Fagan Associates Archive for June, 2012

Americans are becoming accustomed to Summer economic slowdowns as well as pullbacks in their investment portfolios and, if past Summers are any indication, buckle up for more turbulence.

Since the end of the first quarter, the U.S. stock market as represented by the Standard & Poor’s 500 has declined by more than four percent through this past Thursday as economic data across-the-board, both here and abroad has weakened considerably.  Initial Claims for Unemployment Benefits, Housing Starts, Retail Sales, Personal Income and Consumption, Consumer Sentiment, Industrial Production, Business Sales and Inventories as well as and inflationary pressures have all been fraying around the edges.  Although still positive, Gross Domestic Product (the sum of all goods and services produced in the United States), has slowed to a crawl as both businesses and individuals alike have turned a wary eye to the upcoming Presidential Election in November, the approach of another bout with the debt ceiling, the end of the Bush era tax cuts in addition to the situation outside the United States, specifically the liquidity and potential solvency crisis within several European countries.  Let us state that these are all cause for concern and have written extensively within The Record as well on our website (www.faganasset.com) regarding these issues.

The Open Market Committee of the Federal Reserve, the body that determines monetary policy, after its meeting June 20, released a statement that contained the following cautionary notes.  “Information received since the Federal Open Market Committee met in April suggests that the economy has been expanding moderately this year.  However, growth in employment has slowed in recent months, and the unemployment rate remains elevated….Household spending appears to be rising at a somewhat slower pace than earlier in the year.  Despite some signs of improvement, the housing sector remains depressed.”

Also this past week the Federal Reserve released its updated projections for the economy in which its “central tendency” (removal of the three highest and lowest estimates) for annualized U.S. Gross Domestic Product this year now ranges from 1.9% to 2.4% as compared with 2.4% to 2.9% in April, ranges from 2.2% to 2.8% in 2013 as compared to 2.7% to 3.1% in April and between 3.0% to 3.5% during 2014.  The Federal Reserve is also projecting the Unemployment Rate to gradual decline through 2014, but does not see it going below seven percent.

What’s the Fed to do?  Despite the self-described limitations of the impact, solely of monetary policy, the Fed has extended Operation Twist, in which it is selling approximately $270 billion of shorter-term U.S. government debt and buying the same amount of longer-dated maturities, hoping to reduce the cost of borrowing, thus spurring economic growth.

THE BOTTOM LINE – Despite these cautionary signals, the U.S. economy as well as stock market is nonetheless the “cleanest shirt in the laundry.”  At some point in time investors will hold their respective noses and put money to work in the stock of publicly traded companies domiciled in the United States.  That said, over the near term we remain cautious and expect this choppy trading environment to continue.  Buy on weakness, not strength.  Trade up in quality.  Look for dividend paying companies or companies with long-term, secular growth stories (NKE, MCD, AAPL, etc…) and most importantly, be patient.

As investors head into the Summer months there is much to worry about.  Here in the United States the upcoming Presidential Election should bring with it heightened political rhetoric and, believe it or not, even less of an attempt from our politicians to fix the economy.  In addition, the United States will most likely hit its debt ceiling again, the legal amount set by Congress that the Federal Government can borrow, by the end of 1912.  The last time this occurred back in 2011 it rocked the financial markets and resulted in a first-ever downgrade of the debt rating of the United States.  Domestically, last but not least, the Bush-era tax cuts, meant to spur economic growth, expire at the end of 2012 which, if not acted upon, will automatically result in tax increases for the vast majority of Americans.

The picture abroad looks much worse than here at home as Europe continues to wrestle with their debt problems.  Unlike the United States, the European Union and the European Central Bank lack the legal authority to effectively deal with this mess, leaving them somewhat rudderless.  Hopefully, with German leadership, this problem will be dealt with soon or at least the can will be kicked down the road.  Either way, it is a headwind for the stock market.

All the above begs the question, “what’s an investor to do?”  With this in mind, we’ve come up with several options, all of which entail the investor shoulder some risk but also provide an alternative to your zero percent bank account or ½% Certificate of Deposit.  Managing risk played a greater role in determining which investments are noted below rather than the potential return.  With this in mind, we researched investments that are managed by individuals with a lengthy track record; performed relatively well during the financial crisis of 2008; held bonds with relatively short average maturities thereby limiting the negative impact of a rising interest rate environment; and also whose portfolio of bonds were predominantly investment grade.

The first no-load mutual fund that fits the above criteria is the MetWest Total Return Bond fund (MWTRX), established in March of 1997 and managed since its inception by Tad Rivelle.  This fund currently has over $20 billion in assets, fell by only 1.74% during 2008 and holds bonds whose average maturity is only 7.50 years, 75% of which are rated A or better by Standard & Poor’s.  Their historical return has also been very competitive, rising 4.44% year-to-date, by 6.18% over the past year and by an average annual 11.72%, 8.39% and 6.87% over the trailing three, five and ten years, respectively.

Another rather conservative choice for cautious investors is the PIMCO Total Return Fund (PTTRX), established in 1987 and managed since its inception by William Gross.  This fund currently has over $258 billion in assets, actually rose by 4.82% during 2008 and holds bonds whose average maturity is only 8.93 years, 80% of which are rated A or better by Standard & Poor’s.  Their historical return has also been very impressive, rising 5.15% year-to-date, by 5.90% over the past year and by an average annual 9.10%, 9.24% and 6.95% over the trailing three, five and ten years, respectively.

A final conservative choice for ultra-cautious investors is the Payden GNMA Fund (PYGNX), established during 199 and managed since its inception by Gary Greenberg.  This fund has over $1 billion in assets, rose by 7.69% during 2008 and holds bonds whose average maturity is less than six years, 95% of which are rated A or better by Standard & Poor’s.  Their historical return has also been very impressive, rising 2.14% year-to-date, 6.26% over the past year and by an average annual 7.21%, 7.44% and 5.80% over the trailing three, five and ten years, respectively.

Keep in mind that even one step away from your bank account entails you assuming some risk.  However, to a certain extent, this risk can be quantified.  One risk, not noted above but certainly out there if the potential for a negative impact on these bond funds should interest rate begin to rise.