S&P 500 Earnings Update

Summary

Earnings Scorecard: Of the 496 companies that have reported earnings to date for Q3 2013, 73% have reported earnings above the mean estimate and 52% have reported sales above the mean estimate.

Earnings Growth: The blended earnings growth rate for Q3 2013 is 3.5%. The Consumer Discretionary has the highest earnings growth rate for the quarter, while the Energy sector has the lowest earnings growth rate for the quarter.

Earnings Guidance: For Q4 2013, 92 companies have issued negative EPS guidance and 11 companies have issued positive EPS guidance.

Valuation: The current 12-month forward P/E ratio is 15.0. This P/E ratio is above the 10-year average of 14.0. See Factset.com chart below for historic view.

 

Are The Models Broken?

Recently I read an article about several investment firms that were making changes to their quantitative process for their models.  Just last month, GMO, a highly regarded investment institution, published a report noting changes they made to their quantitative model, which had stated the S&P 500 index is about 50% overvalued!  Even the popular firm Vanguard is launching a new Quantitative Strategy as part of their line up.

So why all of the changes?  Our guess is that there is a profound disconnect between current asset prices and economic fundamentals that has rendered the models useless.

A good deal of the disconnect seems to be with the decline of the U.S. dollar.  When the global currency system was established several decades ago with the U.S. dollar as the reserve currency, the US was more than 50% of the world's GDP.  It is now around half of that amount, causing their to be more dollars in the world then there is demand for them.  Also QE by the Fed has accelerated this process and threatens the long-term value of the dollar.  One has to wonder if the new models will be able to handle the disconnects that will likely manifest in an economic environment where monetary policy is not as accommodative.

We must also keep an eye on inflation versus deflation debate as the central banks around the globe face great challenges in resurrecting but containing inflation while making sure a deflationary spiral does not take hold. 

Real Income versus Fed Balance Sheet

 

Since just before the start of the last recession, median household income has been declining at a significant rate.  At the same time, the Federal Reserve's balance sheet has exploded to just shy of $4 trillion.   

 

It is increasingly clear that the primary beneficiaries of Ben Bernanke’s wealth effect are financial assets not median income or employment. Unfortunately, the Federal Reserve seems to have learned nothing from the aftermath of the dot-com and housing bubbles of the recent past. Like politicians, they never ever admit wrongdoing or acknowledge the negative effects or unintended consequences of their policies.

 

U.S. Balance Sheet In The Red

The picture painted by the federal balance for fiscal year 2012 (which was recently released) shows a nation with a negative net worth of more than $16 trillion, according to the Treasury Department's year-end reports and calculations from banking analyst Dick Bove.  Hopefully Congress can come up with some solutions to our fiscal dilemma.  Balance sheet details are below.



The United States Balance Sheet ending on September 30, 2012

Assets	Billions		Liabilities	Billions
Cash & other monetary assets	$206.20		Accounts payable	$65.20
Accounts and taxes receivable	$111.20		Federal debt securities held by the public	$11,332.30
Loans receivable and MBS	$859.60		Federal empl. and veteran benefits payable	$6,274.00
TARP direct loans and equity investments	$40.20		Environmental and disposable liabilities	$339.00
Inventories and related property	$299.00		Benefits due and payable	$166.20
Property, plan t and equipment	$855.00		Insurance and guarantee program liabilities	$156.40
Debt and equity securities	$110.20		Loan guarantee liabilities	$74.60
Investments in GSEs	$109.30		Liabilities to GSEs	$9.00
Other assets	$157.60		Other liabilities	$432.60
Total	$2,748.30		Total liabilities	$18,849.30

Bond Market Recovery - Real or Not?

The bond market is currently enjoying a decent recovery from a sharp selloff it experienced over the summer on Federal Reserve taper talk.  As welcome as this recovery will be for many bond holders, it in no way gives this market the all clear going forwards. It is a very common characteristic of early stages in bear markets of asset classes that the initial break comes rather quickly and without prior warning.  We can bet that almost nobody predicted the sharp spike higher in yields over the summer.  And that once it has run its course is followed by a strong rally (which we are likely now experiencing) that can remain in place for many weeks or even months.

Unfortunately this period of low volatility and recovery is rarely used by investors as an opportunity to sell positions; instead investors typically pour money back to the asset class in question arguing that they are buying a favored asset class at a discount.  Ironically, this was the case with gold in 2012 when holdings of the metal peaked in late December some several months after the price had already peaked at a significantly higher level. This allowed losses in the metal to remain fairly muted before its sudden collapse in earlier this year, which was matched by substantial liquidation of gold holdings.

Over the next several months, it is likely the bond market currently offers little upside and is far more dependent on the actions of central banks than the equity market.  While positions in individual bonds with short-term maturities and reasonable yields should hold up well, the high grade corporate bond market, bond funds, as well as the Treasury markets are likely to have significant downside volatility at some point in the future.  We will keep an open mind about how much longer this period can last, but the likelihood of a happy ending for those investors that take it for granted looks increasingly remote.

Politics, Politics, Politics...

After more than two weeks of a government shutdown and threats by Congressional Republicans to not raise the debt limit without serious spending cuts, Republicans conceded late Wednesday in their bitter fight with President Obama over the new health care law.  The House and Senate approved last-minute legislation ending a 16-day government shutdown and extending federal borrowing power to avert a financial default.

The shutdown sent Republican poll ratings plunging and this is the main reason an agreement was reached.  Most Americans believe it is the Republicans who are at fault.  However, everyone is at fault when House and Senate members put politics over progress.  The shut down cost the government billions of dollars and damaged the nation’s international credibility.

In the end President Obama refused to compromise so Republican leaders had to back down from their hard line stand and compromise on a deal.  Under the agreement to reopen the government, the House and Senate are directed to hold talks and reach accord by Dec. 13 (right before their holiday break) on a long-term blueprint for tax and spending policies over the next decade.  President Obama said stated that he is willing to talk about the budget once the government was reopened and the debt limit raised.

Unfortunately, there are absolutely no guarantees that Congress can work out a deal before mid-January, and there is deep skepticism in both parties that those involved in the budget negotiations, can bridge the divide between the two parties. It is possible we will go through the same process again in less than 90 days; which could rattle the markets especially if the government shuts down again.

Gov't Shutdown Actually Positive for Markets

The U.S. congressional standoff that shut down the government for the first time in 17 years could be considered an opportunity for investors, if history is any guide.
The Standard & Poor’s 500 Index has risen 11 percent on average in the 12 months following a government shutdown, according to data compiled by Bloomberg on instances since 1976. There have been 17 government shutdowns since 1976, with five of them occurring within three months of each other, according to data compiled by Bloomberg.

The last time there was speculation about a U.S. government shutdown was in August 2011, when the S&P 500 fell more than 11 percent in three days.  Stocks tumbled during the stalemate between President Barack Obama and Congress over whether to raise the debt ceiling and S&P stripped the U.S. of its AAA credit rating during the month.

The losses were later reversed over the next few months, as the Federal Reserve pledged to hold the benchmark interest rate near zero and maintain bond purchases to support the economy.

Although analysts’ have reduced earnings estimates for Q3 for the S&P 500, they still expect a significant improvement in earnings growth in the fourth quarter of this year (current quarter).  Earnings growth is expected to be up 10% in the fourth quarter vs. 3.2% growth for the third quarter.  This should add support to the stock market after the debates in Congress are resolved.  

Hopefully, when all of the silly games by Congress have concluded, the markets will rebound in the coming months, assuming earnings growth in the fourth quarter is strong.

Too bad this wasn’t an election year…

The Fed Is Not Going Away

Wow.  That about describes what the Fed decided when it announced it was not going to scale back asset purchases.  We thought for sure the Fed was going to cut back its stimulus.  This was the best chance for the Fed to begin exiting asset purchases while transitioning to a new Fed Chief in January.  It is very clear now that the Fed is likely never exiting; it is never cutting back on stimulus. 

The Fed has just put itself in a box that it isn’t going to be able to get out of.  Printing money and purchasing assets leads to lower rates and helps to re-inflate the real estate market.  At the same time, these low rates also help keep the government's borrowing costs low at a time when it's running huge deficits.

Did you know that despite the national debt being nearly triple what it was in the mid-1990’s, the nominal interest payments are actually about the same as they are today? This means that despite the far higher national debt, the government pays about the same amount as interest on this debt as it did 20 years ago.  Instead of paying 3% and 7% on 1-year and 10-year Treasury bonds for example, the government is currently paying about 0.25% and 2.75%. Keeping interest rates low is not necessarily just about benefiting the economy (although that is the intent), but rather about keeping the government itself solvent in a time of major political and fiscal problems.

With the Fed announcement this week, the markets broke out to new all-time highs.  While the Fed will never publically admit, part of the reason they decided not to taper is the Fed is fearful of what it would do to the equity markets.  The Fed has been involved in the capital markets now for over 5 years and counting.  The economy, as well as the stock and bond markets, is relying on this stimulus.  If the Fed stops providing stimulus it could cause another crisis, at least that’s what they probably believe.

Now the next Fed meeting isn’t until December.  At that time, Bernanke will be just a few short weeks from stepping down.  We should also know who the new Fed chief will be in the next month.  After the December meeting the next meeting is in March, and the new Fed chair will be barely two months into the job. We don’t expect any changes to policy until at least that time. 

The Fed is going to continue to print until it is forced to stop.  Unfortunately they don’t even know when that will be.  The Feds actions are likely going to create other issues yet to be determined.  The eventual comeuppance will not be pretty, but it’s impossible to know when it will occur.  As with most things in life, timing is everything.   

Why The Fed Will Taper

If you think the Federal Reserve has been happy with the rapid rise in Treasury yields, particularly the 10 year yield, you would be mistaken.  The Fed has to be very uncomfortable with the velocity of this recent move, which has seen the 10 year yield climb up from 1.6 percent to 2.9 percent in just 3 short months.  So how does the Fed keep the 10 year yield from climbing even higher, even as their policies are being questioned?  The Fed tapers asset purchases.

The central bank likely believes that is creating a number of possible asset bubbles that will only get worse if the Fed continues down the current path.  The Fed is probably becoming fearful that any further increase in speculative driven behavior could threaten the financial stability of the U.S. banking system in the future.  Tapering will show the markets the Fed is very serious about creating price stability and is working to return capital markets to normal function.

However, tapering could rattle the markets as it comes at a time when economic data has been mixed to slightly weaker than expected.  Rattled markets would likely mean a flight to safely (treasuries) which could push down the 10 year yield.  In this scenario the Fed gets everything they want – lower interest rates, less asset purchases each month, and less liquidity flowing into the stock market.  Can someone say Goldilocks?

Tapering - What Will Happen?

Let’s assume for a moment the Federal Reserve starts to taper and the economy does just fine.  Economic data remains decent and GDP continues to grow at a modest pace.  What will the Fed do if the economy can handle "less Fed intervention"?  The assumption is the Fed will decide to taper more quickly.  If it is determined that tapering doesn't hurt the economy, expect the Fed to taper at a faster rate, which given the current environment will likely hurt stocks more than bonds. Volatility will likely increase.

 

Now let's assume the Federal Reserve starts to taper and it impacts the economy.  Economic data starts to show a decline in activity and GDP growth slows markedly.  Will the Fed stop tapering and start buying again? Very likely.  But the market may not assume this outcome and may decline.  In this crazy, upside down world the Fed has created, it's very possible that the Fed will taper, economic data gets worse, the Fed "un-tapers", starts purchasing again, and markets rally as they realize the Fed and QE is here to stay.  Volatility will likely increase in this scenario as well. 

 

Based on these assumptions we can likely conclude that volatility in the markets (both stock and bond) is likely to be around over the next few months regardless of what the Fed ultimately decides to do.

S&P 500 Earnings Estimate Update

Due in part to negative EPS guidance, analysts have lowered earnings expectations for the third quarter. The estimated earnings growth rate for Q3 2013 is 4.8%, down from an estimate of 6.9% at the start of the quarter (June 30). Seven of the ten sectors have recorded a decline in expected earnings during this time, led by the Materials and Information Technology sectors.

The Materials sector has seen the largest drop in expected earnings growth (to 1.1% from 15.3%) since the start of the quarter. Companies in the Metals & Mining industry have witnessed the largest cuts to estimates during this time.  The Information Technology sector has witnessed the second largest decrease in expected earnings growth (to 1.8% from 5.5%) since June 30.

Although analysts have reduced earnings growth expectations for Q3 2013 (to 4.8% from 6.9%) and Q4 2013 (to 11.1% from 12.1%) since June 30, they still expect a significant improvement in earnings growth in the second half of 2013 relative to the 1st half of 2013.  For Q3 2013, two of the ten sectors are projected to see double-digit earnings growth: Financials (11.7%) and Consumer Discretionary (10.0%).

However, estimated revenue growth rates for both Q3 2013 (2.8%) and Q4 2013 (0.7%) are expected to be below estimated earnings growth rates, particularly for Q4 2013. No sector is expected to see double-digit revenue growth in either quarter.

Interestingly enough, earnings estimates for 2013 continue to decline (as they have all year).  Current expectations are for $108.50 for fiscal 2013 as of July 31st, down from roughly $112.00 in January, and down from roughly $110.50 at the end of April.  It is highly unlikely markets can continue to rise if earnings estimates continue to decline.

Institutions Becoming More Cautious?

Every week, the Bank Of America Merrill Lynch equity strategy team breaks out data on how much clients are buying and selling.  The report looks at the average of a 4-week time frame.  Over the last few months, the big institutional clients at the bank have been rotating out of stocks on a consistent basis, while the average investor seems to continue to like to buy into the market.

According to this week's data, the amount of selling by institutional clients over the past four weeks has hit the highest level on record.  "Net weekly sales by this group were the largest since March, and the sixth-largest in our data history (since 2008)," writes BAML strategist Savita Subramanian in a note. "And on a four-week week average basis, outflows by institutional clients are the largest in our data history."

While this is only one piece of market data and should be taken in context, it's important to pay attention to what institutions are doing.  While markets can always continue to move higher, it's usually wise to be aware of the actions of institutions, especially when retails investors are doing the exact opposite.

 

 

Smart Investors Losing An Edge?

Big Macro swings in capital markets are confounding even the veterans.

 

Stan Druckenmiller, a one-time chief investment officer of Soros Fund Management, says that investing is becoming harder for him, “because the importance of my skills is receding”. According to an interview with Goldman Sachs said:

 

“My strength is economic forecasting, but that only works in free markets, when markets are smarter than people. That’s how I started. I watched the stock market, how equities reacted to change in levels of economic activity and I could understand how price signals worked and how to forecast them. Today, all these price signals are compromised and I’m seriously questioning whether I have any competitive advantage left.”

 

“Ten years ago, if the stock market had done what it has just done now, I could practically guarantee you that growth was going to accelerate. Now, it’s a possibility, but I would rather say that the market is rigged and people are chasing these assets, without growth necessarily backing confidence. It’s not predicting anything the way it used to and that really makes me reconsider my ability to generate superior returns.”

 

Throw market manipulation by central banks and things get really confusing, says Druckenmiller: “If the most important price in the most important economy in the world is being rigged, and everything else is priced off it, what am I supposed to read into other price movements?”

 

Global macro managers bet on big economic trends and policy decisions. But many have found it difficult to time the frequent ups and downs of markets in which swings are often driven by announcements from politicians or central bankers.  Druckenmiller is not alone. In November Geoff Grant, founder of U.S. hedge fund manager Grant Capital, said that he was shutting down because "he has decided his global macro strategy didn't have an edge in today's markets."

 

One of two things may be happening in this new world of investing; either the baton is being passed onto central bankers to rule the day, possibly indefinitely; or we are approaching an extremely vulnerable juncture in financial markets.  We may look back and realize that following the smart money investors out of financial markets may have been the smartest move of all.  Only time will tell.

  

Something Has Changed

After an ugly day like we had yesterday, we should expect the market to stabilize a bit.  It's very rare for the market to drop by more than 1.5% three days in a row.

After the worst day so far this year on Thursday, when we sold off on large volume and declining stocks far outpaced advancing stocks, it is reasonable to look for some sort of bounce.  It's just the nature of the market.  However, the action over the past two days is a bad sign and indicative that something has changed in the market.

Market participants have enjoyed small pullbacks over the past few years with little fear of a steep decline because they could always count on a friendly Fed and its unending supply of liquidity.  However, we may not be able to count on the Fed (at least that is the perception) to keep on buying bonds and this adds real risk to the idea of a quick recovery in the markets.  The liquidity has been the main driver of the markets over the past few years.
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As we mentioned last week, it was odd to see so many sectors and asset classes declining without pause.  We stated that it was either a correctional rotation out of certain sectors and asset classes into other sectors/asset classes, or it is foreshadowing a change in market behavior.  We now know it was foreshadowing a possible change in market behavior.

While it's impossible to predict what the market will do over the next week or month, we can always hedge against various outcomes.  One way to do this is to raise some cash to protect against downside risk.  Cash also allows one to take advantage of opportunities created by the increased volatility. 

It's possible this could be just your run-of-the-mill correction in the global markets; with the markets eventually finding a floor and recovering to new highs.  It's also possible that global markets, driven mainly by central bank liquidity, are realizing that maybe they can't make it on their own.

Underneath the Surface

As volatility in the global markets has increased, we are witnessing unprecedented declines in various sectors and asset classes - all at the same time.  While the broad markets in the U.S. are only about 5 % off of their highs, many areas of the market have fallen much further.  While the decline can be partially attributed to the possibility the Fed may end quantitative easing (which many don't believe will happen soon), it doesn't explain it completely.  The dollar for example should be rising, not falling if the Fed is planning to curb its fiscal program.

Since a picture is definitely worth a thousand words we have posted several charts below.  These charts are of various sectors over the past few months.  Pay special attention to the last few weeks on the right side of each chart.

Either these is a correctional rotation out of certain sectors and asset classes into other sectors/asset classes, or it be foreshadowing a change in market behavior. 

Commodities

 

Copper

Dollar

 

 

Emerging Markets

 

Emerging Markets Debt

Japan

Real Estate

Bonds

Maximize Social Security Benefits

Would you like to maximize the Social Security benefits your spouse gets at the same time you maximize the benefits you will receive?  The answer is most likely yes! 

You may be able to using a Social Security procedure known as "file and suspend"  If you are married and have reached your full retirement age (FRA), you can simultaneously file for Social Security, then request that your benefits be suspended until you reach age 70.  After you have suspended benefits, then your spouse could apply to begin receiving Social Security benefits based upon your earnings record.  

In some instances where one spouse has not worked for pay, or earned considerably less income than the other, the benefit the spouse would receive could be higher than the benefit the spouse would receive under his or her own work record.  

Here is an example of how "file and suspend" works.  Let's assume Stan and his wife Julia have both reached age 66. He is eligible for a monthly $2,000 benefit, while Julia, if she were to file for Social Security, would get $500 a month based on her work record. Henry decides to invoke his file-and-suspend option.  At the same time or shortly thereafter, Julia can file to receive her spousal benefits based on Henry's earnings. Those benefits will be $1,000, 50% of what Henry was eligible to receive at 66.  In other words, because Henry has taken the file-and-suspend option Julia's benefits immediately jump by $500 a month.

If you reach your full retirement age and delay collecting your benefits until age 70, your eventual benefit will grow by 8% each year between ages 66 and 70 according to the social security administration. 

Under this scenario, when Henry finally starts collecting his benefits at age 70, he would find that his monthly check would be $2,640, not the $2,000 he would have received at age 66.

Although filing for Social Security and then suspending payments can be financially beneficial, it won't increase benefits for all couples. The file and suspend option isn't helpful when one spouse worked for the Federal or state government and is receiving a pension. 

It won't work in instances where two spouses earned similar amounts over their careers. If the husband files-and-suspends his spouse would get 50% of his benefits—but that 50% would yield a monthly check that would be lower than the one she would be eligible for under her own earnings record. 

Also, obviously, you should consider your health before deciding to postpone your Social Security benefits. If you are in good health and have  a history of longevity in your family, this may be a great option.  Conversely, if you are not in good health and/or need the cash flow, file and suspend may not be the best strategy.

File and suspend involves delaying full benefits so you need to have access to funds to be able to make up the difference you would have received if you were collecting full benefits at FRA.

If you are about to turn 66 keep in mind that you don't have to rush to make a decision about file and suspend immediately. You can use that option later. Conversely, if you have invoked your file and suspend option, but then find you do need your Social Security check before you turn 70, you can immediately reinstate getting your benefits. 

Information on file and suspend may be found at the link below:

http://www.ssa.gov/retire2/suspend.htm

Housing Market in Trouble?

It seems like there may be a bit of a perception problem in housing.  While the most recent housing data definitively shows housing prices on the rise across most of the country, mainly due to all cash deals, there is conflicting data underneath the surface.  According to recent figures, mortgage interest rates are on the rise across all durations while at the same time lumber futures continue to decline after peaking in March. While this may be just a temporary slowdown based on lower demand from China, it will be important to monitor developments in the coming months.  See charts below.

Sentiment Reaching Extremes

As the US indices continue to move higher without missing a beat, the sentiment indicators over the past month are starting to show extreme readings.  In the past few years these readings have been associated with moderate to meaningful pullbacks in the markets.  Courtesy of SentimenTrader on the chart below you can see the spread between the institutional investors and retail investors has widened to levels not seen since the fall of 2012, right before the market corrected.  The higher the number the more confident that group is the market will be higher in the coming weeks.  While the spread can continue to widen if the market continues to climb, the risk to reward ratio is not looking very attractive.  Remember, we always want to follow the smart money (green line) and right now they are not particularly confident.   

S&P 500 Earnings Estimates Decrease

Back in February we noted that while the US markets continue to move higher, operating earnings for S&P 500 companies for the year ending 12/31/2013 continue to move lower.  We called this an interesting divergence.  At that time, the most recent projection for 2013 composite earnings was roughly $111.50.

Flash forward a few months and the final numbers for 2012 have been posted ($96.82) and the estimates for 2013, surprisingly continue to decrease.  As of May 1st, the S&P 500 operating earnings estimates for 2013 have decreased to $110.52.  While the decrease doesn't seem that significant, it's the trend that is worrisome.  The earnings estimates have been declining each month this year.

If we assume all the companies in the S&P 500 will post earnings of $110.52 for 2013 (current estimate) and we know the final results for 2012 were $96,82, the expectation is for earnings growth of roughly 14% for 2013.  We would consider this solid growth, especially in the current economic environment.  Since the markets tend to follow earnings we could expect the markets to increase roughly 14% +/- for the year assuming the estimates become reality.

Well, the US market, as measure by the S&P 500, is already up 12% so far this year.  If the earnings estimates stop declining and begin to move higher, we can rationally expect the markets to move higher along with earnings.  But if the earnings estimates continue to decline, we would expect this reality of slowing earnings growth to eventually catch up to the markets.  Right now perception is reality and the perception is earnings estimates will increase in the second half of the year.  While this may definitely prove to be correct, the current facts show the opposite.  If this divergence doesn't resolve itself for the positive in the near term, we should expect volatility in the market to increase.  Earnings estimates will be important to watch in the weeks/months ahead.
 


 

Lowest Yield on Treasuries in History

They say a picture is worth a thousand words.  The chart below of the 10-year Treasury yield (the rate on which mortgages are based) is at it's lowest point in recorded history and could move even lower in the coming months.  Unprecedented in terms of our history.


Click on picture for larger image.

Real Average Hourly Earnings

Although the economy may be slowly improving, the reason it probably doesn't feel that way to most people is because real average hourly earnings (earnings factoring for inflation) have declined since 2009 while average hours per week worked has risen over the same time period.  Companies are paying workers less on average and asking them to work more hours.  Unfortunately this is not what we want to see at this point in an economic recovery.

 

Employment Report Update

The graph below shows the job losses from the start of the employment recession, in percentage terms.  The red line represents the current recession. The zero on the X axis shows maximum job losses and each recession is aligned at this maximum point.

As you can see in the chart, all of he post WWII recessions show strong employment growth in the months immediately following the peak unemployment percentage (zero point), except for the most recent recession.  Although we are headed in the right direction, we still have a way to go to get back the jobs that were lost. 

In the most recent report from the Labor Department, the US created 88,000 jobs in the month of March, far less than was expected and the lowest reading in a year.  After such a strong number in February, this comes as a bit of a surprise to many.  This decrease indicates there was a slowdown in hiring although it may be a temporary phenomenon.

Micro Lending

Micro Lending is the extension of very small loans, called micro loans, to impoverished borrowers who typically lack any form of collateral, steady full-time employment and a verifiable credit history.  It is designed not only to support entrepreneurship and alleviate poverty, but also in many cases to empower women and uplift entire communities. In many communities worldwide, in developed and developing nations alike, women lack the highly stable employment histories that traditional lenders tend to require. This reality might result from factors such as leaving the paid workforce to care for children and elderly relatives. As of 2010 an estimated 75 million men and women held micro loans that totalled US $38 billion.  Grameen Bank, who first founded micro loans, reports that repayment success rates are between 95 and 98%. As of 2012, micro lending is widely used in developing countries and is presented as having "enormous potential as a tool for poverty alleviation."

The principles of micro lending have also been applied in attempting to address several non-poverty related issues. Among these, multiple Internet-based organizations have developed platforms that facilitate a modified form of peer-to-peer lending where a loan is not made in the form of a single, direct loan, but as the aggregation of a number of smaller loans, often at a reduced or negligible interest rate.

New platforms that connect lenders to micro-entrepreneurs are emerging on the Web, for example Kiva, Zidisha, and World Vision Micro all provide aggregate loans to micro-entrepreneurs.  In 2010, US based non-profit Zidisha became the first peer-to-peer micro lending platform to link lenders and borrowers directly across international borders with any intermediaries.  One of the great features of the program is that lenders can track the progress of the recipient of their loan.

If you are looking to a philanthropic alternative to direct giving of cash to a charity, web-based micro lending sites may be a viable option to consider.

Obamacare Taxes in 2014

At the end of 2012, we discussed the implementation of the Affordable Care Act also known as Obamacare.  The article discussing the taxes which began in January of this year can be found here:  Obamacare 2013.  The taxes which began in January are the first phase of the Act with the second phase coming in January of 2014.  While we are still roughly 8 months away, we thought we would mention that health care insurance premiums could dramatically increase as insurance providers pass on the new taxes to consumers (see Tax on Health Insurers below). Anyone who is paying for health insurance should expect an increase in premiums.

Below is a summary of the taxes that will take effect in 2014.

Individual Mandate Excise Tax (Jan 2014): Starting in 2014, anyone not buying “qualifying” health insurance must pay an income surtax according to the higher of the following:

	1 Adult	2 Adults	3+ Adults
2014	1% AGI/$95	1% AGI/$190	1% AGI/$285
2015	2% AGI/$325	2% AGI/$650	2% AGI/$975
2016 +	2.5% AGI/$695	2.5% AGI/$1390	2.5% AGI/$2085

Exemptions for religious objectors, undocumented immigrants, prisoners, those earning less than the poverty line, members of Indian tribes, and hardship cases.

 

Employer Mandate Tax (Jan 2014): If an employer does not offer health coverage, and at least one employee qualifies for a health tax credit, the employer must pay an additional non-deductible tax of $2000 for all full-time employees.  Applies to all employers with 50 or more employees. If any employee actually receives coverage through the exchange, the penalty on the employer for that employee rises to $3000.  If the employer requires a waiting period to enroll in coverage of 30-60 days, there is a $400 tax per employee ($600 if the period is 60 days or longer).

Tax on Health Insurers (Jan 2014): Annual tax on the industry imposed relative to health insurance premiums collected that year. Phases in gradually until 2018. Fully-imposed on firms with $50 million+ in profits.

With the economy still struggling to grow at full capacity, we expect these additonal taxes could weigh heaviliy on consumer spending in 2014.

Dow Jones Average At All-time High

This past week saw the Dow Jones Industrial Average reach an all-time high.  The S&P 500 index isn’t far behind, just a few percent from its all-time high established in October 2007.  It has been a long 13 years for most investors.  This dreary market has conditioned most investors to fear the worst from capital markets.

However, unlike the backdrop to the market peaks of 2000 and 2007, both economic conditions and monetary policy remain favorable to the equity markets going forward. In March 2000, the Fed had been raising rates for a full year.  There was one more rate hike in May 2000 that essentially ended the bull market.  It wasn’t until the following year the Fed would lower rates for the first time.  Unfortunately, business models by US corporations were predicated on unrealistic expectations and the slowdown in the economy was quite severe.

In 2007 the Fed had just started to wake up to the severity of the subprime crisis when the market peaked. Indeed the decision to reduce the discount rate in August and the Fed funds rate in September provided the final spurt that took the S&P 500 to its new high on October 12, 2007.  We don’t need to remind readers what happened in over the next year and one half.

The situation today is much different.  The Fed remains in permanent liquidity mode and continues to buy bonds at a furious pace, with no end in sight.  While we worry about the long term implications of Fed policies to the economy and the dollar, it has definitely worked wonders for the equity markets.  Monetary policy is a very important determinate to investing in equity markets, and remains a positive influence.

In addition, economic growth over the past two years has been positive, albeit modestly so.  Corporations and consumers continue to deleverage which is another plus. 

None of this guarantees it will be smooth sailing and we would expect the next downturn in the markets to be very volatile, especially if the market keeps climbing at the current pace.  If the market continues to increase at this rate it will almost double by this time next year.  We don’t think that is very likely.

Most Expensive States in the US

While surfing the Internet to research a particular piece of tax information, I came across an article listing the 10 most expensive states for 2012.  What surprised me was that Vermont and Alaska were in the top 10.  Sadly, in a few years it's possible Connecticut could move to #1 or #2 with increased income tax and sales tax rates implemented in 2012.  See the top ten list below:

10. Massachusetts

Movie ticket: $10.77
Rent: $1,450
Doctor visit: $145.33
Gallon of gas: $3.503
T-bone steak: $9.61

9. Vermont

Movie ticket: $9.19
Rent: $1,354
Doctor visit: $102.50
Gallon of gas: $3.494
T-bone steak: $8.75

8. Maryland

Movie ticket: $10.86
Rent: $1,577
Doctor visit: $87.98
Gallon of gas: $3.625
T-bone steak: $10.28

7. Rhode Island

Movie ticket: $10.85
Rent: $1,375
Doctor visit: $149.00
Gallon of gas: $3.606
T-bone steak: $10.51

6. New Jersey

Movie ticket: $10.86
Rent: $1,631
Doctor visit: $83.24
Gallon of gas: $3.449
T-bone steak: $9.91

5. California

Movie ticket: $10.81
Rent: $2,524
Doctor visit: $121.27
Gallon of gas: $3.741
T-bone steak: $10.25

4. New York

Movie ticket: $13.06
Rent: $3,378
Doctor visit: $140.40
Gallon of gas: $3.884
T-bone steak: $14.25

3. Connecticut

Movie ticket: $10.38
Rent: $1,993
Doctor visit: $116.74
Gallon of gas: $3.845
T-bone steak: $10.82

2. Alaska

Movie ticket: $10.50
Rent: $1,437
Doctor visit: $156.42
Gallon of gas: $3.941
T-bone steak: $10.64

1. Hawaii

Movie ticket: $10.31
Rent: $2,658
Doctor visit: $129.13
Gallon of gas: $3.987
T-bone steak: $7.80

 

An Interesting Divergence

While the US markets continue to move higher in 2013, operating earnings for S&P 500 companies for the year ending 12/31/2013 continue to move lower - an interesting divergence.  The most recent projection has 2013 earnings of roughly $111.50 for the S&P 500 Index.

As you can see in the chart below, the estimates for 2013 during the first 6 months of 2012 stayed about the same until companies provided more guidance for the next year around July 2012.  This is when earnings estimates for 2013 began to decline.  During the last quarter of 2012, the decline in earnings estimates for 2013 decreased more dramatically.  While the decline may just be an adjustment to have more accurate numbers, we find it interesting that in January 2012, the expectations for earnings for the calendar year 2012 were roughly $110.00.  However, the actual operating earnings for the S&P 500 will likely come in around $98.00, well below the $110.00 estimate from January 2012.

If the estimates right now ($111.50) are accurate the markets should experience solid earnings growth in 2013 versus 2012.  However, if these estimates continue to move lower over the course of this year (as they did last year), we would expect the markets to adjust expectations accordingly causing volatility to increase.  Earnings estimates will be an important barometer of the economic health of the economy and should be watched carefully over the coming months.

Expectations for 2013

 

As we begin 2013, the financial markets appear to only be concerned with the existence or non-existence of macro headlines and events.  At the end of 2012 it looked like the market was about to nosedive because of the fiscal cliff issue.  But a last minute deal sent the market up into the beginning of the year for one of the best January returns on record.  There seems to be a disconnect between market movements and basic fundamentals.  Chasing momentum and liquidity can be a dangerous venture because when the markets turn, all of the momentum driven gains can be wiped out in a short period of time.  Surprisingly, the markets have basically returned half of an average year's return in just one month.

We continue to look for attractive risk/reward opportunities, but find it difficult in a market that does nothing but move higher.  We expect the market to have a respectable year if the economy continues its modest growth track and fiscal policies continue.

However, we wonder how long current fiscal policies can be sustained.  Long term, secular trends with a reliance on deficit spending, ongoing stimulus, tax increases, and central bank intervention to promote growth are simply not sustainable in our opinion.  Intervention is not a viable solution and there is likely going to be a cost to fix all of this.  What are policy makers going to do when the economy begins to slow down again? Guess that's for someone else to worry about. 

Growth in Food Stamps vs Payroll Jobs

Since the Great Recession officially ended in 2009, the growth in individuals on food stamps has greatly outpaced the rate of job growth.  The number of food stamp recipients has jumped by over 30% since June 2009, while the number of non-farm payroll jobs has grown by just 2% over that same time period.  Considering many of the jobs created are in low wage industries, the household sector is clearly still suffering.