Every day we watch what is going on in the world and are constantly given reasons to be concerned, stressed and worried about our immediate futures and beyond. As we get ready to celebrate this traditional holiday, it is a good time to remind ourselves that we do indeed have many things about which to be thankful and to focus on those. Here is a variation of these sentiments as they relate to what is going on in the economy and world markets.
In 2012 there were many reasons for markets to potentially melt into panic. The ongoing crisis in Europe, persistent economic troubles in the US, volatility in China and other developing markets, and the uncertainty around the US elections all threatened to impact the market in a severely negative way. Yet as we head into the Thanksgiving holiday the S&P 500 is up just over 10% year-to-date, and brief periods of heightened uncertainty have been tempered by long stretches of relatively low volatility growth. Of course, this does not mean that we are out of the woods, and vigilance remains the order of the day. But it is important sometimes to step back and remember that more often than not the worst case does not eventuate even when the news would sometimes suggest otherwise. Revolutions don’t happen more often than they do happen. For that we can be thankful.
The election was bitterly contested and often depressing in terms of the quality and temperament of the discourse. But as we move beyond the election into the challenges that lie ahead in the coming years, we can be thankful that we have robust mechanisms in place to keep the basic integrity of our political system intact, certainly relative to just about any other example you could imagine. Fortunately we Americans have a strong optimistic side to our character which gives us confidence that in the end we can figure out and solve our most pressing problems.
No doubt we will have more in the way of caustic commentary on events around us as the days and weeks progress. But for now, we simply want to be thankful for the things for which we can be thankful, and to wish each and every one of you a safe, healthy and happy Thanksgiving.
Now that the election is over and done with, US investors have turned their focus once again to the looming fiscal cliff and deepening recession in Europe – and their reaction has been anything but kind. At close on Wednesday, the Dow Jones Industrial average was down a whopping 313 points, once again bringing it below the 1300 mark.
Much of this negative reaction was brought on by comments by European Central Bank (ECB) President Mario Draghi, who discussed concerns about Germany, the Eurozone’s biggest economy. A 1.8%month-on-month fall in industrial production as well as a 3.3% decline in factory orders have resulted in the European Commission reducing Germany’s 2013 growth forecast by around half – it is now expected to grow 0.8% next year rather than the previous estimate of 1.7%.
Most disconcerting about these numbers, as Draghi stated, is that “Germany has so far been largely insulated from some of the difficulties elsewhere in the euro area”. However, these new reports and growth estimates suggest that the Eurozone’s largest economy is not immune to the problems that have been plaguing other member countries for quite some time now; most notably “deplorably high” unemployment , a weak economic outlook and a an ongoing three year long debt crisis.
The European Commission’s 2013 growth prediction for the rest of the Eurozone countries is not any better – a paltry 0.4% growth is expected, barely above recession territory.
But investors shouldn’t necessarily panic – this sentiment is vastly different from the lead-up to Draghi’s star turn in late July when he succeeded in gaining approval for the ECB to conduct sovereign bond-buying programs intended to reduce market volatility and borrowing costs for struggling Eurozone countries. The best advice for investors in our opinion is to stay disciplined and watch how the various economic concerns in both the US and Eurozone continue to play out. If we can get through the next couple months without a worst-case scenario playing out it could lead into opportunities for growth in 2013.
At the end of the third quarter the S&P 500 was perched at 16.44% year to date, a stark contrast to where we were at the same time last year at -8.68%. Driving this rally, as we have noted in a handful of these market commentaries, have been the policy measures made by central bankers around the globe. The Fed initiated a massive undertaking with so-called QE3 (or QE4ever as the financial wags put it) by pledging to buy a theoretically unlimited amount of federal debt. That followed on the heels of the aggressive measures announced earlier in the summer by ECB head Mario Draghi to “do what it takes” to shore up the Eurozone. What has ensued is what we refer to as a synthetic rally – a rally that is not being driven by fundamental economic drivers, but rather by policies meant to stimulate the economy.
So why is it important to recognize the difference between a synthetic rally and an organic growth-driven rally? In large part because of the unique nature of the unknowns. Investors, analysts and sundry financial experts alike are struggling to anticipate and make sense of what factors are really driving current market conditions during this policy driven period. With the announcement of QE3, one would have normally expected treasury yields to rise – however, yields have still not reached the already meager levels seen at the beginning of the year. This is a prime example of the lack of rhyme and reason that keeps market observers perplexed as they look for signs of transition back to organic growth and a more “normal” valuation-driven climate.
This transitional period will likely be fraught with the kind of volatility that investors have become (reluctantly) accustomed to over the past 4 years. Contributing to the turbulence will be an unhealthy admixture of political factors and wagers about the unknown, but inevitable, end of spoon-feeding by the Fed. Most immediately the passing of the 11/6 election and pending fiscal cliff loom large, but renewed inflation risk and sharply higher interest rates also lurk in the copses in the not-too-distant future.
A real growth period will announce itself by headline numbers like GDP and unemployment rates – but we may expect fleeting glimpses of the promised land via economic indicators such as consumer confidence and the various housing numbers which, as they start to rise, reflect and also encourage improvement in public sentiment. Current numbers are beginning to show some of these tantalizing glimpses, and that could turn into a high-likelihood case for 2013.
But even if that becomes our likeliest-case scenario we are mindful that the path is not paved nor the way smooth. Many variables remain to play out, starting with an election whose outcomes will very likely be dominating influences in the days and weeks after November 6.
With less than one month to go until Election Day the political narratives are in full swing. Dead-center in the crosshairs of the economic debate is the subject of taxes: what will happen to the Bush-era rates on income and capital gains, what about the payroll tax, Medicare contribution taxes and all the rest that no doubt have the CPAs and tax attorneys of the world busily at work helping their clients make sense of what might happen. The questions that tend to come our way, as investment advisors, is how changes in tax policy may impact investment portfolios and what action, if any, one should take.
Wagging the Dog
When it comes to decisions around taxes the fundamental tenet of our beliefs is this: taxes are the tail, investment policy is the dog. In other words, your investment policy should drive tax decisions; tax decisions, or reactions to changes in tax policies, should not drive investment policy. The tail should not wag the dog. If you have a taxable, non-qualified portfolio then when evaluating two alternative approaches, all else being equal it makes sense to opt for the one that is more tax-efficient. But first make sure that all else is equal. As in: if both alternatives are equally prudent in view of my long-term return objectives, risk tolerance and other relevant considerations, and alternative A is more tax-efficient than alternative B, then alternative A is the right choice. That’s how to make investment decisions around taxes. Pay attention to those operands “if, and, then” – because they matter.
Uncertainties and Probabilities
Here’s how not to make investment decisions around taxes: make decisions today, irrespective of whether they are in line with your investment policy, because of tax policy changes that might happen tomorrow. Right now there is a great amount of uncertainty. We don’t know who is going to win the presidential election, who will be in control of the Senate or the House of Representatives, or what margin of control the majority parties have to work with, or any number of other variables that will influence how tax policies are fashioned. We don’t know what dynamics will be at play as opposing sides try (or not) to reconcile their differences to avoid the “fiscal cliff”. The possible outcome generating much of the debate among investors about what to do is the long term capital gains tax, which could go back up to 20% from the 15% level that was established as part of the Bush cuts in 2003.
In our opinion there is a logical way to address this question, which is simply this: If your investment policy doesn’t contemplate any necessary asset sales that would trigger a long term capital gains tax event, don’t create asset sale mandates just to “lock in” a 15% rate. However if, in the context of your overall asset planning and income generating plans over the next twelve months or so, you identify asset sales that are likely to take place, and you are relatively indifferent as to the timing now or one year from now, then perhaps it makes sense to think about selling when you are certain about what the capital gains rate is rather than when you don’t know what it will be. That’s prudent, and that is wholly in line with investment policy dictating tax actions – the dog wagging the tail, as it should be.
Election season brings out the snake-oil salesmen and Chicken Littles of the world, running around with hyperventilating headlines about how the sky is falling and you have to act now. Nonsense. Successful investors are the ones who ignore the breathless hype and stay disciplined and patient.
Every month for the past three years, economists and financial professionals everywhere have waited with bated breath to hear the U.S. employment reports – economic indicators that offer insight into the current economic state of the country. Lately though, these reports have provided more confusion than clarity.
Payroll Processor Automatic Data Processor (ADP) reported on Wednesday that private businesses added 162,000 new jobs in the month of September – 9,000 more than the 153,000 that was expected by economists.
The Institute for Supply Management released a separate report illustrating that new orders in the non-manufacturing industry boosted the services sector to 55.1, the highest level since March. Unlike its manufacturing counterparts, companies in the services sector have remained stable despite the still-perilous situation in Europe, slowing growth in China and the looming U.S. fiscal cliff.
On Friday the Bureau of Labor Statistics (BLS) will release nonfarm payroll data, which includes government workers. Economists are currently predicting a rise of 118,000 for total nonfarm payrolls and unemployment to remain at 8.1%, an estimate that is unlikely to change despite the better than expected ADP report released this morning. Over the past couple of years ADP reports have not been especially helpful at predicting nonfarm payroll data – just last month large gains forecasted by ADP data missed by a long shot – a mere 96,000 jobs were added in August.
So what do these numbers mean for the economy as a whole? Not a whole lot. The discrepancies among economists’ expectations and actual numbers suggest that we are unsure of when the economy will start improving on the whole. That is not to say that the economy isn’t growing however – the steady improvement in ADP numbers and jobless claims (which clocked in at the lowest level since July) clearly indicate that the economy is improving, albeit slowly.
As the presidential debates get into full swing tonight the employment numbers could have a significant impact for both the candidates. Another disappointing jobs number could put Obama in the hot seat again – last month the unimpressive report fell in the wake of the Democratic National Convention and probably muted at least part of the “bounce” these conventions tend to produce. However, “Nobama” supporters take heed – should the Friday numbers significantly exceed expectations it could provide the President with a boost regardless of who is deemed to have won tonight’s debate. Wait and see.