Schwartz Financial Weekly Commentary 5/21/12

The Markets

There wasn’t much to ‘Like’ in the financial markets last week as stocks took a hit on another round of global worries. High on the list of concerns were:

·         Continuing anxiety over Greece’s ability to avoid default and remain in the euro.

·         Rising borrowing costs for Italy and Spain.

·         Ongoing fears of an economic slowdown in China.

·         Loss of faith in the banking system due to JPMorgan’s $2 billion (and growing) bad bet.

·         A very tepid response to the highly anticipated stock market debut of Facebook.

Source: CNNMoney

Investors are particularly frustrated that the European debt situation keeps popping up like dandelions. After two years and 17 euro zone summits, the issue is still not resolved. In fact, it might be worse than ever as Europe is quickly running out of road to kick the can down, according to BusinessWeek.

Greece is at the epicenter of this worldwide concern despite the fact that its population is less than the state of Ohio. Like the subprime crisis before it, investors are concerned that Greece may be the falling domino that kicks off a series of undesirable effects. If Greece has a disorderly collapse, it could spread to other weak European countries and then ripple out to the rest of the world.

Unfortunately, the time for easy solutions has long passed. Central banks and governments around the world have already added trillions of dollars to their balance sheets so they don’t have much room to maneuver. And, here in the U.S., we have a potentially bruising election and looming tax and fiscal matters to deal with by the end of the year.

When you add it up, 2012 is on track to be another dramatic year in world affairs.     

Data as of 5/18/12	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	-4.3%	3.0%	-2.9%	12.5%	-3.2%	1.7%
DJ Global ex US (Foreign Stocks)	-6.1	-2.8	-20.5	5.0	-7.4	3.7
10-year Treasury Note (Yield Only)	1.7	N/A	3.2	3.2	4.8	5.2
Gold (per ounce)	0.4	1.0	6.2	20.0	19.3	17.7
DJ-UBS Commodity Index	0.9	-3.3	-16.5	4.3	-4.7	3.2
DJ Equity All REIT TR Index	-6.7	6.0	2.7	27.7	0.2	9.9

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable.

WOULD YOU GIVE YOUR MONEY TO THE U.S. GOVERNMENT for 10 years and lock in a negative yield? Well, that’s exactly what happened last week as investors handed over $13 billion to the government and, in return, received 10-year Treasury Inflation Protected Securities (TIPS). These securities were sold at a record low negative yield of 0.39 percent, according to The Wall Street Journal.  

TIPS are a bit different from traditional government securities because, “The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater,” according to the Treasury Department.

Now, why would anybody buy a TIPS with a negative yield when they could buy a traditional 10-year government security with a yield of about 1.7 percent last week? The answer lies in the difference between the two yields.

As reported by Bloomberg, the yield difference between a 10-year TIPS and a comparable 10-year Treasury security was 2.04 percentage points on May 17. Analysts call this the “break even inflation rate.” It means investors were expecting inflation to average 2.04 percent over the next 10 years. When you add the 2.04 percent expected inflation rate to the negative 0.39 percent yield of a TIPS, you get close to the yield of a traditional 10-year government security.

From an investment standpoint, if inflation averages more than 2.04 percent over the next 10 years, then owning TIPS might be a better deal than owning the traditional 10-year government security. Likewise, if inflation averages less than 2.04 percent over the next 10 years, then owning the traditional 10-year security might be better, according to The Vanguard Group.  

With its built-in inflation protection component, TIPS are traditionally viewed as a hedge against inflation rather than a play on interest income.

As an advisor, it’s important for us to know the break even inflation rate that is embedded in TIPS. Knowing the market’s best estimate of inflation provides data we can use to help us value and analyze other investments that may be affected by changes in investors’ inflation expectations.

Weekly Focus – Did You Know…

There is only one word in the English language with all five vowels in reverse order. Try to guess what it is before reading below for the answer. 

Source: http://www.byfaith.co.uk/paul2028.htm 

The answer is “subcontinental.”

Value vs. Growth Investing (5/18/12)

Name	1-Week	YTD	4-Week	13-Week	1-Year	3-Year	5-Year
US Market	-4.55	3.82	-6.50	-4.96	-2.17	15.51	-0.55
Large Cap	-3.96	4.32	-6.04	-3.67	0.06	14.29	-0.91
Large Core	-3.86	4.56	-5.68	-3.70	0.77	13.90	0.69
Large Growth	-4.88	7.56	-7.91	-3.20	4.60	17.17	1.46
Large Value	-3.16	1.11	-4.57	-4.07	-5.20	11.87	-5.07
Mid Cap	-6.27	2.64	-8.01	-8.28	-7.88	18.49	-0.05
Mid Core	-6.15	3.53	-7.09	-7.44	-4.41	20.36	1.01
Mid Growth	-6.54	3.28	-9.41	-9.01	-9.47	18.60	0.90
Mid Value	-6.14	1.16	-7.60	-8.46	-9.84	16.35	-2.36
Small Cap	-5.83	1.84	-7.05	-8.80	-8.54	18.78	0.85
Small Core	-5.95	2.16	-7.35	-9.30	-10.49	17.62	-0.30
Small Growth	-5.66	1.54	-7.29	-8.81	-8.84	18.44	1.46
Small Value	-5.85	1.78	-6.50	-8.27	-6.19	20.21	1.09
US Core	-4.43	4.20	-6.06	-4.79	-1.01	15.54	0.85
US Growth	-5.27	6.26	-8.17	-4.80	0.65	17.65	1.41
US Value	-3.96	1.18	-5.33	-5.29	-6.24	13.33	-4.08

©2004 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) is not warranted to be accurate, complete or timely. Morningstar is not responsible for any damages or losses arising from any use of this information and has not granted its consent to be considered or deemed an “expert” under the Securities Act of 1933. Past performance is no guarantee of future results.  Indices are unmanaged and while these indices can be invested in directly, this is neither a recommendation nor an offer to purchase.  This can only be done by prospectus and should be on the recommendation of a licensed professional.

Office Notes:

What Is a "Stretch" IRA?

Finding a method to leave a lasting legacy to your loved ones without increasing their tax burdens can be difficult and complicated. A “stretch” IRA may be a useful approach that can benefit your heirs for generations to come.

A stretch IRA is not a special type of IRA but rather a term frequently used to describe this IRA strategy, also known as a “multigenerational” IRA, that can be used to extend the tax-deferred savings on inherited IRA assets for one or more generations to benefit future beneficiaries.

Here’s how it works. You let the funds accumulate in the IRA as long as possible. You name as beneficiary someone younger, perhaps a son or daughter. When you have to start taking required minimum distributions (RMDs) from your traditional IRA after turning age 70½, you take only the minimum annual amount required by the IRS each year. (If you fail to take a minimum distribution, you could be subject to a 50% income tax penalty on the amount that should have been withdrawn.)

When your beneficiary inherits your IRA, he or she might also have the ability to take required minimum distributions (RMDs) based on his or her life expectancy. (RMDs are calculated each year and must begin no later than December 31 of the year following your death.) In this way, your beneficiary would have the potential to stretch the distributions over his or her own lifetime, which enables the funds to continue compounding tax deferred for a longer period and avoids a large initial tax bill. Your beneficiary can also name a beneficiary, who can potentially stretch the distributions even longer.

There is a limit to how long you can “stretch” an IRA. The IRS doesn’t want to postpone taxes indefinitely. The distribution period cannot extend beyond the first-generation beneficiary’s life expectancy. For example, if you designated your son to be the sole beneficiary of your IRA and he was 40 when you died (and you hadn’t yet reached the age for taking RMDs), he could take RMDs based on his 37.6-year life expectancy, starting the year after you died. If he died 20 years later, his designated beneficiary could continue taking minimum distributions based on what would have been your son’s remaining life expectancy (20.8 years).

Of course, nonspouse beneficiaries of IRAs face some hurdles. There are different sets of rules to determine the RMDs that a non-spouse beneficiary must receive. They depend on whether the original account owner died before, on, or after reaching the required beginning date for RMDs. Not only are these rules complex, but they can have far-reaching implications. Spousal beneficiaries of IRAs have more options than non-spouse beneficiaries.

If you have a desire to extend your financial legacy over future generations and don’t need the IRA assets for income during your lifetime, then this strategy may be appropriate for you. Because many tax and distribution rules must be followed, make sure to seek legal or tax counsel before making any final decisions.

Note: Make sure the provisions in your IRA allow beneficiaries to take distributions over their lifetimes and to name second-generation beneficiaries. Distributions from traditional IRAs are taxed as ordinary income. Distributions prior to age 59½ are subject to a 10% federal income tax penalty (this rule does not apply to IRA beneficiaries, who must begin taking minimum distributions no later than December 31 of the year following the original owner’s death). Beneficiaries also have the flexibility to take out more than the minimum distribution at any time.

Best regards,     

Michael L. Schwartz, RFC®, CWS®, CFS

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This information is provided for informational purposes only and is not a solicitation or recommendation that any particular investor should purchase or sell any security. The information contained herein is obtained from sources believed to be reliable but its accuracy or completeness is not guaranteed.  Any opinions expressed herein are subject to change without notice.  An Index is a composite of securities that provides a performance benchmark.  Returns are presented for illustrative purposes only and are not intended to project the performance of any specific investment.  Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly.  Past performance is not a guarantee of future results.

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.

* The DJ Global ex US is an unmanaged group of non-U.S. securities designed to reflect the performance of the global equity securities that have readily available prices. 

* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.

* Gold represents the London afternoon gold price fix as reported by the London Bullion Market Association.

* The DJ Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.

* The DJ Equity All REIT TR Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.

* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.

* Past performance does not guarantee future results.

* You cannot invest directly in an index.

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