Save & Invest - Fourth Quarter 2010
http://www.watermarkasset.com/articles/50/1/Save-amp-Invest---Fourth-Quarter-2010/Page1.html
By Mark Miller
Published on 01/18/2011
Don’t be fooled. The Great Recession is still with us though it is
surely being masked by the great experiment now known as The Great
Reflation. Two years into the implosion of the greatest credit and
asset bubble in history, governments and central banks around the world
continue to provide credit and liquidity in an attempt to keep their
economies and financial markets afloat. This experiment in financial
manipulation continued in the fourth quarter, driving stocks back up to
levels not seen since the collapse of Lehman Brothers in September
2008...
Don’t be fooled. The Great Recession is still with us though it is surely being masked by the great experiment now known as The Great Reflation. Two years into the implosion of the greatest credit and asset bubble in history, governments and central banks around the world continue to provide credit and liquidity in an attempt to keep their economies and financial markets afloat. This experiment in financial manipulation continued in the fourth quarter, driving stocks back up to levels not seen since the collapse of Lehman Brothers in September 2008.
US stocks as measured by the S&P 500 Index saw a total return of 15% in 2010. It’s easy to forget that at the time Fed Chairman Bernanke gave his speech on August 26th, raising the possibility that the Fed would begin purchasing US Treasuries under a program now known as QE2, the S&P was down -6.1% for the year. Markets started to rally on the news, finally kicking into warp drive when President Obama and Congressional Republicans reached a tax deal on December 16th. From the end of August to December 31st, the S&P 500 gained nearly 20%, erasing year-to-date losses and igniting the “animal spirits” of equity investors.
Surprisingly, interest rates, measured by the 10-year Treasury, were actually lower at the end of the year (3.299%) than at the beginning (3.834%). Bond prices, moving in the opposite direction, hit their lows in early April and then recovered gaining 6.5% for the year (BarCap US AGG Bond TR Index).
With investors being punished by low interest rates on cash and savings, and the Fed showing that it is willing to do whatever is needed to transition the economy from recovery to expansion, it’s no surprise that the US dollar continued its decline and the best performing asset classes in 2010 were commodities and emerging market stocks, up 30% and 19.2% respectively. The bubbles are forming; the Great Reflation has begun.
Strategy
If the passage of time allows for perspective, we are far enough along now to reflect on the past ten years while formulating reasonable outcomes for the years ahead. The tech bubble was followed by a crash, then the recession and deflation of 2000-2002. Greenspan’s Fed led the first effort at reflation with low interest rates and easy money, resulting in housing, commodity, energy and world food market bubbles.
And now, the process has begun again. Except this time the consumer is tapped out and the government isn’t far behind. World economies may be too fragile to withstand another spike in energy and food prices. We see this as a time for continued caution and a focus on wealth preservation; a time for prudence over greed in light of artificial prices in what is still a manufactured economy. There will be plenty of opportunity to make money as the capital created by central banks seeks a home. But, this is a good time to be a contrarian, maintaining a margin of safety in what is certain to be a volatile and uncertain time ahead.
We’re focused on interest rates and the value of the dollar. We’re looking for unemployment numbers to improve, and the housing market to stabilize and then grow. We’re concerned with state level debt and the municipal bond market. And, we’re watching to see if our elected leaders in Washington will be able to address the unfunded liabilities of Social Security and Medicare that can no longer be “kicked down the road”.
We are greatly encouraged by the decline in household debt levels and a recovery in retail sales. Home sales remain slow, but they are improving. Personal income is on the rise. The largest S&P 500 companies are holding more cash than a year ago, over $900 billion, raising the prospect of higher dividend payouts and a continuation of stock buybacks now up for five quarters in a row. The ADP private payroll number showed a record gain of 297,000 jobs in December. If that turns out to be a real number, we may finally start to see GDP growth. And that, my friends, is what we need.
Watermark Update
Thanks to you, our firm continues to grow and prosper. We ended 2010 with more than $150 million under management and a nationwide client base. Our size and the scope of our services demand that we remain focused on delivering a timely, secure, client driven experience to each of you.
With that objective, in 2010 we: upgraded our hardware and software systems; increased our security to further protect your data; improved our disaster recovery and business continuity plans; and, established a second custodial platform with TD Ameritrade. We have instituted a service known as “One Call Now” that allows us to quickly and immediately contact all our clients via an email or phone call should it be necessary to do so. Watch for our message as we periodically test the system.
In 2011 we will continue to evaluate our service providers with an eye toward greater investment flexibility and financial stability. We will continue to enroll clients in the electronic delivery of Watermark quarterly reports through the secure sharefile system on our web site. And, we will be producing an updated Form ADV, our regulatory document, in a plain English format in compliance with new SEC requirements. In fact, all our processes are being redesigned to closely match the requirements of our regulator.
We will continue to modify and improve the ways we communicate with you. Our fourth quarter reports are coming to you in a new format. Hopefully, you will find them as informative as the old version. We now have considerable flexibility in delivering your information and I’m certain that the formats will be changed as we learn how to best communicate what we all want to know.
Finally, we are exploring the implementation of a Video Knowledge Center on our website. Done correctly, we see this as another way to efficiently communicate with you through the many various tools we have at our disposal in today’s technological world.
In Conclusion
Our outlook is more serious than pessimistic, despite the litany of concerns outlined above. In fact, we expect stocks to do well this year. Stock performance, however, may differ from the performance of the economy. We’re focused on the economy as that is where long-term wealth is ultimately created.
US stocks as measured by the S&P 500 Index saw a total return of 15% in 2010. It’s easy to forget that at the time Fed Chairman Bernanke gave his speech on August 26th, raising the possibility that the Fed would begin purchasing US Treasuries under a program now known as QE2, the S&P was down -6.1% for the year. Markets started to rally on the news, finally kicking into warp drive when President Obama and Congressional Republicans reached a tax deal on December 16th. From the end of August to December 31st, the S&P 500 gained nearly 20%, erasing year-to-date losses and igniting the “animal spirits” of equity investors.
Surprisingly, interest rates, measured by the 10-year Treasury, were actually lower at the end of the year (3.299%) than at the beginning (3.834%). Bond prices, moving in the opposite direction, hit their lows in early April and then recovered gaining 6.5% for the year (BarCap US AGG Bond TR Index).
With investors being punished by low interest rates on cash and savings, and the Fed showing that it is willing to do whatever is needed to transition the economy from recovery to expansion, it’s no surprise that the US dollar continued its decline and the best performing asset classes in 2010 were commodities and emerging market stocks, up 30% and 19.2% respectively. The bubbles are forming; the Great Reflation has begun. Strategy
If the passage of time allows for perspective, we are far enough along now to reflect on the past ten years while formulating reasonable outcomes for the years ahead. The tech bubble was followed by a crash, then the recession and deflation of 2000-2002. Greenspan’s Fed led the first effort at reflation with low interest rates and easy money, resulting in housing, commodity, energy and world food market bubbles.
And now, the process has begun again. Except this time the consumer is tapped out and the government isn’t far behind. World economies may be too fragile to withstand another spike in energy and food prices. We see this as a time for continued caution and a focus on wealth preservation; a time for prudence over greed in light of artificial prices in what is still a manufactured economy. There will be plenty of opportunity to make money as the capital created by central banks seeks a home. But, this is a good time to be a contrarian, maintaining a margin of safety in what is certain to be a volatile and uncertain time ahead.
We’re focused on interest rates and the value of the dollar. We’re looking for unemployment numbers to improve, and the housing market to stabilize and then grow. We’re concerned with state level debt and the municipal bond market. And, we’re watching to see if our elected leaders in Washington will be able to address the unfunded liabilities of Social Security and Medicare that can no longer be “kicked down the road”.
We are greatly encouraged by the decline in household debt levels and a recovery in retail sales. Home sales remain slow, but they are improving. Personal income is on the rise. The largest S&P 500 companies are holding more cash than a year ago, over $900 billion, raising the prospect of higher dividend payouts and a continuation of stock buybacks now up for five quarters in a row. The ADP private payroll number showed a record gain of 297,000 jobs in December. If that turns out to be a real number, we may finally start to see GDP growth. And that, my friends, is what we need.
Watermark Update
Thanks to you, our firm continues to grow and prosper. We ended 2010 with more than $150 million under management and a nationwide client base. Our size and the scope of our services demand that we remain focused on delivering a timely, secure, client driven experience to each of you.
With that objective, in 2010 we: upgraded our hardware and software systems; increased our security to further protect your data; improved our disaster recovery and business continuity plans; and, established a second custodial platform with TD Ameritrade. We have instituted a service known as “One Call Now” that allows us to quickly and immediately contact all our clients via an email or phone call should it be necessary to do so. Watch for our message as we periodically test the system.
In 2011 we will continue to evaluate our service providers with an eye toward greater investment flexibility and financial stability. We will continue to enroll clients in the electronic delivery of Watermark quarterly reports through the secure sharefile system on our web site. And, we will be producing an updated Form ADV, our regulatory document, in a plain English format in compliance with new SEC requirements. In fact, all our processes are being redesigned to closely match the requirements of our regulator.
We will continue to modify and improve the ways we communicate with you. Our fourth quarter reports are coming to you in a new format. Hopefully, you will find them as informative as the old version. We now have considerable flexibility in delivering your information and I’m certain that the formats will be changed as we learn how to best communicate what we all want to know.
Finally, we are exploring the implementation of a Video Knowledge Center on our website. Done correctly, we see this as another way to efficiently communicate with you through the many various tools we have at our disposal in today’s technological world.
In Conclusion
Our outlook is more serious than pessimistic, despite the litany of concerns outlined above. In fact, we expect stocks to do well this year. Stock performance, however, may differ from the performance of the economy. We’re focused on the economy as that is where long-term wealth is ultimately created.