Schwartz Financial Weekly Market Commentary 4/1/13

The Markets

 

U.S. stock markets finished the week – and the quarter – on a positive note.

 

The Federal Reserve’s accommodative monetary policy and strong profit growth helped provide the lift needed to propel the S&P 500 Index to a record high. The Dow Jones Industrials Index also finished the week above its previous record close. For the quarter, the S&P 500 was up about 10 percent, the Dow was up about 11.3 percent, and the NASDAQ finished up about 8.2 percent.

 

Despite the strong performance overall, markets were somewhat choppy during the week. Concerns about Cyprus and the Eurozone debt crisis overshadowed markets early on. A positive report on durable goods from the Commerce Department helped push markets higher, as did a home-price index report from Standard & Poor's Case-Shiller that showed the biggest yearly increase in home prices since the summer of 2006. This report seemed to have held more sway with investors than either weaker-than-expected new home sales or lower-than-anticipated consumer confidence. Late in the week, the GDP growth rate for the fourth quarter of 2012 was revised upward, but remained sluggish at 0.4 percent annually.

 

The U.S. Treasury market generally has benefitted from worries inspired by the Eurozone debt crisis. The latest episodes in the crisis – the Cyprus bank bailout and Italy’s failure to form a government – helped nudge rates lower last week. The U.S. continues to be perceived as relatively safe.

 

Fears about Eurozone debt issues generally have had a positive effect on gold prices, too, helping the precious metal reach a record high price in September 2011. That has not been the case this year. Gold finished the quarter down by more than 5 percent.

              

Data as of 3/29/13	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	0.8%	10.0%	11.6%	10.2%	3.6%	6.2%
10-year Treasury Note (Yield Only)	1.9	N/A	2.2	3.9	3.5	3.9
Gold (per ounce)	-0.6	-5.6	-4.6	13.0	11.3	17.1
DJ-UBS Commodity Index	-0.4	-1.1	-3.3	1.4	-7.8	2.0
DJ Equity All REIT TR Index	1.4	7.9	17.8	16.8	7.1	12.5

Notes: S&P 500, 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.

 

how fast should the united states’ economy be growing? According to The Economist, “In the three years since the end of the recession in mid-2009, growth averaged 2.2 percent, barely half the 4.2 percent average of the seven previous recoveries.” This begs the question: How fast should the economy be growing?

 

Economists, academics, and policy makers have been trying to figure that out. Many have started with an economic theory put forward by noted economist Milton Friedman in 1964. His “Plucking Model” postulates the business cycle is like a string attached to a board. The board represents “the ceiling of maximum feasible output.” Once in a while, the string is plucked down by recession and then it springs back. The idea is the depth of a recession will be mirrored by the strength of the recovery that follows.

 

At first blush, the Plucking Model doesn’t appear to apply to this recovery. The Great Recession was the deepest downturn since World War II, and the country hasn’t snapped back. According to several recent reports, there may be a reason for this. Our ‘ceiling of optimal output’ – the fastest rate at which our economy is expected to grow – may be lower than it used to be.

 

• Productivity and Potential Output Before, During, and After the Great Recession, a working paper from the San Francisco Federal Reserve, found growth in the U.S. was slowing in the mid-2000s although the slowdown was largely unrecognized before the Great Recession.
• What Accounts for the Slow Growth of the Economy After the Recession, a Congressional Budget Office study, determined about two-thirds of the difference between America’s current growth rate and the average growth after previous recoveries is due to long-term trends including demographic changes. The other one-third is credited to low demand for goods and services.
• Disentangling the Channels of the 2007-2009 Recessions, by James Stock of Harvard University and Mark Watson of Princeton University, also found slower growth in the U.S. is largely the result of demographic trends such as a limited labor supply as Baby Boomers have begun to retire and the number of women joining the workforce has leveled off.

 

Considered together, the reports seem to indicate U.S. economic growth began slowing before the recession and, unless demographic trends shift, our country may continue to experience slower growth.

 

Weekly Focus – Think About It

 

“I've missed more than 9,000 shots in my career. I've lost almost 300 games. Twenty-six times, I've been trusted to take the game winning shot and missed. I've failed over and over and over again in my life. And that is why I succeed.”

--Michael Jordan

Value vs. Growth Investing (3/31/13)

Name	1-Week	YTD	4-Week	13-Week	1-Year	3-Year	5-Year
US Market	1.53	11.02	3.89	11.02	14.36	13.10	6.47
Large Cap	1.56	10.20	3.68	10.20	13.44	12.43	5.51
Large Core	2.06	13.03	4.44	13.03	17.83	13.74	6.83
Large Growth	1.65	7.27	3.13	7.27	7.71	12.14	6.59
Large Value	1.00	10.73	3.53	10.73	15.48	11.52	2.98
Mid Cap	1.62	13.15	4.33	13.15	16.61	14.78	8.55
Mid Core	1.64	13.23	4.32	13.23	17.57	16.87	9.75
Mid Growth	1.60	10.83	3.11	10.83	11.23	14.10	7.00
Mid Value	1.63	15.52	5.59	15.52	21.32	13.29	8.77
Small Cap	1.01	13.27	4.81	13.27	17.38	14.63	9.84
Small Core	1.14	13.32	5.19	13.32	17.00	13.96	9.07
Small Growth	0.95	11.62	4.00	11.62	13.56	15.13	9.15
Small Value	0.92	14.79	5.17	14.79	21.62	14.71	11.18
US Core	1.90	13.10	4.47	13.10	17.78	14.48	7.69
US Growth	1.60	8.24	3.18	8.24	8.75	12.82	6.90
US Value	1.13	11.97	4.06	11.97	17.05	12.10	4.70

©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:

 

Sequester:  What Now

 

On Friday, March 1^st 2013, a series of Federal spending cuts—known as the “sequester”—went into effect.  While the story has dominated the news, a lot of the information out there can be hard to decipher.  There are so many numbers to keep track of, and so many ways to spin these cuts politically. 

But what is the sequester?  What exactly happened, and why?  Most importantly, what kind of affect will it have on the economy, and by extension, the markets?  As a financial advisor, I want to help answer these questions for you.  So I’ve included some of the most frequently asked questions about sequestration on the following pages, along with the simplest, clearest answers I can provide. 

Of course, if you have any questions this letter doesn’t answer, please feel free to contact me.  My team and I are monitoring the markets, Washington, and the relationship between them, so we stand ready and waiting to help you understand anything that might be unclear to you.  Providing help for investors is our business, so please let us know if there’s ever anything we can do.  

 

Frequently Asked Questions about the Sequester

Q: What is the sequester? 

A: The sequester is a series of automatic budget cuts that will decrease Federal spending by $85 billion dollars this fiscal year alone.¹  (The fiscal year ends on September 30.)  Assuming that Congress does nothing to stop them, these cuts will eventually total $1.2 trillion over 10 years.¹ 

Q: Why is the sequester happening? 

A: In 2011, the United States faced what’s become known as the debt-ceiling crisis.  The debt ceiling is an often misunderstood term, but in essence, it’s the limit beyond which the Department of the Treasury cannot borrow.  The debt ceiling does not prevent Congress from creating legislation that would incur more debt, so in 2011, President Obama asked Congress to raise the ceiling in order to pay for the obligations we’ve already incurred.  Many in Congress were opposed to this, so a deal was negotiated.  Congress passed the 2011 Budget Control Act, which did three things.  First, it raised the debt ceiling.  Second, it created a special committee, whose purpose was to find ways to reduce our deficit by $1.2 trillion.  Third, it created the automatic budget cuts, that would take place if the committee could not agree to reduce the deficit, totaling the amount the committee was supposed to have reached.² 

The point of the budget cuts—called sequestration—was that they were so large, and so indiscriminate, that they would act as an incentive for Congress to compromise.  Unfortunately, Congress was not able to compromise, so what was originally intended to act as an artificial threat became reality. 

Q: What do these automatic budget-cuts do? 

A: I’ll try to keep this answer as number-free as possible.  The $85 billion dollar cut is divided in half between defense spending and non-defense spending.  The total can be broken down like this:³

·         $42.7 billion decrease in discretionary defense funds.

·         $26.5 billion decrease in discretionary non-defense funds.

·         $11.2 billion decrease in Medicare spending.

·         $5.0 billion decrease in other areas.

The latter three categories all make up “non-defense” spending. 

Q: What does “discretionary” mean? 

A: Broadly speaking, there are two different ways the Federal government spends money: mandatory and discretionary spending.  Discretionary spending is all money spent at Congress’s discretion, which is set on a yearly basis through appropriation bills.  Mandatory spending refers to money allocated to areas that do not have to be renewed on a yearly basis.  These areas are provided for by laws other than appropriation bills.  Three examples of mandatory spending are Medicare, Medicaid, and Social Security.  The government must spend money on these areas unless a separate law is passed saying otherwise.

As far as the sequester goes, most of the budget cuts are from discretionary funds, meaning the spending Congress sets on a yearly basis rather than on the more permanent areas.  This means that Social Security, Medicaid, and active-duty military spending is untouched.  The exception to this is Medicare, where payments to providers and health insurance plans will be cut by 2% for a total of 11.2 billion. 

Q: Why does this matter? 

A: All these budget-cutting efforts are for one thing: to get a handle on our national debt.  But the fact that most of the cuts are on discretionary spending, rather than mandatory, lessens the impact of these cost-saving measures.  Why?  Because mandatory spending—on Social Security, Medicare, Medicaid, and defense programs—is rising at a much faster rate than discretionary spending.  Imagine it like cleaning your house.  Congress is cleaning up the kitchen and the living room, but it’s the basement and garage that are filling up at the fastest rate.  Some cleanup is better than nothing, but if the basement and garage fill up faster than you can clean the other rooms, you’ll still end up with a bigger mess to clean than when you started. 

Q: So is the sequester good or bad? 

A: There’s a fundamental truth when it comes to all government decisions on spending: if you try to fix one problem, you will probably make another worse.  It’s not really anyone’s fault, it’s just the nature of the beast.  For example, right now we have both a debt problem and an unemployment problem.  But fixing one means exacerbating the other.  To directly create jobs, the government must spend money.  But that increases our debt.  To lower our debt, the government must make cuts, but that will cause us to lose jobs. 

So from a debt-problem standpoint, the sequester is good.  Not nearly good enough, but better than nothing.  Economically speaking, however, the sequester is like playing with fire.  Our economy is growing at an extremely slow rate, and experts expect these cuts will slow it down even more.⁴  Whether a further slowdown will lead to a second recession is uncertain, but it’s possible.  In addition, these budget cuts mean many government departments will have to lay off or furlough their employees.  This will increase our unemployment rate.  Here’s how I look at it: imagine you are in the hospital recovering from surgery.  You’re getting better, but before you get released, you decide to start losing weight by running hard on the treadmill.  Well, the exercise could help your weight problem, but it would probably delay your recovery from surgery.  That’s sort of what the sequester is like for the economy, and it’s the main reason for all the doom and gloom headlines you’ve been seeing lately.   

Q: So how will this news affect markets?  How will it affect me? 

A: So far, the news doesn’t seem to have affected the markets very much.⁵   When you consider that we’ve known about the sequestration for months and have had time to prepare, this isn’t surprising. 

Generally speaking, an economic slowdown isn’t good for the markets.  And when the government cuts spending, it can sometimes impact certain private sectors.  For example, defense cuts could impact the defense industry, because contractors could have less business.  We won’t know for a while what the real effects will be, because the cuts don’t all go into place at once.  It’ll be several months down the road, when the lay-offs start happening, when national parks start closing, and when lines at airports get longer, that we’ll start to see a visible difference.  How the markets react then is still unknown. 

The best thing we can do is be aware of what’s going on.  Now you know what’s happened, and you know what could happen.  So the smart thing to do is plan ahead.  My team and I can help you watch the markets and discuss how to prepare for any potential downturn.  Give me a call at 215-886-2122.  I’d love to speak with you.

 

Sources:

¹ “The Budget and Economic Outlook: Fiscal Years 2013 to 2013,” Congressional Budget Office, accessed March 4, 2013.  http://www.cbo.gov/sites/default/files/cbofiles/attachments/43907-BudgetOutlook.pdf

² “Estimated Impact of Automatic Budget Enforcement Procedures Specified in the Budget Control Act,” Congressional Budget Office, accessed March 5, 2013.  http://www.cbo.gov/publication/42754

³ “The Sequester: Mechanics and Impact,” Bipartisan Policy Center, accessed February 21, 2013.  http://bipartisanpolicy.org/sites/default/files/Sequester%20Overview.pdf

⁴ “Automatic Reductions in Government Spending—aka Sequestration,” Congressional Budget Office, accessed March 5, 2013.  http://www.cbo.gov/publication/43961

⁵ “S&P 500 Index,” CNN Money, accessed March 5, 2013.  http://money.cnn.com/data/markets/sandp/?iid=C_MT_Index

 

Regards,

,

Michael L. Schwartz, RFC®, CWS®, CFS

 

P.S.  Please feel free to forward this commentary to family, friends, or colleagues.  If you would like us to add them to the list, please reply to this email with their email address and we will ask for their permission to be added. 

 

Michael L. Schwartz, RFC®, CWS®, CFS, offers securities through First Allied Securities, Inc., A Registered Broker/Dealer,  Member FINRA-SIPC.  Advisory Services offered through First Allied Advisory Services, A Registered Investment Advisor.

Schwartz Financial Service is not an affiliate of First Allied Securities, Inc.

 

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.

 

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