Making Cents

How Fast the Markets Recover

Posted by Curtis A. Smith, CFP® on 5 March 2010 | 0 Comments

Tags: Stock Markets, DJIA, Black Monday, 2008-2009, 2001-2002, 1987, 1974, NASDAQ, Stock Market Recovery, Investing,

The stock market is amazingly resilient. You might be surprised at how fast the stock market can change … for the better. Let’s look at how the market has recovered remarkably – and quickly – from some notable downturns.

2008-2009. The collapse of the subprime mortgage markets triggered a recession and made 2008 the poorest year for stocks since 1931. The Dow Jones Industrial Average fell 10% in June 2008 and fell 10% again in October 2008, losing 19.12% for the year. On March 9, 2009, the major U.S. indices closed at 12-year lows with the S&P 500 at 676.53.(source)(source)(source)

Then the market took off. Investors who swore off stocks in early 2009 lost out on one of the great rallies. From the March 9 lows to the end of 2009, the S&P 500 soared 64.83% while the NASDAQ gained 78.87% and the Dow gained 59.28%.(source)

2001-2002. After the four-day closure of the stock market following 9/11, the Dow fell 685 points to 8,920 on September 17. It kept falling, losing 14.26% in a week to close at 8,235 on September 21. But what happened next? A huge gain. The Dow closed 2001 at 10,021 – a 21% rebound in less than three months.(source)

There were more challenges ahead. On October 9, 2002, the Dow had fallen to 7,286. But on Halloween, the Dow sat at 8,397 – a 10.6% gain in 22 days.(source)

As for the people who panicked and bailed out of the stock market, they ended up kicking themselves: in 2003, the DJIA gained 25.3%, the S&P 500 26.4%, and the NASDAQ 50%.(source)

1987. October 19 was Black Monday: in a contagion of selling exacerbated by unchecked computer technology, the Dow lost 22.6% in one day, falling to 1,738, a 508-point loss.(source) (That would be akin to a 2,400-point one-day drop today.) The S&P 500 lost 20.4%.8 By comparison, the initial “Black Monday”, the stock market crash of 1929, represented a 12.8% market loss.(source)

Then the recovery kicked in. During the next two trading days, the Dow gained nearly 300 points – and it closed 1987 at 1,939, gaining back all of the loss and ending up 2% for the year.(source) By January 1990, the DJIA was at 2,800.(source)

If you were fortunate enough to invest $1,000 in the S&P 500 index at the close of Black Monday and reinvested your dividends, you would have wound up with about $10,800 20 years later.(source) If you had invested in the Dow stocks a week before Black Monday, you would have lost 30% on your investment in the crash … but if you held on, your investment would have gained 462% over the next 20 years.(source)

1974. With investors fretting over rising inflation and the energy crisis, the Dow loses 30% of its value during the first three quarters of the year. Suddenly, the Dow gains 16% in October.(source) In early December 1974, the Dow is at 577; in July 1976, it hits 1,011.(source)

So while the Dow, S&P and NASDAQ have been through some rough periods (and even a poor decade), the important thing is how they have climbed historically.

On August 12, 1982, the Dow was at 777. On January 14, 2000, it was at 11,722.98. That’s a 1,500% gain in 17½ years.(source) This is why people stay in the market through the downturns. This is what the market is capable of achieving. There are periodic descents, but history is definitely on an investor’s side.

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Don't Miss the Match!

Posted by Curtis A. Smith, on 19 February 2010 | 0 Comments

Tags: 401k, Retirement Plan Contributions, 401k Match, Retirement Planning, Dollar Cost Averaging, Investing, Compound Interest, Financial Planning

Don't Miss the Match!

The 401(k) plan is one of the most widely-utilized wealth creation tools offered Americans. These retirement savings plans have several advantages, including dollar cost averaging, tax savings and tax deferral.  However, one of the most powerful advantages is the company match. If your company offers a match, are you making the most of it?

Not taking advantage of the company match is like passing up “free money”.  Most rational people don’t walk past a $5 bill on the ground without picking it up, but that’s what people do every day when they don’t contribute enough to their 401(k) to get the full company match. A full one-third of employees don’t take advantage of this feature, and it may make their retirement less comfortable.(source)

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The Potential of the BRIC Nations

Posted by ICMC Staff on 17 February 2010 | 1 Comments

Tags: BRIC, Brazil, Russia, India, China, Foreign Stocks, Foreign Markets, Investing, Asset Allocation, Financial Planning, Economic

Brazil. Russia. India. China. These four nations have some of the fastest-growing economies on earth and are becoming drivers in the world economy. In the coming decades, they may command as much attention as the U.S., Japan and other “heavy hitters” … or more.

The future aside, we know one thing about the BRIC nations and other emerging markets: collectively, stocks in these countries have outperformed U.S. stocks for the last 20 years.

During this past decade alone, the MSCI Emerging Markets Index brought a total return of 102.4% while the S&P 500 posted a total return of -10.0% (-24.1% before dividends). Across the 1990s, the S&P 500 produced a total return of 432.0% - pretty impressive. Yet the MSCI Emerging Markets index posted a total return of 2408.6% for that decade.(source)(source)

Great volatility … but also great potential. If U.S. stocks soar or fall, emerging markets really feel the effect. We’ve seen them recoil in the first quarter of 2010. Yet short-term slumps aside, there are compelling arguments for investing in emerging market equities as part of a diversified portfolio.

Look at last year’s returns. In 2009, the benchmark index in Brazil (the Bovespa) gained 82.66%. Russia’s RTS gained 128.62%. India’s Sensex 30 advanced 81.03% and China’s Shanghai Composite rose 79.98%.(source)

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How Your Personality Affects Your Financial Decision-Making

Posted by Curtis A. Smith, CFP® on 12 February 2010 | 2 Comments

Tags: Risk Tolerance, Personality, Decision Making, NAPFA, Financial Planning, Investing, Goals and Objectives

All investors are not created equal. That’s why many fiduciary fee-only CFP® start their initial client meetings with a discussion of money attitudes, goals and risk tolerance – the driver at the root of all investment decisions. Some financial planners do this by general conversation, others by detailed surveys they ask their clients to fill out.

The survey route can be a more valuable tool because it forces clients to face their money issues, perhaps for the first time. Despite the difficulty in facing up to such key issues, individuals get a better idea of where their money strengths and weaknesses really lie.  Often, the real difficulties lie in how money is spent.

The real value of answering a lot of questions about your risk tolerance is to tell you what you don’t know – how the sources of your money, the way you made it, your money viewpoints and current methods of handling it will inform every decision you make about it in the future.

The most important thing a questionnaire can reveal is your true money priorities and behaviors. Trained financial advisers, such as CERTIFIED FINANCIAL PLANNER™ professionals – use both conversation and surveys to reach some firm answers that might surprise you.

Are there particular money types? In reality, you’ll find quite a number of surveys out there that define money types in particular ways, but you’ll find personalities that are common on the scale from conservative to liberal. Deborah L. Price, a Financial Planning Association member and founder and CEO of the Money Coaching Institute, offers these scenarios in an article titled, “What’s Your Money Personality?”:

The Innocent: Price notes that innocents often live in denial, are easily overwhelmed by financial information and rely heavily on the advice and opinions of others. They tend to be the most trusting because they generally don’t see people or situations clearly – which leaves them open to bad decisions at best and fraud at worst.

The Victim: She notes that victims are people who tend to live in the past and blame their woes on outside factors and situations they claim they can’t control. These people may have been abused, betrayed, or have suffered some great financial loss, but they generally see life as a self-fulfilling prophecy that they can’t change.

The Warrior: Generally seen as a successful person in the business and financial worlds, they will listen to advisors, but they make their own decisions. They tend to be great caretakers.

The Martyr: These people generally put other people before their own financial health. They use their money to rescue others based on their high expectations for themselves and the people they’re rescuing, but these decisions may be costly in the long run.

The Fool: The Fool, explains Price, is a combination of the Innocent and the Warrior because they have no clue about what they’re doing but they’ll act fearlessly. They are financially adventurous and they act on impulse.

The Creator/Artist: These people often have a love/hate relationship with money. They’re constantly struggling to make their finances work, but they often feel that caring about money means something bad.

The Tyrant: Price reports that this type hoards money and uses it to manipulate others. They may have everything they need, but they’re never comfortable with their lives because they fear losing control.

The Magician: Price defines the The Magician as the ideal money type. They’re aware of their circumstances and responsibilities and can see situations very clearly.

A fiduciary fee-only CFP® tries to see through the static to find out what you really need to create a solid financial life. But it might make sense to ask yourself a few questions before you and your planner sit down:

1.    How would you describe your financial status right now?

2.    What’s important about money to you?

3.    What’s your family history with money?

4.    What do you do with your money?

5.    If money wasn’t an issue, what would you do with your life?

6.    Has the way you’ve made your money – through work, marriage or inheritance – affected the way you think about it in a particular way?

7.    How much debt do you have and how do you feel about it?

8.    Are you more concerned about maintaining the value of your initial investment or making a profit from it?

9.    Are you willing to give up that stability for the chance at long-term growth?

10.    What are you most likely to enjoy spending money on?

11.    How would you feel if the value of your investment dropped for several months?

12.     How would you feel if the value of your investment dropped for several years?

13.    If you had to list three things you really wanted to do with your money, what would they be?

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IRA Contribution Deadline

Posted by ICMC Staff on 5 February 2010 | 0 Comments

Tags: IRA, Roth IRA, Investing, Retirement Plan Contributions, Retirement Planning, Financial Planning

IRA Contribution Deadline 

Don’t miss the IRA contribution deadline! Make sure you make your 2009 IRA contribution before April 15, 2010! Fully funding your IRA for 2009 (and 2010) could mean a tremendous boost toward saving for retirement.

If you’ve been contributing $50 or $100 to an IRA each month, there’s room to contribute a lot more. Putting $600 or $1,200 in your IRA annually is nice, but you can direct up to $5,000 into your IRA for tax year 2009 (and up to $6,000 if you turned 50 in 2009).

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January 2010 Monthly Economic Update

Posted by Curtis A. Smith, CFP® on 2 February 2010 | 0 Comments

Tags: Economic, Core Series, Investing, Financial Planning, Foreign Stocks, Commodities, Interest Rates, Federal Reserve, Housing

 

The month in brief. Wall Street had an eye on Washington for much of last month. Anticipation of earnings season gave way to concern over what might happen if proposed limits on bank risk went into effect, and what might happen if federal tax credits in the housing market went away. Stock and commodities markets fared poorly as some economic data led traders, economists and investors to wonder how much of the recession recovery was attributable to government measures. Still, consumer confidence was on the rise and the economy was clearly on the mend.

Domestic economic health. Some very good news arrived in January: according to the Commerce Department, the preliminary 4Q GDP reading was +5.7%, the best quarter in six years and 1.0% higher than the expectations of analysts. Consumer spending represented 2.0% of the gain. Additionally, the Conference Board’s survey of consumer confidence hit a two-year high last month.(source) The University of Michigan consumer sentiment poll rose by 1.6 points to 74.4.(source) The latest consumer spending data showed a 0.2% gain for December. January also brought the best news on factory output in five years – the Institute for Supply Management’s manufacturing index read 58.4 for the month.(source)

Other news items bothered the Street. In late January, President Obama rolled out a proposal he referred to as “the Volcker rule”. Developed with input from former Federal Reserve chairman Paul Volcker and former SEC chair William Donaldson, the rule would prohibit banks and bank holding firms from getting involved in hedge funds or conducting proprietary trading operations.(source) Intended as a corrective to the behavior of the 2000s, the proposed limits on bank size and bank risk sent stocks skidding, as investors saw reduced potential for bank profits. Tightening in China, debt problems in Greece and a downgrade of the U.K.’s banking system didn’t help the mood.

In terms of rates we all watch, things stayed pretty much the same: the benchmark interest rate remained between 0-0.25% after the latest Federal Open Market Committee meeting, and the Senate reconfirmed Ben Bernanke as Fed chair. We learned that the jobless rate stayed flat in December at 10.0%.(source) The inflation rate (CPI) had inched north 0.1% for December, up 2.7% over the last 12 months with core CPI rising 1.8% in that stretch.(source)

A previously obscure Massachusetts state senator became a person of influence on Capitol Hill. The unexpected election of Sen. Scott Brown (R-MA) effectively derailed passage of the Obama administration’s seemingly assured healthcare reforms. White House press secretary Robert Gibbs claimed that the health care reform bill was still “inside the five-yard line.” There were signals that health insurance reform might be the new tack.(source) This was great news during January!

Global economic health. Concerned about an overheated economy, China told its commercial banks to boost capital ratios; that led to the worst market day in Asia since early November, and it was the first in a series of cautions from the government.(source) China’s GDP was +10.7% in 4Q 2009 with December showing amazing annualized gains in industrial output (+18.5%) and retail sales (+17.5%).(source) The Bank of Japan forecast moderate improvement for that nation’s economy; Japan’s jobless rate fell to 5.1% in December, and its vehicle sales went north in January for the sixth consecutive month.(source)

In Europe, the government of Greece wrestled with a $75 billion budget deficit. Standard and Poor’s took the United Kingdom’s banking system off of its global list of “most stable and low-risk” banking systems.(source) Yet Eurozone consumer confidence increased for the tenth consecutive month in January, even as the latest figures showed unemployment had reached 10.0% for November.(source)(source)

World financial markets. Indices in a few of the BRIC nations posted gains last month. Venezuela’s Caracas General pulled off a 7.7% increase, and Russia’s RTSI rose 3.3%; the Jakarta Composite in Indonesia gained 3.0%. (The world’s best performing index was the CASE 30 in Egypt, which rose 7.8% last month.) Most world indices took monthly losses, as follows: Hang Seng, -8.0%; Shanghai Composite, -8.8%; Sensex, -6.3%; All Ordinaries, -5.9%; Nikkei 225, -3.3%; STOXX 600, -2.4%; DAX, -5.9%; CAC 40, -5.0%; FTSE 100, -4.1%. The MSCI World Index fell 3.67% in local currency terms; the MSCI Emerging Markets index lost 4.47% in January.(source)(source)(source)

Commodities markets. Most commodities struggled on the NYMEX last month. Three posted January gains of 5% or better: coal, +8.31%; sugar, +9.80%; orange juice, +5.46%. Platinum prices went up 3.15% and palladium prices gained 0.93%. Gold lost 1.20%, silver 3.89% and copper 8.79%. Gold ended the month at $1,083.00 per ounce. Crude oil, which finished January at $72.89 per barrel, lost 8.15% for the month. Crops were hit hardest, with soybeans down 12.83%, wheat down 12.47%, corn down 13.99% and oats down 17.69%. The U.S. Dollar Index gained 2.07% last month.(source)

Housing & interest rates. What would happen with the housing market without federal subsidies in place? The latest new and existing home sales figures made analysts wonder. Purchases of existing homes fell by 16.7% while new home purchases dipped 7.6%; both figures reflected the assumption that government tax credits were expiring.(source) Construction spending slipped 1.2% in December.(source) On the bright side, National Association of Realtors tallies put existing home sales for 2009 approximately 5% above levels of 2008.(source)

What about mortgage rates? Did 30-year FRMs manage to average under 5% for another month? The answer is yes. On January 28, Freddie Mac tracked average interest rates on 30-year FRMs at 4.98%. Rates on 15-year FRMs were averaging 4.39%, rates on 5-year hybrid ARMs were averaging 4.25% and rates on 1-year ARMs averaged 4.29%.(source)

Major indexes. January brought some chills to Wall Street, with the proposed “Volcker rule” and concerns about financial pressures in China, England and Greece affecting the three marquee indices.

 

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The Decade in Review

Posted by ICMC Staff on 28 January 2010 | 0 Comments

Tags: Lost Decade, Investing, Financial Planning, Economic, Commodities

A turbulent ten years. The 2000s gave us remarkable opportunity and remarkable volatility. They tested our patience, and many investment strategies. They taught us to hold on, hang in there and diversify.

Stocks. Was it really a “lost decade”? It depends on how you were invested. Yes, the Dow ended the 1990s at 11,497.12 and ended the 2000s at 10,428.05, amounting to a 9.30% slip. The S&P 500 lost 24.10% in the same interval. If you had invested a lump sum into an index fund tracking the S&P 500 on December 31, 1999 and left those assets untouched for ten years, you would have ended up with a sizable loss.(source)(source)

Well, that sounds dismal - but how many of us actually invest this way? Very few of us make one lump sum investment and just watch it for ten years. Thanks to diversification, rebalancing and constant inflows of new money, quite a few investors were able to grow their assets and/or outperform the S&P 500 in the past decade.

The fact is, five sectors of the S&P 500 gained 10% or more across the 2000s – health care (+10.85%), utilities (+10.92%), materials (+24.91%), consumer staples (+31.84%) and energy (+102.12%).(source)

Few articles about the “lost decade” mention this notable factoid: the Russell 2000 advanced 23.90% during the 2000s.(source) Mutual funds that focused on buying undervalued small-company stocks gained an average of 8.3% annually in the 2000s.(source)

Outside America, developing stock markets shattered all expectations while the developed markets mirrored American performance. Look at the decade-long gains in key indices in some of the BRIC nations, as measured by CNBC.com: China, +72%; India, +249%; Brazil, +301%; Russia, +863%. Compare those gains with the benchmark indices in Japan (-44%), France (-34%), Great Britain (-22%) and Germany (-14%) in the past decade.(source) Emerging market mutual funds gained an average of 9.3% per year in the last ten years.(source)

Commodities. It was a decade of amazing gains in the broad commodities market. From the end of 1999 to the end of 2009, gold advanced 278.52%. How about silver and copper? Silver gained 208.91% and king copper rose 287.78%. Crude oil rose 210.00% during the 2000s.(source)

How great a decade was it for the commodities sector? Only one notable commodity posted a ten-year loss from 12/31/1999 to 12/31/2009. That was palladium, which retreated 8.98%. On the other hand, we know that 16 commodities gained 100% or more across the decade.(source)

The two biggest gainers during the 2000s were a pair of crops: sugar (+340.36%) and cocoa (+293.31%).(source)

Highs and lows. We are 10 years past the bursting of the tech bubble – March 10 will mark the 10th anniversary of the NASDAQ’s all-time high of 5,132.50.5 And of course, a decade-defining geopolitical event rocked the markets 18 months later.

General Motors and Chrysler filed for bankruptcy protection in 2009; at the start of the decade, so did Enron - the company that Fortune Magazine ranked as “most innovative” each year from 1995-2000.(source) In 2008, Lehman Brothers, Morgan Stanley, Goldman Sachs, Merrill Lynch, and Washington Mutual either folded, mutated, or were bought up while AIG, Freddie Mac and Fannie Mae were bailed out.

The Dow hit a new high of 11,723 in January 2000, a post-9/11 closing low of 7,286 in October 2002, and then ended 2003 at 10,453 (as the DJIA gained 25.32% that year while the dollar lost 14.67%). The Dow hit new peaks of 11,727 on October 3, 2006 and 14,164 on October 9, 2007. A close of 11,215 on July 2, 2008 officially marked the start of a bear market.(source)

From March 9, 2009 closing lows to the end of the year, the Dow shot up 59.28% and the S&P 500 advanced 64.83%.(source) This led to some to entertain tantalizing thoughts about the birth of a new bull market. Or it is simply a cyclical bull in a secular bear? The jury is still out, as the saying goes; we can hope for the best.

What did we learn? The 2000s taught us lessons about irrational exuberance (companies that had never made a dime were probably not worth billions) and lessons about the value of diversifying your portfolio. We also learned lessons in perseverance – those who stayed invested have seen their portfolios make a strong recovery.

The 2000s put investors through some seemingly unimaginable financial headlines. It was a rare decade, an aberrant one in stock market history – for example, the Dow hadn’t had a negative decade since the 1930s, and it had advanced 228.25% over the 1980s and 317.59% for the 1990s.(source) Will we see it make a double- or triple-digit advance in the next ten years? We don’t know. Past performance is no indicator of future success. Yet the awesome potential of the stock market should not be dismissed – and with economies healing the world over, it is clearly time to look forward and stay invested.

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Managing Inflation Risk

Posted by Curtis A. Smith, CFP® on 22 January 2010 | 0 Comments

Tags: Inflation, Hedging, Total Return Strategies, TIPS, commodities, financial planning, investing, core series, economic

As the capital markets have improved, more investors have shifted their concern from weathering the financial crisis to anticipating the inflationary effects of rising federal spending and debt. Many people are asking how they can prepare for potentially higher inflation. This blog post explores two basic ways to address inflation uncertainty and highlights asset groups that may prove useful.

As you consider strategies, remember the difference between expected and unexpected inflation. Asset prices already reflect the market’s expectations about future inflation, given all available information. Inflation may turn out to be worse than expected, and this risk of unexpected inflation is what some investors may want to manage.

Hedging vs. Total Return Strategies

Investors can prepare for unexpected inflation by following one of two basic strategies—hedging the immediate effects of inflation or earning a total return outpacing inflation over time.

Hedging involves choosing assets whose value tends to rise with inflation. Although holding these assets may reduce the total return of a portfolio, the positive correlation with inflation can help an investor keep up with rising consumer prices, at least over the short term. (Correlation refers to the co-movement of asset returns. When two assets are positively correlated, their returns tend to move together; when negatively correlated, their returns are dissimilar.)

Candidates for hedging include retirees, fixed income investors, and others who would experience a diminished living standard during an inflationary period. These investors are willing to forfeit long-term growth potential for more immediate inflation protection.

In a total return strategy, an investor attempts to outpace inflation by holding assets that are expected to earn higher real (inflation-adjusted) returns. This investor is willing to give up short-term inflation protection for an opportunity to grow real wealth. Younger investors are typically well suited for this strategy because they have many years until retirement and expect their earnings to advance faster than the inflation rate. As they save and invest for the future, they can accept more risk through greater exposure to higher-return assets, such as stocks.

To insulate a portfolio from unexpected inflation risk, both strategies may employ some combination of stocks, short-term fixed income, and Treasury Inflation-Protected Securities (TIPS). Let’s consider each of these:

Stocks

Equity securities have provided a positive inflation-adjusted return over the long term. From 1926 through 2008, the total US stock market, as measured by the CRSP 1-10 Index, outpaced inflation by an average of 6.16% per year. (see end notes) To achieve this higher expected real return in stocks, however, an investor had to accept more risk, as measured by greater volatility in returns, and endure periods when stocks did not outpace inflation. As a result, stocks may be less effective for hedging short-term inflation and more suitable for investors who want to beat long-term inflation by earning a higher total return.

Some investors assume that high inflation leads to lower stock market performance, while low inflation fuels higher stock returns. In reality, inflation is just one of many factors driving stock performance. US market history since 1926 shows that nominal annual stock returns are unrelated to inflation.

Fixed Income (Bonds)

Higher inflation can hurt bondholders in two ways—through falling bond market values triggered by rising interest rates, and through erosion in the real value of interest payments and principal at maturity. This inflation exposure tends to impact the prices of long-term bonds more than those of short-term bonds, and investors can mitigate the effects of rising interest rates by holding shorter-term instruments.

Many types of investors may benefit from holding short-term bonds. When interest rates are climbing, a portfolio with shorter-term maturities enables an investor to more frequently roll over principal at a higher interest rate. This can help inflation-sensitive investors keep up with short-term inflation and enable total return investors to reduce portfolio volatility, which can lead to higher compounded returns and growth of real wealth.

Treasury Inflation-Protected Securities (TIPS)

Issued by the US government, TIPS are fixed income securities whose principal is adjusted to reflect changes in the Consumer Price Index (CPI). When the CPI rises, the principal increases, which results in higher interest payments. At maturity, an investor receives the greater of the inflation-adjusted or original principal. The inflation provision enables TIPS to preserve real purchasing power and hedge against unexpected inflation.

TIPS are generally a good short-term inflation hedge since principal is adjusted for changes in the CPI. They are also a good portfolio diversifier for some long-term investors due to their negative correlation with equities and relatively low correlation with most types of fixed income assets. TIPS were introduced in 1997, so these correlations are based on a relatively short sample period.

However, keep in mind TIPS prices have also have been affected by changes in real interest rates, so TIPS may not track inflation one-to-one in the short term or over longer periods of time. In fact, TIPS can lose market value if real interest rates increase.

Commodities

Commodity futures, as well as gold and oil, are perceived as effective inflation hedges because their returns are positively correlated with inflation. But commodities are more volatile than stocks, and their returns do not always rise with inflation because of this significant volatility. So adding these assets to a portfolio may increase real return volatility, which could offset the benefits of hedging.

Investors should also consider the economic argument against holding commodities. Unlike stocks, commodity futures do not generate earnings or create business value. They are essentially a speculative bet in which there is a winner and loser at the end of each trade. Moreover, a broad-based stock portfolio already has significant commodity exposure through ownership of companies involved in energy, mining, agriculture, natural resources, and refined products.

Summary

While the media have featured divergent opinions and theories about the effects of recent government actions on inflation, no one really knows how consumer prices will respond to the complex forces at work in the economy and markets. Investors should carefully review their financial circumstances and investment goals before making changes to their portfolio.

As you assess your exposure to a high-inflation scenario and form a strategy that reflects your financial goals and risk tolerance, consider that:

•    Expected inflation is built into asset prices. In our view, markets efficiently integrate all known information into prices. Thus, current prices already reflect expectations of future inflation. Only unexpected news will affect the inflation outlook.

•    Hedging unexpected inflation has a cost. Investments traditionally regarded as effective short-term inflation hedges have lower historical returns than stocks—and some have much higher volatility.

•    Volatility matters. Evaluating assets solely on their ability to track inflation disregards the effect of volatility on returns and risk. Some assets that are positively correlated with inflation have large return variances, and adding these to a stock and bond portfolio may increase overall volatility.

Even with the prospect for higher inflation, investors who take a total return approach may be better served than those who choose assets based on correlation with the CPI. By choosing assets with higher expected long-term returns and maintaining broad diversification, investors can seek to grow real wealth and preserve the purchasing power of their dollars.

Complimentary related commentary include this Money Cents Newsletter article:
 
Managing Asset Allocation in Your Investment Portfolio 
 
Endnotes
Real return calculation:  (1+CRSP 1-10 Index return)/(1 + US CPI)-1. The CRSP 1-10 Index is a market capitalization weighted index of all stocks listed on the NYSE, Amex, NASDAQ, and NYSE Arca stock exchanges. CRSP data provided by the Center for Research in Security Prices, University of Chicago.

Disclosures
Inflation is typically defined as the change in the non-seasonally adjusted, all-items Consumer Price Index (CPI) for all urban consumers. CPI data are available from the US Bureau of Labor Statistics.

Stock is the capital raised by a corporation through the issue of shares entitling holders to an ownership interest of the corporation. Treasury securities are negotiable debt issued by the United States Department of the Treasury. They are backed by the government’s full faith and credit and are exempt from state and local taxes.

CRSP is a non-profit center that also functions as a vendor of historical data. CRSP end-of-day historical data covers roughly 26,500 stocks, both active and inactive. OTC bulletin board stocks are not included.

The indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results, and there is always the risk that an investor may lose money.

Diversification neither assures a profit nor guarantees against loss in a declining market.

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2009: The Financial Year in Review

Posted by Curtis A. Smith, CFP® on 13 January 2010 | 1 Comments

Tags: economic, federal reserve, foreign markets, commodities, investing, inflation, quarterly update,

The year in brief. The market improved; the economy improved. The doomsayers with visions of “Dow 4,000” were disproven. The Great Recession in all probability ended. Unemployment reached  and remains at 10%, and major automakers went bankrupt, reorganized and shed brands. Stocks went on a nine-month rally of historical proportions. Major healthcare reform made its way through Congress. It was a hard year for Main Street but a gratifying year for Wall Street.

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Fourth Quarter 2009 Economic Update

Posted by ICMC Staff on 6 January 2010 | 0 Comments

Tags: Economic, Commodities, Financial Planning, Foreign markets, Investing, Quarterly Update

The quarter in brief. The rally continued, the economy showed definite signs of improvement, and the biggest health care reform in decades inched toward reality. Stocks upwardly appreciated, with the S&P 500 rising 5.49% for the quarter.(source) Commodities experienced even higher gains. A wave of buyers rushing to take advantage of federal credits helped the real estate market. World economies were growing healthier.

Domestic economic health. Let’s look back at some key economic indicators during the quarter. Consumer spending, for one. Personal spending rose 0.6% in October and 0.5% in November; personal incomes rose 0.3% for October and 0.4% for November.(source) The jobless rate climbed to 10.2% for October, then declined to 10.0% with only 11,000 jobs lost in November, the tiniest payroll decline since the start of the recession.(source) Remember, the consumer is 70% of the economy, and it will be interesting to see if there really was a Christmas spending spree this year. This is doubtful, as consumers remain nervous about government spending and taxation legislation Congress may soon enact.

The key U.S. manufacturing index (the ISM) went 55.7, 53.6 and 55.9 across October, November and December – victories three, four and five, if you will, in a five-month winning streak.(source) Its sibling, the ISM service sector index, went from 50.6 in October to 48.7 for November (the new orders gauge came in at 55.6 and 55.1 those successive months).(source) Durable goods orders rebounded from a 0.6% decline in October to a 0.2% gain the ensuing month.(source)

The Consumer Price Index rose 0.3% in October and advanced 0.4% for November. For November, there was actually a year-over-year rise in CPI (+1.8%). PPI rose shockingly in November (+1.8%) after a 0.3% gain the previous month; the shock was mostly due to a 6.9% month-over-month jump in the price of energy goods.

The Federal Reserve kept interest rates at record lows while dropping occasional hints that rates might necessarily rise in coming quarters. After much contention, the House and Senate passed differing versions of health care reform legislation, with the bills yet to be reconciled as 2009 drew to a close.

Major indexes. The fourth quarter of 2009 was not as amazing for the market as the preceding quarter, but we’ll take it just the same. The fourth quarter brought a big descent in the CBOE VIX (the “fear index” fell 14.92%). With a strong concluding quarter, the Dow gained 59.28% from the March 9 close to the end of the year. The S&P 500 and NASDAQ respectively gained 64.83% and 78.87% in the same time frame.(source) Does it feel like a great year? These returns are amazing considering the collective mood of the country currently.

%Change	4QTR2009	3QTR2009	YTD 2009
Dow Jones	+7.37%	+14.98%	+18.82%
NASDAQ	+6.91%	+15.66%	+43.89%
S&P 500	+5.49%	+14.98%	+23.45%
10 YR TIPS	-5.13%	-12.36%	-30.84%

Global economic health. The data suggests a global recovery is in full swing, with Asia’s economies leading the way. By December, manufacturing indices in China, South Korea, India and Taiwan all showed growth (though Australia’s actually showed contraction).(source) The PMIs in Europe followed suit. The Eurozone PMI was 51.2 in November and 51.6 in December. PMIs in Germany, Italy, England and France were all above 50 for December, with France’s index the highest at 54.7. At the quarter’s end, manufacturing in the U.K. was growing at the fastest rate in two years.(source)

The IMF and the OECD respectively predict 3.1% and 3.4% growth for the global economy in 2010, with the bulk of emerging and developing economies heating up to 5% growth or better. In this quarter, we learned that China’s economy grew 9.0% in 3Q 2009 as India’s economy grew 7.9%.(source)

World financial markets. Investors cheered worldwide as stock indices made further impressive gains. Would you have guessed the Nikkei 225 would have climbed 4.08% in the fourth quarter? It did, and that index climbed 19.04% in 2009 – its first positive year since 2006. Hong Kong’s Hang Seng gained 4.38% in 4Q 2009, and the Shanghai Composite advanced 17.91%. The U.K. FTSE 100 rose 5.43%.(source) The MSCI World Index rose 4.11% in the quarter. The MSCI Emerging Markets Index rose 6.88%.(source)

Commodities markets. The hottest commodity of this quarter was orange juice: prices rose 41.04% in three months. Palladium prices rose 36.65%. Corn prices were up 20.49%. Many other commodities gained between 10-20% last quarter: sugar (+11.73%), copper (+18.71%), platinum (+13.54%), crude oil (+12.39%), heating oil (+17.97%), oats (+18.88%), natural gas (+15.10%), milk (+19.08%), wheat (+18.36%), gasoline (+15.15%) and diesel fuel (+13.63%). In fact, only two widely traded commodities went negative during the fourth quarter: coal (-4.64%) and cattle (-0.39%). Gold? Silver? Well, gold was +8.61% for the quarter and silver was +1.12%. Gold finished the quarter at $1096.20 per ounce. The U.S. Dollar Index gained 1.70% last quarter.(source)

Housing & interest rates. New home sales were down 11.3% for November after rising (a greatly revised) 1.8% for October; the numbers are up and down because first-time buyers thought federal housing credits geared to help them would expire this fall. Existing home sales rose (a revised) 9.9% for October and 7.4% for November.(source)(source) Pending home sales, which had risen for nine straight months, raised eyebrows by slipping 16.0% in December.(source) Housing starts reversed, diving 10.1% for October but rising 8.9% a month later.(source)

Mortgage rates of 30-year FRMs touched record lows but eventually climbed above 5% again. From the last 3Q Freddie Mac survey to the last 4Q Freddie Mac survey, the average interest rate on a 30-year FRM went from 5.04% to 5.14%. Across the quarter, averages on 15-year FRMs inched north from 4.46% to 4.54%. However, averages on 5-year ARMs moved south from 4.51% to 4.44%, and rates on 1-year ARMs went from 4.52% on September 24 to 4.33% on December 31.(source)

1st quarter outlook. For the first time in a long time, good news is nice to hear. Many analysts thinkwe are just two or three quarters into a U-shaped recovery that will play itself out across the next few years. Of course, there are concerns to watch: how the Fed and the Obama administration choose to wind down the stimulus effort, when and how the Fed finally makes a move with interest rates, and the indicators in the housing market. But barring a major geopolitical or economic event, much of the optimism (and federal support for the economy) will likely be sustained through the coming quarter and perhaps the next two. The Great Recession is slowly becoming a memory, and a classic “January effect” may kick off further upward movement on the major stock indexes. 

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