Below is this week’s market commentary from Craig Columbus, our chief economist. This week’s selected articles mostly pertain to Europe as that has dominated US trading/markets over the past few weeks. Where Is the ECB Printing Press?
In my opinion, John Mauldin has done some of the best writing on the European debt crisis because he focuses on the deep, underlying structural issues rather than on the pronouncements of Europe’s leaders. Take, for example, the fact that few have reported that the “voluntary” haircut on Greek bonds only applies to private reditors: “Greece has been told that they can write off 50 percent of their debt held by private entities, but not that owed to the IMF, ECB, or other public entities. This means something more like a 20-30 percent haircut on total debt. Sean Egan suggests that eventually Greece will write off closer to 90 percent.”
2010 has been pretty volatile so far for most asset classes. Stocks and bond have traded all over the board and May was particularly ugly for global stocks and the corporate bond market. But one sector has held up really well: high-yield municipal bonds. I actually did a post on this a year ago and this space has been really interesting to follow since then. Prices for high-yield municipals fell off a cliff in late 2008 due to a liquidity crunch and heavy flight-to-quality trade. In May, during intense volatility, credit spreads on the benchmark high-yield corporate bond index widened by another 141 basis points to almost 7% above treasuries. However, the yield difference between investment-grade munis and high-yielding munis widened by only 2 bps to about 3.5%.
As the Senate passed the Financial Reform Bill (aka FinReg) 60-39 last Thursday, many investors and financial advisors are speculating about how this legislation may affect the financial services industry—specifically the relationship between investment advisors and retail consumers. FinReg was passed for three vital reasons: to end the “too big to fail” mentality, to protect the taxpayer by ending bailouts, and perhaps most importantly to protect consumers from unscrupulous financial practices. Some advisors fear that the implementation of a fiduciary standard will somehow inhibit investment opportunities and give the SEC overpowering regulatory authority. It is important to note that passing FinReg does not automatically create a fiduciary standard for investment advisors; it merely tasks the SEC with engaging in a six-month study to determine whether brokers provide investors with advice under a fiduciary standard (as defined in the Investment Advisers Act of 1940). In my eyes, that six month period gives Wall Street a chance to ‘fight back’ against these game-changing rules, or prepare for them, or some combination of both.
Equity markets around the world have been under heavy pressure this month from a widening European sovereign debt crisis. The following commentary addresses short-term opportunities and long-term issues facing investors in light of this latest European sovereign debt crisis. There is no denying that several key charts are flashing technical caution and send an important message about global economic activity. As of this writing the important Shanghai Composite is down 34% from its August peak while the Reuters/Jefferies CRB (Commodity Research Bureau) Index has fallen 16% since January. Both are near key 50% retracement levels, which if violated, could harken moves back to the lows seen during the height of the most recent recession. The charts for several other markets are also flirting with major topping formations. That being said, corporate profits in the United States have been very strong, as the impending austerity slowdown in the European economy and stronger dollar have yet to meaningfully impact American bottom lines while companies are still reaping the benefits of prior cost-cutting measures. United States exports to Europe are still three times larger than to emerging nations, so one could argue that stocks are simply readjusting to the revised prospects for the world’s real economy. Despite the haircut for European weakness, the U.S. recovery remains intact as does the emerging market growth story.
The issue of financial regulation has taken center stage over the past few weeks. This was inevitable given the circumstances surrounding the recession: a bursting bubble in the real estate market exacerbated by rampant greed and a total lack of transparency on Wall Street. If history has taught us anything, it’s that capitalism thinks and acts much faster than regulation. After the damage is already done, regulators scramble to assign blame and over-regulate to compensate for their own glaring errors. My article today pertains to my end of the industry: financial planning and investment advice. While advisors are typically regulated by either FINRA and/or the SEC, there is a huge amount of confusion about the standards advisors need to follow when it comes to selling products and offering investment advice. There is also confusion about ‘who is’ an advisor because there is no state-issued designation for financial planners the way there is for accountants and financial analysts. The closest thing we have is the Certified Financial Planner (CFP) which is controversial among industry professionals for a variety of reasons ranging from the ethical requirements to the fees. As our field grows continues be in great demand, it’s important that regulators maintain some clear-cut rules and regulations for financial professionals in the business of giving advice.
Some baby boomers still think of smart investing as buying and holding a portfolio of blue chip stocks. Such investors, lost in their memories of stable dividends and low volatility, cringe at the idea of trading in their blue chips for index investments. They also cringe at the inclusion of commodities in newer, diversified portfolio models. The reality is that the past decade, plagued by high volatility and market scandals, has changed the investment landscape, quite possibly forever. The recession of 2008-2009 has also caused a major attitude change for investors. Whereas capturing big gains was the priority during most of the past decade, many investors I’ve been speaking with are now more focused on asset conservation and risk avoidance.
There is an interesting article in this month’s Financial Planning Magazine which questions how realistic it is for the dollar to “fail” on a global scale. These sorts of articles aren’t unusual these days as much debate takes place over US debt, continued foreign investment, rising gold prices, etc. The article’s main contributor, Frank Wei of FundQuest, argues that the dollar is too important to both the global economy and the financial system for it to experience a sudden collapse. Any further declines, he argues, will be gradual.
I’ve gotta say—I was a bit surprised by the opening life of Evan Simonoff’s column in the October Financial Advisor magazine. He said “Who among us (referring to the financial advisor community) really takes this 60% rally in equity prices seriously.” He then goes on to say its “remarkable” how many observers are convinced this rebound is for real. Evan’s column, The Long View, which I read most months, usually provides careful analysis to its arguments. However, this month I was a bit disappointed. Simonoff cites Liz Ann Sonders throughout the article who, it turns out, is actually pretty optimistic about the big market bounce. I didn’t find much if any of the solid data I would expect from an article which looks to support an overall bearish sentiment amongst advisors. Based on what I’ve been hearing at recent financial advisor conferences around New York City, the sentiment is anything but bearish. So let’s take a look at why some advisors might actually take this rally in equity prices seriously.
My clients frequently ask ‘when is the right time’ to start taking Social Security. The most correct answer which is given by both advisors and the Social Security Administration is that you should turn on this income stream when you reach your Full Retirement Age (FRA). Collecting at your FRA is the first opportunity at which you can collect your full benefits and continue to work if you so desire. If you collect your benefits before your FRA they will be reduced and, depending on your earned income, they could be reduced even further. Even so, some people are buzzing about the idea of taking benefits early. After some careful pondering I’ve concluded that this isn’t necessarily the worst idea for some people in certain situations:
I had lunch over the weekend with a fellow money manager specializing in municipal bonds. Because of the growing volume of municipal bond business, I like to gather opinions about where the best opportunities are right now in this space. It’s no secret that the current yield spread between treasuries and municipal bonds is totally out of whack. In case you don’t know the historical norms, here is some background: Because municipal bonds purchased by state residents are often free of state and federal taxes, they typically yield less interest to investors than treasury securities with comparable maturities. Lately, treasuries yields have been abysmal in light of the recession. The ‘flight to safety’ play has treasury prices sky high and yields very low. Similarly, the highest rated municipal bonds (AAA) are paying much less interest than municipals bonds in the A and BBB space. I asked my friend if the depressed prices of these highly graded (but not highest graded) muni bonds are accurately reflecting a serious risk of default, or if this could potentially be an opportunity for investors to get paid while the market recovers. I was told that short-medium term treasury prices are ‘unsustainably high’ and quite possibly nothing more than a hiding spot which may disappear if investor’s appetite for risk continues to climb. We also went through a variety of trading strategies which may be profitable if treasury prices continue falling and municipal bond prices (mid-spectrum) continue to rise.