30,000 Foot View

Gridlock. To Most People it’s Become a Dirty Word. Gridlock Evokes Images of the Recent Government Shutdown and the Possibility of a United State Default on the Debt. Gridlock Has Raised the Specter of Systemic Risk Such as the United States and the World Experienced in 2008 and 2009. It Promotes a Chicken Little Syndrome That the Sky is Falling.

Unresolved Systemic Issues Still Remain Despite Dodd Frank. The Law Put Into Place to Deal with Financial Institutions That Are “To Big To Fail” and Risky Assets Still Held by Banks. Dodd Frank Attempts to Eliminate Conflicts of Interest That Have Been Created in the Financial System Revolving Around Proprietary Trading by Large Banks such as JP Morgan’s Resulting 6 Billion Dollar Loss at the Hand of the London Whale.

Government Has Yet to Decide What to do With Fannie Mae and Freddie Mac and the Trillions of Dollars of Mortgages They Hold. They Are Also Virtually the Only Organizations Capable of Creating Liquidity in Real Estate by Buying Mortgages Created by Financial Institutions Freeing Up Capital to Create More Mortgages. The Same Business Model That Led to the Bailouts.

The Point is it is Very Difficult to Run an Economy Where the Uncertainty of What the Rules of the Road Are and May be Still Prevails. This Affects Cost, Profitability and Business Models. Gridlock Between Democrats and Republicans Have Protracted the Process as a Manifestation of a Country Battling Itself. A Civil War of Philosophies and Ideologues Built Around Winners and Losers Rather than Creating a Level Playing Field for All.

Yet, Progress Has Been Made. The Government Has in Place Regulations Raising Required Bank Tier 1 Capital to 6%. This is an Increase From 4% and Brings Tier 1 Bank Capital in Line With the Requirements of Basel of III. The SEC Has Passed New Regulations Requiring Broker-Dealers to Maintain Assets in Excess of 1 Dollar per Dollar of Liabilities Along with Reporting and Audit requirements.

At the Same Time Our Elected Officials Are Grappling with Immigration Reform, Gun Control and a Myriad of Constitutional Civil Liberties That Have Been Called Into Question. Issues Raised by the Activities of the National Security Agency, the Internal Revenue Service and Guantanamo Bay Call into Question Basic Constitutional Protections and Rights. Many of Us Thought These Issues Had Been Settled by Supreme Courts Long Past.

Years of Terrorism Still Creates National Stress Which is Embodied in the Continuation of the Patriot Act. New Technologies such as the Proliferation of Drones and the Immediacy by Which Information and Data is Communicated by Mediums Such as Smart Phones, Tablets and Social Media and the Resulting Need for Cyber Security Have Disrupted our Society. Commerce Has Been No Exception. Congress Still Has Not Tackled Tax Reform or Entitlements Such as Social Security and Medicare.

The Full implementation of the Affordable Care Act Began his Fall. The Health Care Exchange is Off to an Auspicious Start Due to the Technical Glitches of the Website. However, the Health Care Law Underpins Individual and Family Financial Security From Catastrophic Loss. This May Help Bring Large Swaths of People Who Previously Could Not Get Health insurance Before Due to Pre-Existing Conditions or Affordability Concerns Back Into the Mainstream Economy. Thus, Helping to increase Consumer Confidence and Perhaps Bolstering Consumer Spending Over Time.

Hang on to Your Hats as the Debate Over Raising the Debt Cap Plays Itself Out Over the Winter. We Have Now had a Few Years’ Worth of Experience of the United States in a AA Credit World. If Detroit, Jefferson County Alabama and Stockton California Are Examples then I for One do Not Want to See Another Credit Downgrade.

How Has the Economy Done in 2013? The U.S. Economy Has Shown Some Signs of Recovery in 2013. Job Growth Topped 200,000 in October and November. October Included the Partial Federal Government Shutdown. Interest Rates Have Risen Over the Course of the Year. In Most Circumstances Rising Interest Rates Indicate Stronger Demand for Goods and Services and a Strengthening Economy. Particularly, as the U.S. Recovers from Severe Recession and Slow Growth. However, Rising Interest Rates Can Also Have the Effect of Dampening Demand for Products and Services. As an Example, as Rates Have Risen Home Purchases Have Slowed.

Gross Domestic Product (GDP)

Gross Domestic Product Released by the Bureau of Labor Statistics Show the Economy Grew 1.8% in the 1st Quarter, 2.5% in the 2nd Quarter and 4.1% in the 3rd Quarter of 2013. The Expectation for 4th Quarter GDP is 2% to 2.5%.

Interest Rates

Rising Interest Rates Are Especially Problematic in the Face of Quantitative Easing. The Federal Reserve Seeks to Keep Interest Rates Low to Provide Business With Cheap Money to Expand and Hire. The Fed Also Looks to Use Cheap Money as an Incentive for Consumers to Spend.

The Rise in Interest Rates is Exemplified by the Substantial Move Up in the Yield of the 10 Year Treasury From a Low in 2013 of 1.6% and stands at 3.026% as of December 31, 2013. The Federal Reserve Has In it’s December Meeting Begun to Taper Back on Quantitative Easing and Lowered the Amount of Bonds it is Buying from $85 Billion to $75 Billion in the Belief the Economy is Nearing the Ability to Start Running on its Own.

As of December 31st the 30 year Treasury is at 3.97%,the 30 Year Fixed Mortgage Rate is at 4.54% and the 15 Year Fixed Mortgage is at 3.57%. Earlier This Year 30 Year Fixed Mortgage Rates Were Below 4% Which had the Effect of Stimulating Demand for the Purchase of Homes. Since Rates Have Risen Demand for Homes Has Slowed.

Employment

The Nations Job Prospects Improved in 2013 as the Unemployment Rate Has Fallen to 7.0%. The Non-Farm Payroll Report Showed New Jobs Created Grew at Over 200,000 in October and November. In Previous Months the Jobs Growth Number had Fluctuated Between 140,000 and 195,000. 200,000 Has Been the Magic Number for the Federal Reserve. The Central Bank Has Said it is Targeting Unemployment at 6.5% to End Quantitative Easing.

Quantitative Easing

The Fed Has Lowered the Amount of Treasury and Mortgage Backed Bonds it Has Been Buying From $85 Billion to $75 Billion per Month in December. In the Late Spring-Early Summer Federal Reserve Chairman Ben Bernanke Announced a Data Dependent View Regarding the Tapering of Quantitative Easing. This Touched Off a Wave of Speculation and Market Volatility Around Rumors the Federal Reserve Might Begin Tapering Back Early on the Amount of Bonds It Has Been Buying.

The Fed’ Has Several Reasons for Continuing Quantitative Easing. First, to Get Through the Current Debate and Gridlock surrounding the Raising of the Debt Cap. Second, to Wait for More Employment Data to Help Ensure the Unemployment Rate Continues to Fall. Third, to See Additional Numbers with Respect to Inflation.

The United States and the Globe Have Recently Been Seeing Numbers From Measures of Inflation That Have Shown a Degree of Disinflation (A Slowing in the Rate of Price Inflation). Given Inflation is Below the Fed’s Target of 2% Continuing Quantitative Easing Acts as a Counter Weight to Disinflationary and Deflationary Trends in the Economy. If Not Held in Check Falling Rates of Inflation Could Cause Asset Prices to Fall Such as Stocks, Bonds and Real Estate Perhaps Triggering a Number of Scenarios Ranging From Recession, Depression or Stagflation. The Federal Reserve Wants to Avoid a Situation Where Asset Prices Fall While Interest Rates Rise.

The Federal Reserve’s Primary Measures of Inflation, Disinflation and Deflation Include the Consumer Price Index (CPI) and the Producer Price Index (PPI). The CPI was Up .5% in the June after increasing .1% in May. The index for All Items Less Food and Energy Was Up .2% in June the Same as in May. The PPI Was Up .8% in June. In September the CPI Increased .1% and 1.7% Year over Year Excluding Food and Energy. September Also Showed a Negative Month to Month Reading in the PPI of -.1%. However, the Year Over Year Number for September was .3%. October’s CPI Reading Showed a Drop of -.1%. Excluding Food and Energy the Reading Rose .1%.

November’s CPI Reading for All Items was unchanged. Novembers CPI Reading for All Items Less Food and Energy was .2%. The PPI for November Total was -.1%. Less Food and Energy the Reading Was .1%.

Additionally, Janet Yellen’s Confirmation as Ben Bernanke’s Successor as Head of the Federal Reserve is Expected to Occur in the Beginning of January.

Housing

In the Early Spring of 2013 through the Early Fall Real Estate Showed Significant Growth. Year Over Year Numbers Showed Double Digit Returns. By the Fall of 2013 Rising Interests Squelched Demand for the Purchase of Homes. The Median Price of an Existing Home Was $214,200 in June. Pending Home Sales Dropped 5.6% in September. However, the Case Schiller 20 City Index Was Up 12.4% Year Over Year in September. The National Association of Realtors Reported the Median Existing Home Price in September Dropped to $199,200. While Rising Mortgage Rates Have Had an Effect on Home Purchases the Fact There was Growth in the Housing Market was Encouraging.

The Median Price of Existing Homes Fell to $196,300 in November. Total Existing Home Sales Dropped 4.3% and were 1.2% Below November 2012 levels. “This is the First Time in 29 Months Sales Were Below Year-Ago Levels” According to the National Association of Realtors.

Manufacturing

Manufacturing Showed Growth in 2013. In July the Institute for Supply Management Purchasing Manager Index Report (PMI) (a Gauge of Manufacturing Activity) Showed an increase to 55.4 From 50.9 Representing an Increase of 4.5. A Reading Above 50 Indicates Expansion. The New Orders Index Increased by 6.4% in July to 58.3. The Production Index by 11.6 to 65. “Comments From the Panel Generally Indicated Stable Demand and Slowly Improving Business Conditions.”

In November the ISM (Institute for Supply Management) Report Showed Octobers Reading at 56.4. “The PMI Increased Progressively Each month Since June, With October's Reading Reflecting the Highest PMI (thus far) in 2013. The New Orders Index increased Slightly in October by 0.1% to 60.6%, While the Production Index Decreased by 1.8% to 60.8 percent. Both the New Orders and Production Indexes Registered Above 60% for Three Consecutive Months. The Employment Index Registered 53.2%, a decrease of 2.2% compared to September's Reading of 55.4%. The Panel's Comments Were Generally Positive About the Current Business Climate; However, There were Mixed Responses on Whether the Government Shutdown and Potential Default Have Had Any Effect on October's Results."

The December ISM Report Showed Manufacturing Expanded for 7 Consecutive Months. The PMI Came in at 57 the Second Highest Reading for 2013. New Orders Increased .6 to 64.2. Of the 18 Manufacturing Segments the Report Follows 13 Reported Growth in December.

Motor Vehicle Sales Have Held Steady at an Annualized Rate Between 14 million and 16 million Automobiles per Month for 2013. Total Annual U.S. Auto Sales Were 15.6 Million. A High Level of Sales for the Automobile Industry Created by the Age of the Average Car in the United States. December Sales did Not Meet Expectations

Consumer Spending

According to the Wall Street Journal “U.S. Consumers Spent Cautiously in September Ahead of the Government Shutdown. Separately, a New Consumer-Confidence Reading Showed Americans Continuing to Downgrade Their Expectations for the Economy Into November, a Bad Omen for Spending Going Forward. The Thomson-Reuters/University of Michigan Index of Consumer Sentiment Fell to a Two-Year Low of 72 in November from 73.2 in October.

Personal Spending, a Broad Measure of Consumer Outlays on Items From Refrigerators to Health Care, rose 0.2% in September. While That Was In Line With Economists' Forecast of a 0.2% increase and Matched the Average Rise Over the July-Through-September Period, it was Still a Tepid Reading When Taken in Broader Context.”

Reuters Reported “Consumer Spending Rose In November at the Fastest Pace Since June and an Upbeat Sentiment Reading for December Suggests Consumers Will Keep Shopping Despite Tepid Income Growth.” Consumer Spending Rose in November by .5%

Retail Sales Have Fluctuated From a Rise of .1% and .6% in April and May to a Reading of -.1% in September. Bloomberg Business Week Reported “Consumer Demand Was Anemic During the Holiday Season”. Sales of Holiday Items did Increase 2.3% Compared With Last Year.” However, “Retailers Got There by Lowering Prices and Continuing Reliance on Discounts. This Holiday Season is One Where Absolute Dollars Sales Gains in Consumer Spending Were Held Back by Heavy Retailer Price Discounting in an Attempt to Stimulate Demand.”

Bloomberg Also Reported Consumer Spending Reported in December rose .2% Following a Gain of .4%.the Previous Month. Incomes Rose 2.6% Increasing the Savings Rate to a 3 Year High.

Leading Economic Indicators

The Conference Board’s Index of Leading Economic Indicators (LEI) in the U.S. increased 0.9 Percent in September following a 0.7 Percent Increase in August, and a 0.4 Percent Increase in July. “The September LEI Suggests the Economy Was Expanding Modestly and Possibly Gaining Momentum Before the Government Shutdown, said Ken Goldstein, Economist at The Conference Board. Beyond the immediate Fallout of the Shutdown, the Biggest Challenge is Whether Relatively Weak Consumer Demand, Pinned Down by Weak Wage Growth and Low Levels of Confidence, Will Recover During the Final stretch of 2013 and Into 2014. ”

The LEI Increased .2% in October. “This Marked the 4th Consecutive Increase Since July. The Increase in the Index Supports Our (the Conference Board’s) Forecast That the U.S. Economy is Poised to Grow Somewhat Faster at 2.3% in 2014 Compared to 1.6% in 2013.”

The LEI Increased .8% In November. This Reading Continues a “Broad Based Upward Trend Suggesting Gradual Strengthening Economic Conditions Through Early 2014.”

How Have the Markets Performed

Fueled by Quantitative Easing the S&P 500 is Up 29.6% for 2013. The DOW Gained 26.5% and the NASDAQ Was Up 38.3%. Small Cap Stocks as Tracked by the Russell 2000 Index Were Up 37.1% in 2013. International Stocks Tracked by the MSCI EAFE Index Are Up 18.71% on a Price Basis as of January 3rd 2014.

Bonds

Bond Prices have Fallen as Yields Have Risen. As of This Writing the 10 year Treasury Stands at a Yield of 2.99% 10 Year AAA Rated Tax Free Municipal Bonds Maintain a Yield of 2.65%. AAA Rated 20 Year Tax Free Municipal Bonds Are at 3.95% and AAA Rated 10 Year Corporate Bonds Are at 3.43%. AAA 20 year Corporates Are at 4.18%. This Compares to Yields Earlier in the Year Approximately 1% to 1.5% lower.

This is the Exact Opposite Result the Fed Has Wanted to Create. The Idea Behind Quantitative Easing is to Depress Yields and Thus Raise Bond Prices to Stimulate Demand and Increase Employment.

Commodities

Commodities Have Been Down in 2013. In 2012 Goldman Sachs Announced the End of the Commodity Super Cycle. The Dow Jones-UBS Commodity Index fell 11.12% percent over 2013. Conversely, the Morgan Stanley Commodity Related Equity Index is Up 10.2 percent in the Same Period.

The Emerging Markets Have Played a Significant Role in Commodities from Foodstuffs to Metals. The Decline in Global Demand (Particularly in China) Has Led to a Decline in the Value of Metals, Energy and Agricultural Products.

Gold is at $1238.60 Down From $1684.90 January 1, 2013. Gold Hit It’s All Time High of $1,923.70 in September 2011.

Silver Stands at $20.21 per ounce. Silver’s High was $49.51 in April 2011.

Oil Stands at $94.22 per Barrel. Down From 108.05 in July.

Natural Gas Stands at $4.35 per Cubic Foot. Down From 5.354 in January 2013.

Where Are the Markets Headed?

Looking in the Rear View Mirror Only Tells Us Where the Economy Has Been. Remember, Past Performance is Not an Indicator of Future Performance. However, There Are Forward Looking Indicators We Can Use to Get a Glimpse of What Lies Ahead.

The Conference Board’s Leading Index of Economic Indicators (LEI) Has Been Up Every Month Since July. This is an Indicator the Economy Has Been Expanding and Foretells Future Expansion.

The Markets Themselves Are an Indicator of Future Economic Expansion. The Markets Strong Performance in 2013 Foretells Economic Expansion. Absent Any Shocks to the Economy Such as a Government Shutdown, Congressional Failure to Raise the Debt Cap, War, Terrorist Attack or Other Unforeseen Event the Economy’s Consensus Forecast is 2% to 2.5% for 2014. However, Optimistic Forecasts are in the 3.0% Range.

The Markets Have Been Staring Congress Down While Tea Party Republicans Have Been Staring Back at the Markets Daring Them to go Down. Yet, Despite Political Brinksmanship the Markets Have Refused to Fall.

We Can Thank the Fed for It’s Foresight to Keep QE Infinite Going. As the Only Arm of Government Addressing Employment, GDP Growth, Capital Formation, Business Investment and a Host of Other Issues the Fed Has Singlehandedly Kept the Economy Upright.

According to Zacks Research ”For the Q3 (Third Quarter) Earnings Season as a Whole, Total Earnings for the 484 S&P 500 Companies That Reported Results as of Thursday Morning November 21st, Were Up +4.9% From the Same Period in 2012. With 65.3% Beating Earnings Expectations with a Median Surprise of +2.53%. Total Revenues for These companies Were Up +3.0%, With 41.7% Beating Revenue Expectations With a Median Surprise of +0.12%. The Results From These 484 Companies Compare to What These Same Companies Reported in Q2 (2nd Quarter) and the Average for the Last 4 quarters. The Earnings and Revenue Growth Rates, Which Looked Weaker in the Earlier Phase of the Q3 Reporting Cycle, Improved Materially.

The Earnings and Revenue Growth Rates for the 86.4% of Retail Sector Companies in the S&P 500 That Have Reported Already Are Modestly Better than What Has Been Seen From Those Same companies in Recent Quarters. But the Beat Ratios, Specifically on the Revenue Side, Remain Very Weak, With the Sector’s Revenue Beat Ratio the Second Worst of All 16 Zacks Sectors in the S&P 500.

Estimates for Q4 Have Started Coming down. Though Judging by Guidance, They Likely Still Have Plenty of Room to go Down. The Picture Emerging Would Hardly be the First Time Estimates Would be Coming Down Like This. We Have Been Seeing This Play Out Quarter After Quarter for More Than a Year Now. The Market Hasn’t Cared Much About This Uninspiring Earnings Picture Thus Far, Likely a Reflection of the Ever-Supportive Fed. And With Most Market Participants Expecting the Fed to Hold Off on Making Any Changes to its Policy Stance till at Least Through April 2014, They May See No Reason to Worry About Negative Estimate Revisions for Q4.” Given the Fed has Begun Tapering Quantitative Easing in December it Remains to be Seen How the Markets Will React.

Goldman Sachs Sees U.S. Growth Accelerating to 3% and “Another Solid Year for Equities, Notably in Developed Markets, With Some Caveats of Course. Goldman’s David Kostin and Other Strategists Laid Out Their S&P 500 Forecasts for Next Year, Reiterating an End-2014 Target of 1,900, a gain of 6% — Its Fair Value Estimate. (Note, That’s a Little More Sunshiny Than the 12-Month S&P Target of 1,840 from Morgan Stanley).

Here Are the Caveats Though. Goldman Says Given the Big Run in the S&P 500 — Some 26% Year-to-Date — the Index Could Fall 6% in the Next Three Months and 11% Over the Next 12 Months, to Levels of 1,700 and 1,600, Respectively. And the Investment Bank Sees a 67% Probability of a 10% Drop at Some Point in 2014”.

The Investment Advisor is Cautiously Optimistic for 2014. The Investment Advisor Sees GDP Growth Between 2.5% and 3.5% for 2014. The Investment Advisor Believes There is a Substantial Probability of a Market Correction between 5% and 20% of Current Market Index Values Over the Next 12 Months. A Number of Catalysts May Trigger a Correction Ranging from Tapering of Quantitative Easing, Raising of the Debt Cap, Regulation as a Result of Dodd Frank, Tax Reform or Other Unforeseen Shocks to the Economy. The Markets Have Proven Resilient to Such Events and The Investment Advisor Believes These Swoons Will be Short Lived.

They Investment Advisor Also Sees a Slow Continued Fall in the Unemployment Rate to the Fed’s Target for Unemployment of 6.5%. The Fed’s Taper is an Indication the Economy is Improving and Has Gained Enough Steam so as Not to Need this Type of Life Support. While Tapering May Act as an Initial Headwind to the Markets Performance as Long as Corporate Earnings Increase the Markets Will Continue to Rise.

Bonds Will Not Fare as Well in 2014. Tapering by the Fed Opens the Spigot for Yields to Rise and Bond Prices to Fall. The Investment Advisor sees the Yield on the 10 year Treasury Bounded Between a Low of 2.25% and a High of 3.5%.

The One Exception to This is Short Term Rates. The Federal Reserve has Developed a Facility that Will Allow it to Keep Rates for Cash Equivalents (Maturities of 1 Year of Less) at or Near Current Rates as it Tapers Back on Quantitative Easing. To Keep the Recovery Going it is Important the Yield Curve Remain Steeply Positively Sloped. Low Interest Rates Have Been Pushing Money Into the Markets. A Rise in Short Term Rates Could Slow the Markets Ascent if Bonds Provide a Less Risky Alternative and Siphon Off Funds That Are Being Driven Into Equities for Better Returns. However, the Fed is Already Taking Steps to Avoid This.

There Are Issues Between the Disparities That Have Been Created by Quantitative Easing Between Wall Street and Main Street. But, the Fed is Not Equipped to Deal with This Problem. The Fed’s Roll is Financial. The Real Economy Cannot Completely Take Off on Its Own Until Fiscal Policy is Applied to the Same Problems. At the Same Time, the Markets Performance Which is Driven by Earnings Performance Will Embolden Companies to Hire and the Recovery Will Broaden. In the Meantime, Those Invested in the Markets Will Have Done Quite Well. 2014 Marks the Bottom of the 7th Inning for the Recovery Since the Financial Crises Began.

The Investment Advisor Seeks to Help You Navigate These Currents and Headwinds in Ways Which Will Empower You in Making Decisions About Your Investments and Finances. The Investment Advisor Believes in Providing You With Information Across Multiple Disciplines Will Help You Put Events in Context and Will Help You Leverage Information to Achieve Your Investment Goals.

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