Merriman

As the S&P 500 reaches new highs, it is interesting to think about the volume of bad news we have faced over the bull market of the past 4 years. We were subjected to what seemed to be an epidemic of economic challenges, from the fear that Troubled Asset Relief Program (TARP) would lead to runaway inflation, to the debt ceiling debate and the “fiscal cliff” we were sure to tumble over at the beginning of the year. There was news of more global concerns over the world, with new challenges faced in feeding and providing fresh water for the ever growing global population, which now exceeds 7 billion people. There have been many headline stories building a case for a grim outlook of the future. It seems to me that the good news is usually more subtle and harder to find.

I recently picked up a copy of  “Abundance – The Future Is Better Than You Think.” The authors, Peter Diamandis and Steven Kotler, make a case for optimism. They present a neurological reason for why we are more sensitive to bad news than we are at recognizing opportunity. Fear has served the human race well in many ways for many years; it activates our limbic system, which manages our “fight or flight” circuitry. Diamandis and Kotler then look at how we have solved problems of scarcity in the past, and examine amazing advances in science and engineering that are being made right now.

This book presents a different perspective than we are bombarded with in the daily news, and I think it’s worth reading. Diamandis and Kotler explore some very exciting new technologies that are making giant strides against some of the world’s biggest challenges, like scarcity in access to energy, clean water and good medical care.

“I’m not saying we don’t have our set of problems; we surely do. But ultimately, we knock them down” -Peter Diamandis.

Before finding the book, take a few minutes out of your day to listen to his inspirational and educational TED talk here.

There are many things in short supply, but uncertainty is not one of them. Three economists1 have compiled an index of uncertainty, which is comprised of newspaper coverage of policy-related uncertainty, expiring federal tax code provisions and disagreement among economic forecasters. You can see the trend in Figure 1 below. The index peaked with the debt ceiling imbroglio in late 2011, fell in the early part of 2012 and then rose again.

Throughout the year there has been a great deal of focus on a number of worrisome issues, including the U.S. deficit, debt ceiling and the fiscal cliff, high unemployment, and the European debt situation. Reflecting all this angst, investors through November withdrew a net $88.9 billion from actively-managed U.S. stock mutual funds (net of inflows into U.S. stock exchange-traded funds).2 Yet for 2012, stocks were up nicely.

How could stocks have gone up while uncertainty increased? While many people naturally worry about the past and still feel burned by previous sharp plunges in stock prices, the stock market is forward looking, incorporating the perceptions of millions of investors. While national economies are still relatively sluggish, actions taken by the U.S. and European central banks to combat economic weakness are having a positive impact.

Housing, while not rosy, is seeing some welcome improvements, with 6.9% of U.S. consumers planning to buy a house in the next six months, the most since August 1999.3 Confidence among U.S. homebuilders reached a 6 ½ year high in December.4 U.S. sales of previously occupied homes increased to their highest level in three years in November.5 And home prices rose 4.3% in the twelve months ending October 2012 in the S&P/Case-Shiller 20-City Composite.6

Another positive, with major longer-term implications, is the widespread development of hydraulic fracturing (or fracking, the process of extracting oil and natural gas from shale rock). The International Energy Agency projects the U.S. will become the largest global oil producer by around 2020, and a net oil exporter by around 2030.7 While there are important environmental issues associated with fracking, including potential contamination of local water supplies and massive use of water in the process, electricity produced by natural gas gives off 43% less carbon dioxide versus coal. Due to a combination of increased use of natural gas, the weak economy and more fuel-efficient cars, America’s emission of greenhouse gases has fallen to 1992 levels and is expected to continue to fall.8 So, like any energy source, there are costs and benefits. Cheaper energy will lead to more manufacturing being done in the U.S., which is good for the economy. One analyst estimates the U.S. will add three million new jobs by the end of this decade due to the natural gas industry.9

Waiting for that perfect time to invest when there is no uncertainty could lead to cash unproductively sitting on the sidelines. Investing only after good news also means buying stocks after they have gone up. A good example of this is the S&P 500 going up by 2.54% on January 2, the day after the fiscal cliff legislation passed. Another example is the MSCI EAFE index of developed countries in Europe, Australasia and the Far East, which increased 6.57% in the fourth quarter, reflecting the relative lack of bad news, and some stabilizing events, in Europe.

While uncertainty is an uncomfortable fact of life, it is easier to handle by following a well-formulated diversified investment plan that invests in stocks and bonds, the allocation to which incorporates your risk tolerance and long-term needs.

Some of our clients occasionally express concern about the situation in Europe. Here’s what our Director of Research, Larry Katz, has to say about Merriman portfolio exposure to those markets:

Europe’s ongoing debt problems have prompted many investors to consider their European exposure, especially to the euro zone’s weaker countries. While there certainly could be global impacts emanating from any area of the world, a major benefit of true global diversification is the controlled direct exposure to the problems of any given geography.

For example, one of our major portfolios is MarketWise Tax-Deferred, a globally diversified, buy-and-hold portfolio with a value and small-cap tilt.  Half of the stock exposure of this portfolio is in the United States. The other half is distributed throughout the world.

Of the 50% overseas exposure, as of the end of March 2012 just over 22% was in Europe. Notably, most of that exposure was to the stronger European countries. The top six European countries by exposure (United Kingdom, France, Germany, Switzerland, Sweden and the Netherlands) comprised almost 18% of the total invested in Europe. The weaker countries of Greece, Ireland, Portugal, Spain and Italy totaled only 1.73%.

So a 60/40 stock/bond portfolio had just over 1% exposure to these five troubled countries.

Every portfolio has to incur various risks to generate returns. The key is to intelligently diversify so that, under a variety of market conditions, those risks remain under control.

In managing investments, making decisions based on feelings of excessive optimism or excessive pessimism rarely ends well. Maintaining a balanced perspective in an ever-changing and often chaotic world is a difficult yet critically important part of achieving long-term investing success.

To be sure, the news lately has been enough to scare many people into believing that things are shaping up for another 2008 debacle. Seemingly at every turn we hear of the debt crisis in the Eurozone, the possibility that the United States might not meet its deadline to raise the debt ceiling and the ramifications that may have, China potentially slowing down, and the U.S. housing and unemployment figures remaining at disappointing levels. And this is just to name a few!

While the United States and the rest of the world are facing many significant obstacles, and while nobody knows for sure how future events will unfold, I offer the following examples of recent positive, noteworthy items that went largely ignored:

• Japanese auto manufacturers and parts suppliers resumed shipments after being forced to essentially shut down because of last winter’s earthquake, tsunami, and nuclear incident.
• Foreign and domestic auto manufacturers established new plants and/or increased hiring in the United States, and sales increased meaningfully. (more…)

An article by our very own Larry Katz has been featured on MarketWatch.com. Click here to read Larry’s thoughts on how to mitigate the impact of market declines after you’ve already retired.

There was an interesting article in the Wall Street Journal from March 8, 2011 called “Why Small-Cap Funds are Lagging.” It cites a study by Credit Suisse showing that “small-cap funds have increasingly been investing in companies larger than their category name would indicate—and the average fund is underperforming its benchmark.”

The article goes on to say “The average market capitalization of a company in a small-cap fund was about $3.1 billion at the end of 2010, compared to the average market cap of the benchmark Russell 2000 index of about $1.3 billion. The $1.8 billion gap between the two is the largest since September 2008.” (more…)

It was not that long ago when the equity markets were down over 50%, buy-and-hold investing had been declared dead, and many investors had little faith that the markets would recover during their lifetime.  Two years later the equity markets have risen significantly.  Many investors may not understand why as the recovery has occurred during a period of soaring deficits, major bank failures, increased tensions in the Middle East, rising prices for oil and gold, and uncertainty over the financial stability of the European Union.

This article by David Callaway offers lessons that many investors have learned during this most recent downturn:  The market has always recovered without the ability to see nor predict the turning point until after the fact. Buy-and-hold investment strategies are not dead, and investors who stayed the course through thick and thin did quite well. Diversification works, and diversified portfolios have helped to capture the best of market movements.  Quite possibly the most important lesson we can all learn is that as the daily noise of the news grows louder and louder, often times the best thing we can do is tune it out.

With the high volatility in the stock market over the past year, emotions have been running at an all-time high for many investors. Staying on track has become harder than ever.

Although the overall stock market has recovered some of its lost ground this spring, many people are still very spooked by stocks. Unfortunately, that trepidation can lead to decisions that investors may later regret.

Long-term investors have two basic jobs: managing their investments and managing their emotions. You can hire somebody to manage your money — and we think you should. But only you can manage your emotions.

This is important because if emotions get out of control, they can undercut even the best money-management practices. (more…)

Many investors seem to think the past 10 years were a waste. Early in 2008 the Wall Street Journal declared the years since 2000 “the lost decade.” That, of course, is one possible interpretation of the market’s behavior since it peaked in 2000, stumbled through a severe bear market for about three years, roared back to recovery and then fell into its current slump late in 2007.

A client referred to the previous 10 years and said to me: “We really didn’t make as much as we expected, did we?” It was more a statement than a question. And it made me curious to know the facts.

What I found didn’t surprise me a great deal. But I think it might surprise many people. (more…)