Bad News?

JP Morgan’s sudden confession of a $2 billion loss on a “synthetic credit portfolio” last night was the talk of the morning for many reasons, not the least of which was the ammunition such a mistake gives the regulatory push in Congress.  We are not a big holder of the stocks of international money-center banks for precisely this type of risk: if the CEO has no idea about his/her company, how can we?

However, we are often perfectly happy to own the bonds issued by these same banks. Why? Perhaps the chart below can show this better than we can describe things in writing. The graph shows a bond we own for many of our clients (JPM 5.125% 9/15/14, in white) and JPM common stock (orange line).  At the end of the day, as galling as JP Morgan’s confession was, it was the stock that took it on the chin, while the ability of JPMorgan to pay its debts as they come due was deemed unaffected by the markets.

Remember, bad news for a stock may not be bad news for the bonds – and that’s why bonds probably have a place in your portfolio.

Payment at the Pump

In a recent article released by The Economist titled “Feeling Perky: The economic impact of high oil prices,” the cause and potential effects of high oil prices are generally explored.  Many of us are currently experiencing the impact of high oil prices on our wallets and the dread of seeing the illumination of the fuel light.  Some of us drive relatively fuel efficient automobiles such as hybrids and are therefore less impacted by recent increases in gasoline prices.  On the other hand some of us require the use of a SUV, truck, or maybe we just enjoy cruising down the highway in our 1984 Mercury Grand Marquis.  Whatever the reason we are stuck paying the $70+ tab each time we stop in to fill up the tank, and by now some of us are becoming disgruntled.  This begs the question, why have fuel prices risen so drastically and what can we expect from here?

As the article mentions, recent news media chatter has blamed a large portion of the rise in oil prices on oil “speculators.”  In response Obama has rolled out new legislation in an effort to stop these speculators by increasing penalties for market manipulation.  Another explanation for the rise in oil prices is increasing global demand on a fixed global supply.

According to the article, the most likely explanation for rising oil prices is simply that demand is outpacing supply.  Increased demand can be seen in the transition of oil exporting countries into oil importing countries.  These new oil importers are now adding to the load of the diminishing number of oil exporting countries.  In essence there are now more people at the Thanksgiving table, but we still have the same 3 pound turkey.  The effects of rising oil prices are most likely modest at a global level, however we (U.S.) are not concerned with global GDP (Gross Domestic Product) we are concerned with U.S. GDP.  As the article mentions, U.S. GDP will be affected more than global GDP because the U.S. is paying the higher prices by importing oil.

As the article explains there is no easy way out of higher oil prices for two reasons.  First, other sources of energy production are more expensive relative to how much energy is produced.  Second, the cost of transitioning to a new fuel source is high.  So what does it all mean?  The article states that for the economic boom to continue developed and developing nations will need an energy source that is abundant, cheap, and efficient.

 

Source article: http://www.economist.com/node/21553034

Taxes and Dividends

An interesting tidbit crossed our desk the other day related to dividends, which is a topic many clients have been interested in with income from bond holdings at fairly meager levels. Morningstar reports that “342 of the S&P 500 companies increased their dividends (in 2011), while only five cut their dividends, leading to a net annual increase in payout of $41.1 billion, a far cry from the $37.3 billion in dividend cuts created by this group in 2009.” The Morningstar author goes on to posit that he expects healthy dividend increases in 2012 as well. In our view, that may well turn out to be the case in 2012. However, President Obama has proposed some pretty hefty increases in taxes on dividends, to the tune of up to 44.8% in the top tax bracket compared to today’s 15% (calculation by the WSJ). That tax increase, if it comes to fruition, may pose a headwind for increased corporate payouts. We know that when tax rates on dividends were cut in the past, dividend payouts went up as corporations recognized a preference for dividends over share buybacks from many in their shareholder base. It seems reasonable to postulate that a dividend tax over 40% could cause the reverse behavior. Stay tuned.

Bernanke Speaks to Congress

The Federal Reserve chairman, Ben Bernanke spoke in front of Congress today. While always an anticipated event for the media and markets, he didn’t really have much to say that we don’t already know. He encouraged Congress to pass a debt plan that had “fiscal sustainability” and would give confidence to both businesses and consumers. This is not a new concept and yet somehow needs to be reiterated every time he meets with Congress.

He talked about the slow growth in the economy and although there are signs of improvement it still has a long way to go. He expressed that obstacles to this slow growth were due to the depressed housing market and the European crisis. Again, nothing new here. If you took to the streets and asked most pedestrians what the big issues were blocking our economic growth probably 9 out of10 would mentioned those two (along with the lack of manufacturing jobs).

Finally, Bernanke repeated what the Fed said last week that short-term interest rates would stay at 0% through 2014. Prior to last week we had been told at least through 2013 and now we know it will continue through 2014. This isn’t earth shattering news but does put pressure on investors and retirees that need to live off a fixed income.

Given the lack of any new insights, the markets did not react significantly in either direction.

Quick Market Recap for 2011

2011 was not an investment market for the faint of heart. As we discussed in an earlier blog posting, this summer’s volatile markets were a real test for one’s true risk tolerance. Yet despite all the ups and downs in the various markets, as has been the case since 1939, the third year in a president’s term was a positive year for the Dow Jones Industrial Average. Remember, however, the Dow is just an index of 30 large industrial stocks. The S&P 500 which is a broader indication of overall domestic market performance was flat, 0.0% for 2011 before dividends. The Nasdaq composite which represents smaller companies and includes many technology companies was down -1.8% for the year.

When looking at international markets, the story unfortunately was not quite the same. Depending on what index or specific country you looked at, there were losses on the low end of -5.5% for the U.K. all the way to -25.5% for the Italian exchange. Suffice it to say, it was a bad year for the international stock markets.

Finally, not to be left out of the volatility party, the bond markets fell prey to the same market moving events as stocks did such as; the Debt Ceiling Crisis, the downgrade of the U.S. government, the European Debt Crisis, and the Fed telling us interest rates were going to remain low through at least 2013. However, bonds had a little better showing as one would expect when the stock market does not perform as well. Depending on the duration (the average time it takes to receive all the cash flows from a bond ) we saw returns of +2.0% for bonds under three years up to +8.5% as measured by Barclays Capital Aggregate Index, a measure of longer average maturity, investment grade bonds.

We hope that 2012 proves to be a little less exciting in terms of volatility but only time will tell us that. What we do know and continue to believe strongly in, is that the right asset allocation will have the biggest impact long-term on a portfolio’s performance.

Wishing you a healthy and happy 2012.