December 30, 2011
Commentary by Stuart Brown
For this week only…All is quiet
All is quiet the week before the New Year celebration. Could it be Europe has stumbled into a solution of their debt crisis with the circularity of the European Central Bank (ECB) lending billions to the banks, which in turn deposit the funds with the ECB (rather than face counterparty risk by lending to each other or businesses)? Or have the hedge funds, like Congress, simply taken the last week off?
The ECB, still at work, is quietly buying billions of Italian sovereign debt and that has helped keep rates tame. (If paying seven percent marks the end of the world, the debt problem can’t truly be solved.)
In the US, for all the brinksmanship and bluster of the year, the budget has barely been trimmed by a few billion. Bruised by the payroll tax debate, Congress went home leaving the President to quietly ask for another trillion dollar hike to the debt ceiling this week.
(In the spirit of getting something for nothing, who will ever want to see a thousand dollars less in their paycheck? Like the unfunded prescription drug add-on to Medicare, the payroll tax holiday is another Trojan horse bringing forward the day of insolvency.)
But next week, with the Iowa Caucuses, the volume of the political discourse will be turned up again. Congress reconvenes and Wall St. will get us back in the swing of things. There is a trillion dollars of European debt to refinance in 2012, along with another trillion of junk bonds and some hefty Treasury borrowings.
Everyone knows all the woes. Seems to me, that must then, be already priced into the market. It is what is not priced in the market that will prove important as the new year unfolds.
Stocks began the year with a P/E of 17 and ended at 14, or an Earnings Yield of over 7%, historically a tremendous value in light of the thirty-year treasury paying under 3%. Over the next few weeks companies will report their fourth quarter earnings, which are expected to be generally pretty good.
For all its gyrations 2011 was a lot of nothing. The New Year may still be volatile, but is starting from a better valuation and so may very well be more profitable.
I want to thank you for your continued confidence. I hope 2012 comes with great happiness and health and the joy of loving family and friends.
September 12, 2011
Commentary by Stuart Brown
Since 1900, the stock market has averaged six percent growth per year, excluding
dividends. Seldom have stocks been priced as inexpensively as today. When at this valuation in the past, a year later, on average, the market was up over twice the historic average.
Most recently, in June 2009, a dollar invested in the S&P represented 1.7 times the yield on the thirty-year Treasury bond. A year later, the market had risen 28%.
Today, with reported earnings of $85.18 and the S&P at 1169 (an earnings yield of 7.3%) the market is priced at over twice the 3.5% yield of Treasuries.
The stock market has been similarly valued 46 times over the past century. Each following year, the market had rebounded sharply (with the exception of the early years of WWII). There are no assurances as to what the future might bring. But if things unfold the way they have in the past, this could be a very profitable time to own stocks.
There are ways, other than higher prices, for stocks to appear expensive, e.g. if interest rates soared above 9%, the market would no longer look as cheap in comparison. Or if a soft patch turns into full blown recession and earnings decline. There are three moving parts to this model: earnings are reported quarter by quarter, interest rates and the price of the market change moment by moment.
Most recently earnings have been reported for the second quarter and have generally been good. For the Dow Jones Industrial Average, earnings rose on average 14% on 10.5% higher sales. Not bad, but the market, concerned about where earnings might be next year in a slower economy, sold off some 15%. Money moved to bonds, driving the yield on the Treasury down from 4.7% to under 3.5%.
Irene blew her way up the east coast. While hurricanes aren’t known for doing much good, there may be one nice thing about a market decline; once again stocks are offered at a compelling price. Stocks are as cheap as they were in early 2009—at the recent market bottom.
November 01, 2010
Commentary by Joseph Warren
As I stand here today, I can’t help but acknowledge how far things have come and how much has improved since this time last year. About this time in 2008, we were on the edge of an economic abyss and looking into it. But as I suggested in my commentary last November, investors underestimate the ability of the U.S. to self correct and the 39% year‐to‐date return on the NASDAQ is proof. Regardless of this rebound, I believe it my prudent duty to consider what could be different next time.
Here’s the reality: Every time we face a true correction in markets, it is more severe, frightening and painful than the last one.It has to be. Otherwise, prices really won’t correct. This was certainly the case this past fall as fear ran rampant. Nearly every asset went down in value and the Treasury was immersed in a daily game of financial whack‐a‐mole. As it turns out, the world did not collapse and the apocalyptic prognosticators proved incorrect. But I remember how easy it was to understand their arguments as I, along with just about everyone privy, actually examined what was over the ledge for the first time. (Luckily, our headquarters is located on a low floor). No one predicted nor understood the interconnectivity of financial markets, and we’ve seen the consequences of such. Given this fact and the said reality, it may prove futile to spend much time predicting the next financial calamity. Nevertheless, here’s my educated guess on a more frightening scenario that could unfold.
Our recession narrowly avoided becoming the second great depression only by the aid and backing of assets by the U.S. Government. Everything from money markets to car manufacturers was guaranteed. Intrinsic in the ability of the government to stabilize the markets with its guarantees is the assumption that it has the capability to meet these guarantees. If called, the money the government can use to meet these obligations comes from sales of treasury bonds and the printing of dollars, both methods of which the government relied heavily upon during this last crisis. But in my mind, there is a very real possibility these options might not be available next time.
Whether the Treasury likes to admit it or not, there is such a thing as the debt ceiling, and Congress does have to vote on it. More importantly is the fact that there has to be an appetite for treasuries — whetted by interest rates — for them to be acquired. At today’s paltry rates, I’m baffled as to who would really want to buy treasuries. Long‐term critics of this stance argue that treasury auctions continue to run smoothly and foreigners continue to buy our bonds. But closer inspection reveals an interesting trend.
It’s true that holdings of treasuries by foreigners are up throughout this crisis. But so is the total amount of treasury debt and the 29 percent of this total that foreigners hold is about the same percentage it was in August 2008. What’salarming is that of the approximately $1 trillionincrease in treasury debt over the pastyear, half of that came in the form of Treasury Bills (short term debt) and foreigners purchased the vast majority of these bills. To me that indicates that very few were interested in buying long‐term treasuries. The majority of the government’s ability to guarantee and stabilize the economy came from foreign purchases of very liquid and easily redirected money in the form of Treasury Bills. What happens when the interest on those bills, which is paid in dollars and currently averages 0.17 percent, turns into an actual loss for foreign holders because of exchange rates? This leads to my secondconcern: money supply and the ability to print currency.
For the past decade, the government has basically burned the buck by printing dollars. It’s a rather stealthy maneuver as the layman rarely follows the value of the dollar. But the fact is that the total amount of money in the system (the money supply) has doubled in the past decade. The net effect of this policy, a decrease in the value of the dollar, has finally started to make headlines. But in reality, the dollar has been declining in value since 2002 (the change in the value of the dollar is noted in red and the change in money supply in blue in the chart below) and whether we like it or not this has major consequences.
Most tangible assets, like gold and oil, are priced in dollars. If you check their charts you’ll see the effect of a falling dollar. They have skyrocketed in price in recent times primarily because the countries that produce these assets are getting paid in dollars that are going down in value. If this continues, it is my belief that these most vital assets will no longer be priced in dollars and our currency will lose its dominant role. This, of course, becomes self fulfilling: The value of the dollar will plummet if this happens to the extent that our ability to buy goods from other countries is seriously compromised and permanently diminished.
If you want to set the stage for a truly precarious and frightening scenario for the United States, take away its ability to borrow and print money. That’s the type of thing that destroys empires. I’m not necessarily making that prediction as I know predictions have the half life of an open cup of Activia in this business. But I do believe these possibilities need to be recognized and understood by policy makers.
In the end, I have to admit that I don’t know what will cause the next calamity or exactly when it will occur. (If I knew such, I’d probably install a T1 line into the house, link up a few more trading terminals and rarely leave my desk). So, this could be somewhat of a futile exercise. Nevertheless, this is not the first time I’ve run such an analysis. But no matter the accuracy of these thoughts, what I do know is that next time it will be different.
As always, I appreciate your continued trust and confidence.
Warren Capital Group is a registered investment advisor specializing in wealth protection and growth for high net worth individuals, institutions, foundations, and corporations. As a fee-based private wealth management firm, Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of clients and advise them on mortgages, insurance and other aspects of their net worth.
May 01, 2010
Commentary by Joseph Warren
Every time I sit down to write a commentary it seems that some new debacle has emerged that threatens market value. Each has its own unique versions of potential peril and the newest one often seems more dire than the last. Yet the prior dilemma, however intricate and scary it must have been at that moment,has been overcome, or at least postponed. Nevertheless, wealth managers face new issues almost daily as the struggle between progress and restraint continues. What’s important, and what sets Warren Capital apart from it's competitors, is how we handle issues in this constant battle.
In my 2010 outlook piece, I predicted that risk would become a factor again as several countries would be unable to roll their debt as they have become overwhelmed from absorbing the losses of their respective banks. As we’ve noted in the past, simply moving bad debts from one balance sheet to another doesn’t mean the debts disappear. We knew aday of reckoning was coming and it looks like Greece is first in line.
Greece is currently in a major fiscal hole and theyield on two‐year Greek notes, which started at 5.21% this year, has blown out to 14.5%. While this may look insignificant to some, this is a colossal change in terms of sovereign debt. Greece will not be able to roll its debt withoutEuropean Union or International MonetaryFund aid. I would be willing to bet, however,that many Main Street investors are just becoming aware that Greece is on the brink of default and they are have no idea what this means to them. Investors are relying on their professional advisors to steer their assets through the Greece fire. The question becomes whether or not that reliance is the right decision. Therefore, I offer our analysis.
The first thing we do when a problem emerges is try to determine the effect of the worst case scenario. From our perspective, Greece is currently a relatively isolated issue. It is aminiscule portion of the total sovereign debt ofthe world, and European banks most likelywould absorb the default. (This is probably whythere is no actual policy in place to aid Greeceof yet as rhetoric has been the only tool implemented). Nevertheless, we have noexposure to Greek debt and we’ve avoided Portugal and Spain as well, who are next in lineif default contagion spreads. Up until the last few days the debt yield of all of these countries hasn’t come close to reflecting the potential default risk we believed possible. In addition, we can only speculate about a short‐term remedy as there are too many players involved. Some of our sources indicate that Greece will be dropped from the EU, revalue its own currency versus the euro and re‐enter sometime down the road. But this, of course, does absolutely nothing to fix the real problem in Greece. Which brings me to my second point: How can we use this incident to our investment advantage?
When we strategize about specific events affecting investment policy, we look to use those events to make a large gain with reduced risk or to protect principal for unforeseen consequences. The Greek incident offers opportunity for both.
The short term causes of Greece’s problems are all too common. Greece borrowed too much money, manipulated the manner in which it disclosed those borrowings and collateralizedits borrowings with its most prime assets. This type of irresponsibility leads to default. But it’s important to remember that investors don’t buy sovereign debt to take on risk. Most sovereign debt purchasers are willing to accept smaller interest payments in return for assurance. So, the possibility of Greek default requires us to examine the safety of even the most assured investments.
In normal times, sovereign debt would be considered the safest asset. But global recessions constrain economies. With enough pressure, long‐term fundamental issues bubble up and their bursting is accelerated. This is precisely what’s occurring in Greece.
Most economists assert that Greece overextended itself this last decade and the spending on which Greece embarked to combat the recession pushed it to the brink of default. While we agree that Greece is overextended, this bland assertion does nothing to identify how Greece got here. To find out why, we compared economies that are performing well against those that are constrained or contracting.
In 1980, the total population of Greece was about 9.7 million. Today it stands at approximately 10.7 million. That’s an 11% growth in population over 30 years. When compared to India, Brazil and Indonesia, whose populations have all grown nearly 60% or more over the same time, the fundamental reason why Greece is faltering becomes obvious: its population is not growing as vivaciously.
In terms of growth, there are no major economies other than China that can competewith the growth of India, Brazil and Indonesia over the last few decades. Given the tables below, it doesn’t take much to recognize the correlation between population growth and economic growth.(Note that the United States also enters into the growth arena as its percent of population growth has slightly eclipsed China.) Accepting this fact, if we can determine the similarities between countries growing in population, we can simultaneously identify areas of the world where the odds of investment return are increased and avoid areas where a governmentguarantee has limits.
After some serious inspection of a world map, the first two things I noticed were that all the aforementioned growth nations have massive amounts of land at their disposal and they all have direct access to the ocean. Therefore, they have room for population expansion and they can directly access the seas for shipping routes. The next similarity was a little less obvious at first but just as vital.
In India, the domestic currency is the rupee. Brazil has the real. Indonesia has the rupiah. China has the yuan, and we all know about the dollar. What’s important is that each of these countries has a central bank tasked to maintain the “value and stability” of their respective currency. Defining exactly what that task means in terms of respective policy for these central banks is beyond my ability. But one thing I do know is that each of these central banks has the capability to print their own currency in times of strife and all of them did during this last crisis. Greece, on the other hand, is part of the EU and, therefore, does not have the ability to print its way out of this corner. The EU can print Euro’s and they probably will. However, that’s way beyond Greece’s influence. So, the Greek government has little control over its own fate. In the longrun, austerity and restraint are the realsolutions to a national budget problem. But that doesn’t comfort anyone holding Greek debt right now. The only way we can prosper in the long term is to make sure our money is around in the short term. To my knowledge, no one has mentioned any of these root issues thatare pressuring Greece. But these basic points are way too stark to be coincidental.
In recent weeks many scathing headlines havecome out about the manner in which investment companies manage their clients’ money and where their moral responsibilities lie. I completely understand this scrutiny as we are in a high profile business, and the ethics and performance track records of many of our competitors are less than stellar. But let this piece stand as proof that not all of us in the industry are highly overpaid regurgitators of modern investment theory who simply spout the “buy and hold” mantra until a portfolio is decimated. Some of us actually enjoy applying thought and discipline to investment strategy. Land mass, direct access to the seas and central bank independence are factors that, I believe, increase our odds of success as we determine where in the world to deploy capital. I also realize that these observations might counter the opinion of the average investment professional. But that’s the point and why we will continue to produce original thought and results that better the average in this constant battle.
As always, I appreciate your continued trust and confidence.
Warren Capital Group is a registered investment advisor specializing in private wealth management and protection and growth for high net worth individuals, institutions, foundations, and corporations. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of clients and advise them on mortgages, insurance and other aspects of their net worth. As a fee-based personal wealth management firm, Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services.
March 01, 2010
Commentary by Joseph Warren
In the last few weeks investors have been reminded about the complications of credit and debt. Markets around the world have once again declined in value to start the year. This has surprised many, which is ironic as it was only 16 months ago when the financial world was brought to its knees by the credit and balance sheet issues. But perhaps we can use this descent as an opportunity to address the fundamental truth; something must be done to fill the gaps.
Let's first recognize the complete problem. At the end of 2007 there were collectively $100 trillion worth of debts worldwide on the books. Those debts were secured by $50 trillion of assets at a ratio of 50%. The trouble is that the asset base has shrunk because of declining stock markets, housing prices and real estate corrections. If asset bases are reduced and the debt burden is not, you've got a real problem.
This is not the first time I've written about this issue. As I noted early last year, to stop the economic bleeding governments around the world did the only short term things they could. They aided the ailing institutions by assuming the sketchy debt the institutions created and couldn't dump on their clients and turned on the spending spigot. While arguably necessary at the time, neither addressed the underlying asset gap and both contributed to the widening.
Leave it to the masters of finance to pull off this coup, but the fact of the matter is that the failing and insolvent banks used their influence, political connections and fear mongering tactics to pressure governments worldwide to grant them a clean slate. People can moan about this all they want but it doesnft change the reality that those inadequately financed loans have now been transferred onto the balance sheets of their respective governments. If that wasn't a big enough challenge, those further leveraged governments simultaneously implemented spending programs to promote economic growth. Given the performance of many markets so far this year, maybe the day of reckoning is upon us.
In my January newsletter, I predicted that risk would be a factor this year as several countries fail to roll their debt. This happened sooner than I expected as Greece, Portugal and Spain are the headliners right now. Government spending and balance sheet issues are now the factors that lenders of the world (bond purchasers) are considering as numerous nations come to the market to finance their inadequacies. But given low government interest rates, balking by bond buyers should come as little surprise.
Even with all the market fear, interest rates in these three countries remain very low. (Ten]year bonds yield just 6.25%, 4.41% and 4.03% respectively in Greece, Portugal and Spain). It's a wonder why anyone would take on such default risk for so little return. But when further examined, it becomes apparent that this is a global issue and the reason why their rates remain so low is that there are very few better alternatives.
One way to examine sovereign debt risk is to look at the spread over treasuries. Remarkably, the largest spread over 10-year Treasuries that any of these countries face is 2.25%, born by Greece. To me this is the market saying that these spending and indebtedness issues are world wide and that the U.S. is not immune to this virus.
It doesn't take much work to find out how whacked our budget is here in the U.S. There is simply way more government spending than there is tax revenue and itfs been that way for a long time. The maddening solution to date has simply been to pile debt upon debt. It's politically easy to simply raise the debt ceiling. But a few facts and a couple of recent events lead me to believe this game is close to over.
First off, the numbers published by many U.S. government agencies are as manipulative as they are vast. They have implemented accounting tricks that would make Lehman Brothers blush. The truth is that our total debt is currently 85% of GDP and will be 100% of GDP by 2012. These types of numbers are making those Euro countries I mentioned teeter. Moreover, about 50% of our debt is owned by foreigners. If you want an example of how big a problem that is than look no further than Fannie and Freddie. The majority of their quasi government debt at the time they went into conservatorship was owned by Japan and China. There was no way those two countries would have accepted default. And what happened? They forced Fannie and Freddie into taxpayer hands and they have now amassed $1 trillion of losses that Americans will be paying for years. Also of note is the fact that the first few treasury auctions of the year are failing miserably. They have been less than 25% subscribed as no one is willing to buy our debt at these paltry rates. To make matters worse, China was a net seller of treasuries in December as it unloaded $34 billion of its holdings. Itfs time to wake up and accept the fact that the forces pressuring Greece are now surrounding our borders. So, here's what can be done.
To fill the asset and revenue gaps we can raise taxes, reduce spending or create more currency. You can make your own assumptions as to the likelihood of the first two occurring. But I think the third option is either being overlooked or undeservedly dismissed.
Most economists I've consulted say that you can't print your way out of debt or to a balanced budget because it will destroy the value of the underlying currency and create inflation. But recent history contradicts as the Fed has increased the money supply (USM1) by 22% in the last two years and the dollarfs index value is the same as it was in the middle of 2007.
I will, however, confess that printing more money should cause inflation. And that's the beauty of this plan. If we turn on the presses we can buy our own debt while we simultaneously increase asset prices. Genius!
I realize that some of my ideas sound farfetched. But given the state of economic confusion, we are in dire need of some off the wall ideas. I also take solace in the fact that several of my past suggestions have now been implemented in some form or fashion. However odd it sounds, printing our way to solvency is an option that plugs holes. And part of my duty as a citizen, money manager and author is to find a way to fill the gaps.
Warren Capital News
I'm pleased to announce that Simona Sanders has joined Warren Capital as the Director of Business Development. Ms. Sanders previously worked as a manager in the telecommunications arena and has a degree in finance from California State University. Ms. Sanders will be furthering our client services, developing new marketing and relationship platforms and working with our various vendors so we can better utilize their services. In addition, Ms. Sanders is preparing for her Series 7 license and hopes to work as a financial advisor with us in the near future.
As always, I appreciate the continued trust and confidence.
Warren Capital Group is a fee-based registered investment advisor specializing in wealth protection and growth. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of the firm’s clients -- high net worth individuals, institutions, foundations, and corporations -- and advise them on mortgages, insurance and other aspects of their net worth. Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services.
May 18, 2009
Commentary by Stuart Brown
As I explored in my April 22, 2009 blog TheMarketsValue.com (“Fasten Your Seatbelt,”) it is not effective waiting to invest until the absolute bottom in S&P; earnings. This may be because earnings are reported after the fact, meaning companies had a good quarter in order to report one. Sure enough, in the past, the stock market began to pick up six to nine months before earnings bottomed.
Examining what happened in the stock market in the months before a turnaround and recovery from declining earnings since 1911 confirms the observation that the stock market may be a better indicator of recovering economies than the reverse.
For a stock investor the problem with this information is that the recovery is only confirmed in hindsight. Confidence that the market will recover before the economy means investors should worry more about how the market is doing than the economy.
Continue reading this commentary »
April 22, 2009
Commentary by Stuart Brown
In January I noted how cheap stocks were at that time in relation to interest rates. In what appeared to be the best value since the mid-1950s, a dollar invested in the S&P; 500 represented, in earnings, almost 2 ½ times the interest rate on the 30-year US Treasury bond. Nonetheless, the market fell an additional 25% by March 9 before staging the recent record breaking rally.
The whirlwind of the last couple of quarters changed the landscape. As observed in my February 16, 2009 blog (TheMarketsValue.com How to Avoid the Next Lost Decade), the market got more expensive as it declined. This was because fourth quarter earnings declined 35%, though the market, after an historic rise in the last few weeks, is only down only about 10% this year.
It ain’t gonna be pretty. First quarter earnings reports look like a second consecutive decline of 35%. Should investors focus instead on how earnings might look a year from now versus the horrible number companies report in the depths of the current recession? History, though no guarantee of future events, suggests not.
Continue reading this commentary »
March 09, 2009
Commentary by Stuart Brown
On February 10, 2009 the DJIA dropped over 4.5% marking one of those volatile days I cautioned about in my December 4, 2008 blog Time In and Time Out - The Fallacy of Missing the Biggest Days. For the next fifteen days the yellow traffic light is on. Investors should be on the lookout for the market making lower lows. That happened two days later triggering a red light – a signal to sell. Since then the market has dropped almost 1000 points, over 12%.
Fifteen days have passed, but until the market makes a higher high, the light remains red. Caution is the name of the game.
Continue reading this commentary »
February 16, 2009
Commentary by Stuart Brown
Investors adhering to the Buy-and-Hold strategy have just suffered a lost decade. All would like the market to bounce back 50% from here. But just in case..it’s not too late to trade up to an investment vehicle with brakes. Unless such an approach is adopted, expect the volatility of following the market up and down again…or down and then maybe up, if your company survives. “Hang in there,” is the advice that got investors into this trouble in the first place.
Continue reading this commentary »
December 16, 2008
Commentary by Stuart Brown
Wall Street has a number of slogans designed to keep investors in the market during difficult times. One is, “It’s not timing the market, but time in the market.” This is commonly heard along with a reminder that missing the 20 biggest up days means missing the bulk of market performance. While this may be true, it begs the question of what might happen if the 20 biggest down days were similarly miraculously avoided. Answering that question reveals other interesting lessons from the past.
Since 1928 the Dow Jones Industrial Average has compounded a dollar at the rate of 4.6%, not including dividends. If, by amazing bad luck, an investor managed to sell the day before each of the 20 biggest up days in the market and get back in the following day, the return drops to 2.1%. If, by contrast, the investor had the good fortune to sell the day before each of the 20 biggest down days and get back in the following day, the return jumps to 6.8%, thereby considerably outperforming the “buy-and-hold” return. The difference, over 80 years, amounts to a DJIA of 8835 on Nov. 13 (the day I began this study) vs. a theoretical 46,193.
Continue reading this commentary »
