Thursday, July 21, 2011

Stay Focused!

From the Desk of Joe Rollins

The global financial news has been terribly negative over the last several months. There’ve been reports of several countries in the Eurozone sinking in debt one-by-one – first Greece, then Portugal, then Spain, and the bankrupt country du jour is now Italy. All of these countries had basically adopted “cradle to grave” benefits for their people without the corresponding tax revenue to pay for it. In other words, they’ve been writing bad checks to their residents.

In addition, the debate to increase the debt ceiling in the U.S. is ongoing with politics permeating the debate. Republicans and Democrats are ramming heads to see who can get the most political mileage out of an issue that they will likely vote for anyway. Many report that the government’s inability to pay its bills will jeopardize our fragile economy if the debt ceiling isn’t raised, but I believe the debt limit will be increased either just before or soon after August 2nd, the date Treasury Secretary Timothy Geithner told Congress he will no longer be able to do any legal finagling to cover the bills.

For 2011, Congress has been in session a total of 87 days out of about 137 work days so far (64%), and as in years past, they are scheduled for a recess the entire month of August. I rather doubt they’ll miss their summer vacation for something as important as a $14 trillion liability. In short, the debt ceiling will probably be raised in the nick of time, and just before Congress adjourns for its summer recess.

All of these headwinds tend to distract investors from what is really important. In my view, it means little to U.S. taxpayers that Italy can’t manage its own finances. Moreover, how is it relevant to the U.S. that a good portion of Greece’s residents are government employees who pay no income taxes? While their economic situation is depressing and they are clearly facing financial disaster, the potential impact on the U.S. is minimal. I suspect that Greece, Portugal, Spain and Italy will eventually be bailed out by France and Germany anyway, as they are financially and economically sound. Who was it that wanted the U.S. to be more like Europe economically? For investors to fret and sell stocks like mad over this issue makes little sense from a long-term perspective.

I repeat that earnings are the most important element to stock market valuation. Have you noticed the earnings that have already been reported for the 2nd quarter of 2011? They’ve been nothing short of breathtaking! The earnings reported by Google, Coca-Cola, JP Morgan Chase, Wynn Resorts and IBM are worth taking a look at, and the only major corporation reporting negative earnings so far was Bank of America. Of course, their reserves are close to $10 billion in additional bad debts, but they have a capital position greater than the behemoth banking institution, JP Morgan Chase. It’s hard to fathom earnings being any better – and of course, it’s earnings that lead to higher stock prices. Earnings this quarter will be at the highest level ever in the history of the S&P 500 index.

After the yesterday’s closing bell, Apple (AAPL) posted blockbuster earnings for its fiscal Q3 at $7.79 per diluted share – up 122% from their prior year-ago quarter earnings. Apple posted revenue for its fiscal Q3 of $28.57 billion with net profits of $7.31 billion. Its price per share is currently approaching $400. In addition, Apple acknowledged that they currently have over $76.2 billion in cash on hand – a figure that’s almost one-third the GDP of Denmark. That’s incredible!

It’s also relevant to note that approximately 40% of the S&P 500 corporations’ earnings are earned outside the U.S. Therefore, even if you invest in these U.S. corporations, a significant portion of their revenue stream comes from non-U.S. sources.

The two major components of stock values are earnings and comparable interest rates. Interest rates for investors are essentially at zero right now. As such, few CDs, money markets, or other short-term investments, if any, are earning interest at the current time. Investors can purchase numerous stocks with dividend rates well in excess of the 10-year Treasury bond yield (2.97%). Right now, an investor can purchase a stock with growth potential that actual provides a return almost double the 10-year Treasury bond which will only be worth its face value at redemption.

It’s estimated that the S&P 500’s earnings in 2012 will be in excess of $100/share. A rather normalized multiple on these earnings reveals that the S&P 500 should have a valuation of 1,500 – 15% higher than its value today. Those who try to divert attention from earnings being the most important component to stock market investing have an ulterior motive: they are simply attempting to get you to sell at a low price so they can take advantage of investor naiveté.

Some may think I’m being too optimistic about the U.S.’s problems – but believe me, I’m well aware of the enormity of our issues. However, the ongoing debate about raising our debt ceiling is not something that has me preparing for the apocalypse. The budget deficit, on the other hand, is a topic that concerns me.

Our Congress continues to argue over rounding errors on the deficit and President Obama has proposed budget cuts that are insignificant to the total deficit. It appears to me that this administration intends to spend as much of your money as possible as long as they are allowed. Here are a few examples:

As I’ve stated in other posts, I believe that Keynesian demand-stimulus economics has not been a success. During the Great Depression, President Franklin D. Roosevelt tried his hand at this theory. Many people believe that the reason the U.S. was able to pull out of the recession of the late 1930’s was because of the money spent by Congress on work programs. But as history documents, for a 13-month period from 1937 to 1938, there was a reversal of the 1933 to 1941 economic recovery from the Great Depression attributed to spending cuts to balance the budget. Unemployment had reached a staggering 25% as FDR took office, but even with the massive spending on work programs, unemployment never got better than 14.2% until the U.S. geared up for World War II.

Much like the Keynesian efforts taken in the 1930’s, the American Recovery and Reinvestment Act of 2009 has also been a disappointment, and it’s fairly simple to see why. One-third of the stimulus money was given to state and municipal governments to keep employees they probably did not need anyway. As such, rather than using the stimulus money to create jobs, it was used to retain jobs. Once the stimulus money was no longer available to the states and municipalities, those jobs were eliminated. President Obama recently remarked that, “shovel-ready was not as shovel-ready as we expected.” I don’t know about you, but saying we were unprepared seems to be an understatement.

Compare these examples of the utilization of Keynesian economics with Ronald Reagan’s utilization of supply-side economics, wherein his economic policy aimed to reduce income and capital gains taxes, government spending, government regulation, and inflation by controlling the money supply. Reagan embraced the theory that if taxpayers were able to keep more of their money by paying less taxes, the economy and employment would improve. Reagan’s tax cuts undoubtedly had a meaningful impact on the U.S. economy, creating an economic boom that endured for more than 20 years.

Lots of ideas have been coming out of Washington as to how to fix the Federal budget. Many argue that there’s no way for the Federal budget to be cut 25%. Why isn’t that possible?

The Department of Commerce is the government agency in charge of promoting economic development and technological innovation in an effort to improve the living standards of all Americans. There are several bureaus under the department (the Bureau of Economic Analysis, the U.S. Census Bureau, the International Trade Administration are a few), and the department as a whole has approximately 38,000 employees. Could employment at the department be decreased by 25% to only 30,000 employees? Can we afford all of these employees doing whatever it is they do?

What about the Department of Education? In the United States, state and local school districts determine curricula and educational standards, not the U.S. Department of Education. With 5,000 employees, its primary functions are to "establish policy for, administer and coordinate most federal assistance to education, collect data on U.S. schools, and to enforce federal educational laws regarding privacy and civil rights.” Can these tasks not be done with 3,500 employees instead of 5,000?

How about the Department of Housing and Urban Development? Could its program offices function with 25% fewer employees? What do they do? To my mind, there’s no question they could.

While putting 100,000 Federal employees out of work would do little promote employment, it would be a positive change at least in the psychological sense. If we could demonstrate to the rest of the world that the U.S. has a grip on its deficit issues and is actually moving forward in trying to solve those problems, the positive economic impact to businesses would be enormous. The reason unemployment continues to be so high is because of the ongoing uncertainty created by Washington. If someone in Congress for once had the political nerve to promote a program where the Federal deficit was actually addressed, business confidence would skyrocket, the economy would improve, and 100,000 Federal jobs would only be a rounding error to new employment.

Yesterday, the Senate “Gang of Six” unveiled a new bipartisan budget that would reduce the deficit by $3.7 trillion over the next 10 years that was subsequently endorsed by President Obama. However, some members of Congress still apparently don’t understand how strongly the American populace feels about this subject. If Congress adopts the Gang of Six proposal in full – which is highly unlikely – we might cut $3.7 trillion from our deficit over the next decade. But the cumulative deficits even after these reductions over the next decade would be a mind-boggling $15 trillion. That’s totally unacceptable!

In any event, the reason I’m not pessimistic about the U.S. economy is because it’s clear that the public sees that Washington is on the wrong path and will soon make necessary changes. Unlike Greece, Portugal, Spain and Italy, we are nowhere near insolvency – not yet, anyway. Moreover, the U.S. economy is many times the size of all the EU countries combined. We can – with less Federal regulation, lower taxes and a better business environment – solve the deficit issues. If we continue voting for representatives who do not understand finance, however, we will have missed our opportunity to fix it in the next few years.

In summary, it’s important for us to stay focused on the components that truly impact stock prices – earnings and interest rates. I can’t recall another time where both components were so favorable for higher stock prices as they are now.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins

Saturday, July 2, 2011

Halfway Home – Results as Expected (and they’re great!)

From the Desk of Joe Rollins

Thursday was 2011’s halfway mark, and even though the past six months have been volatile for the stock market, it continues to perform basically as I’d projected. During this time period, we’ve endured extraordinary geopolitical events. However, the stock market’s performance is correctly reflecting earnings and not headlines.

As I’ve indicated in prior posts, May and June were controlled by Wall Street traders who tried convincing investors that everything is a short-term trade only to reverse course before investors could respond. Both months were down a total of approximately 8% from April’s highs, and miraculously, the major market indices were up a stunning 3.5% the last four trading days of June. I’m convinced that it was the professional traders – not the investors – trading the market up and down during this past week. If they thought they’d catch everyone sleeping, they were wrong. Keeping our clients invested throughout the quarter – while undoubtedly a bumpy ride – was the right choice.

For the six months ended June 30th, the Dow Jones Industrial Average is up 8.6%; the S&P Index of 500 Stocks is up 6%, and; the NASDAQ Composite is up 5%. As readers of the Rollins Financial Blog likely recall, I projected that 2011 would provide double-digit returns. The fact that the S&P is up 6% for the first six months of the year is actually ahead of my 10% projection for the year.

In spite of the evidence reflecting that the U.S. economy suffered a mild setback during the 2nd quarter, the market still performed favorably. There are many reasons for the setback, but I can’t help but think that the slowdown had to do with the continuing fallout from Japan’s earthquake and tsunami disaster along with China’s obvious effort to slow its economy. But even with the slight decline in the economy, I don’t see any marked signs that it will decline to dangerous levels.

Although the 2nd quarter has come to a close, very few major American corporations have announced that they’ve suffered negative financial results. In the next 10 days, these corporations will start reporting their 2nd quarter earnings, which I think will be nothing short of spectacular. If earnings come in as expected, the stock market is quite fairly priced today. I expect for the market to continue to rise for the rest of 2011, and at year end, we will have enjoyed the third consecutive year of double-digit returns.

Even so, I continue to receive comments and questions about the slowdown in the U.S. economy. While an economy that is growing at 1.9% certainly isn’t robust, it’s also not at recession levels, either. Given that corporate earnings are so good right now and investments in international equities and bond funds have been lackluster, it appears that growth investments in the U.S. are the true winners thus far for 2011.

The U.S. has become a major export power this year. The lower dollar and the efficiencies U.S. manufacturers provide bode well for worldwide distribution. We hold a commanding export position in pharmaceutical drugs, high tech products, entertainment/communication gear, earthmovers, electric generators, medical scanners and jet airplanes. The rest of the world is far behind the U.S. in producing these high-end and specialty items. I don’t expect that to wane in the coming months.

I’ve also received some questions regarding the August 2nd deadline for raising the debt ceiling. Over the next few weeks, Democrats and Republicans must reach a compromise on a debt-reduction plan in exchange for raising the debt ceiling, and then they must write legislation to implement the deal. This matter is complicated and nerve-wracking for many investors, but I don’t think it is a grave financial threat to the U.S. Based on prior similar circumstances, I think a compromise will eventually be reached.

We are now only three months away from the federal government’s September 30th fiscal year end. Interestingly, the House Democrats haven’t even submitted their budget for this fiscal year end, nor have they submitted their budget for fiscal 2012. The U.S. Congress is so incredibly inept that it’s hard to take any deadlines seriously. Most investors believe that a deal will be cut either immediately before the August 2nd deadline – with both sides taking credit for saving the day.

While the first half of 2011 may not have been fabulous, it was at least satisfactory. If the inflation rate winds up being at 2.5% at the close of the year, it’s likely for investments to generate returns at four times that percentage. In the investing world, returns that are four times the rate of inflation create wealth.

How many of you have cash in a money market account or a CD instead of it being invested? Think about the economic effect of inflation on your investments. If you have cash in a money market account making less than one-tenth of 1% today, then you are missing the boat. With inflation at 2.5%, you are suffering a negative rate of return on your investments so far this year.

While there’s certainly no guarantee that the stock market’s returns will be the same for the last six months of the year as it was during the first six months, it seems fairly obvious that anyone who is investing at less than 1% will feel left out if the 3rd straight year of double-digit returns is realized. I fully recognize that I have been telling people for years that NOW is the right time to be invested. Notwithstanding these statements, there is no better time for you to put your underinvested funds to work.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins


In observance of Independence Day, the offices of Rollins Financial and Rollins & Associates will be closed on Monday, July 4th. Please note that all major U.S. stock exchanges will also be closed due to the 4th of July holiday.

If you require immediate assistance on Monday, please contact Joe Rollins at 404.372.2861 or Our office will re-open for business on Tuesday, July 5th at 8:30 a.m.

Be safe, and have a great holiday weekend!!