Why The Debt Ceiling Matters

Two weeks into the government shutdown. Just days away from the country maxing out its credit card by hitting the debt ceiling. Most of the country says what's the big deal, Congress? Just increase or credit limit AGAIN!

I'll tell you the problem and why I'm behind GOP efforts to address a reckless fiscal policy that has our country on the path to slow growth, rising unemployment, which will reduce income for all Americans.

Right now, the country is spending more than it makes. Our debt has exceeded our GDP for the first time since WWII. 

While disputed by free-spending left wingers, numerous studies point to a direct relationship 

between  high government debt levels and slower economic growth.

A slowdown in economic growth may not sound like a big deal, but over time 

it means that Americans in the coming decades will be a lot poorer than they 

would have been. 

According to this analysis, the average American worker will give up $12,000 

over the next two decades by just a 1% decline in GDP.

http://reason.com/archives/2013/10/11/the-morning-after-americas-debt-binge

The country needs to take some stiff medicine now, including major cuts to 

entitlement programs, raising the retirement age and making stiff cuts to other 

government spending. The pain should be shared with  all to protect future generations. 

Corporations do this all the time to weather cyclical downturns and avoid bankruptcy.

As for my investment decision making, I've been lightening up holdings and increasing 

cash accounts. Market 50%, Matress 50%. I still believe equity markets are FED driven, 

and the central bank shows few signs of turning off the free Money spigot. 

I say poor fiscal policy and poor monetary policy. Surging debt load and nonstop money 

being printed spells trouble ahead.  When China starts demanding more interest to buy our debt, 

the huge downward spiral begins.

Let Them Eat Chocolate

Republicans and Democrats have yet to come to an agreement to avoid the so-called fiscal cliff.
The dispute involves whether to increase taxes or cut spending and to what degree to do both. Regardless of the outcome of these discussions domestic economic growth is bound to decelerate both options will help cut the huge amount of government debt however each will cause consumer spending to drop, job losses and lower business investment thereby lowering US GDP output.
Traders on Wall Street have been speculating on whether a deal might be reached thereby causing great fluctuations in the stock market, however the ultimate result of these discussions will surely mean pain for the US economy.
The market is currently trading at about 10 times earnings making it quite attractive and undervalued assuming forward earnings estimates are correct and that growth will come as analyst predict.
Corporate earnings fell 4% in third-quarter and are expected to rise in the coming quarters. Over the next four quarters earnings are expected to increase on average 4% according to analysts estimates
Once again in my opinion those estimates are overly rosy at best I see economic growth increasing by 1.5% to 2% over the next year.
Congressional leaders will do their best to push economic growth along regardless of their intentions with the deficit.
Based on my estimate for forward earnings growth I put the S&P 500 trading at about 14 times earnings slightly below the markets long run average so in my opinion the market is neither cheap nor expensive.
I continue to remain heavily invested in cash in the event that congressional leaders botch this completely and send the US economy into a recession again. I still believe we are a few years out from seen a sustainable increase in stock prices and believe that the current fluctuations in the market have been caused by nothing more than free money from the Federal Reserve finding no better home.
Government must cut spending including entitlement programs and it must raise taxes from a broad-base of taxpayers in order to pay down the debt which becomes the country's major problem for the future.
It is going to take some short-term pain for the markets that has not currently been reflected in market prices. I'm waiting for significant decline in the S&P 500 to below 1300 before I'm going to get back into the market.
It is only when we get to see the actual details of the deficit reduction strategies when the market will begin to realize economic growth in this country is not going to be his fast as many analyst predict.
On a side note we just bought some shares of Hershey company HSY for my girls after visiting Hershey theme park. Most definitely a recession resistant industry. Almost everybody loves chocolate!

By the way please forgive any typos or misspellings as I did this blog posting completely with voice recognition software.

Big Waves, But A Dead Calm

It's been awhile since my last post and I haven't taken any investment actions in that time. Here's why.

We've found ourselves in a bit of a market trough with the S&P 500 index trading (albeit with volatility) between roughly 1250 and 1350 since the beginning of the year. In my last post I indicated the swing-point on my investment decisions was 1250 based on my tempered forecast of global earnings rates for the year ahead. I had parred back some holdings and continue to sit on a pile of cash earning very little.

In fact the only bright point about today's market environment is the low interest rates being offered by banks, which I found too attractive to pass up. We're refinancing our house yet again and saving hundreds in monthly mortgage expense. If you haven't already, and sit with a rate north of 4.5%, I'd suggest you look into it.

The market is currently forecasting a return to growth in the 12 months ahead, according to the consensus S&P 500 earnings forecast for U.S. companies. That makes the S&P index of 1354 roughly valued at 13 times forward operating earnings, which is considerably less than the long-term average of 17, which would put the S&P index closer to 1700. So why am I not excited about this?

Well first of all, I'm not in the camp that U.S. earnings growth will surge to 4% in the second and again in the third quarters of this year. I'm factoring in much more conservative estimates. Second of all, I'm not expecting the market to trade anywhere near the mean P/E ratio, given uncertainty in Europe, U.S. elections, jobs, the possibility of huge tax breaks not being extended next year, global political tensions . . . the list goes on.

Here's where I'm at. I'm thinking flat to slightly higher earnings ahead. I don't see the 4% growth analysts are forecasting. For my money, I'm thinking S&P 500 component earnings of $94 for the twelve months ahead. I'm also going to stick with a cautious multiple of 14 on my estimate, which places the S&P index at about 1320.

 It's up from my previous view, based on some strength in early second quarter earnings reports. But remains below the current market. So below 1300, I make look to dip my toes back in the waters with a quick exit strategy in mind. Times like this I wish I took some surfing lessons.
 

Market getting frothy, time to ring the register

I've started taking some chips off the table. Already cash heavy. But given the recent market run-up is not supported by fundamentals, I'm seeing as this as a good time to take some profits.

I wrote last that I believed the S&P pivot point was 1,250 based on my forecast for global earnings growth this year. I continue to hold that line and my conviction is strengthened by a recent downgrade in growth estimates by global powerhouse China.



Despite signs of emerging growth in the U.S. there are just too many uncertainties (Greek default, contagion spreading to Portugal, Italy, war with Iran, Syria, U.S. election, escalating gas prices) to warrant being fully invested right now.

I continue to believe the U.S. is the safest bet for equities. But my long-term forecast envisions other countries, including Australia, Canada, Brazil, China, even some African nations taking global economic market share. I'm working to put together a cost-effective portfolio that represents significant stakes in these countries.

Mattress is getting even lumpier thanks to the equity run-up.

Why S&P 500 Pivot Point Is 1,250

I'm not going to get into any of the reasons the stock market has been so volatile in the past few months. The talking heads on TV are doing a good enough job confusing/entertaining investors with this.

Rather, I'm going to make a case for why the S&P 500 Index has been leveling out around the 1,250 level and explain why getting in the market below that makes sense. I don't know about you but my mattress has been getting awfully lumpy lately.



When all is said and done in Europe, investors will once again return to corporate earnings as their gauge of stock market performance. What the latest earnings estimates from analysts are telling me is that most are seeing weak growth through the remainder of the year and then stronger performance next year. When analysts are uncertain about growth prospects, they simply use a simple straight line assumption which appears to be the case next year. I'm far less certain.

But for the sake of simplicity, I'm using a conservative $83 per share annual earnings estimate for consolidated S&P 500 index components. (The consensus is $91.59) My estimate assumes significant global economic deterioration in the current quarter followed by stagnancy or tepid recovery next year. I'm obviously more bearish than the consensus, but I don't see us returning to grow rates above 2-3% anytime soon.

So getting back to the 1,250 pivot point. Why is the market going to turn around this point? Based on my conservative earnings estimate, this is the level where the market's P/E ratio (price to earnings) is at its historical mean (~15). Meaning historically, the market would be cheap under 1,250 and expensive above 1,250.

I had been waiting for the market to drop below the 1000 level to put some more mattress money to work. But I'm considering the worst maybe over and that Italy will be the final shoe to drop in this European debt fiasco. I've got my eye on the 1,150 level now. What to buy then? Check back next time.

Let History Be Your Guide

There's never been so much uncertainty in the stock market about the future of the global economy. Half think we can slog along with anemic growth, while the other half think we're headed back to recession.

A chart of the S&P 500 Index is looking like an electrocardiogram since the beginning of August, when serious concerns about European debt problems as well as our country's inability (read gridlock in D.C.) to deal with joblessness and lack of capital spending by firms. Oh, and there's a supercommittee of legislators expected to deliver a plan for massive (trillions) federal spending cuts by November's end.

So, when all is in doubt what is an investor to do? For my money, I'm looking back in history to a similar time of tremendous public doubt about government and the future of the financial system. The behavior of investors then is shaping up much like as it is playing out today.

Following the crash of 1932 (2009), stock rebounded sharply over the next few years 1933-1936 (2010-2011). Then there was another pull-back, followed by a slow and steady rise back. But stocks didn't recover to their pre-crash levels for 25 YEARS! Now with new computer-driven trading technology and supposedly smarter traders, I can see that time frame today condensed by more than half. But that still means we have 5-7 years before all the bad news shakes out of the market -- the deleveraging of the global economy is done.

So . . . I'm saying we're not likely to see S&P 1500 for quite a while. It's at 1154 now.

If you look at the chart above, the best point of entry back then was in late 1941 -- after Pearl Harbor when we declared war with Japan. WWII brought on a period of tremendous economic growth and prosperity for our country and investors profited greatly. We may need a similar extreme global event to kickstart our economy again.

I can't envision one yet. I'm still 50% market 50% mattress.

U.S. downgrade deflates value of ALL investments

Waking up to headlines like this can be scary:

US debt talks teeter on edge of collapse

Experts say buy gold or keep plenty of cash. But few explain the reason why all cash-flow dependent investments will suffer when the credit of the world's largest economy is downgraded.

Here's the not-so short and sweet: When you value a company, or stock, you have to estimate its future cash flows. Obviously, the more expected cash flows, the more valuable the company. But, in order to get the value that you'd pay Today for that company, you must discount those cash flows -- meaning future cash flows are less valuable today. (The old bird in hand saying)

The discount rate almost all financial experts use to discount cash flows is the "risk-free" rate on U.S. government treasuries (U.S. debt). When the U.S. defaults, the ratings agencies (S&P) lower the country's credit rating. Investors in our debt demand to be paid a higher rate of interest in return. And the borrowing cost to the government, and this discount rate, goes up. When the discount rate rises, the value of ALL future cash flows goes down.

Now the two big questions are: Will government debt actually be downgraded, and if so how much will this discount rate rise?

My feeling is that even if the government comes to some last minute agreement to raise the debt ceiling, ratings agencies have already committed to downgrading our debt based on fundamentals. So yes, I think that barring some miracle (like Washington agreeing to the types of dramatic cuts in spending and tax increases needed, but that will cost them their jobs) the U.S. will be downgraded.

How much will investments suffer? I don't think a 5% to 10% correction is out of the question.

I've positioned our portfolio at a tactical non-commitment level of 50% market, 50% mattress. If you are on a shorter-term investment horizon (retirement looming) you should be even more conservative.

Sell all funds that hold primarily U.S. government treasuries, except inflation protected bonds. Maintain international exposure. Look to invest in Swiss-backed government debt (safest in the world). And, if you're uncertain completely, keep your money in an FDIC-backed CD.

Here's the kicker. When the government eventually raised the debt ceiling (and they will), get ready to unload some of your investments. It will be difficult. The market will jump on the news. There will be elation and hope for a resurgence in domestic growth. But nothing ever lasts.

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." -- Warren Buffett