Second Quarter, 2011
My Comments and Opinions
The second quarter of this year set the stage for the political drama that played out in the early weeks of the third quarter. Congress tried to work out a deal that would make sense for the country. The result was yet another authorization to borrow more money. Congress, true to form, had the audacity to call it The Budget Control Act of 2011.
The Budget Control Act was signed into law on August 2, 2011, the day that the U.S. was supposed to run out of money. Great 11th hour show guys! Two days later the Dow Jones Industrial Average closed at 11,383, a decline of 4%. Several foreign markets experienced similar or greater market price declines. Although there is seldom only one reason for a market sell-off, there are a few obvious candidates for this one: A) The failure to craft a debt ceiling bill that would actually bring down the deficits and thus our total debt; B) Worry about a double-dip recession; C) Concerns about Europe's economic health; D) Continued high unemployment numbers and E) Weak consumer sentiment. These conspired to give traders, speculators and some long-term investors reasons to sell.
A five-hundred-point drop from a Dow Jones of 11,896 is 4%. By comparison, the one-day 508 point drop on October 19, 1987 to Dow 1,738 was a 22% decline. As of this writing the market has gone down approximately 13% from the close on July 25th. By comparison, from Oct. 19, 1987 to August 8, 2011, the Dow managed to increase by 9,071 Dow points (10,809 minus 1,738). The news media may never cease howling details of the minute by minute ups and downs, while neglecting the longer view which has been positive since there was a Dow Jones Industrial Average. Market course "corrections" of 10% to 20% are the norm. Markets don't grow straight up. They take the zigzag, long way up.
The U.S. had its AAA credit rating downgraded for the first time by Standard & Poor's on concerns that spending cuts agreed on by lawmakers to raise the nation's borrowing limit won't be enough to reduce record deficits. S&P dropped the ranking one level to AA+, after warning on July 14 that it would reduce the rating in the absence of a "credible" plan to lower deficits even if the nation's $14.3 trillion debt limit was lifted. The U.S. was awarded the top credit ranking by New York-based S&P in 1941. It kept the outlook at negative. "The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics," S&P said in a statement today. Source - NEWSMAX.COM (8/5/2011)
Remember, the stock market was't downgraded by S&P. The U.S. Government was. Going from AAA to AA+ is a very small, but highly symbolic move. It's a warning to the politicians to get the national budget balanced. S&P was looking for cuts of up to four trillion dollars. That didn't happen.
Here's a brief history of market corrections since 1989: 1989 -9.24%; 1996 -11.04%; 1997 -13.01%; 1999 -13.05%; 2000 -13.76%; 2004 -8.81%; 2010 -14.67%. (Source: www.ciovaccocapital.com)
These stock market corrections are measured within the larger bull and bear markets. Market corrections can occur two or three times in a decade. It's normal. Not fun, but normal. Quoting Donald M. Selkin, Chief Market Strategist at National Securities Corporation on August 5, 2011:
“The S&P trades at 11.8 times forward earnings, which could bring a measure of support to stocks. Earnings were $85 in 2010 and are projected to be $100 for 2011, according the analysts who follow these companies. The average P/E multiple for the S&P going back to 1954 has been 16.2. Since 2006, the average P/E multiple as been 14.7.
For all of 2010, earnings increased by +38%, which was the most since 1995. For 2011, first-quarter earnings gained +19% and are projected to gain +13% for the second quarter as reported by Bloomberg Financial and the 17% overall projected gain for 2011 would be the largest two-year advance since the period ended in 1995. The highest ever earnings for the S&P in one year so far took place in 2006, at $88.”
Love it or hate it, we owe more than before the deal was cut. Legislation which was finally signed into law allows our government to borrow an additional $2 Trillion. The law does nothing to reduce the debt over the long term. Instead, it allows for an automatic increase in federal government spending of about 8% per year far into the future and only "reduces" something like $200 Billion of spending per year over the next decade. This means that unless more action is taken, our $14 Trillion debt could grow to well over $20 Trillion during the next decade.
According to the U.S. Treasury Department, our national debt is now roughly equal to our Gross Domestic Product (the sum of everything produced in America, our manufactures and services). From 1945 to 1949 (Roosevelt/Truman presidency) our national debt (War Bonds, etc.) went from 117% of GDP in 1945 down to 93% of GDP in 1949, a decrease of 24%.
("U.S. Federal Deficits and Presidents" http://home.adelphi.edu/sbloch/ deficits.html).
--Stephen Bloch.)
Since 1949 our federal budget deficits have been smaller than our GDP.until this year. The national Debt in 1791 following the War for Independence was $75,463,476.52 according to The Bureau of the Public Debt, U.S. Dept. of the Treasury. For all years save one, 1835, America has been a debtor. If nothing else, the past decade has been a reality check on personal, corporate and government financial planning. The normal business cycle - good years followed by bad followed by good, etc. has not been interrupted. The admonition to put away during the good years so as to be prepared for the not-so-good years is still valid.
On April 27th Ben Bernanke gave the first ever news conference by a Fed Chairman in the 98-year history of the Federal Reserve. Prior to this presentation, Federal Reserve Chairmen reported directly to Congress. "Interest rates will stay low for some time" he assured the nation. This may a very good time to refinance a mortgage or consider buying a home.
Over the years inflation has decreased the purchasing power of our currency. A U.S. Dollar issued in 1926 bought what twelve Dollars buy now. The overall rate of inflation over the past 85 years has averaged a compounded 3%. That's a low number. Should inflation some time in the future approach the rates of the late 1970s and early 1980s, we could be spending deeply devalued currency. The real risk is not a volatile stock market, real estate market or bond market. The real risk is losing purchasing power over time to inflation.
On July 29th the U.S. Department of Commerce, Bureau of Economic Analysis estimated that:
“Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 1.3 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.4 percent. The
Bureau emphasized that the second-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the
source agency. The "second" estimate for the second quarter, based on more complete data, will be released on August 26, 2011.”
There has been a lot said about how the government counts inflation. U.S. Department of Labor Statistics economists John Greenlees and Robert McLelland recently responded: "Has the Bureau of Labor Statistics (BLS) removed food or energy prices in its official measure of inflation? No. The BLS publishes thousands of Consumer Price Indexes (CPI) each month, including the headline All Items CPI for All Urban Consumers (CPI-U) and the CPI-U for All Items Less Food and Energy. The later series, widely referred to as the "core" CPI, is closely watched by many economic analysts and policymakers under the belief that food and energy prices are volatile and are subject to price shocks that cannot be damped through monetary policy. However, all consumer goods and services, including food and energy, are represented in the headline CPI. Most importantly, none of the prominent legislated uses of the CPI excludes food and energy. Social Security and Federal Retirement Benefits are updated each year for inflation by the All Items CPI for Urban Wage Earners and Clerical Workers (CPI-W). Individual income tax parameters and Treasury Inflation-Protected Securities (TIPS) returns are based on the All Items CPI-U."
For over eighty-five years common stocks have bested inflation by a compounded 3% per year. There's no reason to doubt that this trend will be broken. Buy good quality investments. Stay invested. Buy when others are nervously selling. Do you believe that the great companies of America and the world are going to all go bankrupt? Even during the Great Depression that didn't happen.
Robert W. Brimmer, CFP™
DISCLOSURES
The views expressed contain certain forward-looking statements. Although they are forecasts, actual results may be meaningfully different. This material represents an assessment of the market and conditions at a particular time and is not a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any security in particular. The opinions expressed here are the author's and do not reflect any opinion of National Securities Corporation, my Broker/Dealer, or any of its Affiliates. Source material for this letter: Budget Control Act of 2011; newsmax.com; www.ciovaccocapital.com; Donald M. Selkin, Chief Market Strategist at National Securities Corporation; franklintempleton.com; U.S. Treasury; Stephen Bloch at Adelphi.edu/sbloch/deficits; U.S. Dept. of Commerce, Bureau of Economic Analysis, U.S. Dept. of Labor Statistics.
BRIMMER FINANCIAL
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