As is somewhat typical, I enthusiastically sat down to write this quarter’s letter with a head full of ideas, comments and opportunities that I wanted to highlight for the benefit of our wealth management clients. After almost five hours of writing, I realized I had pounded out pages of exciting economic statistics, a thrilling dissertation as to the risks of traditional investment allocation strategies, and a page-turning tome on the joys of portfolio construction. Fortunately, our clients have the benefit of having a first-rate service staff between my boring statistics and themselves. To our staff’s credit…they laughed at my drivel and encouraged me to write something that someone might actually read. As a result of my team’s input, endless pages of economic drivel have been reduced to this letter. This letter will focus on 3 key points investors should pay attention to now.
Over the past several weeks I have had the privilege of participating in a number of industry calls, conferences, and conversations which have made me very encouraged about the state of the economy and the opportunity for investors as we move through the next decade. Obviously, this journey will not be without bumps in the road. However, I firmly believe that given Cascade’s size and our concentration of experienced wealth management professionals we are well positioned to deliver the benefits of comprehensive, integrated wealth management to help guide our clients comfortably through these increasingly complex economic times.
In several conferences we were engaged in discussions with many of the major players in our industry, from our brethren on Wall Street to other firms across America similar to ourselves. In addition, we were privy to insights as to new investment product developments designed to meet the needs of the investing public. As I sat through these discussions I realized that, at Cascade, we have only one product. That product is really an emotional state, that being “Peace of Mind.” It is our primary responsibility to make sure that your financial roadmap aligns with your specific values, goals and objectives. If at any time you feel any misalignment, please feel free to come in, sit down, and discuss how we can be of better service.
Point 1: The economy is getting better.
If peace of mind is the objective, the latest economic statistics should go a long way toward achieving the goal. After an 18 month recession, we have now experienced 21 months of recovery. As I indicated in last quarter’s letter, we have clearly moved from recovery into expansion.
As we look at the graphic to the right, we see that our economy lost $554bn of GDP output during the recent recession, but subsequently regained more than that amount already in the recovery. Likewise, corporate profits have recovered to a level roughly equivalent to pre-recession levels, and corporate balance sheets are sporting more cash than at any time in the last decade. On a household level, we are seeing a continued rise in personal saving, household balance sheet strength, and an improvement in the average American credit score. While it will be some time before we replace all jobs lost in the recession or get to a 5% unemployment level, job creation is improving; new jobless claims are dropping, and unemployment continues to decline.
Point 2: After a 21 month bull market run, there are some things to watch out for.
Since the recovery began, virtually all asset classes have performed well. However, there have been some true standouts. First, emerging markets have delivered outstanding returns. One reason many emerging economies did not experience the disruption of the financial crisis (despite the fact that their stock markets moved roughly in lockstep with the rest of the globe) was simply because they did not have the exposure to over-leveraged housing that the developed markets did. Thus, it made sense that their markets recovered more quickly.
As the chart above shows, having many emerging economies outperform the developed ones is not exactly new. It has been somewhat commonplace for the last three decades. However, as we continue into a market of global expansion, it may be prudent to examine monetary policy in some of these countries versus their policy and inflation rates, as well as the relative valuations of their stocks:
With low real policy rates relative to inflation (and even to their own monetary targets), countries like Russia, India, Argentina and Turkey run the risk of overheating their economy and bear watching. Furthermore, the gains in these markets have led to a relative valuation difference between emerging and developed economies which clearly favors the developed markets. In short, emerging market gains may have created something of an asset bubble in the stocks in these markets. As such, rebalancing to the less expensive developed economies may be prudent.
Another area to keep an eye on is commodities. We’ve all felt the impact of increases in fuel and food costs, regardless of what the CPI says. No one has missed the spike in gold and other metals. As we saw in the last recession, large increases in fuel and other commodity costs can have far-reaching effects on an economic expansion and we obviously monitor this impact. The chart to the left is pretty clear:
Perhaps my biggest fear in commodity pricing is the number of new products being marketed by financial firms designed to allow the “average investor” to participate in the commodity markets. This could lead to serious price spikes with no basis in the supply/demand situation of the commodity itself. Commodity investing is a complex business and can be an important contributor to your overall portfolio construction. Our professionals are happy to discuss how to prudently blend commodity investing into your strategy. Keep in mind that investment products are generally designed and offered when they are easy to sell…not necessarily when they are wise to buy.
Point 3: Investing for income has changed forever.
We all know that the baby boom generation is the largest population group in our history (until Gen Y…but that’s another story) and the leading edge of that group is now entering retirement. Accordingly, they are now looking to convert their decades of
savings and investments into a reliable and predictable income stream to see them through. Unfortunately, they are doing so at the convergence of factors in the investment marketplace that will force them to challenge their beliefs as to what appropriate investment portfolios look like going forward. The story is two-fold: First, retirees are living much longer and they are living more active lifestyles than any other generation in history (we see this as a good thing); second, they are doing so in an interest rate environment that is the lowest in their lifetime. Take a look at the chart to the right:
See the dot on September 30, 1981? At that point, a 10-year-treasury-guaranteed bond offered interest of 15.84%. Today, that same offer brings 3.47%, which equates to a lifestyle-supporting income that is 78% less than could be generated from a safe investment 30 years ago…and we have to live longer on it. As the chart shows, (through declining yields and the underlying increase in bond prices) investors have enjoyed a 30-year bull market in bonds, and frankly, I don’t see how it can continue. Looking forward, I can’t see how traditional asset allocation can possibly serve the oncoming generation of retirees (and other investors). Knowing this, we are now faced with making significant changes in portfolio construction to accomplish this client segment’s goals.
Fortunately, the recent economic downturn has provided an interesting income opportunity. Bank credit has become difficult to get; real estate prices have dramatically “revalued,” and many stocks have dropped to the point that the dividend yield of the equity is in many cases higher than that of the bonds of the same company. Bottom line for investors here is that traditional asset allocation strategies need to be re-evaluated in terms of the reduced income streams and increased pricing risk associated with bond investing.
Your Feedback is Important!
Cascade is pleased to announce that this spring we will be conducting our second client satisfaction survey. Our independent survey company, Quantum Market Research, will be selecting a random sampling of our clients. Please rest assured that no client account information is shared with the research company. If you should have any concerns about contact from them, please call us directly. We last conducted this survey in the midst of market disruption in September of 2008. Those of you who participated gave us tremendous insight which allowed us to be more responsive to your expectations and concerns. If you are selected, please take the opportunity to share your input. We look forward to being of service to you for many years to come.
The Cascade Cyclones Ride Again!
In closing, I want to announce that the Cascade Cyclones, our cycling team supporting the American Diabetes Association Tour de Cure, has kicked off our summer training season. We are doing this in conjunction with our partners at Bicycle Village of Denver. Join us if you can; donate if you can’t or contact Katie Murray in our office to learn about joining the Tour de Cure team closest to your home. Visit our team website by clicking here, or going to tour.diabetes.org, and searching for the Cascade Cyclones in the Longmont, CO tour event under “Join an existing team”.
Have a fantastic spring!