Jim Kopas

In October the U.S. unemployment rate rose to 10.2% thus capturing much of the economic and financial headlines over the last week. This was the first time unemployment surpassed 10% since June of 1983, and only the second time it has reached this plateau since World War II! With the recent news, many economists updated their economic projections and now believe that unemployment will peak by the middle of 2010 and will continue to remain high for several years. Obviously these unemployment numbers illustrate the recent devastating struggles of the U.S. economy; but investors must keep in mind that unemployment is a lagging economic indicator. So you might be curious how the stock market has performed in the past after peaks in unemployment? Historically the stock market has performed exceptionally well after unemployment has peaked!

The chart plots U.S. stock prices (red) and the unemployment rate (blue) over the last 40 years.  Unemployment has decisively peaked 6 times since 1969 and each peak accurately forecasted strong performance for the stock market (green arrows) throughout the following year.  After the peak of unemployment, the stock market advanced on average over the next 1 month, 3 month, 6 month and 1 year time periods.  In fact, only 2 of the 24 time frames exhibited negative returns (the 3 and 6 month periods in 1975).

Many investors are still fearful to enter the market with unemployment above 10% and on the rise.  How can investors expect the stock market to perform prior to the peak in unemployment?  In September 1982 the unemployment rate moved above 10% and finally reached a peak of 10.8% in November and December of 1982. The unemployment rate would remain above the 10% plateau for a total of 10 months and the stock market advanced over 37% during that time!  Yet another encouraging sign for investors.

Using unemployment history as a guide, investors should expect higher stock market prices in the months ahead!

Thanks for Reading – Jim     

Jim Kopas Economy, Investments

As I promised last week, the Pring Turner Captial Quarterly Newsletter is posted below.

Your third quarter portfolio gains were outstanding and added to the previous quarter’s growth. You have traveled a long, long way from the March low point and are now within close range of reaching all-time highs in portfolio values. Economic indicators continue to strengthen and as predicted in our April quarterly newsletter, we believe the recession ended this summer and the economy will continue to recover. 

The improving economy gives the stock market a green light to continue moving ahead into 2010.  However, after six months of a powerful advance without as much as a 10% correction, we now anticipate a short-lived stock market decline.  We will make appropriate adjustments to your portfolio to prepare for a temporary decline and best take advantage of the next stage of the stock market advance. But it is most important to keep in mind the major trend for the market is still up.

CLIENT FORUM

In discussions with a number of clients, several common questions keep coming up. We thought it timely to take this opportunity to use a question and answer format to address foremost concerns we have heard from you.

Q:  My concern is that the economy is fragile, unemployment is still rising and we could easily slip back into recession. It does not feel like a recovery, are you being too optimistic in stating that the recession is over?

A:  The short answer is we see no danger of the economy slipping back into recession.  As discussed in recent newsletters, strengthening economic indicators give us confidence in our upbeat outlook. In fact, leading indicators are surging to their highest growth rates in decades, indicating stronger growth than generally expected! Strength in our indicators virtually guarantees there is no chance of an economic relapse anytime soon.  We are carefully monitoring the data for any changes to that outlook.  As the timeline in our chart illustrates, the sequence of business cycles is unemployment will only improve many months after the economy bottoms. Using history as a guide, we expect the job market will just begin to improve by spring 2010. By this time next year, the unemployment rate will be falling, the official announcement that the recession is over will have been announced, and it will start to actually feel like a recovery to everyone.

Q:  I am concerned that government’s reckless spending and mounting debt levels are going to result in runaway inflation.  What is your opinion?

A:  We understand your concerns but studies of past runaway inflationary periods do not support that outcome at this point. The case for spiraling inflation lacks a number of key components. Today, we have record idle factory use, double-digit unemployment rates, and consumers intent on paying down debt and increasing savings. These factors offset rising government spending and debt levels and argue against a spiraling inflation at this time.  We are alert for possible changes to the inflation outlook that could become problematic a few years down the road.

Q:  Given all the financial turmoil, how is my account performing?

A:  We are pleased to report that typical Pring Turner Capital clients experienced positive returns for the past 12 months and have made back most of the decline wreaked by the 2007-2009 global financial panic and collapse. The most recent quarter performance was the best for our clients since 1987 and the last two quarters are the best back-to-back quarters since 1982!

This decade included two of the deepest back-to-back bear markets in history (50%+ declines each). Your portfolio not only held its own but, adjusted for any withdrawals, is within 10% of hitting an all-time high.  On the other hand, the S&P 500 price needs to advance 40% to do the same!  Our combination of effective tactical asset allocation decisions (less exposure to stocks at tops, and more emphasis near bottoms), and attention to quality, value, and income enabled us to deliver solid returns for you in the most difficult of circumstances.

Q:  What do you see as the biggest risk facing investors today?

A: Oddly enough, it is the impatient and worried investors’ search for safety and income. Investors are stampeding into the apparent safety of government bonds and are buying bond funds in record amounts despite historic low interest rate levels. It is our observation that many of these investors don’t understand that bond prices move inversely to interest rates and just how volatile bonds can be. These investors, with a false sense of security, are unknowingly jumping from the frying pan and into the fire.

We view today’s low level of interest rates as only a temporary condition of this business cycle. Interest rates will move up offering patient investors a better opportunity to receive higher levels of income as the economy picks up steam. Our business cycle research indicates it is very late and too risky to be pouring money into bonds. Potential losses in principal value will quickly swamp any income received as interest rates inevitably move up and bond prices decline.

Q:  Have you made any changes in your disciplines to reduce portfolio risk and temper the volatility I experienced last year?

A:  In spite of our profitable 1, 3, 5 and 10-year performance history, we continuously review and assess our performance.  Our long-standing conservative risk management disciplines, including emphasis on quality, value, income and tactical asset allocation have successfully served our clients well. We still ask ourselves how can we do our job even better?  In response, we have thoroughly reviewed our decision-making disciplines and have added new layers of risk control to do an even better job of protecting your wealth through volatile times.

Q:  How did Charles Schwab do during the financial crisis and is it a safe place to keep my money?

A:  Charles Schwab is a steady performer, earning money in every single quarter of this recession and throughout the global financial meltdown. The reason we selected Schwab as primary custodian for your assets is their conservative and defensive philosophy match our own.  Schwab’s financial strength is rock solid making this market leader a prudent choice as custodian for your money.

Q: How is Pring Turner Capital doing?

A:  As a result of this extraordinarily difficult decade there is an army of disillusioned, confused, and much poorer investors who would gladly exchange their last ten-year portfolio results with your performance! Our strong track record and conservative style is drawing more attention to the firm.  Every aspect of the firm — the conservative philosophy, team experience, knowledge of business cycle behavior, highly personalized service — and our mission to protect our clients’ valuable assets makes us a compelling choice for many wealthy families.

The most important lesson of the last “Lost Decade”, understanding and incorporating the rhythm of business cycles (boom and bust periods), is more important than ever for investment success.  We look forward to applying our knowledge and expertise to generate more profitable returns and investment success for you in the years ahead.

We take this opportunity to welcome new clients to Pring Turner Capital. As always, thank you for your continued confidence and please feel free to contact us with any questions regarding your portfolio.

To view this article in PDF format please click here. As always, please feel free to leave any feedback in the comments sections below. I look forward to your comments and I will have a new investment article posted early next week. – Jim

Jim Kopas Investments

This past week I have been busy finishing up the quarterly newsletter for Pring Turner Capital Group and will have it posted early next week.  Therefore, for the investment article of the week, I have posted an article written by J.D. Steinhilber that does a great job of explaining the current market condition and what investors should expect in the months ahead.  Enjoy!

Market Review: Recent Pullbacks Should Be Viewed in Context

By J.D. Steinhilber

Equity markets just enjoyed their best quarter since 1998, but in the past two weeks have come under a degree of selling pressure not seen since the early June/late July correction. Pullbacks have been relatively minor thus far – clipping only 5% off the S&P 500 – but the odds seem to favor a deeper correction. By any measure, the stock market had gotten extended following seven consecutive months of gains. At its recent peak on September 23, the S&P 500 was 62% higher than its early March low and 20% above its 200-day moving price average. Not since 1983 has the index traded this far above its 200-day moving average. The stock market has entered a riskier phase as a result of this intermediate-term overbought condition and the large gains that have already occurred.

Investors contemplating new commitments to stocks need to be prepared that a correction of 10%+ could occur at any time. Using the S&P 500, the first line of major support comes in at 975-1000, and that may well contain any further weakness that could develop. If those levels give way, the S&P 500 would be vulnerable to a deeper correction to the 925 area, which we suspect would represent the worst case scenario between now and the end of the year. The weight of the evidence suggests that such a correction would be in the context of an ongoing bull market that will extend well into 2010 (at a minimum). Moreover, the upside potential from further advances is significant enough to argue against taking anything other than modest defensive measures at this stage. The trend in stock prices is decisively up; the internal technical health of the market is strong in terms of widespread participation (breadth) and the absence of negative divergences.

Investor sentiment is no longer the strong positive it was just a couple of months ago, when many investors still questioned whether a new bull market was indeed underway. Market optimism has been gradually rebuilt after the devastation of the past bear market, but bullishness can hardly be considered extreme enough to impede further gains.

Valuations are not intrinsically cheap, as they were in the early phase of the rally, but they are reasonably priced, especially in light of the alternatives available to investors. Stocks have discounted a fairly robust recovery in the economy and corporate earnings, and our sense is that expectations have gotten a bit ahead of themselves. When you come through a 25 year secular credit expansion, it will be a multi-year transition process to bring the private sector’s debt levels into alignment with its debt servicing capacity. As a consequence, the recovery will likely be long and drawn out, despite massive ongoing government intervention to stabilize the economy. Disappointing news on the economy seems to be the most likely catalyst for potential downside volatility in the months ahead.

But balancing out this risk for markets is the extraordinarily potent stimulus provided by the Federal Reserve’s ultra-easy monetary policy. Whether through its 0% interest rate policy, which is driving money out of safe deposits and into risk assets, or its continuing direct intervention in credit markets through quantitative easing operations, the Fed has literally flooded financial markets with liquidity and created a powerful impetus towards higher prices for financial assets. The Fed opened the monetary floodgates last fall, producing a surge in money supply growth, which peaked at a 20% annual rate in early 2009.

The financial markets have been the primary beneficiary of the rapid money supply growth in the past year. The prices of goods and services likely will not begin to adjust upward until well into next year, due to the enormous slack in the economy, giving the Fed a green light to keep its foot on the monetary pedal. We are sympathetic to the argument that this is a not a “rational” bull market because the underlying debt problem has not been solved. It is certainly true that the abuse of leverage and the mismatch between aggregate debt levels and underlying debt servicing capacity, which was at the heart of the financial crisis, have not been rectified. Rather, debt has largely been shifted from the private sector to the public sector. But this longer-term reality does not imply that in the short run the wall of money that has been thrown at the system will not be successful in stabilizing the economy and inflating financial markets. Nor does the “liquidity-driven” bull market now at work in financial assets seem likely to go away anytime in the foreseeable future. In the absence of a crisis of confi-dence in the U.S. dollar or in the demand for and pricing of Treasury debt, monetary policy at the Federal Reserve will be dictated first and foremost by employment conditions and the housing market.

Last week’s employment report for September confirmed that the labor market continues to be very weak. The unemployment rate climbed to 9.8%, its highest level in 26 years. The alternate U-6 unemployment rate, which factors in marginally employed (i.e., involuntarily part-time) workers, rose to 17%, its highest level in the history of that data series. Similarly, the housing market remains vulnerable, due to persistent excess supply and the fact that mortgage delinquency rates continue to rise, as a result of unemployment, negative home equity, and forced deleveraging of real estate speculators.

Apart from these factors, the Fed will be under political pressure to resist raising rates in order to prevent the Treasury’s borrowing costs from rising at a time when the government is running multitrillion deficits to shore up the economy. The Federal Reserve will likely keep short-term rates at or near zero for an extended period (i.e. well into 2010). As a result, money will continue to flow out of safe deposits earning a negative real yield, and leveraged “carry trade” investors (i.e. hedge funds) will continue to borrow in U.S. dollars to fund the purchase of higher returning risk assets.

In short, markets should remain well-lubricated with liquidity to prevent a serious breakdown in prices and perhaps support significantly higher prices. So investors must deal with the tension between the knowledge that the debt problem in the economy has largely been “papered over” and the appearance that government sponsored reflation is working (again!), without triggering the repercussions of substantially higher government debt financing costs or a crisis in the U.S. dollar.

Jim Kopas Investments