Year End Update

Interesting Numbers

• Price f a gallon of gasoline in Norway as of 09/12/12: $10.12 (Bloomberg News).
• As of 11/30/12, percentage of price above par value for Emerging Markets Bonds: 9.4%.  U.S. Investment Grade Corporate Bonds: 14.4%.  U.S. Treasuries: 8.1%.  (Eaton Vance).
• American household debt service ratio (% of disposable annual income) as of 08/31/12: 11%.  As of 12/31/07: 14%. (Eaton Vance)
• Pages in the 1933 Glass-Steagall Act: 33.  In the 2010 Dodd-Frank Act: 2,319.
• Estimated net lifetime net transfers from the Government for each American born in 1945: $2.2 Million (The Economist, 09/29/12).
• U.S. government’s results for the 12 months ending 09/30/12 were $2.45 trillion of tax receipts and $3.54 trillion of spending, producing a $1.09 trillion deficit, or the equivalent of borrowing 31 cents for every $1 spent (Treasury Department).
• Maximum 2013 401(k) Deferral: $17,500 ($23,000 if age 50 or older).
• Maximum 2013 Traditional or Roth IRA Contributions: $5,500 ($6,500 if age 50 or older).

Challenges in Europe and Japan

The vicious circle of economic stagnation, deficits and austerity continues in Europe:

• Germany shows little urgency about repairing the Euro when the pressure is off.
• France has taken a dangerous path with its top tax rate raised to 75% (driving out wealth) and lowered retirement age (unsustainable).
• Youth unemployment in Spain and Greece is over 50%.

While Antaeus’ baseline expectation is a continued recession in Europe throughout 2013 – and the eventual withdrawal of some countries from the European Union (e.g. Greece) – few are talking about a country facing even larger long-term challenges: Japan.  With over 200% debt to Gross Domestic Product (GDP) and a shrinking, elderly population, we don’t see how Japan avoids becoming a less affluent nation in the future.

United States

Here at home, we have our own debt issues, fueled by growing life expectancy, rising health care costs and the fact that the average American spends less than 50% of life working full time.  Antaeus’ #1 concern is simple: the risk created by ongoing federal deficits and unfunded entitlements.  With an unfunded welfare system approaching $60 trillion¹ – in addition to the well publicized $16 trillion of U.S. Treasury debt – it is unlikely that Social Security and Medicare will resemble what they are today in coming decades.  Put another way: with roughly 312 million Americans, our liabilities equal roughly $244,000 for every human being in the United States!  Further, if U.S. Treasury debt exceeds 100% of GDP – just a few years away based on the current trajectory – it could be devastating to our long-term growth rates, and even to our currency.  Congress must come up with a solution so that spending and revenue converge.

 A concurrent challenge is the unwinding of quantitative easing, which the Federal Reserve indicates will not begin until at least mid-2015.  The longer we wait to unwind this liquidity, the greater its ultimate increase on the Federal budget’s net interest expenses.  That said, as a scholar of the Great Depression, clearly Ben Bernanke is not afraid to go back to his tool box if Congress allows us to go off the “fiscal cliff.”

On a positive note, North America’s “shale gas revolution” has far-reaching geopolitical and macro-economic implications for the United States: reducing foreign energy dependency, improving the trade deficit, enhancing GDP growth, and providing potential job creation in natural gas, chemicals, fertilizers, pipelines, railroads, regional banks, engineering and construction.  Along with exploding global demand for smart phones and infrastructure, Antaeus believes that shale gas is one of the most significant growth stories this decade.  Of course, while many investment opportunities exist in this area, a key concern is the environmental implications of this paradigm shift.

Markets

As of 12/07/12, Total Return year to date; and since 01/01/11:
17.51%; 7.22% MSCI Europe, Australasia and Far East Index
16.01%; (1.47%) MSCI Emerging Markets Index
13.99%; 21.58% S&P 500
12.05%; 21.39% Gold
6.04%; 17.30% Barclays Aggregate Bond
0.37%; 15.15% Oil

Led by stocks in emerging markets, risk assets have rallied in 2012.  More specifically, over the past two years, investors have piled in to high yield bonds and large stocks paying hefty dividends – leading to relatively high valuations in these areas.  Floating rate bonds, for example, appear to provide a more attractive risk-return scenario at this time.

Looking Forward

Given the various metrics and a rise in valuations, we believe that caution regarding risk assets is prudent at this time; however, there is little appeal in buying Treasuries other than to benefit from a flight to quality during periods of market turbulence.  In this post credit collapse environment, Treasury yields are at historic lows, bonds are trading at premiums, and the relative valuation between the cash flow yields of stocks vs. bonds clearly favors the former.  Our base case is 8.0% annual returns in equities this decade (vs. long-term averages over 10%), and 2.0% for investment grade bonds (vs. long-term averages around 6%).  Antaeus thus does anticipate over-weighting equities vs. bonds once we see a compelling entry point.  We also believe that periods when investors are most risk averse is precisely when danger actually wanes.

Mortgage backed securities probably will do well in coming months due to the Fed’s $40 billion/month buying binge.  Municipal bonds have positive structural fundamentals, including the exit of speculative hedge funds, Obama’s re-election, and the fact that state revenues have risen for 9 consecutive quarters.  So while we would advocate that our clients avoid bond index funds loaded up with Treasuries, diversification is important and there is no guarantee that stocks will move higher.  Also note that governments of developed economies are piling on new regulations and protectionism with abandon.  Such policies arguably encourage corruption while thwarting innovation and efficiency.

Hedging Risk

In this age of de-leveraging, you may want to think twice before investing in any industry that relies on consumer spending.  If you are concerned that Europe’s problems may push the world into a deflationary spiral or depression, maintaining a higher than average cash cushion makes sense.  Similarly, if you believe that reckless fiscal and monetary policy will continue, allocating a small percentage of your portfolio to gold or silver may be a prudent course. 

As always, Antaeus is committed to helping our clients benefit from the power of interest on interest while maintaining prudent diversification.

 Happy Holidays,

Evan P. Welch, CFP^®, AIF^®
Chief Investment Officer

 Disclosure: Indices mentioned are unmanaged and it is not possible to invest directly in an index.  No single strategy can assure profit or guarantee against loss.  Past performance does not indicate future returns.  The opinions expressed in this commentary are those of Antaeus Wealth Advisors, LLC and are based on information believed to be reliable; however, these views may change as information changes or becomes out of date.

 The opinions expressed in this article are those of Antaeus Wealth Advisors, LLC. Securities offered through Cambridge Investment Research, Inc., a Broker-Dealer, and member FINRA/SIPC. Investment advisory services and financial planning offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Antaeus and Cambridge are not affiliated companies.