2014 Third Quarter Updates: King Dollar Reclaims the Throne & The Market - It s The Wall of Worry; Another Spooky October The optimist proclaims that we live in the best of all possible worlds: and the pessimist fears this is true. James Branch Cabell, in the Silver Stallion (1926) There are many tests that can be run during an annual physical, but the simple measures like blood pressure or cholesterol count give a good indication of general health. Similarly, there are basic ways to assess the financial health of a firm. Tracking the price of a stock in relation to its industry peers and in relation to the broader market is like taking the company s financial pulse. It s a simple measure that offers a rough estimate of market sentiment and expectations for that company. A country s currency can also be evaluated in basic ways. Weakness can suggest anything from economic problems to political unrest. Conversely, a strong currency suggests economic might, or, at a minimum, an economy that is outpacing its peers. Recently, the dollar has surged in relation to its peers. The Dollar Index, which is a weighted average of the currencies of the nation s major trading partners, has risen to its highest level in over four years. There are two major reasons we re seeing a resurgence of the greenback, and it may bode well for stocks and the economy. First of all, the U.S. economy is expanding at a faster rate than many developed nations. And growth attracts foreign cash as investing opportunities, including those in stocks, multiply. In addition, for investors looking to park cash in safe, interest-bearing investments, a favorable rate advantage is also a magnet for capital. Yes, short-term rates are near zero, but it is advantage U.S. in bond yields, as the difference between longer-term Treasury bond yields and yields in a number of developed nations widen. And there has been no shortage of talk from the Fed that an eventual hike in interest rates seems destined to occur next year. Securities and Registered Advisory Services offered through Silver Oak Securities Inc. Member FINRA/SIPC
2 It s a different story in Europe and Japan, where economic woes may encourage their respective central banks to increase monetary stimulus, keeping rates at rock-bottom levels for quite some time. Greenback s effect on stocks Conventional wisdom suggests a stronger dollar will make exports less competitive and reduce revenues from sales overseas that are translated back into dollars. Yes, it s a headwind for individual companies, but research by RBC Capital and the Schwab Center for Financial Research (SCFR) suggests the market as a whole won t be hindered by King Dollar. RBC pointed out that a stronger greenback has historically been supportive of higher price/earnings ratios. And SCFR notes that the S&P 500 Index has performed nearly twice as well during dollar bull markets vs. dollar downturns. It s not that stocks have fallen during dollar weakness; they just haven t performed as well. For now, the dollar is enjoying its day in the sun. There will be winners and losers across the economy, but let s not discount the possibility that as a whole, the U.S. economy and the market could be the big winner. Fool s gold From time to time, people ask if I think they should own gold. On occasion, I m even asked whether a portfolio of mostly gold or precious metals is a wise move. It s not that we don t put gold and other natural resources in our portfolios all multiasset strategies have a natural resource position, which can reduce the overall volatility of an investment portfolio. But when it comes to jumping head first into gold, I ll defer to Warren Buffet. Gold gets dug out of the ground in Africa or someplace. Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head. He adds that it s an unproductive asset that will never produce anything, but is purchased in the buyer s hope that someone else will pay more for it in the future. Owners of assets like gold are not inspired by what the asset itself can produce it will remain lifeless forever but by the belief that others will desire it even more avidly in the future.
3 It s the greater fool theory, as there s always a greater fool than me, who will pay more than I paid! No doubt about it, gold has its avid promoters. It always has and always will. They ll hold the faith no matter how high or low the yellow metal goes. Gold has been a store of value for thousands of years; hence its attraction. Moreover, currencies today, including the dollar, are not backed by anything. It is viewed as an inflation hedge or an asset that benefits during times of global or economic uncertainty. But dire predictions made in 2009 that money creation by the Fed would result in runaway inflation, a collapse of the dollar, and a dumping of Treasuries by foreigners have missed the mark by miles! I have to admit, there s plenty of uncertainty around the globe right now. Yet the shiny metal is languishing and down over 35% from its September 2011 high of $1,895 per ounce. There are a number of reasons for this, including the stronger dollar, increased talk that the Fed is preparing to hike interest rates next year, an improving U.S. economy, and low inflation at home. That financial news channel I applaud your efforts to learn more about investing and planning. It will pay dividends in many ways, and my team is here to assist you as you take steps to educate yourself. But I caution you about spending too much time in front of the financial news channels dotting the cable landscape or the many Internet sites that are just a mouse click away. It s not that they don t report hard news. They do. But there are times when markets get volatile and the shrillness meter hits alarming levels. Just a couple of months ago, when the Dow fell over 300 points in one day, I jumped onto MarketWatch over the weekend and found a section highlighting the most popular stories. 1. Warning: the Plunge in Stocks Is Just Beginning. Well, stocks quickly recovered and claimed new highs. 2. S&P 500 Suffers Largest Weekly Loss in 2 Years. True, but we emphasize the longer term and continually stress that your plan should take into account setbacks in the market. Be very careful of allowing weekly volatility sidetrack a multiyear plan. 3. 10 Things Winemakers Won t Tell You. This article may have been worthwhile, but it s not market-related.
4 4. 3 Market Warning Signs that Predict a 20% Tumble. See my comment on article number one, above. Three of the top four stories are playing on the fears of investors. Simply put, bad news sells. But it can be confusing if the noise isn t filtered. It s been over 570 days since we ve had a 10% drop in the S&P 500 Index, or a decline that would officially be called a correction. Going back to mid-1940s, the median time period between corrections has been 121 trading days, and the average has been 273 trading days. Markets never move up in a straight line, and we are due for a 10% pullback, which, coupled with the expanding economy, would be healthy. No one can accurately predict when that might occur, and one day it will. But the portfolios we recommend have a long-term time horizon and are designed to get you to your ultimate financial goal. Stay focused on the goal and make adjustments that take into account changes in your personal circumstances, not fear-mongering that can be deafening during market volatility. Things I m watching There are no shortage of tailwinds benefiting stocks. Even as the Fed appears poised to start tightening policy, interest rates could remain at historical lows for the foreseeable future. In addition, the European Central Bank is increasingly discussing more monetary stimulus. And let s not forget that corporate earnings are rising, the U.S. economy is growing, and companies continue to repurchase shares, which not only represents confidence but a real demand for equities. Yet the skies are never completely clear. One risk: There has been an exodus of funds from the high-yield, or junk, bonds. The Fed s low rate policy has encouraged a reach for yield, and hundreds of billions of dollars have gone into low-quality, high-yield debt. Typically, a stronger economy is good for bondholders because it makes it easier for debt-laden firms to pay down debt and meet scheduled interest payments. However, a strong economy could prompt the Fed to hike rates, which could lead to rising defaults, especially among companies that have high leverage and low bond ratings. In a perfect world, we d have a seamless hand-off of the baton between the Fed s decision to raise rates and a stronger economy and faster earnings growth. But we don t live in a perfect world, and that brings about volatility. Junk bond yields have backed up, especially among the lowest-rated bonds. What s unknown: Will the jump in yields stabilize as the improved return attracts buyers, or will
5 we witness selling of investment-grade bonds amid expectations of eventual hike in rates by the Fed? And will that spread to the stock market and force a long-awaited correction? In recent years, there s been a very close correlation between performance in junk debt and stocks. But many variables go into the stock-price equation, including but not limited to earnings, dividends, economic expectations, corporate stock buybacks, and monetary policy by the Fed and major global central banks. Rising profits and an improved economic outlook are tailwinds for stocks. What s going on in the bond market matters and is worth watching. Stay tuned: I hope you have found this review to be both educational and helpful. If you have any questions or would like to discuss any matter, please feel free to give me or any of my team members a call. As always, I am honored and humbled that you have given me the opportunity to serve as your financial advisor. Keep the Faith!