Fagan Associates Archive for January, 2012

Shortly after its regularly scheduled meeting regarding Monetary Policy the Open Market Committee of the Federal Reserve, Chaired by Ben Bernanke issued a press release that stated that “the committee decided today to keep the target range for the federal funds [the interest rate at which member banks borrow from each other from the reserves held at the Federal Reserve] at 0 to ¼ percent and currently anticipates that economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”

This was somewhat of a surprise and tacks on nearly one year from a somewhat recent press release from the Fed which put the end of this accommodative interest rate policy somewhere in mid-2013.  The released noted that “while indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated.  Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed.  Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable.”

Some analysts are cautious regarding the length of time that the Fed will keep interest rates low, concerned that the Fed foresees a slowing of the current pace of economic growth while others believe that this historically accommodative interest rate policy will ultimately fuel inflation.  We believe that the truth is somewhere in between as the Federal Funds rate along with market rates will remain low at least through the balance of 2012.  After that, the pace of economic activity will determine the direction of interest rates.  Why bother predicting interest rates through 2012?  The further out you travel in time, the foggier even the Fed’s crystal ball becomes.

What to do now?  For those that are borrowing, lock in historically low interest rates now.  Refinance your mortgage, refinance your credit cards and if needed, purchase a new automobile at or near zero percent.

For those that have saved, be very wary of longer-dated bonds and bond funds.  The best days for bonds are well past.  Purchase bonds that will mature in a maximum of eight years.  In fact, we might even consider trading in longer-dated maturities for these noted immediately above.  Be careful of stretching for income, even in the stock market, in the form of drastically overweighting utilities or consumer staples as dividends will become less attractive should interest rates begin to rise.  Along with some allocation to dividend payers, look for investments with secular growth stories such as Nike or Apple Computer.

Finally, be nimble.  All recommendations and plans of action are subject to change.  The Fed has given you an idea of where they “think” the economy and interest rates are headed.  However, the further one projects out there more variables are involved and therefore the more room for error.

It used to be so much easier—5 for ’05 or 8 for ’08.  Twelve for ’12 is certainly a lot of ideas.  However, the current news and upcoming events on the table, namely the problems with the Euro, the U.S. Labor and Housing Markets, the Presidential Election and the Olympics, we have plenty of resources.

1.      Occupy Wall Street will feel like renaming itself Occupy White House midway through the year.  This is not either liberal or conservative thinking.  It’s just that people are and will continue to be fed up with politics as usual.  This will keep the market on edge for the majority of the year.  Currently, we expect that by the close of 2012, the S&P 500 will reward patient investors with a total return (capital appreciation plus dividends) somewhere in the upper single digits, let’s call it 8.00% to 10.00%.

2.      Stay short.  It sounds like it should be a Randy Newman song, but we’re talking interest rates here.  We believe rates are headed somewhat higher here (FINALLY).  Thus funds like Payden GNMA (PYGNX), Double Line Total Return (DLTNX) and MetWest Total Return (MWTRX) do a good job of balancing the quest for returns with risk management.

3.      Medals and ballots.  We get treated to the Olympics and an election in2012.  Nike should be a winner but with it hovering around $100 it isn’t inexpensive.  Broadcasters and advertisers also should do well.

4.      A time and a place.  International funds have grossly underperformed their domestic counterparts.  We believe there is value in making investments internationally.  Perception is very negative and must be overcome.  This will take time.  Nevertheless, we own shares of Diageo (DEO) the spirits maker as well as companies with a majority of their revenue coming from outside the United States such as McDonalds (MCD), Intel (INTC), Mastercard (MA), Conoco Phillips (COP) and General Electric (GE) and would look to incorporate mutual funds such as Harding Loevner Emerging Markets Fund (HLEMX), the Tweedy Browne Global Value Fund (TBGVX) and the Sextant International Fund (SSIFX) as the year unfolds.

5.      Start big, end small.  (This is our Atlanta Falcons impression.)  We favor large cap over small cap but as it becomes clearer the economy is on the road to recovery, small caps could begin to outperform. Look for the Adirondack Small Cap Fund (ADKSX) as well as Baron Asset (BARAX) as the year progresses.

6.      Unleash the inner karma.  What does this mean?  As with 2011, calendar year 2012 will be a year that alternately makes you smile, makes you cry then makes you wonder.  It will be important to remain calm during market meltdowns as well as realistic during up spikes.  An Exchange Traded Fund that might help you survive these Maalox moments is the S&P Dividend ETF (SDY) whose objective is to invest in companies that have INCREASED their dividend every year for at least the past twenty-five years and currently sports a yield of nearly 3.25%.

7.      Energy shines. “Black gold, texas tea”!!  China, India and Brazil will continue to consume larger amounts of commodities, but energy will be the commodity that is the most in demand, whose price, relative to other commodities, will be most predictable. For those reasons, Conoco Phillips (COP), Exxon Mobil (XOM), Chesapeake Energy (CHK), Northern Oil & Gas (NOG), and National Oilwell Varco (NOV) fit the bill.  For those who wish exposure in the sector on a broad, more diversified basis, the SPDR Energy Exchange Traded Fund (XLE) makes sense.  Conoco Phillips sports a particularly healthy dividend (3.7%) and is more than 10% from its 52-week high.

8.      Where’s the beef? Money markets and short-duration Certificates of Deposit will become increasingly less attractive.  Over the past few years, investors have flocked to these investments, with many most likely running FROM the volatile stock market rather than TO these rather paltry yielding investments.  We believe investors will grow weary of these meager 1.00% returns during 2012 and accept more risk for potential returns.

9.      Return of the dinosaur.  Even the average Joe can facebook, use twitter and access his/her favorite blogs.  We believe that some of the major tech winners of 2012 are going to be big, established companies with hordes of balance sheet power. Consider Intel (INTC) or Microsoft (MSFT), for example, they sport dividends of 3.30% 2.80%, respectively and have billions of dollars on their balance sheets ready to be cagily invested.  Compare this to ten-year U.S. Treasury Notes at 1.92%.  Apples to Oranges, but nonetheless investments to consider.

10.   Exhaustion.  Americans (never a patient lot to begin with) will declare the end to pessimism and negativity by simply going out and spending.  We saw the first signs of this around the holidays.  Be aware this will benefit YUM Brands (YUM), McDonalds Corp (MCD), Deckers Outdoors (DECK), and Cabelas (CAB).  The desire of Americans to enjoy their lives, be optimistic and forward thinking will finally win out over the darkness that has held this country in its grips since the 2008s real estate meltdown.

11.   Real estate and the job markets will rebound.  Well, at least they won’t head further down.  We are beginning to see signs of stability in the worst hit property markets of Florida, Nevada and California as well as more consistent growth in the labor market.  Despite the underlying warts, the U.S. Unemployment Rate nonetheless is now officially 8.4%.

12.   By the end of this year, banks will eventually be good investments.  This is a sector that requires patience as well as caution.  We are just beginning to dip our toes into this pool.  However, with many U.S. banks, including J.P. Morgan Chase (JPM), PNC Bank (PNC), FNB Bank (FNB) and First Niagara (FNFG) sporting long-term track records of relatively low percentages of non-performing loans, these should begin to make their ways back into favor.

This article is the last of a four part series that pertains to year-end financial planning.  The articles have appeared on consecutive Sundays during December in “The Record” and include, in order, “Year-End Tax Planning for Shareholders of Individual Stocks and Bonds” which appeared December 11^th, “Year-End Tax Planning for Shareholders of Mutual Funds” which appeared December 18^th, “Year End Tax Planning – Charitable Giving which appeared last Sunday, December 25^th and finally, this article entitled “2011 Review – 2012 Preview.”

Calendar year 2011 was one was one which stymied the vast majority of investors, both professional and individual alike, as both found themselves whipsawed by domestic as well as international political, corporate, and geopolitical events as well as what mother nature had to throw at us in the form of the Spring Tsunami in Japan and Hurricane Irene which ravaged the Eastern Seaboard of the United States.

Indeed the past year was much like a roller coaster that at times, churned your stomach and prompted you to grab for the Maalox.  However, like a roller coaster, the year ended where it started as going into the final day of trading this past Friday, the Standard & Poor’s 500, excluding dividends, was up a grand total of 0.43%.  All in all, we consider calendar year 2011 a success!

A success you might say?  To this we respond with a resounding “yes!”  Quite simply, in addition to the two events noted above, consider what investors went through on the “Comet” ride.  Consider the Arab uprising in the Spring which began in Egypt and then swept through Saudi Arabia, Libya, Syria, Tunisia, Yemen, Bahrain, Algeria, and then leapt overseas morphing into the nonviolent Occupy Movement here in the United States.  This was just the beginning.  Investors were on the edge of their trading seats as our elected officials in their infinite wisdom and knowledge passed deadline after deadline regarding the raising of the debt ceiling back in late July and early August prompting a first ever downgrade of the “triple A” credit rating of the United States by Standard & Poor’s.

While these events were taking place, the European debt crisis simmered on the back burner through much of the Spring and early Summer only to move to the front as rioting in Greece occurred when politicians began to discuss the implementation of budgetary austerity measures.  This discussion pushed the yields on Greek sovereign debt to nearly 60% which, like a contagion, spilled over into other European countries sitting on the Mediterranean Sea, notably Italy and Spain.  It was only through measures taken by global Central Bankers that at least temporarily stemmed this contagion by adding liquidity into the financial system.  Although this will buy Europe time, it does not solve the issue of solvency.  One reason why we consider this year from an investment perspective a success is because when you look around you, unchanged isn’t bad.  The French Stock Market fell approximately 17% last year while the German, British and Swiss bourses slipped approximately 15%, 8% and 6%, respectively.

There’s a country song by Rodney Atkins which states “if you’re going through hell, keep on going.  Don’t slow down.  If you’re scared don’t show it.”  That is exactly what the United States did during 2011 because although the housing and labor markets have remained in the doldrums since the recession began in 2008, we are exiting calendar year2011 in better shape than we entered it as housing inventories are being worked off and jobs have begun to be created.  All in all the economy has weathered many body blows, but remains on the upswing.  That is a plus.

For the reasons noted above, we are happy investment returns have been flat for 2011.  However, the real question is what will calendar year 2012 bring.  In a nutshell, we currently believe calendar year 2012 will bring more of the same as 2011 in terms of volatility and “Maalox Moments,” but with a bias to the upside.  Furthermore, we believe if we are wrong it will be because this outlook will have been too conservative.  There is a real potential for a recovery in the manufacturing sector as more companies are returning jobs to our shores, a recovery in the housing market for reasons noted above and an energy boom.  However, the wild card remains our elected officials.  Will they take the necessary steps to rein in spending on entitlement programs such as Medicare, Medicaid and Social Security without compromising this slow, but mounting recovery or will they continue to take the easy way out, passing the buck until after next year’s Presidential Election?  A balancing act between temporary stimulus and long-term spending discipline is paramount if we are to right the U.S. Economic Ship.  If this occurs, we believe the stock market is in for more than double digit gains in 2012.  That said, we put this likelihood at less than 50% resulting in our more cautious outlook outlined earlier in this paragraph.

Best wishes for a Happy, Healthy, and Prosperous New Year!