News, Vision & Voice for the Advisory Community
Trendmeister Isbitts canvasses burning topics ranging from gold to the bond bubble to the rise of the Millennials, explains why the 'plastics'-like word of the year is 'dividends' and boldly revisits his predictions for 2012
January 14, 2013 — 4:49 AM UTC by Guest Columnist Rob Isbitts
Another year older and deeper in debt. But enough about the U.S. government, let’s focus on where we have been with our clients as RIAs and where we are going.
Around this time last year, I listed a dozen issues I thought you and your clients should really be focusing on in 2012. Here’s a review of those, and a baker’s dozen for 2013. Note that I don’t have enough material to keep adding another observation every year, so we’ll cap this list at 13 each year hence. See: 12 for 2012: A dozen issues you and your clients should really be focusing on this year.
Stock market had a solid up year … or was it just a quarter?
As you may recall, the S&P 500 Index broke even in 2011. In 2012, with a presidential election in November and a fiscal cliff looming in the final days of the year, following financial developments often seemed like watching an NBA game. You could take as many breaks from the action as you wanted to — as long as you were there for the fourth quarter. Final score: the S&P 500, without dividends, rose 13.41%. (The total return index rose an even 16%). See: Can we handle the truth? The 30-year golden era for the S&P 500 may have been a period of decent growth juiced by leverage.
But the gain for the year pretty much occurred in the first quarter. The index finished March at 1408, and in a volatile final day of the year as the fiscal cliff drama dragged out, the index crossed through that exact point again before finishing 2012 at 1426.19. In between, there was a lot of jockeying for position, within a range of about 1475 to 1267. So, after that big first quarter — as the venerable sportscaster Warner Wolf used to say — “you could have turned your TV sets off right there!” But if you had, you would have missed a lot of things that to your clients were relatively invisible, but to you could provide much perspective for 2013. See: Smelling blood on Wall Street, genteel family offices are using the 'S’ word, study shows.
This list and you
The 12 items on my 2012 list are secular (i.e., long-term) in nature. They are themes you will want to watch for at least the next few years. I feel strongly that these issues not only will have a lot to do with how your portfolios perform but are some of the best conversation-starters with your clients in meetings and phone calls. After all, would you rather be one of those advisors who preach the right thing (investing to one’s long-term objectives), yet find themselves constantly explaining short-term performance to clients?
If you change nothing else in your practice in 2013, I hope that you will recognize just how vital it is to offer more than just your own take on the standard financial-TV-soaked issues that are intended for traders, not investors. See: Why smart diversification and risk management are your best friends.
I have found over and over that an advisor’s clients are more concerned that their advisor has their back and is not simply parroting what some gigantic firm has to say in “Wall Street language.” Instead, find a way to identify key issues and themes that your clients can’t get from Cramer or “Fast Money” and distill those issues into plain English. Then, tell them about it and keep telling them about it. It is better than any mass-marketed “drip” campaign you can find for client retention, and positions you as a true advocate for them. See: How 5 seriously overworked buzzwords can come between you and your client.
So, without further ado, here are my “13 for 2013” — what you should be watching for.
While short-term sentiment surveys are one piece of this, there is a far more prominent trend at work. Investors are running from the stock market. Fund flows out of stocks are massive and have been for a few years. The punch line: Much of the outflow is finding a home in high-quality fixed-income funds. This creates the potential for yet another rude awakening for retirees and pre-retirees. With bond rates at these low levels, one has a choice of a low positive return or a potentially large negative return in the years ahead. Who wants that choice?
Investors still think the stock market is money pit. This has pushed apathy to the extreme (if such a thing is possible). More on the critical implications of that later. To me, the stock market is more disorganized right now than anything else. That’s not the same as a money pit. I think professional investors are making that distinction much more easily than their clients are today. As an advisor, it is your job to not simply be a “yes-person” to your client on his or her own investment sentiment. Rather, look at both sides and emphasize that investing is rarely black and white, but rather “shades of gray.” And no, I am not trying to stoke an unusually high level of arousal with that expression. See: 5 counterintuitive reasons why the investment vehicle of the the decade is … stocks.
2. The U.S. misery index
The misery index is simply the sum of the headline unemployment rate (the one the government refers to internally as “U-3”) and the core inflation rate (the version that excludes food and energy). At year-end, the misery index stood at 9.46%. The unemployment rate was 7.7% and the Inflation rate was a mere 1.76%. Lost in all of the hoopla over the fiscal cliff is that inflation is so low, one wonders if deflation is more likely going forward. We can thank the secular advancements in technology and efficiency for that. While food prices appear to be in a long-term rising trend, energy prices may moderate because of new oil supplies and our glut of natural gas. The misery index now stands at its lowest level since September 2009. See: 10 investment ideas that STILL don’t work.
3. U-6 Unemployment
This is the measure of joblessness that includes those who are underemployed —are working part time but want to work full time, or have been unemployed for more than 99 weeks. These unfortunate folks are left out of the U-3 number described above. U-6 closed 2012 at 14.4%. While that is the lowest level since January of 2009, it is still discouraging to think that one out of every seven Americans is unable to work to the level they desire.
4. Trading ranges versus a true market move
As noted earlier, we are in an S&P 500 trend range. It’s a fairly wide range but still a range. Stock chartists will tell you that until we break decisively above the historic high level of about 1560, that range is intact. Until then, we are in bear-market mode. That does NOT mean that you sell your stocks and go into hibernation. It simply reminds us that the rules of engagement are different than they are when the market is in a long-term bull market. One must exercise an ongoing level of caution in periods like this, far more than in a confirmed bull period like the 1990s. To be clear, these are long-term trends we are talking about, not something that is likely to change dramatically in a month or even in a year.
5. Correlation among stocks
There are times when it’s a “stock market” and others when it’s a “market of stocks” — that is, the degree to which individual stocks move together fluctuates. In 2011, correlations were very high. That’s great for indexers, since the ability to add value via active management is scant. But if there’s one unrelenting debate in the advisor business, it is whether active management is better than passive, or vice-versa. See: Understanding the recent rise in correlations and how you can turn it to your advantage.
I manage money primarily on the active side, but use some exchange-traded funds, and ETFs are blamed by some for that spike in correlation in 2011. Think about it: If more and more investors invest in indexes instead of stocks themselves, the market becomes more of a singular being. But to the surprise of some (not me), 2012 was a year of rapidly declining correlation, based on the CBOE S&P 500 Implied Correlation Index. In fact, correlation declined by more than 20% during the course of 2012. See: How Russell is faring since joining the competitive ETF party with an all-star ex-Barclays crew.
Bottom-line: Active management is likely to regain some fans soon. (OK, now start the debate in the comments section over that statement.)
6. 'Safe haven’ status of the United States
As I told many clients last year, the term “high-quality bond” has become an oxymoron, and thanks to the oxy-morons in Washington, D.C., we are staring at the possibility of another downgrade in the U.S. debt rating. That could be what is at stake in March as the latest debt ceiling haggle ensues.
But will that damage the status of the U.S. dollar as the world’s strongest currency (or as its often referred to, a “reserve currency”)?
Whether the debt is downgraded or not almost misses the point. Remember one of the first rules we learned in the business — the value of an asset is whatever someone will pay for it. The dollar may have some bruises, but it is not as if other nations’ financial situations are lining up to take the mantle of “safe haven” away from us. They all have warts. Watch to see if the D.C. activity this spring is treated with anything more than a yawn from analysts of the U.S. dollar and U.S. government bond investors.
7. How stock market volatility and bond rates affect retirees’ investment decisions
As I see it, high-quality (Treasury, municipal, investment grade corporate) bond funds are the worst investment on the planet at this point. Ironically, it’s where a lot of your clients’ assets are likely sitting. See: Five steps to get your clients out of bonds and into alternative, low-volatility investments.
There are many ways to upgrade clients before the dung hits the fan on bonds, but will you stick to the status quo because it has worked for so long? I will discuss an alternative approach to bonds for income and preservation in an upcoming article and in an upcoming webinar my firm is hosting. It is an approach that is very client-friendly and logical, yet sparsely used in our industry at this point.
Of the many current evaluators of the people’s feelings about investing, one I find intriguing is the Google Investment Index. It simply tracks the frequency of Google queries for investment-related terms such as gold, oil and others. As of the end of 2012, the index was at a nine-year low and has fallen steadily since the financial crisis of late 2000. That’s a sign that people don’t care about investing in equities like they used to, or that they have piled into bond funds so as to go with a winner.
Advisors know that this is not likely to continue, but their clients are frozen in their tracks and need help deciphering this. I think the best chance we have of a meaningful up year for stocks in 2013 is the fact that few are expecting it, and the market typically rewards the least amount of people possible. The next sustained period of gains in stock prices will likely occur while many are still fighting the last war, and licking their wounds over how bad it was in 2008. Remember that long-term bear markets like the one we have been in since at least 2000 tend to end not with a crash, but when no one cares anymore. I think we are getting to that point, but it is anyone’s guess as to whether 2013 is when it happens.
8. Survival of the euro
What a year of turmoil for Europe! In the end, it can best be described through a medical analogy. When an illness is acute, one’s reactions are very emotional. When that illness becomes chronic, we learn to deal with it better since we know it has stabilized.
Europe’s predicament may turn out to be more of a chronic situation than an acute one. While some of the weaker countries are getting their act together versus a year ago, you can still expect to see occasional market-moving shockers coming out of the U.K., Germany and others to continue. Perhaps the telltale sign of the future of the euro currency and the European Union itself is to look at how countries such as Ireland do in 2013.
Ireland was the first of the so-called “PIIGS” (Portugal, Italy, Ireland, Greece and Spain) to start its recovery, and the test will be if European aid to its weaker members actually helps stoke economic improvement. But if massive aid to Greece, Spain and Italy proves to be more of a Band-Aid than a progressive action, it doesn’t really matter what happens anywhere else. The world markets will fixate on those areas again. See: Five scary investment scenarios.
9. Gold as a 'currency of choice’
I am far from a gold bug. I see there being a high speculative element in gold’s price (not only now but for the past several years), and the current price level of gold is neither excessively high nor about to fall off a (non-fiscal) cliff. And while we still see media reports that explain a good day for gold as one in which investors view it as an alternative to the paper currencies of the globe, I am not sold on that explanation. See: Should RIAs buy gold now as a hedge?.
In 2013, look to see if gold is still what people gravitate to in times of strife. And if they do push the price up, is it a knee-jerk response or a sustainable one? During 2011, I think gold may have transitioned from the world’s favorite currency to more of a temporary fix for gold bugs to back their opinion.
I think there is anecdotal evidence for my statement — are we not saturated with TV and radio commercials about gold-buying services? It smacks of house-flipping, only with better liquidity. The biggest gold purchases are by sovereign governments, not individuals, and we will have to see if the pace of their gold acquisition keeps up with the past few years. It is always fashionable to laud something that has just gone up. But perhaps the bullish case is fading now.
10. China: emerging world player or fading giant?
I have to laugh every time someone talks about how much China’s economy is struggling. In the short term, sure it is. But who are we to criticize a country that is considered slumping when their gross domestic product growth is more than 7%? That’s about four times that of the United States, by the way. See: Winter winds hitting bond investors, China takes a pass, alternatives posted strong gains: Morningstar data.
China is too big to ignore, and as long as it owns a massive amount of our debt, it will be plenty relevant. This is particularly true of the relationship between China and its immediate neighbors, the Southeast Asian countries. They are joined at the proverbial hip with China, yet also benefit from a “trickle down” effect: As China’s middle class grows, countries such as Vietnam and Indonesia replace the Chinese as the low-cost providers of many goods shipped around the world. Taken all together, Southeast Asia is still one of the best long-term themes going in my book. See: Performance envy strikes investors as a familiar pattern sets in.
11. The energy mix
We have all read about the changing dynamics in the energy space. Oil has been king, and both here and abroad we are finding more of it in the ground. Natural gas is plentiful, but its progress in gaining a bigger share of world energy usage seems forever stalled (due primarily to political and environmental issues).
Solar and even wind have their fans and detractors, but they don’t seem to be going away. Nuclear, now that the furor from the Japan incident nearly two years ago has faded, has not entirely lost its footing either.
With these rivals to King Oil, who will the winners and losers be? The answer could have a noticeable impact on your clients’ long-term returns from here forward. Energy stocks were about 16% of the S&P 500’s weighting back in 2008, and that figure is now closer to 10%. That is a sign that as the energy mix expands and supply/demand trends become more solidified, there could be a lot of money to be made. It is also possible that nearly all of the major competing forms of fuel described above could do well. All I am saying is, don’t sleep on this economic area in 2013, or beyond. See: Six things to know about the winners and losers in November’s market.
12. The Millennials — a powerful yet unheralded demographic trend
The baby boomers have a rival — the Millennials. This generation, born between 1982 and 1994, is starting to have a very significant impact on our world and in turn on the markets. Their adoption of technology and telecommunications systems at a very young age, their attitudes about politics, and their sheer size as a group make them impossible to ignore. And for you, the RIA, they also represent the next generation of clients. See: How to execute a social media strategy: Take a college kid to lunch.
In particular, 2013 has the potential to usher in a sea change via the tablet computer and cloud data storage, with traditional tech icons and newcomers jockeying for position.The investment implications of the Millennials will be fascinating to watch. It is also required as part of a comprehensive analysis of investment markets going forward.
13. Dividends in a post-fiscal cliff era
This last of the 13 issues to watch is the most important to RIAs and their retired or retiring clients.The dividend yield of the S&P 500 index as of Jan. 1 was 2.14%. Other than 2009 (in the middle of the banking crisis), this was the highest yield to start a calendar year since 1996. See: Dividend stocks deserve a second look at a fearful time.
To me, this is one of the most significant facts for RIAs and their clients to know going into 2013. And before 1996, how far back in history do you have to go to find dividend yields that low? Never, in records going back to 1871 (referencing data from Robert Schiller and Standard & Poor’s). What does that say? I think it says that dividend yields are in the very early stages of breaking out to the upside on a long-term basis after falling for years. Consider the following:
a. Baby boomer retirees — Boomers have affected the world at every stage of their lives. Why shouldn’t they impact it again now that they are retiring in massive numbers? Yes, they will “consume” villas in the Sunbelt, cruises, etc. But they are also likely to consume equity dividends. That is, if their advisors are hip to the idea that equity dividends will rival bond interest payments as a staple of the retiree’s income portfolio.
b. Bond yields way down — and rising bond interest payments — implies falling bond prices, while rising dividends can be associated with improved corporate strength, which allows the business to increase what is paid out in dividends to shareholders. That is, while bond yields and stock yields are low, if they both reverse their long-term trends, one (stocks) is more likely to be beneficial to investors than the other (bonds).
c. Corporations have the cash — their balance sheets are in much better shape in aggregate compared to consumers and governments. As I see it, dividends win either way: A company pays out a small portion of its profits if it wants to use the rest to try to grow earnings. Or, it will respond to excessive regulation and political inaction by spending less on growth initiatives and paying more of its cash out in dividends. The special dividends many firms paid late in 2012 are an indication that shareholder-friendly corporations are sensitive to the significance of the dividends they pay.
Once upon a time, dividends made up much more significant part of equity total returns than they do now. This phenomenon really took hold in the last decade. In 2013, watch closely and read between the lines to see if corporate behavior stokes the already-growing trend toward dividends’ regaining their once-prominent portion of the total return delivered by equity investing.
Predictions: Past and present
Caution: Nothing you are about to read is actionable … but please read it anyway, and give us your opinions in the comments section. I say that predictions are not actionable because while they indicate what a strategist or advisor thinks, I have yet to meet one who crafts their portfolio around a one-year forecast of where the stock and bond markets will be. Ours is an ever-evolving story, and investing should account for that. Still, it’s a good idea to at least think about it once a year. Besides, since Wall Street gurus are notoriously bad at picking targets for the major indexes, you are unlikely to embarrass yourself.
HOW MY PREDICTIONS FOR 2012 TURNED OUT
• For 2012, I targeted an S&P range of 1000-1430, with a close of 1400. If they had stopped trading for the year on Dec. 31 at 9:35 a.m. ET instead of 4 p.m. that day, I would have been spot-on with the closing figure. Instead, the market rallied and closed that day and the year at 1426.
• The market exceeded my predicted high, but not by much (1475), and the index took off to the upside to start the year and never returned to the 1258 level it closed 2011 with. That was the start and low for 2012.
• I thought the yield of the 10-year Treasury note would have a volatile year, ranging from 1.7% – 3.6%, and predicted a close of 2.8%. Apparently, the fiscal cliff didn’t scare anyone as much as I thought it would — in 2012, at least. The U.S. “safe-havened” its way to a record low 10-year-Treasury yield of 1.39%, and didn’t eclipse 2.39% on the high end. The close of 1.76% was right near my predicted low for the year, but I thought we’d see that decline in yields well before the election. That would have given the bond market time to sell off about 1% before the year ended. That’s the thing about calling a level at a finite date — the story does not always unfold as fast as you think it might. For that, we can all thank Ben Bernanke.
I also made some comments about what I thought would characterize the market environment in 2012. Here they are repeated, plus my reaction to what actually happened:
• 40% range from top to bottom in S&P 500 (way off! As noted above, the range was less than 20%, which is unusually low. The election was the likeliest explanation, as investors spent the last three quarters of the year about as still as the little lizards are when my cat is about to pounce on them).
• Emerging markets hold up much better this time around (the MSCI Emerging Markets Index modestly outperformed the S&P 500, returning just over 17%).
• Europe works toward real reform at a snail’s pace, but the market eventually gets used to it (as discussed above, I think this is what is happening).
• Treasury rates spike, retrench, but set the stage for a very nervous credit market in 2013, post-election. (They didn’t spike as high as I thought, but as for the nervous credit market in 2013? I couldn’t agree with myself more.)
• Gold more likely hits $1,000 instead of $2,000 (it didn’t hit either, but my point then and now is that $2,000 is not the “layup” some think it is.
The time is now
So here we are in 2013. Taxes are higher, but not as high as they might have been. The stock market is now four years removed from anything resembling a devastating decline, yet many investors fear it.
But those same investors feel nice and comfy parking massive amounts of capital at 1%-3% in bond funds, unaware that any meaningful kick-up in rates could lead to negative returns. I just don’t get it, and will devote a lot of coverage this year to how financial advisors can educate, prepare and act in the best interests of their clients to rescue them from the inevitable bursting of the bond bubble.
Finally, here are my “best guess” numbers for where the stock and bond markets will go in 2013:
High Low Close
1590 1290 1510
10-year U.S. Treasury yield
High Low Close
3.70% 1.75% 3.50%
Enjoy the New Year!
Rob Isbitts (firstname.lastname@example.org), a 26-year industry veteran, is the founder and chief investment strategist of Sungarden Investment Research (www.sungardeninvestment.com). Sungarden provides advisors with an investment process, portfolio design and model portfolios. Rob has written two investment books, created several portfolio strategies, and is a former chief investment officer and mutual fund manager. He offers advisory services through Dynamic Wealth Advisors, a registered investment advisor.
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Asset Manager for RIAs, Separate Account Manager, Alternative Investments
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