The market showed a nice gain the first half of the week, only to reverse course and close with little change. For the week, the Dow was lower by 0.2%, the S&P was off 0.3%, and the Nasdaq also fell 0.2%. Gold mirrored the move in the stock market, losing 0.5% on the week. Oil rose slightly, gaining 0.9% to $86.73 per barrel. The foreign Brent crude, used for much of our gas here in the East, closed above $108.
Source: Yahoo Finance
The week was again primarily about the “fiscal cliff” negotiations coming out of Washington. Talks between the involved parties were described as “serious,” but similar to the last several weeks, we didn’t look any closer to an agreement as the week ended.
As we discussed the last couple weeks, it still appears there will be no agreement by the year-end and we will cross over that cliff. Our best guess is the new year would then see politicians immediately cut taxes back to the lower levels for all but the top rates. This has us worried the market may weaken as we close out the year.
Though it may depend on the type of agreement reached (whether in the next couple weeks or new year), we may see a pop in the market when we finally have an agreement and certainty on the subject. We do think that a “bad” deal could send markets lower, though.
One tax break that unfortunately looks to be on the chopping block is the tax exemption for municipal bonds. For no justification other than them being favored by the wealthy, the break looks to have bipartisan support. The move would dramatically alter the muni bond sector and borrowing costs for municipal governments are guaranteed to rise.
Giving us a break from the fiscal cliff talks, the Fed held one of their policy meetings this week. It was no surprise that they will keep interest rates at these historic lows, plus continue their bond-buying stimulus program (in which they print $85 billion a month).
There were some new wrinkles, though. Instead of keeping rates low until 2015 as previously reported, they will stay low until the unemployment rate reaches 6.5% (we are currently at 7.7%).
That triggered some confusion. The unemployment rate dropped a full percentage point over the past year (though largely due to people leaving the labor force). If that trend continued, could the Fed possibly raise rates next year? It looks like the Fed is using this number more as a guidepost and not a hard trigger, so rates will probably stay low until at least 2015.
Still, this new metric could return us back to the time when good news was bad news. We know how addicted the market is to stimulus. Each tick closer to the 6.5% number is a tick closer to less stimulus, and the market could sell off as a result.
Another new wrinkle was that the Fed welcomes even more inflation, despite their mandate of stable prices. They are trying their darndest to reflate the housing sector, thinking this is the way to cure the economy. Never mind the housing situation was clearly an unsustainable bubble to begin with and reflating it is not a safe policy (in our humble view).
The Wall Street Journal had two good editorials on that subject this week (LINK 1, LINK 2). We’ve had four years of this stimulus which has done very little to help the economy. A rational person would change course when such a lack of results is obvious. Yet they double-down and venture even further into uncharted territory as potential unintended consequences grow.
Once these easy money policies go into effect, they become very difficult to remove. We see that in Japan, who have had stimulus programs for the past twenty years. Until we see a period where the currency is stable and taxes are low, the economy will continue to slog along, never gaining any traction.
One key point to consider, these stimulus programs keep borrowing rates lower for the government. That is important, since we’ve borrowed enormous sums of money in recent years. The lower rates allow us to do so, since it is not as costly to pay back. This rewards the profligate behavior and prevents any needed reforms from taking place – until it’s too late.
Back to the news of the week, where economic data was mixed. Initial jobless claims improved and industrial production rose, while retail sales came in below expectations and small business outlook dropped by a record amount.
Monthly inflation also showed a decline, thanks largely to lower energy prices. While most people welcome these lower prices, unfortunately the Fed fails to see such benefit.
Next Week
Yet again, next week will be a busy one. As the week progresses, we will get info on manufacturing in the New York region, the strength of housing, a final revision to last quarters GDP, leading economic indicators, personal income and spending, consumer sentiment, and last but not least, durable goods data.
Also, we may see a bit more action as investors squeeze activity into the week, since the Christmas holiday has shortened the following week.
Investment Strategy
While there is essentially no change in our strategy from last week, we are becoming more cautious into the year end. Not only are we worried about the situation in Washington, we’ve seen many companies issuing special dividends before the year end that investors have scooped up. Once that dividend is paid, we worry those investors will sell, sending the broader market lower.
Looking further out, corporate earnings have steadily declined on lower revenues, so fourth quarter earnings have the potential to disappoint. Frankly, it is not inconceivable for the Fed to ramp up even more stimulus if the markets start to suffer.
Another worry is the potentially higher taxes next year. Higher taxes stifle growth, a growth that actually brings in more money to the government rather than simply raising taxes.
Though we aren’t looking to do any buying or selling in stocks at this point, if a buying opportunity were to present itself, we still like higher-quality stocks. This is more of a long-term play. We also like smaller and mid sized stocks that don’t have a strong correlation to the market and Europe.
With the Fed committed to printing more money, as well as many central banks around the world, we still like gold despite the recent weakness. We aren’t looking to reduce our positions at this point, but wouldn’t add to them, either.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth may weigh on commodity prices in the short run, though.
As for bonds, Treasury bonds yields aren’t at their historic lows (where prices were near historic highs), but the trend is moving back that direction. A short position (bet on a decline in price) provides a nice hedge here but we believe the potential for profit is low at this time. We also think TIPs are important as we still expect inflation to increase.
A big question mark has been introduced in the muni sector as we discussed above. If all remains the same, Municipal bonds would still work with the higher taxes looming on the horizon.
Finally, in international stocks, we are less enthusiastic on developed markets, but not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
As we discussed the last couple weeks, it still appears there will be no agreement by the year-end and we will cross over that cliff. Our best guess is the new year would then see politicians immediately cut taxes back to the lower levels for all but the top rates. This has us worried the market may weaken as we close out the year.
Though it may depend on the type of agreement reached (whether in the next couple weeks or new year), we may see a pop in the market when we finally have an agreement and certainty on the subject. We do think that a “bad” deal could send markets lower, though.
One tax break that unfortunately looks to be on the chopping block is the tax exemption for municipal bonds. For no justification other than them being favored by the wealthy, the break looks to have bipartisan support. The move would dramatically alter the muni bond sector and borrowing costs for municipal governments are guaranteed to rise.
Giving us a break from the fiscal cliff talks, the Fed held one of their policy meetings this week. It was no surprise that they will keep interest rates at these historic lows, plus continue their bond-buying stimulus program (in which they print $85 billion a month).
There were some new wrinkles, though. Instead of keeping rates low until 2015 as previously reported, they will stay low until the unemployment rate reaches 6.5% (we are currently at 7.7%).
That triggered some confusion. The unemployment rate dropped a full percentage point over the past year (though largely due to people leaving the labor force). If that trend continued, could the Fed possibly raise rates next year? It looks like the Fed is using this number more as a guidepost and not a hard trigger, so rates will probably stay low until at least 2015.
Still, this new metric could return us back to the time when good news was bad news. We know how addicted the market is to stimulus. Each tick closer to the 6.5% number is a tick closer to less stimulus, and the market could sell off as a result.
Another new wrinkle was that the Fed welcomes even more inflation, despite their mandate of stable prices. They are trying their darndest to reflate the housing sector, thinking this is the way to cure the economy. Never mind the housing situation was clearly an unsustainable bubble to begin with and reflating it is not a safe policy (in our humble view).
The Wall Street Journal had two good editorials on that subject this week (LINK 1, LINK 2). We’ve had four years of this stimulus which has done very little to help the economy. A rational person would change course when such a lack of results is obvious. Yet they double-down and venture even further into uncharted territory as potential unintended consequences grow.
Once these easy money policies go into effect, they become very difficult to remove. We see that in Japan, who have had stimulus programs for the past twenty years. Until we see a period where the currency is stable and taxes are low, the economy will continue to slog along, never gaining any traction.
One key point to consider, these stimulus programs keep borrowing rates lower for the government. That is important, since we’ve borrowed enormous sums of money in recent years. The lower rates allow us to do so, since it is not as costly to pay back. This rewards the profligate behavior and prevents any needed reforms from taking place – until it’s too late.
Back to the news of the week, where economic data was mixed. Initial jobless claims improved and industrial production rose, while retail sales came in below expectations and small business outlook dropped by a record amount.
Monthly inflation also showed a decline, thanks largely to lower energy prices. While most people welcome these lower prices, unfortunately the Fed fails to see such benefit.
Next Week
Yet again, next week will be a busy one. As the week progresses, we will get info on manufacturing in the New York region, the strength of housing, a final revision to last quarters GDP, leading economic indicators, personal income and spending, consumer sentiment, and last but not least, durable goods data.
Also, we may see a bit more action as investors squeeze activity into the week, since the Christmas holiday has shortened the following week.
Investment Strategy
While there is essentially no change in our strategy from last week, we are becoming more cautious into the year end. Not only are we worried about the situation in Washington, we’ve seen many companies issuing special dividends before the year end that investors have scooped up. Once that dividend is paid, we worry those investors will sell, sending the broader market lower.
Looking further out, corporate earnings have steadily declined on lower revenues, so fourth quarter earnings have the potential to disappoint. Frankly, it is not inconceivable for the Fed to ramp up even more stimulus if the markets start to suffer.
Another worry is the potentially higher taxes next year. Higher taxes stifle growth, a growth that actually brings in more money to the government rather than simply raising taxes.
Though we aren’t looking to do any buying or selling in stocks at this point, if a buying opportunity were to present itself, we still like higher-quality stocks. This is more of a long-term play. We also like smaller and mid sized stocks that don’t have a strong correlation to the market and Europe.
With the Fed committed to printing more money, as well as many central banks around the world, we still like gold despite the recent weakness. We aren’t looking to reduce our positions at this point, but wouldn’t add to them, either.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth may weigh on commodity prices in the short run, though.
As for bonds, Treasury bonds yields aren’t at their historic lows (where prices were near historic highs), but the trend is moving back that direction. A short position (bet on a decline in price) provides a nice hedge here but we believe the potential for profit is low at this time. We also think TIPs are important as we still expect inflation to increase.
A big question mark has been introduced in the muni sector as we discussed above. If all remains the same, Municipal bonds would still work with the higher taxes looming on the horizon.
Finally, in international stocks, we are less enthusiastic on developed markets, but not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
