BOOK SUGGESTIONS FOR VORACIOUS READERS

From the Desk of Joe Rollins

In the past, I’ve shared my suggestions for certain books that might be of interest to readers of our blog. As you can probably guess, I’m unable to read much of anything (besides tax law) from January through late April, but once tax season is over I try to catch up on all the books I find of interest. Since the end of April, I’ve read American Sniper; Lone Survivor; The Amateur; Game Change; Killing Lincoln; The Road to Freedom; Service; Fearless, and; Moneyball. I’ve been a busy guy!

I found all of these books to have interesting aspects, but for some reason, I enjoyed the military books, American Sniper, Fearless, Service, and Lone Survivor, the most. If you want to gain a better understanding of and appreciation for the military, I highly suggest these books.

I find books that focus on the demanding work of the U.S. Navy SEALs to be especially fascinating. The incredible hardships SEAL candidates must endure are thought-provoking, particularly since SEALs are too old to serve by the age of 35. Undoubtedly, SEALs are brave and highly skilled. I am in awe and thankful for everything they do for our country.

Likewise, if you think that our military is only successful because of its sheer, overwhelming force, then these books will give you a better understanding of our current military’s precision as compared to only a short time ago. For instance, the U.S. has tragically lost close to 7,000 troops in the wars in Afghanistan and Iraq, but during the much shorter Vietnam War, the U.S. lost in excess of 50,000 troops. War is never pleasant, but today’s technology provides precision-guided weapons as compared to manpower, providing for far fewer casualties.

Considering my fascination with economic and political matters, I am always looking for a good read on either of those subjects. But generally speaking, they are so negative and depressing that I find myself craving something more uplifting. The tremendous work that our military performs under the tremendous pressures of war is encouraging and speaks volumes to the security of the United States. It is also imminently more interesting at the current time than economics or politics.

If you really want to read stories of incredible courage and patriotism, I recommend any of the books mentioned above.

Best regards,
Joe Rollins

Blame it on the Greeks – AGAIN!

From the Desk of Joe Rollins

Since May 1st, the S&P Index of 500 Stocks has gone down 5.25%, but on the positive side, it’s still up 5.6% for the year so far. The market is in turmoil again due to Greece’s anticipated exit from the euro-zone. Every positive component that causes an increase in the stock market is being realized and the U.S. economy continues to improve, yet stocks continue to fall.

While I struggle sometimes to understand the reasons for the extraordinary moves we are seeing on the U.S. stock market, some investors find themselves so mystified that they fear for their long-term retirement assets. As far as the economic crisis surrounding Greece is concerned, I find it hard to make a legitimate argument for those ongoing concerns to cause such a dramatic loss in value on the U.S. stock market.

A recent report reveals that Greece’s entire 2011 GDP stands at $312 billion, which reflects 100% of every dollar spent by every resident of Greece and is commensurate to the GDP of the small state of Connecticut. It is now estimated that the market capitalization of the U.S. stock market is roughly $55 trillion. Since the 1st of May, the market has gone down 5.25%, meaning it has lost $2.9 trillion in value – eight times Greece’s entire GDP! The reaction we’re seeing is way out of proportion to Greece’s potential impact on the global economy.

Greece has been unable to dig out of its current debt woes by the austerity measures it has taken thus far. The will to reduce their standard of living just doesn’t seem to exist. With a goal to cut Greece’s government debt from 160% of GDP to 120% of GDP by 2020, Greece has pledged to cut the minimum wage and make labor markets more flexible. They have also instituted a new property tax and are placing 30,000 civil servants on partial pay. By and large, the Greek public has grown tired of the bailout conditions, with a wave of protests and strikes over the last week. Even so, Greece has collected very little tax revenue and spends a percentage well in excess of their revenues. As such, it is unlikely that these austerity measures will ever work – the deficit is just too large to overcome.

It’s important to remember that even if Greece were to exit the euro-zone, it will likely have little effect on profitability in the U.S. In many regards, I do not see Greece’s return to a new drachma currency as having terribly negative consequences. By reverting to the drachma from the euro, Greece could effectively and quickly devalue their currency. This truly should not have a negative impact on the U.S. economy.

Even with the reduced economic activity in Europe, earnings are continuing to accelerate in the U.S. Since earnings are the paramount reason for higher stock prices, investors should be more focused on that good news. As an example of how strong earnings have been, they are already at the highest level ever recorded in American finance. U.S. based earnings grew 15% in 2011, and for 2012, they are expected to grow another 10%. Believe it or not, earnings are anticipated to increase 12.5% in 2013. Even if earnings grow at only half of those projections, higher stock prices are very likely.

Don’t drink the Kool-Aid! As I heard one trader say on the financial news this morning, “Maybe the European contagion was overstated.” Duh!! The reality is that stock markets don’t go down endlessly when earnings are accelerating like they are today.

Since my last blog, there has been a wealth of good financial news. Check the headlines and you’ll see these positive trends:

The price of oil has fallen from triple digits to approximately $90/barrel, which is a gigantic movement in the oil market over a relatively short period of time. While gasoline is still expensive, it is dramatically less expensive than it was three weeks ago, and this positive economic stimulus is just starting to be felt.

Interest rates on long-term mortgages fell this week to the lowest ever recorded in the history of U.S. finance. Now you can obtain a 30-year mortgage for less than 3.8%. At no time in U.S. history have interest rates ever been this low.

For the first time ever, German Bunds – the German government’s federal bond – are now trading below 2%. The U.S. 10-year bond is currently trading at 1.72%. Never in the history of these two government-issued bonds have they ever traded this inexpensively.

U.S. earnings for the first quarter of 2012 exceeded all prior earnings records. It’s anticipated that earnings will increase in every quarter for the remainder of 2012 and 2013.

Even though the GDP for the first quarter registered at 2.2%, most economists are forecasting that GDP in the second, third and fourth quarters of 2012 will be at least 2.5%. There is no current evidence of any major downward moves in GDP so far in 2012.

At the end of the day, there’ve been no changes in true economic barometers since my May 1st post. If investors are confused as to why the market would drop 5.25% in only a three-week period when the financial news is no worse than it was three weeks ago. It can only be explained by how traders make money in financial markets. Traders can’t make a decent living without high volatility in the stock market. If the market goes straight up or straight down, then it’s virtually impossible for traders to compete with long-term investors. Therefore, it’s imperative for them to move the market in one direction or the other even if the basis for that movement is misplaced.

What we’re seeing now is a classic case of irrational fear. I see nothing in the financial markets today to justify this negative swing, and therefore, I feel the market will quickly recover. As I’ve said so many times before, when you invest in the market for the long-term, it’s possible for there to be 10% movements in either direction. I believe that’s what we’re seeing now.

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

Best regards,
Joe Rollins

U.S. CORPORATE EARNINGS EXPANSION

From the Desk of Joe Rollins

Before I start my financial ramblings, I want to provide those of you who’ve inquired about my children, Josh and Ava, with an update. Josh turned 17-years old today, and he’s a great kid. He’s in his junior year at Woodward Academy, and he continues to excel at golf and is doing quite well in his studies. It’s hard to believe that he’ll be starting college in just over a year – it feels like he was just born yesterday!

As for Ava, she’ll be turning one on May 22nd. Although she’s not quite walking, she is almost 32-inches tall and is nearly 26-pounds. She brings us an awful lot of joy in spite of her undying will to destroy the house and create chaos morning, noon and night. No one said that being a father at 62-years old would be easy, and while it’s not a cakewalk, it is still very rewarding.

And now, on to the less interesting stuff…

The month of April has closed and the first four months of 2012 have provided exceptional stock market returns. For instance, the stock market has already had an increase in value that is more expected for an entire year than just four months alone. The S&P Index of 500 Stocks is up 11.9% for the first four months of the year, the Dow Jones Industrial Average has charged ahead at 9.1%, and the NASDAQ Composite is at 17.3%. These returns are quite unexpected – but welcome – for a four-month period.

In spite of this performance, the public’s skepticism and its distrust of Wall Street and the government has caused some of our clients to want to back off from stock market investing. In this post, I’ll give you some reasons why doing so would be a bad idea.

As much as I’d like to, I can’t forget the devastation that occurred in investor portfolios during the financial meltdown of 2007 and 2008. However, many investors are unfamiliar with the performance of the indices since that time period. If we measured the period from June 30, 2007 through April 30, 2012, the results would reflect that the S&P is up 2.47%. Likewise, the Dow is up 11.22%, and the NASDAQ is up 21.85%. For all the gloom and doom expressed during the 2008 financial meltdown, the indices have recovered every dollar of that downturn, plus a little more.

These are extraordinary times for investing. With all the negative publicity being reported on a daily basis, it’s important to focus on the items that make stock markets increase. Ponder these positive trends:

Even though earnings expectations for the last several years have been lofty, actual earnings have actually exceeded those expectations. Earnings are presently greater than at any other time in the history of the United States. Since earnings are what impact stock prices the most, this is the number one driving force of higher stock prices.

The U.S. Federal Reserve has essentially guaranteed that interest rates will not be increased until mid-2014. This means that for the next two years, interest rates will continue to border on zero. Higher interest rates can inversely impact stock market prices in that as interest rates increase, stock values go down. Further, higher interest rates create competition for investment dollars.

Undoubtedly, we’d all like to see an increase in jobs and the debt sectors of the market start to rally. However, from a stock market perspective, we’re actually better off with GDP being marginally positive but not completely on fire. If we had an economy exploding to the upside, interest rates would almost assuredly need to increase to accommodate higher economic activity. With a GDP reported in the first quarter of 2012 of only 2.2%, we’re currently experiencing a Goldlilocks economy – it’s not too hot, nor is it too cold. For stock market investing, a GDP of 2% to 3% is quite satisfactory.

As mentioned above, earnings are at an all-time high. Imagine how high earnings could be if GDP really took off like it should. Earnings could increase even higher if GDP were stronger.

Even though the stock market has increased approximately 30% from October 1, 2011 through April 30, 2012, stock prices are still cheap. With the P/E ratio still at moderate levels, it’s possible that the market will continue to expand as the year continues.

The 10-year Treasury bond continues to hover below 2% annual interest rates. As long as the 10-year Treasury continues at almost historic lows, you can expect to see stock prices expand. The current dividend rate of the S&P 500 is higher than the rate on the 10-year Treasury bond.

Of course, I could also provide a list of negatives, but in my opinion, the positives far outweigh the negatives at the current time. High on the list of negatives, however, is Washington’s total inability to appropriately function. I fully expect capital gains rates to increase in 2013 regardless of who is President – not because they should, but because Congress refuses to work together to accomplish anything. While income tax rates will undoubtedly increase in 2013, I don’t anticipate that to impact the stock market until interest rates start increasing in mid-2014.

Unquestionably, the U.S.’s extraordinary deficits are a risk to our financial future. As an optimist, however, I doubt the public will allow these deficits to continue running amuck. Therefore, while the deficits are potentially endangering to our long-term financial security, I believe that we’ll soon have new elected officials in Washington who will change that scenario for the better.

Those who continue to jump in and out of stock market investing are surely learning that it is impossible to be a successful market timer. The market moves up more days than it moves down, and it is believed that the market moves up on twice as many days as it moves down. Moreover, the days with large increases far exceed those days with large decreases. If you try timing your investments, you are certainly more likely to avoid big down days, but more importantly, you dodge the more numerous big up days.

Knowing when to sell isn’t the hard part of market timing – it’s when to buy. While it’s not difficult to cut long-term risk in the stock market by market timing, it is virtually impossible to boost long-term returns using this technique. Purely on the fact that up days far exceed down days, investors are almost always better off being invested for the long-term rather than utilizing short-term strategies.

Another positive concerns upcoming lower energy prices. There are almost daily financial news reports concerning the detriment of higher energy prices on the U.S. economy, and after spending billions of dollars on alternative energy efforts, it seems clear that no expenditure will make any type of dent in our need for fossil fuels. Our best bet would be to better utilize those fossil fuels, which is happening in this country. As we exploit new drilling in the U.S., the price of oil will fall as the summer progresses. I project that by the end of 2012, energy should be significantly lower – by at least 15% – than it is today.

I fully expect the stock market to suffer some sideways movement during the summer months given the large increase in the stock market in the first four months of the year. However, I don’t see a major sell-off due to reasonable valuations, and I certainly don’t foresee us trading out of our positions in order to avoid a small sideways movement. Every day will not be a winner, but by year-end, there should be rewards for having stayed invested.

With interest rates continuing at low levels and with earnings continuing at higher levels, I expect for the market to continue to rise for the rest of the year and forecast the S&P 500 to be 1,540 by December 31, 2012 (current valuation = 1,394). Therefore, based on a low valuation, it’s perfectly possible for the market to increase 10.5% for the remaining months in the 2012 year. This would mean that the S&P 500 index would have a total return at December 31, 2012 in excess of 20%. Wow!

My S&P 1,540 forecast above was not just pulled out of thin air. To arrive at this projection, I reviewed Standard & Poor’s estimate for 2012 earnings for the U.S.’s 500 largest stocks, which they have placed at $110. I then placed a low multiple of 14 on that projection to arrive at 1,540. Again, 14 is a relatively modest multiple; over the last 30 years, the average multiple on the S&P has been approximately 20. My multiple of 14 reflects a conservative price from a long-term perspective, and it is not impractical.

For skeptics who’ve avoided making IRA contributions for fear that the market is in for a big tumble, I can only reemphasize that the market is up over 30% in the last seven months alone and they missed that run-up. Cash sitting in money market accounts is earning practically nothing right now while money invested in securities is creating true long-term wealth. If you are a client, I encourage you to set up a meeting with us so we can show you our strategy for building your assets for a stronger, more secure retirement.

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

Best regards,
Joe Rollins