CK Communiqué

At the end of February, Apple’s stock market value hit a record high of $500 billion, which has only been accomplished by four other companies:  Microsoft, Exxon Mobil, Cisco and General Electric.  At this point Apple is the highest-valued company in the world, and its valuation is higher than the GDP of Saudi Arabia, Taiwan or Poland.

As if size weren’t enough, Apple is also one of the fastest-growing technology companies.  Last year its sales grew by 73%, and it posted the second-most profitable quarter in history for any US company.

While these facts are interesting, the takeaway for investors is that while the US and world economy may still be recovering, it is encouraging that well-run businesses have an opportunity to flourish.  Also noteworthy is the fact that the other four companies who have topped the $500 billion mark have subsequently dropped due to various factors such as the end of the technology bubble or a drop in oil prices. 

Source: http://finance.yahoo.com/news/at–500-billion–apple-is-worth-more-than-poland.html

Normally, investors buy bonds for income, and don’t expect to get a whole lot of growth from that part of their portfolio.  And they buy stocks primarily for their growth potential.  Right?

Well, recently, as stock prices have crawled sideways and Treasury rates have dropped, the U.S. markets have given us something that experienced investors haven’t seen since the 1950s.  The average dividend yield on stocks in the Standard & Poors 500 index (1.95%) has moved up past the yield on 10-year Treasury bonds (currently hovering around 1.93% a year).

In other words, investors can get the growth potential of a stock investment, but be paid more, in current income, than they would get from plain vanilla government bonds.

In days of yore – before roughly 1955 – it was accepted wisdom that since stocks were risky, investors should be paid more to own them.  As you can see from the chart below where the blue line is Treasury rates and the red line is large cap stock dividends, there have been times when stock investors were paid a LOT more, in part because of depressed share prices during the Great Depression, but overall because investors were willing to accept less market risk than they have been for the past half century.

The chart also shows the opposite extreme.  In the 1980s, when inflation drove bond rates through the roof, companies focused on providing capital gains rather than current income at the period’s high tax rates.  Why pay dividends when you can plow earnings back into operations and turn ordinary income into capital gains?

It is hard to know how long we’ll be able to buy stocks that pay us higher yields than we’re getting on our Treasury investments.  As you can see from the chart, dividends are still fairly low by historical standards, and any uptick in stock prices would drive that red line correspondingly downward.  Similarly, analysts keep telling us that Treasury rates can’t keep dropping forever.  So for now, let’s enjoy an unusual market opportunity that investors last experienced back when Dwight Eisenhower was President, one of those interesting moments in investment history that you probably won’t see covered by the investment press.

With inflationary pressures growing, it makes sense for some of a portfolio’s fixed income investments to be allocated to certain “safe” stocks for enhanced yield as well as potential for growth.

Sources:

Treasury rate:  http://www.multpl.com/interest-rate/

S&P 500 Dividend rate: http://www.multpl.com/s-p-500-dividend-yield/

Let’s start with some interesting facts on charitable giving:

• The largest slice of the charitable giving pie comes from individuals, at $227.41 billion in 2009 — contributing to 75 percent of total giving — followed by foundations ($38.44 billion / 13 percent), bequests ($23.8 billion / 8 percent), and corporations ($14.1 billion / 4 percent). 
• Giving USA Foundation™ and its research partner, the Center on Philanthropy at Indiana University, reported that total charitable contributions from American individuals, corporations and foundations were an estimated $290.89 billion in 2010, up from a revised estimate of $280.30 billion for 2009. The 2010 estimate represents growth of 3.8 percent in current dollars and 2.1 percent in inflation-adjusted dollars, even though real income declined over the same period.
• Approximately 65 percent of US households give to charity, with an average annual contribution of $2,213 and mean of $870. When we look at high net worth households, the numbers change quite drastically. An astounding 98 percent of high net worth households give to charity.
• According to the IRS, households with income under $50k give about 2% of income and the percentage grows to 3.4% for households with adjusted gross income over $500,000. 

Individuals clearly play an important role in supporting charitable work; now let’s look at the role the government plays in encouraging or discouraging giving.

In order to discourage over-estimating charitable gifts, as of 2007 the Federal Government will not allow anyone to deduct a charitable gift that cannot be traced to a credit card, debit card, check, or letter from the charity.  As a result, taxpayers can no longer deduct cash gifts so Toys for Tots, Salvation Army Santas and church giving (placing cash in the collection plate) are being discouraged.  In both 2010 and 2011 the amount of gifts given by check rose yet Toys for Tots donations declined!  The 2011 decline was so great that the deadline was extended and in the end thousands of children did not receive toys.  The restriction on cash gifts has limited these typical holiday giving opportunities, turning taxpayers into Scrooges!

A study by the Center for Philanthropy released in October states that tax rates have the greatest effect on charitable giving and that eliminating the Bush Era tax cuts would decrease charitable giving by about $2.4 billion a year but would raise revenues by about $300 billion a year.  In addition, the Congressional Budget Office study released in 2011 showed that if all taxpayers could deduct charitable gifts (not just itemizers) then charities would have received $2 billion more in gifts and the treasury would have lost $5.2 billion in tax revenues. 

The good news is that in spite of the strong effect that tax laws have on charitable giving, people are inspired to continue giving in tough economic times.

Although most of the news lately has been centered on the negative economic effects of the European sovereign debt crisis and the US structural debt problem, the news from China has been much more encouraging.  On November 16^th, the Wall Street Journal reported that China is indeed growing its domestic economy as it claims.  In addition, the Chinese current account surplus has dropped from 5.1% of its Gross Domestic Product (GDP) to about 3%.  In a speech by President Barack Obama to the G20, a group of finance ministers and central bank governors from 20 major economies, the president urged the organization to pass a resolution stating that a country would need to appreciate its currency if its current account surplus was greater than 4% of its GDP.  A current account surplus generally indicates that a country is exporting more than it imports, and appreciating its currency would make foreign imports less expensive, which would help balance out the surplus.  In 2006 the Chinese current account surplus was about 9%, in 2007 it topped 10%, in 2008 it hovered just under 10%, and in 2009, as the Chinese government instituted its $500 billion domestic spending program and the world economy shrunk its surplus, it dropped to 6%.  In 2010 it fell to about 5.1% and for 2011 it is projected to come in around 3%.

Adding to the good news from China is the fact that domestic consumption is growing.  Currently each Chinese spends and produces about one tenth as much as his/her American counterpart.   According to the CIA report, China’s GDP is expected to reach $6 trillion by the end of 2011 while the US GDP is just under $15 trillion.  So currently the US GDP is about double the Chinese GDP.   On a per capita basis the US GDP is about $50,000 ($15 trillion divided by 300 million) while the Chinese is $4,600 ($6 trillion divided by 1.3 billion people).  So, if the Chinese were to grow domestic demand sufficiently so that Chinese per capita GDP equaled the US, the Chinese GDP would be $60 trillion and the Chinese domestic demand would solve the US unemployment issues (not to mention the European and world economic problems!).  Obviously this growth will not happen overnight but the trend is very important and positive.

A China with growing domestic demand and a shrinking current account surplus can assist with US and world economic growth.  This news, although barely discussed, may save the world.  We need to remember that China has 1.3 billion consumers so the sooner Chinese demand grows, the better it is for the growth of world trade.  Although the short term effect of the news is to blunt US criticism of Chinese yuan currency policy, the long term issue is much more robust and speaks well for the US economy as we finish 2011 and enter 2012!

A recent article in Barron’s magazine discussed a lawsuit filed by Ameriprise employees over losses in their 401(k) plans.  The employees claim that Ameriprise favored funds managed by its subsidiary, which had a poor investment record and high fees.  The 401(k) fund suffered $20 million in investment losses, but some of the fees went back into Ameriprise’s pockets, according to the lawsuit.  This lawsuit begs the question:  if Ameriprise as an entity so flagrantly flaunts its fiduciary responsibility as to have its own employees bring a lawsuit, then how can those same employees justify recommending Ameriprise and its products for their clients?

Source: http://www.advisorone.com/2011/09/30/ameriprise-sued-by-employees-over-401k-losses

One of the methods by which we can gauge the economic might and influence of a country is the effect a foreign country has on the internal affairs of another country.  Today, we are witnessing just such a power move.  In South Africa, Bishop Desmond Tutu is being celebrated on his 80th birthday.  Dignitaries from around the world were invited.  According to a report on National Public Radio (NPR), the Dali Lama was refused a visa to enter South Africa as a threat even though he received a personal invitation from Desmond Tutu.  This is the equivalent of the United States refusing entry to an invited guest of Benjamin Franklin or Alexander Hamilton.   As the Chinese are feeling more secure in their economic might, it appears they are using that power to further their political agenda.  China – whose GDP is currently about 1/3 of the US’s – is expected to catch up with us in the next ten years.  Will such shows of power become commonplace?  What will our thoughts concerning that global order be?  I wonder…

We are looking at a shrinking US middle class. Proctor and Gamble, historically a company that sold products to middle class America, is changing their strategy to separately target high- and low-income consumers because they do not see the trend changing. Citigroup has created an index fund using this “hourglass” theme – companies that sell products to either high- or low-income households – and it has returned 56.5% since the fund’s beginning in December 2009 compared to 11% for the Dow. I am certain that the change started earlier but the signs were hidden in the housing bubble. Now with that bubble burst, the issue is more pronounced. I do not see anything to reverse this trend until after the 2012 election. I have no idea if we will elect someone to fix the problem then, so the loss of the US middle class may be the new NORMAL! What can we do to work with this new paradigm?

http://finance.yahoo.com/blogs/daily-ticker/america-middle-class-shrinks-p-g-adopts-hourglass-145429009.html

August was a cruel month for equities throughout the globe! Here in the US, the S&P 500, the most representative of the major equity indices, fell 6.1%. Ouch. But looking at that number in a vacuum is not very helpful.

Across a wide range of indices, the US market was one of the strongest performers, even stronger than China although China’s gross domestic product was almost 10 times higher.
Across our Global Macro model’s Global Equity market league tables, here was the score for August 2011:

1.Greece = down -23.9%

2.Germany = down -19.2%

3.Italy = down -15.6%

4.Russia = down -13.4%

5.Austria = down -12.7%

6.South Korea = down -11.9%

7.France = down -11.3%

8.Argentina = down -10.7%

9.Sweden = down -10.6%

10.Taiwan = down -10.4%

11.Hang Seng = down -8.5%

This is where diversity amongst different assets and exposure to fixed income securities comes in handy!

There is a great op-ed piece in the Wall Street Journal by Michael J. Boskin, professorof economics at Stanford University:  click here to read.

Basically the article states that studies show that successful deficit reduction requires five steps by ourlawmakers.1. $5 of spending cuts for each $1 of taxes raised. There are studies to prove this.2. Create enforceable procedures. The example given was creating a cap on spending withsequestering of funds when the cap was exceeded (we need the consequence).3. Fight gimmicks. Currently the baseline for determining whether there is a cut or increase intaxation starts from the assumption that the Bush Era tax cuts will cease January 1st, 2013 soany increase in taxes which is less than that is a tax cut (figures don’t lie, but liars figure!) Wehave something called automatic budgeting which for 2012 states that federal budgets areexpected to increase 7% so any increase spending less than 7% is a draconian cut (more lying).4. Quickly correct unintended consequences. At the end of the 1970s, with little research, thegovernment thought that with wages growing at a lower rate than inflation, adjusting SocialSecurity wages to the average wage increase would create a smaller benefit than matching it toinflation. Of course, the government timed the change (1977) just as inflation was peaking andafter 1984 inflation was more minimal and real wage growth was large More than thirty yearslater, we still have benefits for Social Security tied to wage growth rather than inflation. Wagegrowth is now trailing inflation and unfortunately, the government, responding to the past 30years, is considering tying Social Security benefits to inflation!5. Fundamental problems must be dealt with rather than passed along for future generations.Social Security, Medicare, Medicaid, education, health care and infrastructure collapse all mustbe dealt with. The Greeks have been playing footsy with this issue for decades and now the fixis so painful that there are riots in the street. The Japanese have not dealt with their structuralissues for at least 20 years and now they seem to have a new leader every six months or so.Italy has not dealt with their structural issues and the country’s GDP has not grown in betterthan 10 years!

Hopefully our political system is not so broken that we need to feel the pain that these other countriesare feeling to solve our issues. We have a window of opportunity and now is the time to take advantageof it. The unfortunate alternative will be to look back on the 20th century as the best century of ourcountry and regret that we wasted the opportunity to keep that greatness going.

Today, the Associated Press reported that consumer spending did not increase in May which means that although we had two straight months of improving household income, consumers are still worried about the economy. Our spending is falling into a pattern that reflects an earlier period (pre 1990s) when fear about job security was more prevalent. Added to that problem is the hangover from record household debt and we have what I like to call the Zombie Consumer! Consumers are too worried about the future to spend: they are the walking dead of consumers.As long as most of our consumers are Zombie Consumers, our economy will not grow at a rapid enough pace to decrease the unemployment numbers. So, we may have to wait for the housing sector to improve which probably will take a few years. For this reason, we can expect low interest rates throughout the rest of 2011.The real issue for our economy may be what happens in Greece and the Middle East, and we have little control over those factors.