Financial Insights Blog

Where’s the Growth? – Opportunities in Emerging Economies

The overall sentiment of the market and global economy has continued to swing back and forth between confidence and skepticism. More soft data points, political bickering, stubborn unemployment, etc. continue to plague us, but there are opportunities to be had even though the future is cloudy. Believe it or not, there are areas we view optimistically.

Many companies have reported solid earnings recently with 73% of the Standard & Poor’s (S&P) 500 beating earning expectations for the second quarter, despite the economic soft patch we hit and the Eurozone’s financial issues. Corporations have shored up balance sheets and have reached all-time highs with the amount of cash they have available, putting them in generally strong and healthy financial positions. However, political inaction and the inability of the lawmakers in Washington and in other developed countries to make effective policy decisions has created vast uncertainty. The Europeans struggle to set aside their pasts and cultural differences to form any type of fiscal or banking union although it seems apparent they need a more unified approach. In Washington, we have two diametrically opposed parties who have become so polarized that they can’t find any common ground. These problems are ideological and hinder their abilities to make decisions. Given this polarization and paralysis, companies have opted to compile cash or return it to shareholders in the form of higher dividends or stock repurchases and not re-invest for future growth or spend on additional hiring. On a global level, developing economies currently hold 67% of the world’s total cash reserves compared to 37% in 2000 underlining the relative strengthening of their balance sheets over the past decade. We will likely continue to see slow growth rates and a lack of re-investment in developed economies until this uncertainty dissipates and there is more clarity from lawmakers.

There are areas with strong growth potential however – specifically emerging markets and multinational corporations with revenue streams derived from emerging economies. While the developed world is riddled with the problems of over consumption, astronomical debt, expensive labor forces, and policy inactions, the emerging countries and strong corporations have healthy balance sheets, trade surpluses, serve a growing middle class with an eye to higher living standards, and perhaps most importantly can make and execute policy decisions. While this generates its own risks, these entities will do what’s needed to stimulate their economies or make good investments when appropriate. These factors allow multinationals and developing economies to be much more decisive and direct with the re-deployment of profits and cash that will likely lead towards more growth opportunities in the short and long-term horizons.

Multinationals have already begun to re-deploy their cash through building manufacturing plants, ramping up advertising campaigns, and opening offices abroad. Although the demand from developed nations in emerging markets is expected to slow, there is a lot of room for domestic demand growth and investment, especially relative to domestic demand growth in developed nations, as living standards and incomes rise for the consumers in these emerging economies. They are growing rapidly and have the financial means, demographics and desire to become larger global players. Of course, the million dollar question is when to add exposure to this volatile market segment.

For more discussion on that and other points we have included two articles from portfolio managers at PIMCO and Oppenheimer funds on the outlook for emerging markets, where opportunities exist, how specific countries are shaping up, the effects of the Eurozone outcome on these opportunities and more.

We hope you find this interesting and useful as we continue in our effort to provide you with our thoughts and insights. White swans?! Believe it or not – they do exist. If you have questions or would like to discuss anything in more detail. Please give us a call.

PIMCO Outlook Series June 2012
Oppenheimer Focus Piece 2012

Robert J. Miller
Wealth Advisor/VP Operations
Greater Midwest Financial Group, LLC.
102 N Karlov Ave
Chicago, IL 60624-3047

robert.Miller@lpl.com

Securities Offered Through LPL Financial
Member FINRA/SIPC

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Stock investing involves risk including loss of principal. International investing involves special risks such as currently fluctuation and political instability and may not be suitable for all investors.

NAVIGATING WAVES OF UNCERTAINTY

Risk on, risk off. I sometimes feel as if I am watching a “clap on, clap off” commercial. I mentioned when I last wrote that slow growth, uncertainty, volatility and a substantial correction were all likely. We’ve seen all of that.

Since my last correspondence we have navigated this wave of uncertainty by taking profits and raising our cash and ultra short term bond positions. In early April we followed up our technology related stock sales with two additional moves to reduce US and global stocks and convertible and high yield bonds. In early May we quickly cut our global stock exposure after the anti-austerity votes by the Greek and Dutch. Especially problematic was the ouster of France’s leader and his replacement by a “socialist” politician. While I don’t feel austerity alone can solve Europe’s problems, or the US’s for that matter, the jettison of Europe’s current plan without a credible replacement could create a shock – hence the wave of uncertainty. We also have reacted to the softer US data points that have emerged this Spring.

So where are we now? Taking profits and reducing risk have paid off. By early June major stock market averages had given back all or most of the year’s gains. We were able to mute the effect of that negative wave of uncertainty considerably.

What are our biggest concerns? Policy risks!! – not just from European leaders, but from our own. If no actions are taken by year end, we face a fiscal cliff. A 600 billion dollar tax hike will hit Americans. Ouch! And energy, food and other commodity speculation is still rampant and damaging. Economists say in theory that speculation doesn’t change prices over the long haul, but they can cause 20% distortions in current prices. If gas prices are $.75 or $1.00 higher per gallon than real demand dictates, and that happens every time it looks like the economy is starting to gain some momentum, it steals the average persons discretionary income in a big way. It robs them of money they should be spending on automobiles and televisions. And when those prices persist until it looks like we are maybe headed back into recession, consumers change their behavior. They cannot, or will not, commit to major purchases, like buying houses and instead continue to worry about their jobs.

Where are we headed next? Down the same road but the next wave is probably up. Gas prices are currently down almost 25% from recent peaks. Consumer spending will likely strengthen data points in the coming months — at least until they get squeezed again. Europe has no choice but to address their issues now. They need a fiscal union, not just a loose monetary one. At a minimum, they need coordinated and supportive banking policies to prevent runs on banks and to deal with poorly capitalized ones. But solutions are achievable.

And what about our US politicians? The Governor Walker recall election results seem to indicate that spending constraints are supported by US voters. Now if only we can get support for raising additional revenues, in my opinion best done with a national sales tax, we might actually get on a sustainable fiscal path ourselves.

So, prospects for higher growth are really possible. Housing prices appear to have stabilized in most areas of the country. In the absence of any major shocks … you get the idea.

In closing, after May’s pullback we recently added to our consumer discretionary position. Once again, America’s amazing consumers are the engine that’s powering the global economy. We remain cautious but alert at the wheel. Hopefully gas prices will behave so we all can enjoy the summer driving. But don’t forget to wear your seat belt, just in case.

Sincerely,

Donald J. Miller, CFP®
CEO/Principal

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

WHAT A DIFFERENCE A QUARTER MAKES!

Stocks enjoyed very strong gains during the quarter. In fact, it was a quarter of milestones for the broad averages, with the Standard & Poor’s (S&P) 500 breaking through to new post-financial crisis highs, the Dow Jones Industrial Average (The Dow) eclipsing the 13,000 level for the first time since May 2008, and the NASDAQ reaching 3,000 for the first time in over a decade. The quarter’s gains leave the S&P 500 11% short of the all-time highs set in October 2007 and 30% above the 2011 lows set six months ago in October. The solid returns for the broad market were driven primarily by improving U.S. economic news, most notably jobs and consumer data, and investors increasing comfort with Europe’s challenges.

So what do you do after a quarter like that? Stay objective and keep things in balance! That’s why for our income and most conservative investors we recently took profits on our tech heavy positions. Hopefully you remember we made significant investments in that area in March 2009. So, after a large run up, over 20% in the 1st quarter alone, it made sense to trim those positions to more targeted weightings.

Where did we rebalance to? To a more conservative, out of favor, and/or more income oriented investments. We added to clients bond ladders, buying intermediate corporate bonds in the financial sector. We added a position in high quality preferred stocks that are expected to pay solid, tax efficient, qualified dividends. We also established a position with a real estate income focus. Yes, it really looks like prices are stabilizing and probably headed north.

You might ask, if we expect this bull market to continue, albeit with a possible significant correction and increased volatility, why was this action important for our investors taking income from their portfolio? There are two answers. The first lies in the difference between portfolios in distribution (ones that are taking regular withdrawals) and ones that are not. If you’re a growth investor and the market goes up 7%, down, and back up, you get the 7%. If you rely on your portfolios for living expenses and take money out regularly, some of that money will be taken out when the market is down and therefore will not be around to rebound. You won’t get the full 7%. So, managing fluctuations and volatility are critical to the success of an investor requiring withdrawals.

The second reason is that clients who rely on regular distributions also need to have a high percentage of their pay out funded by predictable interest and dividend payments – if they want their money to last. Selling something to pay expenses can be a disaster. Sometimes everything is down (think about the last few years). And we all know that if you have to sell when the market is down… it is not so pretty. So, taking profits from non income producing areas and using them to boost the cash flow that supports required payouts is a double benefit. Managing risk and structuring more certain outcomes are critical to successful retirement income planning. And you thought we were just buying low and selling high!

Well, that’s it for today. I hope you appreciate the market update and some insight into the science that guides our decision making. There’s a lot going on so I’m sure I will be in touch soon. In the meantime if you have any questions, do not hesitate to call.

Sincerely,
Donald J. Miller, CFP®
CEO/Principal

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Stock investing involves risk including loss of principal. Investing in specific industries is subject to higher risks and volatility than investing more broadly.

I’m writing to update you on current market conditions and other noteworthy items.  We promised to give you our thoughts more frequently and to try to avoid lengthy letters.  So here it goes.

 Year-to-date returns in most clients’ accounts are up substantially.  As we suggested, a lack of black swans is creating an environment where the drumbeat of slow steady growth is getting louder; and while many are jumping on the wagon to get “caught up”, we thankfully are not. 

 We added to US equities three times in the last quarter based on methodical portfolio and macroeconomic analysis – not based on market timing.  Because we held the line on protecting assets in last year’s eventful and volatile markets, our returns over the last 13 months have, we feel, been strong – especially on a risk-adjusted basis and especially in light of the Fed’s zero short-term rate policy and historically low long-term rates. 

 And, despite the temptation to sell now and wait for the big correction, we think we need to take this opportunity to take profits and more normally weight portfolios – reduce overweighting in large cap value and bonds and rebalance to add global and mid-cap exposure.

 The issue of what areas will do best in the year ahead seem to be based on credit conditions.  Do they favor “risk on” or “risk off” assets? 

 We see credit improvement on three fronts. 

 One, consumers are expanding revolving credit use – probably because of an improving job picture. 

 Two, fear is subsiding that Europe’s financial crisis will cause a global meltdown.  Ironically, Greece’s fiscal pain may be spurring other nations to fund a solution and avoid the nasty repercussions if it spreads.  There’s even talk of market-based labor reforms in Europe – not just austerity.  I wonder if it will spur spending and tax reform here before it’s too late. 

 Three, serious discussion is underway about reflating the housing market with more quantitative easing and potentially meaningful foreclosure forbearance.  Stabilizing housing prices and lower refinanced monthly payments should help consumers boost the economy. 

 So, if the trends continue, we need to more evenly weight the areas we minimized last year – the “risk on” assets like financials, Europe, and commodities.  To be sure, we have a disaster plan in place should certain events interrupt or reverse these trends.  However, we know our job is to focus on what is, not what ifs.

 Before closing, I want to quickly mention a couple of other items. 

You may have noticed that year-end LPL Financial reports show ex-dividend payments as a decline in market value.  They add back the capital gains and dividends in the dividend column.  So while December was essentially flat from a performance standpoint, it would appear that accounts had a large decrease in market value that month.  This wasn’t so glaring in prior years because either the year-end was up sharply or funds didn’t pay a lot of gains out because they had stored capital loss carryforwards from the financial crash years.  However, in every period a dividend or gain is paid, it negatively impacts the “increase or decrease in market value” entry.  And gains and dividends paid are a hugely positive event.  Please see this LPL Market Value Letter of Explanation that explains this in more detail.

 Finally, I want to remind you of the income and estate tax uncertainty that surrounds our planning this year. 

 Provisions such as making tax-free distributions from IRAs to charities, deducting state taxes on your federal returns and relieving many from the Alternative Minimum Tax (AMT) were not extended last year.  Also looming large are the Bush-era tax cuts and the expansion of the Federal Gift & Estate Tax Credit.  Both are set to expire this year.  Because of the current deficits, and polarization of Congress and the White House, we expect the debate will probably extend into the 11^th hour.  The final resolution may largely depend on the outcome of the elections and the politicized dynamics of the so called “lame duck” Congress.  Just when you thought it couldn’t get any better!  Right.

 Alright, so I did okay on the reporting more often but not the lengthy letter.  Either I like to talk or there’s a whole lot going on, probably both.  Thanks for the trust and confidence.  Talk with you soon.

Sincerely,

Donald J. Miller, CFP®

LPL Registered Principal

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  All performance referenced is historical and is no guarantee of future results.  All indices are unmanaged and may not be invested into directly.  Stock investing involves risk including loss of principal.  International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.  Mid-capitalization companies are subject to higher volatility than those of large-capitalized companies.  The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

Please click on the link below to view the LPL 2012 Oulook.

LPL’s 2012 Outlook – Summary

It has been a tumultuous third quarter with the Standard and Poor’s (S&P) 500 index down 15% since mid-July. Essentially, global markets have largely priced in a recession.  Indeed sentiment data, like consumer confidence, has been decidedly negative, but key economic data has been positive. Last week the Labor Department reported solid gains in jobs and revised the previous month’s estimates higher as well.  Also, the Institute of Supply Management (ISM) data confirmed a slowly expanding economy.  In fact, estimates for third quarter growth are in the 2 to 2 ½% range – hardly a recession.

So what’s creating all the angst and volatility and what are we doing about it?

Clearly, concerns about ineffective policies, here and abroad, to deal with European debt problems and sputtering US growth and job concerns are the chief culprits.  Fortunately, it looks like Europe is getting serious about its sovereign debt issues.  Recently, they authorized a US-style TARP fund to ensure its banks will remain solvent.  But they’re not out of the woods yet.  And, unfortunately, because next year’s elections are looming, US policy decisions remain fractured and politically motivated.  Therefore, we believe volatility will continue over the next year.

Our response?  We want to hedge portfolios against excessive volatility. In fact we believe we can even potentially profit from it.  In order to try and accomplish this, we’ve done two things. First, we sold a position that was diversely invested but typically actively hedged against downturns.  However, through the summer decline, it essentially did no hedging.  So we made the decision to try to better position the money.  Second, with the proceeds of the sale, we’ve worked to identity an opportunity to try and use the volatility of the S&P index to our advantage.  This index volatility typically rises with concerns about recessions, debt crises, oil price shocks, natural disasters, terror attacks, and policy mistakes.  Because it is complicated, however, we intend to speak to every client before implementing it in your portfolio.

The other action we have recently taken is to reestablish our position in an investment similar to the one we took profits in last June.  We feel slow growth and profitability will continue despite policy concerns.  Since we sold our unhedged position last month, we feel we need reasonable exposure to growth and convertible bonds. 

In summary, it has been an interesting last month or two.  However, we not only have a plan for continued slow growth and volatile markets, we are executing it in a way that attempts to manage risk and take advantage of opportunities.  We plan to contact everyone affected by our strategy change.  In the meantime, of course, feel free to contact or call us to initiate discussion or with questions or concerns.  We always appreciate hearing from you.

Best regards,

Donald J. Miller, CFP®

LPL Registered Principal

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  All performance referenced is historical and is no guarantee of future results.  All indices are unmanaged and may not be invested into directly.  Bonds are subject to market and interest rate risk if sold prior to maturity.  Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price.