Bull markets climb a wall of worry and 2012 was no exception. As we move into 2013 concerns about debt, deficits, and GDP growth continue to befuddle investors. After two ferocious bear markets in the past decade many are still worried about the return of capital rather than their return on capital. Investors clearly prefer bonds to stocks as money flows demonstrate.
Institutional investors like Warren Buffet and Lee Cooperman of Omega Advisors believe US government bonds are in bubble territory. Cooperman points out that Cisco Systems sold at 100 times earnings with no dividend in 2000 while US government 10 year notes had a yield of 6 %. Now CSCO sells for 10 times earnings with a 2.75 % yield and Treasuries yield 1.91%. Where is the bubble? He further stated that buying Government bonds now is like bending over to pick up a dime in front of a steam roller.
Simply put holders of long dated bonds will get rolled over when interest rates rise. The Fed has maintained a zero interest rate policy for 48 consecutive months. This policy is unlikely to continue forever.
Trillion dollar deficits and zero interest rates do not a sound fiscal policy make. The US Government is on a crash course with economic reality.
Now that we have sidestepped the fiscal cliff and raised taxes on married couples earning over $450,000 we need to address spending cuts in earnest. This next bout of negotiation comes to the fore in March as we face the prospect of increasing our $16.4 Trillion debt ceiling. Early signs indicate that another political battle looms.
As for history helping us predict stock market returns, we see two choices on the menu. Since 1926 the average return for the first term of a new President is 8.2 %; however for an incumbent it turns out to be - 0.3 %.
Despite easy money policies in Europe, Japan and the USA we believe the developed world will manage GDP growth between 1-2 %.
Better growth will come from the BRIC nations and other developing countries. These nations have low social spending obligations and tax rates. They have high savings rates. Their populations are looking to build wealth rather than spend it. They have a growing middle class with better balance sheets personally and governmentally. Finally their stock markets sell at levels that do not fully reflect their growth prospects.
The US stock market is not expensive at DJIA -13,391 and SPX-1458 .This level about 13.2 times $110.00 2013 SPX earnings expectations. Historically the price earnings ratio has averaged 15.33 on the S&P 500 Index. Bond yields no longer exceed stock yields, which had been the case for most of the past fifty years. Dividends are still tax advantaged along with capital gains. We conclude that shares are still attractive.
Our bond strategy is to identify and invest in low duration assets that provide solid yields. One example is Doubleline Total Return Bond Fund. This fund is invested in a combination of guaranteed and non guaranteed mortgage backed bonds with duration of 1.15 years and a current yield around 6 %, far higher than the entire Treasury curve.
The Federal Reserve policy of buying $90 billion per month of Treasuries and Mortgaged Backed Securities makes MBS a very sound choice with housing prices now stable and rising.
Come March, another debt crisis will likely materialize. We are more confident that interest rates will rise on steady economic activity than we are that our leaders will meet the challenges of this ongoing debt and deficit dilemma. If we fail to control our budget another downgrade of US debt is in the cards.
We continue to believe that developed countries are willing to risk higher inflation and currency debasement in order to remain competitive in global markets. Ironically this is a benefit to stock markets as long as inflation remains relatively low given the alternative yields from bonds.
We expect hard assets and stocks to outperform bonds in 2013. Unfortunately, the volatility of these asset classes keeps many investors at bay. Trying to remain rational in an irrational world is not always easy.
Our goal is to reduce the volatility of portfolios while retaining risk on positions in order to increase returns.
Best wishes to you and your family for a healthy and prosperous year.
Douglas Coppola
January 4, 2013
Client First Advisors, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Client First Advisors LLC and its representatives are properly licensed or exempt from licensure. No representation is being made that the information presented is accurate, current or complete, and such information is at all times subject to change without notice. Client First Advisors, LLC does not provide legal, accounting or tax advice. Any statement regarding such was written in connection with the explanation of the matters described herein and was not intended to be relied upon.
