least I won’t be blindsided”. I suggest he already is.

“We Have Reached the Point that Delineates an Expansion from a New Recession”

John Hussman asks What if the Fed Throws a QE3 and Nobody Comes?

With regard to the economy, I noted two weeks ago that the leading evidence pointed to a further weakening in employment, with an abrupt dropoff in industrial production and new orders.

Mike Shedlock reviews the litany of awful figures we’ve seen since then, focusing on the new orders component of global purchasing managers indices: U.S. manufacturing new orders and export orders plunging from expansion to contraction, Eurozone new export orders plunging (only orders from Greece fell at a faster rate than those of Germany), and an accelerating decline in new orders in both China and Japan.

Recall that the NBER often looks for “a well-defined peak or trough in real sales or industrial production” to help determine the specific peak or trough date of an expansion or recession. From that standpoint, the sharp and abrupt decline we’re seeing in new orders is a short-leading precursor of output. As the chart below of global output suggests, I continue to believe that we have reached the point that delineates an expansion from a new recession.

On the employment front, Friday’s disappointing report of 80,000 jobs created in June may be looked on longingly within a few months, as we continue to expect the employment figures to turn negative shortly. That said, it remains important to focus on the joint action of numerous data points, rather than choosing a single figure as an acid test. I noted last week in Enter, the Blindside Recession, GDP and employment figures are subject to substantial revision.

Lakshman Achuthan at ECRI has observed the first real-time negative GDP print is often seen two quarters after a recession starts. Earlier data is often subsequently revised negative. As for the June employment figures, the internals provided by the household survey were more dismal than the headline number. The net source of job growth was the 16-19 year-old cohort (even after seasonal adjustment that corrects for normal summer hiring). Employment among workers over 20 years of age actually fell, with a 136,000 plunge in the 25-54 year-old cohort offset by gains in the number of workers over the age of 55. Among those counted as employed, 277,000 workers shifted to the classification “Part-time for economic reasons: slack work or business conditions.”

Permabears?

Hussman has been labeled a “permabear”. So have I. So has Dave Rosenberg. So have many others. It only seems that way. The reality is Hussman, I, and Rosenberg were bullish at the March 2009 bottom.

However, the market shot up so far, so fast, that valuations became quickly stretched.

I cannot speak for the others, but I surely underestimated the effect of global coordinated liquidity move by central bankers virtually everywhere (US, EU, UK, China, Australia, Canada, etc.).

The result was we had a 10-year stock market rally in three years. Those patting themselves on the back for their “no recession” call were correct only because of  a massive coordinated liquidity pump by central bankers worldwide.

Unless the “no recession” callers specifically counted on that, then they were lucky with their forecast.

What about now?

What if the Fed Throws a QE3 and Nobody Comes?
What if stock market valuations reach typical bear market valuations?
What if a recession is really at hand?

I do not believe the Fed is in control. Such ideas are a myth.

If the Fed could prevent recession we would never have them. Yet we do, don’t we?

The fact of the matter is Fed tail-chasing policies combined with fractional reserve lending and moral-hazard bailouts have amplified the crest and trough  of every boom and bust.

Deep Problems

Hussman comments …

Our economic problems run far deeper than what can be healed by more reckless bubble-blowing by the Federal Reserve. At the center of global economic turmoil is a mountain of bad debt that was extended on easy terms by weakly regulated lenders with a government safety net. Global leaders have done all they can to protect the lenders at the expense of the public – to make good on the bond contracts of mismanaged financial institutions by breaking the social contracts with their own citizens. The limit of this unprincipled madness is being reached.

The way out is to restructure bad debt instead of rescuing it. Particularly in Europe, this will require numerous financial institutions to go into receivership, where stock will be wiped out, unsecured bonds will experience losses, senior bondholders will get a haircut on the value of their obligations, and loan balances will be written down. Bank depositors, meanwhile, will not lose a dime, except in countries where the sovereign is also at risk of default. Even there, depositors will probably not lose any more than they would if they held sovereign debt directly. In the U.S., the pressing need continues to be mortgage restructuring, and an emerging recession is likely to bring that issue back to the forefront, as roughly one-third of U.S. mortgages exceed the value of the home itself

Recognizing the Limits of Madness

I agree. The key statement is “The limit of this unprincipled madness is being reached.”

The problem is not only recognizing the limits of “unprincipled madness” but also recognizing the market’s willingness to play along. It always lasts longer than one thinks possible.

At the end of the line, every possible person is sucked into belief current conditions can go on forever. We saw that in the 2000 dot-com bubble, the housing bubble, the commercial real estate bubble that followed the housing bubble, and we see it now in the “Fed is omnipotent belief bubble”.

The only reason we have escaped recession so far is the amazing effort central bankers and global governments have put forth to avoid what needs to be done. Congratulations to those who recognized this condition in advance.

However, no credit can be given to those with the misguided belief such policies and efforts will last perpetually. The end of the line always comes.

No Decoupling

There was no decoupling in 2008 and there will be no reverse decoupling now. For further discussion please see Will the US Economy Continue to Decouple From the Rest of the World?

Recession Has Begun

In this case, the data speaks for itself. We are at the end of the line. The recession is not coming, it is not down the road, it is not likely, it is not at even at-hand.

Rather, the recession has begun. Fiscal stimulus from Congress is not coming and no amount of QE is going to stop it.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: China Import, Consecutive Quarters, Current Conditions, Economic Contraction, GDP Growth, Global Collapse, Global Economy, Global Recession, Hussman, Import Growth, International Monetary Fund, International Monetary Fund Imf, Macroeconomic Factors, Nber, Necessary Condition, Partial Transcript, Payroll Report, Protectionism, Recessions, Trade Surplus, World Gdp
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U.S. Exports: A Lower Gear, but Still Cruising

Tuesday, July 10th, 2012

by Milton Ezrati, Lord Abbett

July 2, 2012

Exports have remained one of the few consistent bright spots in this otherwise subpar economic recovery. The growth of exports at times has added as much as two percentage points to the overall pace of the economy’s expansion and is a major reason why American manufacturing has staged a comeback in recent years—a “renaissance” some have called it. But of late, with the dollar rising against both the euro and the yen, and with growth overseas slowing or, in Europe’s case, falling, questions have arisen about the sustainability of U.S. export strength. Doubtless, the pace of gain will slow, but probabilities suggest that the growth will continue.

The American export boom actually took off in 2007, stood up remarkably well during the 2008–09 recession, and has generally picked up momentum since. As Table 1 shows, exports of goods and services jumped 13.3% in 2007 and continued to grow almost apace in 2008, even as the global financial crisis rocked world economies. Unsurprisingly, exports fell during the global recession year of 2009, but they rebounded into 2010 and 2011, despite the disappointing pace of the global expansion. Even more recently, as China has reduced its overall growth expectations and Europe has fallen into recession, export growth so far this year has actually accelerated. Because exports amount to barely 15% of all U.S. economic output, this performance, impressive as it is, could not turn a sluggish recovery into a rapid one, but it has been fast enough at times to add considerably to the pace of growth. In late 2007, net exports accounted for more than half the economy’s overall expansion. In 2010 and early 2011, they accounted for one-third of the economy’s overall growth.

The expansion of the global economy, especially the emerging world, explains some of these gains. The 2007 export jump, especially, reflected the booms in China, India, and other emerging economies that were proceeding at the time and that consumed industrial supplies and raw materials for which the U.S. economy, among others, was in a good position to provide. Of course, the global downturn in the late 2008/early 2009 helps explain the export drop averaged in 2009, but that picture quickly changed as the emerging economies resumed their rapid growth trajectories in 2010 and in the early part of 2011.

Also explaining the American export picture are the declines in the dollar’s foreign exchange rate, which cumulatively enhanced American producers’ price competitiveness. Between 2002 and 2007, for example, the euro rose about 40% against the dollar, while the yen rose more than 15%. These favorable (for exports) currency patterns continued through much of this more recent period too, further enhancing America’s competitive position. In 2007 alone, the dollar cheapened almost 10% against the euro and then rose only slightly since, at least until much more recently. The move against the yen was even more dramatic. Between mid-2007 and late 2011, the yen rose almost 40% against the dollar. Not only did the currency moves give U.S. producers inroads into the European and Japanese markets but, more significantly, they also gave a significant edge against the European and Japanese competition in faster-growing third markets, such as China, India, and Brazil.

There can be no denying, however, that the dollar’s recent gains, if they persist, will strip away some of this competitive edge. In recent weeks, for instance, the euro and the yen have each cheapened almost 5.5% against the dollar. But because previous dollar declines had given American producers such huge pricing advantages, even recent dramatic currency moves leave much of this country’s former global pricing advantage intact. According to calculations by the OECD (Organization for Economic Cooperation and Development), underlying measures of comparable pricing (what econometricians refer to as purchasing power parity), put today’s euro, at about $1.25, only just on a competitive par with dollar-based production. Comparable calculations for Japan show the yen still giving American producers a huge 35% pricing advantage against the Japan-based competition.

Though combined with slowing global growth, recent dollar strength will retard the future rates of export gain, but it should be clear that relative pricing advantages have hardly proceeded far enough to erase it. For one, trading arrangements are based on ongoing pricing and supply relationships built over long periods of time. Those that have developed in favor of American products during these past years of great American pricing advantages will take a long while to unwind. Given the American advantage implicit in the still pricey yen, it is doubtful that such a process has even begun or will begin for some time yet. If the euro is closer to competitive parity, it still offers no special pricing advantage that would prompt buyers to switch away from established American suppliers. On this basis, exports should continue to contribute to aggregate growth in the U.S. economy, albeit at a reduced rate, say, growing 8–10% rather than within the 14–17% range of the past three years.

Table 1. U.S. Exports of Goods and Services

Source: Bureau of the Census, Department of Commerce.
*Through April annualized.
+ Calculated from December through April and expressed at an annual rate.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

Tags: American Export, Booms, Economi, Economic Output, Economic Recovery, Export Boom, Global Economy, Global Expansion, Global Financial Crisis, Global Recession, Growth Expectations, Lord Abbett, Milton Ezrati, Momentum, Pace, Percentage Points, Probabilities, Renaissance, Sustainability, World Economies, Yen
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All You Had To Do Was Wait (Grant)

Tuesday, July 10th, 2012

From Mark Grant, author of Out of the Box

All You Had To Do Was Wait

“What makes people so impatient is what I can’t figure; all the guy had to do was wait.”

-Ken Kesey

It was approximately twelve months ago that I called for a U.S. ten year at 1.25%. The yield back then was around 2.25%. We are a scant 26 bps from my prediction now and we have seen a 75 bps drop in yield during this time period. This has been fueled by the continuing “moments” generated in Europe and the demand for anything having some sort of safe haven status. We now have a second driver which is the recession in Europe and the substantial slowdown in the economy of China which I predict will place America in recession by either the fourth quarter of this year or the first quarter of the next.

The American stock market, always myopic in its view, is about to be hit by what it does pay attention to which is earnings. Europe represents 25% of the global economy and the recession there is about to have a very substantial impact on the revenues and profits of many American corporations. It was inevitable, as hindsight will expose, and now as our earnings season gets underway it will get documented in the numbers. If you don’t delight in losing money you will find that the yields of many senior and subordinated corporate bonds far outpace the returns of dividends and certainly the depreciation in value will be far less. Further, in times of economic stress, it is far safer as has been proved time and time again to be towards the top of the capital structure in bonds rather than in the bottom of the capital structure which is equities.

I can report a wide array and a great diversification of viewpoints on just what will take place in Europe but what also can be said with certainty is that most institutional investors all agree that there is a lot of risk on the table now. As part of this process I also wish to congratulate the media. Many commentators in the Press or on television are no longer willing to take the official press releases as fact. There are more people who are not only questioning the headlines but who are looking past them in trying to decipher not only their accuracy but there meaning. I suppose this has occurred by one announcement after another coming from the Continent that was so shaded and so misleading that eventually people woke up to the fact that inaccurate data was being provided and being provided in a systemic fashion. Then there is the timeline issue where plans are tossed out, do not materialize and are being held to account as mollifying statements that somehow never seem to achieve their goals. Whether it was the statements of the IMF and the EU that the new structural plan for Greece would produce a debt to GDP ratio of 120% or the giant firewall that would prevent Spain or Italy from ever needing to be bailed out or the bailout for Spain which their Prime Minister called “A Great Victory for Europe;” the cries of “wolf” are falling on less and less accepting ears.

“The secret of being a top-notch con man is being able to know what the mark wants, and how to make him think he’s getting it.”

-Ken Kesey

It may work, for a moment, to rally equities after the next new piece of sliced white bread is announced but then the reaction flattens out and then the market declines as reality sneaks back in and finds its rightful place at the table. From the very beginning with the first European bank stress test which counted what Europe wanted to be counted and ignored what should have been counted to the second one which was falsified by its methodology; results begin to occur and calamities begin to happen, such as with Dexia, as the real data forced what the phony data reported tried to hide. Europe may cook the books and allow for risk-free assets or the Spanish central bank may allow for “smoothing” and carrying Real Estate at levels with no reflection of reality in them but when mortgages are not paid and commercial loans are delinquent; the lack of revenues and profits tell the accurate tale whatever was allowed to be ignored or not.

All of the time wasted on firewalls and great deceptions worked in the short term but the height of a fence does nothing to help a horse or a nation which is sick inside them. Europe has vastly overspent and tried their best to whitewash the financials of the countries and the European banks and now, and each quarter out for some time; we are going to see a worsening financial landscape for the European nations and their banks. This will not be Armageddon or the end of the world but it is going to be quite painful and have a decided impact on the United States and perhaps the scaring may be deep. In Europe that have mouthed so much nonsense for such a long period of time that they have come to believe in what they have manufactured. This is not uncommon historically but the depth and breadth of it is without comparison. Germany says one thing to placate France and Italy believes the drivel that is touted by the Netherlands and now Greece wants the ECB to forgive their $238 billion in Greek debts on the basis of a united Europe, which would bankrupt the ECB, and then it becomes clear that someone has to pay for all of this and countries start banging on the doors of the asylum to get out. Listen carefully; the banging has begun and will grow loader and more raucous during the balance of the year.

“The world news might not be therapeutic.”

-One Flew Over The Cuckoo’s Nest

Tags: American Corporations, American Stock Market, Bps, Capital Structure, Commentators, Corporate Bonds, Depreciation, Diversification, Earnings Season, Economic Stress, Economy Of China, Global Economy, Having Some Sort, Hindsight, Institutional Investors, Mark Grant, Recession, Safe Haven, Slowdown, Substantial Impact
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