FOFViewForm Object
(
    [form:protected] => FOFForm Object
        (
            [model:protected] => LegacyinterfaceModelCommentaries Object
                (
                    [default_behaviors:protected] => Array
                        (
                            [0] => filters
                            [1] => access
                        )

                    [__state_set:protected] => 1
                    [_db:protected] => JDatabaseDriverMysqli Object
                        (
                            [name] => mysqli
                            [nameQuote:protected] => `
                            [nullDate:protected] => 0000-00-00 00:00:00
                            [_database:JDatabaseDriver:private] => joomla
                            [connection:protected] => mysqli Object
                                (
                                    [affected_rows] => 1
                                    [client_info] => mysqlnd 5.0.11-dev - 20120503 - $Id: 15d5c781cfcad91193dceae1d2cdd127674ddb3e $
                                    [client_version] => 50011
                                    [connect_errno] => 0
                                    [connect_error] => 
                                    [errno] => 0
                                    [error] => 
                                    [error_list] => Array
                                        (
                                        )

                                    [field_count] => 1
                                    [host_info] => Localhost via UNIX socket
                                    [info] => 
                                    [insert_id] => 0
                                    [server_info] => 5.5.46
                                    [server_version] => 50546
                                    [stat] => Uptime: 1448318  Threads: 1  Questions: 203273  Slow queries: 0  Opens: 62  Flush tables: 1  Open tables: 55  Queries per second avg: 0.140
                                    [sqlstate] => 00000
                                    [protocol_version] => 10
                                    [thread_id] => 18626
                                    [warning_count] => 0
                                )

                            [count:protected] => 17
                            [cursor:protected] => 
                            [debug:protected] => 
                            [limit:protected] => 0
                            [log:protected] => Array
                                (
                                )

                            [timings:protected] => Array
                                (
                                )

                            [callStacks:protected] => Array
                                (
                                )

                            [offset:protected] => 0
                            [options:protected] => Array
                                (
                                    [driver] => mysqli
                                    [host] => localhost
                                    [user] => joomlauser
                                    [password] => default
                                    [database] => joomla
                                    [prefix] => ap_
                                    [select] => 1
                                    [port] => 3306
                                    [socket] => 
                                )

                            [sql:protected] => 
SELECT COUNT(*)
FROM (
SELECT `#__legacyinterface_commentaries`.*
FROM `#__legacyinterface_commentaries`
WHERE (`access` IN ('1','1'))) AS a
                            [tablePrefix:protected] => ap_
                            [utf:protected] => 1
                            [errorNum:protected] => 0
                            [errorMsg:protected] => 
                            [transactionDepth:protected] => 0
                            [disconnectHandlers:protected] => Array
                                (
                                )

                        )

                    [event_after_delete:protected] => onContentAfterDelete
                    [event_after_save:protected] => onContentAfterSave
                    [event_before_delete:protected] => onContentBeforeDelete
                    [event_before_save:protected] => onContentBeforeSave
                    [event_change_state:protected] => onContentChangeState
                    [event_clean_cache:protected] => 
                    [id_list:protected] => Array
                        (
                            [0] => 0
                        )

                    [id:protected] => 0
                    [input:protected] => FOFInput Object
                        (
                            [options:protected] => Array
                                (
                                )

                            [filter:protected] => JFilterInput Object
                                (
                                    [tagsArray] => Array
                                        (
                                        )

                                    [attrArray] => Array
                                        (
                                        )

                                    [tagsMethod] => 0
                                    [attrMethod] => 0
                                    [xssAuto] => 1
                                    [tagBlacklist] => Array
                                        (
                                            [0] => applet
                                            [1] => body
                                            [2] => bgsound
                                            [3] => base
                                            [4] => basefont
                                            [5] => embed
                                            [6] => frame
                                            [7] => frameset
                                            [8] => head
                                            [9] => html
                                            [10] => id
                                            [11] => iframe
                                            [12] => ilayer
                                            [13] => layer
                                            [14] => link
                                            [15] => meta
                                            [16] => name
                                            [17] => object
                                            [18] => script
                                            [19] => style
                                            [20] => title
                                            [21] => xml
                                        )

                                    [attrBlacklist] => Array
                                        (
                                            [0] => action
                                            [1] => background
                                            [2] => codebase
                                            [3] => dynsrc
                                            [4] => lowsrc
                                        )

                                )

                            [data:protected] => Array
                                (
                                    [start] => 260
                                    [limitstart] => 260
                                    [option] => com_legacyinterface
                                    [view] => commentaries
                                    [Itemid] => 616
                                    [layout] => 
                                    [task] => browse
                                    [directionTable] => asc
                                    [sortTable] => published_on
                                    [filter_order] => published_on
                                    [filter_order_Dir] => desc
                                    [savestate] => 1
                                    [base_path] => /var/www/html/apcms/components/com_legacyinterface
                                )

                            [inputs:protected] => Array
                                (
                                    [get] => JInput Object
                                        (
                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

                                                    [attrBlacklist] => Array
                                                        (
                                                            [0] => action
                                                            [1] => background
                                                            [2] => codebase
                                                            [3] => dynsrc
                                                            [4] => lowsrc
                                                        )

                                                )

                                            [data:protected] => Array
                                                (
                                                    [start] => 260
                                                )

                                            [inputs:protected] => Array
                                                (
                                                    [get] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
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                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [start] => 260
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [post] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [cookie] => JInputCookie Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                    [get] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                    [start] => 260
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [post] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [cookie] => JInputCookie Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [files] => JInputFiles Object
                                                                        (
                                                                            [decodedData:protected] => Array
                                                                                (
                                                                                )

                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                    [get] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
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                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
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                                                                                                            [3] => dynsrc
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                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [start] => 260
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [post] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
                                                                                                            [11] => iframe
                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [cookie] => JInputCookie Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [tagsMethod] => 0
                                                                                                    [attrMethod] => 0
                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => applet
                                                                                                            [1] => body
                                                                                                            [2] => bgsound
                                                                                                            [3] => base
                                                                                                            [4] => basefont
                                                                                                            [5] => embed
                                                                                                            [6] => frame
                                                                                                            [7] => frameset
                                                                                                            [8] => head
                                                                                                            [9] => html
                                                                                                            [10] => id
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                                                                                                            [12] => ilayer
                                                                                                            [13] => layer
                                                                                                            [14] => link
                                                                                                            [15] => meta
                                                                                                            [16] => name
                                                                                                            [17] => object
                                                                                                            [18] => script
                                                                                                            [19] => style
                                                                                                            [20] => title
                                                                                                            [21] => xml
                                                                                                        )

                                                                                                    [attrBlacklist] => Array
                                                                                                        (
                                                                                                            [0] => action
                                                                                                            [1] => background
                                                                                                            [2] => codebase
                                                                                                            [3] => dynsrc
                                                                                                            [4] => lowsrc
                                                                                                        )

                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [files] => JInputFiles Object
                                                                                        (
                                                                                            [decodedData:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
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                                                                                                    [attrArray] => Array
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                                                                                            [data:protected] => Array
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                                                                                            [inputs:protected] => Array
                                                                                                (
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                                                                                    [env] => JInput Object
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                                                                                            [options:protected] => Array
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                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
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                                                                                            [data:protected] => Array
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                                                                                            [inputs:protected] => Array
                                                                                                (
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                                                                                    [request] => JInput Object
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                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
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                                                                                                        )

                                                                                                    [attrArray] => Array
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                                                                                                )

                                                                                            [data:protected] => Array
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                                                                                                    [limitstart] => 260
                                                                                                    [option] => com_legacyinterface
                                                                                                    [view] => commentaries
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                                                                                            [inputs:protected] => Array
                                                                                                (
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                                                                                        )

                                                                                    [server] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
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                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
                                                                                                        (
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                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [HTTP_AUTHORIZATION] => 
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                                                                                                    [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate
                                                                                                    [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                                                    [PATH] => /sbin:/usr/sbin:/bin:/usr/bin
                                                                                                    [SERVER_SIGNATURE] => 
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                                                                                                    [SERVER_NAME] => wordpress.hubtech.tv
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                                                                                                    [REMOTE_ADDR] => 54.234.190.237
                                                                                                    [DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                                    [REQUEST_SCHEME] => http
                                                                                                    [CONTEXT_PREFIX] => 
                                                                                                    [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                                    [SERVER_ADMIN] => ben@hubtech.tv
                                                                                                    [SCRIPT_FILENAME] => /var/www/html/apcms/index.php
                                                                                                    [REMOTE_PORT] => 36042
                                                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                                                    [SERVER_PROTOCOL] => HTTP/1.0
                                                                                                    [REQUEST_METHOD] => GET
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                                                                                                    [REQUEST_URI] => /?start=260
                                                                                                    [SCRIPT_NAME] => /index.php
                                                                                                    [PHP_SELF] => /index.php
                                                                                                    [REQUEST_TIME_FLOAT] => 1516508327.124
                                                                                                    [REQUEST_TIME] => 1516508327
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                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [session] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
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                                                                                                    [xssAuto] => 1
                                                                                                    [tagBlacklist] => Array
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                                                                                                            [4] => basefont
                                                                                                            [5] => embed
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                                                                                                            [12] => ilayer
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                                                                                                    [attrBlacklist] => Array
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                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                    [__default] => Array
                                                                                                        (
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                                                                                                            [session.timer.start] => 1516508327
                                                                                                            [session.timer.last] => 1516508327
                                                                                                            [session.timer.now] => 1516508327
                                                                                                            [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                                                (
                                                                                                                    [data:protected] => stdClass Object
                                                                                                                        (
                                                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                                                (
                                                                                                                                    [commentaries] => stdClass Object
                                                                                                                                        (
                                                                                                                                            [limitstart] => 260
                                                                                                                                            [filter_order] => published_on
                                                                                                                                            [filter_order_Dir] => desc
                                                                                                                                        )

                                                                                                                                )

                                                                                                                        )

                                                                                                                )

                                                                                                            [user] => JUser Object
                                                                                                                (
                                                                                                                    [isRoot:protected] => 
                                                                                                                    [id] => 0
                                                                                                                    [name] => 
                                                                                                                    [username] => 
                                                                                                                    [email] => 
                                                                                                                    [password] => 
                                                                                                                    [password_clear] => 
                                                                                                                    [block] => 
                                                                                                                    [sendEmail] => 0
                                                                                                                    [registerDate] => 
                                                                                                                    [lastvisitDate] => 
                                                                                                                    [activation] => 
                                                                                                                    [params] => 
                                                                                                                    [groups] => Array
                                                                                                                        (
                                                                                                                            [0] => 9
                                                                                                                        )

                                                                                                                    [guest] => 1
                                                                                                                    [lastResetTime] => 
                                                                                                                    [resetCount] => 
                                                                                                                    [requireReset] => 
                                                                                                                    [_params:protected] => Joomla\Registry\Registry Object
                                                                                                                        (
                                                                                                                            [data:protected] => stdClass Object
                                                                                                                                (
                                                                                                                                )

                                                                                                                        )

                                                                                                                    [_authGroups:protected] => Array
                                                                                                                        (
                                                                                                                            [0] => 1
                                                                                                                        )

                                                                                                                    [_authLevels:protected] => Array
                                                                                                                        (
                                                                                                                            [0] => 1
                                                                                                                            [1] => 1
                                                                                                                        )

                                                                                                                    [_authActions:protected] => 
                                                                                                                    [_errorMsg:protected] => 
                                                                                                                    [_errors:protected] => Array
                                                                                                                        (
                                                                                                                        )

                                                                                                                    [aid] => 0
                                                                                                                )

                                                                                                        )

                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [jrequest] => JInput Object
                                                                                        (
                                                                                            [options:protected] => Array
                                                                                                (
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                                                                                            [filter:protected] => JFilterInput Object
                                                                                                (
                                                                                                    [tagsArray] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [attrArray] => Array
                                                                                                        (
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                                                                                                    [tagBlacklist] => Array
                                                                                                        (
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                                                                                                            [12] => ilayer
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                                                                                                    [attrBlacklist] => Array
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                                                                                                )

                                                                                            [data:protected] => Array
                                                                                                (
                                                                                                )

                                                                                            [inputs:protected] => Array
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                )

                                                                        )

                                                                    [env] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
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                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [request] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
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                                                                            [filter:protected] => JFilterInput Object
                                                                                (
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                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
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                                                                                    [attrBlacklist] => Array
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                                                                                )

                                                                            [data:protected] => Array
                                                                                (
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                                                                                    [limitstart] => 260
                                                                                    [option] => com_legacyinterface
                                                                                    [view] => commentaries
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                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [server] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
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                                                                                    [xssAuto] => 1
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                                                                                        (
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                                                                                            [19] => style
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                                                                                    [attrBlacklist] => Array
                                                                                        (
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                                                                                )

                                                                            [data:protected] => Array
                                                                                (
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                                                                                    [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate
                                                                                    [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                                    [PATH] => /sbin:/usr/sbin:/bin:/usr/bin
                                                                                    [SERVER_SIGNATURE] => 
                                                                                    [SERVER_SOFTWARE] => Apache/2.4.16 (Amazon) PHP/5.5.31
                                                                                    [SERVER_NAME] => wordpress.hubtech.tv
                                                                                    [SERVER_ADDR] => 10.28.13.29
                                                                                    [SERVER_PORT] => 80
                                                                                    [REMOTE_ADDR] => 54.234.190.237
                                                                                    [DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                    [REQUEST_SCHEME] => http
                                                                                    [CONTEXT_PREFIX] => 
                                                                                    [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms
                                                                                    [SERVER_ADMIN] => ben@hubtech.tv
                                                                                    [SCRIPT_FILENAME] => /var/www/html/apcms/index.php
                                                                                    [REMOTE_PORT] => 36042
                                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                                    [SERVER_PROTOCOL] => HTTP/1.0
                                                                                    [REQUEST_METHOD] => GET
                                                                                    [QUERY_STRING] => start=260
                                                                                    [REQUEST_URI] => /?start=260
                                                                                    [SCRIPT_NAME] => /index.php
                                                                                    [PHP_SELF] => /index.php
                                                                                    [REQUEST_TIME_FLOAT] => 1516508327.124
                                                                                    [REQUEST_TIME] => 1516508327
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [session] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
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                                                                                            [1] => body
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                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
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                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
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                                                                                    [attrBlacklist] => Array
                                                                                        (
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                                                                                            [2] => codebase
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                                                                                            [4] => lowsrc
                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                    [__default] => Array
                                                                                        (
                                                                                            [session.counter] => 1
                                                                                            [session.timer.start] => 1516508327
                                                                                            [session.timer.last] => 1516508327
                                                                                            [session.timer.now] => 1516508327
                                                                                            [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                                (
                                                                                                    [data:protected] => stdClass Object
                                                                                                        (
                                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                                (
                                                                                                                    [commentaries] => stdClass Object
                                                                                                                        (
                                                                                                                            [limitstart] => 260
                                                                                                                            [filter_order] => published_on
                                                                                                                            [filter_order_Dir] => desc
                                                                                                                        )

                                                                                                                )

                                                                                                        )

                                                                                                )

                                                                                            [user] => JUser Object
                                                                                                (
                                                                                                    [isRoot:protected] => 
                                                                                                    [id] => 0
                                                                                                    [name] => 
                                                                                                    [username] => 
                                                                                                    [email] => 
                                                                                                    [password] => 
                                                                                                    [password_clear] => 
                                                                                                    [block] => 
                                                                                                    [sendEmail] => 0
                                                                                                    [registerDate] => 
                                                                                                    [lastvisitDate] => 
                                                                                                    [activation] => 
                                                                                                    [params] => 
                                                                                                    [groups] => Array
                                                                                                        (
                                                                                                            [0] => 9
                                                                                                        )

                                                                                                    [guest] => 1
                                                                                                    [lastResetTime] => 
                                                                                                    [resetCount] => 
                                                                                                    [requireReset] => 
                                                                                                    [_params:protected] => Joomla\Registry\Registry Object
                                                                                                        (
                                                                                                            [data:protected] => stdClass Object
                                                                                                                (
                                                                                                                )

                                                                                                        )

                                                                                                    [_authGroups:protected] => Array
                                                                                                        (
                                                                                                            [0] => 1
                                                                                                        )

                                                                                                    [_authLevels:protected] => Array
                                                                                                        (
                                                                                                            [0] => 1
                                                                                                            [1] => 1
                                                                                                        )

                                                                                                    [_authActions:protected] => 
                                                                                                    [_errorMsg:protected] => 
                                                                                                    [_errors:protected] => Array
                                                                                                        (
                                                                                                        )

                                                                                                    [aid] => 0
                                                                                                )

                                                                                        )

                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                    [jrequest] => JInput Object
                                                                        (
                                                                            [options:protected] => Array
                                                                                (
                                                                                )

                                                                            [filter:protected] => JFilterInput Object
                                                                                (
                                                                                    [tagsArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [attrArray] => Array
                                                                                        (
                                                                                        )

                                                                                    [tagsMethod] => 0
                                                                                    [attrMethod] => 0
                                                                                    [xssAuto] => 1
                                                                                    [tagBlacklist] => Array
                                                                                        (
                                                                                            [0] => applet
                                                                                            [1] => body
                                                                                            [2] => bgsound
                                                                                            [3] => base
                                                                                            [4] => basefont
                                                                                            [5] => embed
                                                                                            [6] => frame
                                                                                            [7] => frameset
                                                                                            [8] => head
                                                                                            [9] => html
                                                                                            [10] => id
                                                                                            [11] => iframe
                                                                                            [12] => ilayer
                                                                                            [13] => layer
                                                                                            [14] => link
                                                                                            [15] => meta
                                                                                            [16] => name
                                                                                            [17] => object
                                                                                            [18] => script
                                                                                            [19] => style
                                                                                            [20] => title
                                                                                            [21] => xml
                                                                                        )

                                                                                    [attrBlacklist] => Array
                                                                                        (
                                                                                            [0] => action
                                                                                            [1] => background
                                                                                            [2] => codebase
                                                                                            [3] => dynsrc
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                                                                                        )

                                                                                )

                                                                            [data:protected] => Array
                                                                                (
                                                                                )

                                                                            [inputs:protected] => Array
                                                                                (
                                                                                )

                                                                        )

                                                                )

                                                        )

                                                    [files] => JInputFiles Object
                                                        (
                                                            [decodedData:protected] => Array
                                                                (
                                                                )

                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
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                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
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                                                                            [2] => codebase
                                                                            [3] => dynsrc
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                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [env] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [request] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [start] => 260
                                                                    [limitstart] => 260
                                                                    [option] => com_legacyinterface
                                                                    [view] => commentaries
                                                                    [Itemid] => 616
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [server] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
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                                                                            [2] => codebase
                                                                            [3] => dynsrc
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                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [HTTP_AUTHORIZATION] => 
                                                                    [HTTP_HOST] => wordpress.hubtech.tv
                                                                    [HTTP_ACCEPT_ENCODING] => x-gzip, gzip, deflate
                                                                    [HTTP_USER_AGENT] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                    [HTTP_ACCEPT] => text/html,application/xhtml+xml,application/xml;q=0.9,*/*;q=0.8
                                                                    [PATH] => /sbin:/usr/sbin:/bin:/usr/bin
                                                                    [SERVER_SIGNATURE] => 
                                                                    [SERVER_SOFTWARE] => Apache/2.4.16 (Amazon) PHP/5.5.31
                                                                    [SERVER_NAME] => wordpress.hubtech.tv
                                                                    [SERVER_ADDR] => 10.28.13.29
                                                                    [SERVER_PORT] => 80
                                                                    [REMOTE_ADDR] => 54.234.190.237
                                                                    [DOCUMENT_ROOT] => /var/www/html/apcms
                                                                    [REQUEST_SCHEME] => http
                                                                    [CONTEXT_PREFIX] => 
                                                                    [CONTEXT_DOCUMENT_ROOT] => /var/www/html/apcms
                                                                    [SERVER_ADMIN] => ben@hubtech.tv
                                                                    [SCRIPT_FILENAME] => /var/www/html/apcms/index.php
                                                                    [REMOTE_PORT] => 36042
                                                                    [GATEWAY_INTERFACE] => CGI/1.1
                                                                    [SERVER_PROTOCOL] => HTTP/1.0
                                                                    [REQUEST_METHOD] => GET
                                                                    [QUERY_STRING] => start=260
                                                                    [REQUEST_URI] => /?start=260
                                                                    [SCRIPT_NAME] => /index.php
                                                                    [PHP_SELF] => /index.php
                                                                    [REQUEST_TIME_FLOAT] => 1516508327.124
                                                                    [REQUEST_TIME] => 1516508327
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [session] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                    [__default] => Array
                                                                        (
                                                                            [session.counter] => 1
                                                                            [session.timer.start] => 1516508327
                                                                            [session.timer.last] => 1516508327
                                                                            [session.timer.now] => 1516508327
                                                                            [session.client.browser] => CCBot/2.0 (http://commoncrawl.org/faq/)
                                                                            [registry] => Joomla\Registry\Registry Object
                                                                                (
                                                                                    [data:protected] => stdClass Object
                                                                                        (
                                                                                            [com_legacyinterface] => stdClass Object
                                                                                                (
                                                                                                    [commentaries] => stdClass Object
                                                                                                        (
                                                                                                            [limitstart] => 260
                                                                                                            [filter_order] => published_on
                                                                                                            [filter_order_Dir] => desc
                                                                                                        )

                                                                                                )

                                                                                        )

                                                                                )

                                                                            [user] => JUser Object
                                                                                (
                                                                                    [isRoot:protected] => 
                                                                                    [id] => 0
                                                                                    [name] => 
                                                                                    [username] => 
                                                                                    [email] => 
                                                                                    [password] => 
                                                                                    [password_clear] => 
                                                                                    [block] => 
                                                                                    [sendEmail] => 0
                                                                                    [registerDate] => 
                                                                                    [lastvisitDate] => 
                                                                                    [activation] => 
                                                                                    [params] => 
                                                                                    [groups] => Array
                                                                                        (
                                                                                            [0] => 9
                                                                                        )

                                                                                    [guest] => 1
                                                                                    [lastResetTime] => 
                                                                                    [resetCount] => 
                                                                                    [requireReset] => 
                                                                                    [_params:protected] => Joomla\Registry\Registry Object
                                                                                        (
                                                                                            [data:protected] => stdClass Object
                                                                                                (
                                                                                                )

                                                                                        )

                                                                                    [_authGroups:protected] => Array
                                                                                        (
                                                                                            [0] => 1
                                                                                        )

                                                                                    [_authLevels:protected] => Array
                                                                                        (
                                                                                            [0] => 1
                                                                                            [1] => 1
                                                                                        )

                                                                                    [_authActions:protected] => 
                                                                                    [_errorMsg:protected] => 
                                                                                    [_errors:protected] => Array
                                                                                        (
                                                                                        )

                                                                                    [aid] => 0
                                                                                )

                                                                        )

                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                    [jrequest] => JInput Object
                                                        (
                                                            [options:protected] => Array
                                                                (
                                                                )

                                                            [filter:protected] => JFilterInput Object
                                                                (
                                                                    [tagsArray] => Array
                                                                        (
                                                                        )

                                                                    [attrArray] => Array
                                                                        (
                                                                        )

                                                                    [tagsMethod] => 0
                                                                    [attrMethod] => 0
                                                                    [xssAuto] => 1
                                                                    [tagBlacklist] => Array
                                                                        (
                                                                            [0] => applet
                                                                            [1] => body
                                                                            [2] => bgsound
                                                                            [3] => base
                                                                            [4] => basefont
                                                                            [5] => embed
                                                                            [6] => frame
                                                                            [7] => frameset
                                                                            [8] => head
                                                                            [9] => html
                                                                            [10] => id
                                                                            [11] => iframe
                                                                            [12] => ilayer
                                                                            [13] => layer
                                                                            [14] => link
                                                                            [15] => meta
                                                                            [16] => name
                                                                            [17] => object
                                                                            [18] => script
                                                                            [19] => style
                                                                            [20] => title
                                                                            [21] => xml
                                                                        )

                                                                    [attrBlacklist] => Array
                                                                        (
                                                                            [0] => action
                                                                            [1] => background
                                                                            [2] => codebase
                                                                            [3] => dynsrc
                                                                            [4] => lowsrc
                                                                        )

                                                                )

                                                            [data:protected] => Array
                                                                (
                                                                )

                                                            [inputs:protected] => Array
                                                                (
                                                                )

                                                        )

                                                )

                                        )

                                    [post] => JInput Object
                                        (
                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

                                                    [attrBlacklist] => Array
                                                        (
                                                            [0] => action
                                                            [1] => background
                                                            [2] => codebase
                                                            [3] => dynsrc
                                                            [4] => lowsrc
                                                        )

                                                )

                                            [data:protected] => Array
                                                (
                                                )

                                            [inputs:protected] => Array
                                                (
                                                )

                                        )

                                    [cookie] => JInputCookie Object
                                        (
                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

                                                    [attrBlacklist] => Array
                                                        (
                                                            [0] => action
                                                            [1] => background
                                                            [2] => codebase
                                                            [3] => dynsrc
                                                            [4] => lowsrc
                                                        )

                                                )

                                            [data:protected] => Array
                                                (
                                                )

                                            [inputs:protected] => Array
                                                (
                                                )

                                        )

                                    [files] => JInputFiles Object
                                        (
                                            [decodedData:protected] => Array
                                                (
                                                )

                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

                                                    [attrBlacklist] => Array
                                                        (
                                                            [0] => action
                                                            [1] => background
                                                            [2] => codebase
                                                            [3] => dynsrc
                                                            [4] => lowsrc
                                                        )

                                                )

                                            [data:protected] => Array
                                                (
                                                )

                                            [inputs:protected] => Array
                                                (
                                                )

                                        )

                                    [env] => JInput Object
                                        (
                                            [options:protected] => Array
                                                (
                                                )

                                            [filter:protected] => JFilterInput Object
                                                (
                                                    [tagsArray] => Array
                                                        (
                                                        )

                                                    [attrArray] => Array
                                                        (
                                                        )

                                                    [tagsMethod] => 0
                                                    [attrMethod] => 0
                                                    [xssAuto] => 1
                                                    [tagBlacklist] => Array
                                                        (
                                                            [0] => applet
                                                            [1] => body
                                                            [2] => bgsound
                                                            [3] => base
                                                            [4] => basefont
                                                            [5] => embed
                                                            [6] => frame
                                                            [7] => frameset
                                                            [8] => head
                                                            [9] => html
                                                            [10] => id
                                                            [11] => iframe
                                                            [12] => ilayer
                                                            [13] => layer
                                                            [14] => link
                                                            [15] => meta
                                                            [16] => name
                                                            [17] => object
                                                            [18] => script
                                                            [19] => style
                                                            [20] => title
                                                            [21] => xml
                                                        )

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                                    [title] => Rounding Third and Heading for Where?
                                    [slug] => sungarden_010215
                                    [fulltext] => 

These past few weeks, with the year winding down and investment strategy decisions to think about (always), I spent a lot of time with my research team analyzing historical stock market index data as far back as 1871.  First conclusion: I am sick and tired of analyzing historical stock market index data!  We did this to see what today’s investor might learn from market history.

Why now?  Because we are at a precarious point in stock market history.  Given the strong market returns of the last half-decade or so, recent market index returns are in rarified air.  And while there is certainly historical evidence that when markets surge as they have since the S&P bottomed in early 2009, there is trouble ahead, there is plenty of evidence to say that this object (the market) that has been in motion since that time can stay in motion for a while.  As hedged investors, we are always trying to figure out how to do what we do better.  Historical analysis like this is a key part of that.

Rather than exhaust you (and lose your attention along the way) with the guts of our analysis, let me just start 2015 with a summary of our observations and conclusions.

 

S&P 500 INDEX (Total Return through 12/29/14) – RECENT PERFORMANCE HISTORY (Ycharts.com 2014)

  • Up 236% since 2/28/2009
  • Up 102% since 2/29/2000

HISTORICAL OBSERVATIONS

  • Depending on what time frame you look at, the stock market has either done very well or just OK in a historical context. Buried within this time period is a pair of 40%+ declines.  The S&P 500 Total Return has an annualized return of 5% in about the past 15 years but an annualized return of about 23% in about the last six years.
  • There is no definitive historical pattern we have found that says “do this” or “do that” to succeed after a 200% run-up in stock prices
  • Markets can go up a lot longer and lot higher than any of us imagines
  • Yet, major declines following major advances are inevitable…it is just a matter of how long it takes until the market peak occurs, and how deep the eventual drop will be
  • The threat of a major decline following a more than 200% rise in the S&P 500 Index since early 2009 is real. But who knows when it will come home to roost?  Certainly not us.  But our approach is not based on guessing, it is based on accounting for many different scenarios.
  • Whatever cushion bonds provided in the past is largely gone, due to interest rates which persist at levels well below normal for an economic recovery

IMPLICATIONS FOR INVESTMENT PLANNING

  • Enjoy the ride up, but it is essential to have as part of your investment process a clear-cut approach to combating major declines in stock prices
  • Rather than try to determine when a life-changing market decline will happen and what will cause it, make proactive risk-management a part of your ongoing strategy…not only when market turmoil occurs, but always
  • Investing to track a major market index like the S&P 500 has had a very good run the past half-decade and is now immensely popular. But do not be fooled into thinking that recent past is prologue.  The S&P 500 Index, after strong runs higher like this one, becomes a list of past winners. And with all the money now invested in index funds, when it goes the other way, the unraveling can be quick and thorough as we have seen twice in the past 15 years.
  • Instead, be prepared to diversify your equity portfolio along some additional dimensions, beyond sectors, market cap sizes, etc. such as:

1. Holding period diversification

2. Investment theme diversification

3. Dividend level diversification

 

THE SUNGARDEN TEAM WISHES YOU A VERY HAPPY AND PROSPEROUS 2015!!

© Sungarden Investment Research

www.sungardenresearch.com

 

[description] => These past few weeks, with the year winding down and investment strategy decisions to think about (always), I spent a lot of time with my research team analyzing historical stock market index data as far back as 1871. First conclusion: I am sick and tired of analyzing historical stock market index data! We did this to see what today’s investor might learn from market history. [author] => Robert Isbitts [legacyinterface_firm_id] => 402 [published_on] => 2015-01-02 [digest_date] => 2015-01-02 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2015-01-02 20:58:25 [created_by] => 945 [modified_on] => 2015-01-02 21:03:16 [modified_by] => 945 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2262 [hits] => 0 ) [1] => stdClass Object ( [legacyinterface_commentary_id] => 2183 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15421 [apv_conversation_id] => 3031 [content_type] => market-commentary [title] => Falling Energy Costs And Economic Impacts [slug] => streettalk_123114 [fulltext] =>

"If you repeat a falsehood long enough, it will eventually be accepted as fact."

In the financial markets and economics it is a common occurrence that the media and commentators will latch on to a statement that supports a cognitive bias and then repeat that statement until it is a universally accepted truth.

When such a statement becomes universally accepted and unquestioned, well, that is when I begin to question it.

One of those statements has been in regards to plunging oil prices. The majority of analysts and economists have been ratcheting up expectations for the economy and the markets on the back of lower energy costs. The argument is that lower oil prices lead to lower gasoline prices that give consumers more money to spend. The argument seems to be entirely logical since we know that roughly 80% of households in America effectively live paycheck-to-paycheck meaning they will spend, rather than save, any extra disposable income.

As an example, Steve LeVine recently wrote:

"US gasoline prices have dropped for more than 90 straight days. They now average $2.28 a gallon, which is remarkable considering that just a few months ago, some of us were routinely paying $4 and sometimes close to $5.

Not so coincidentally, the US economy surged by 5% last quarter, and does not appear to be slowing down. "

If you read the statement, how could one possibly disagree with such a premise? If I spend less money at the gas pump, I obviously have more money to spend elsewhere. Right?

The problem is that the economy is a ZERO-SUM game and gasoline prices are an excellent example of the mainstream fallacy of lower oil prices.

Example:

  • Gasoline Prices Fall By $1.00 Per Gallon
  • Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
  • Gas Station Revenue Falls By $16 For The Transaction (-16)
  • End Economic Result = $0

Now, the argument is that the $16 saved by the consumer will be spent elsewhere. This is the equivalent of "rearranging deck chairs on the Titanic."

Increased consumer spending is a function of increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend. Let's use another example:

Example:

Big John Has $100 To Spend Each Week On Retail Related Purchases

  • Big John Fills Up His Truck For $60 (Used To Cost $80) (+$20)
  • Big John Spends His Normal $20 Per Week On His Favorite Craft Beer
  • Big John Then Spends His Additional $20 Savings On Roses For His Wife (He Makes A Smart Investment)

-------------------------------------------------
Total Spending For The Week = $100

Now, economists quickly jump on the idea that because he spent $20 on roses, there has been an additional boost to the economy. However, this is false. John may have spent his money differently this past week but here is the net effect on the economy.

Gasoline Station Revenue = (-$20)
Flower Show Revenue = +$20
----------------------------------------------------
Net Effect To Economy = $0

Graphically, we can show this by analyzing real (inflation adjusted) gasoline prices compared to retail "control purchases." I am using "control purchases" as it removes retail gasoline sales, automobiles, and building materials from the retail sales number to focus more on what consumers are buying on a regular basis.

Gasoline-Prices-PCE-111814

The vertical orange line shows peaks in gasoline prices that should correspond (according to mainstream consensus) to a subsequent increase in retail sales.

Another way to show this graphically is to look at the annual changes in Personal Consumption Expenditures (PCE) in aggregate as compared to the subsection of PCE spent on energy and related products. This is shown in the chart below.

PCE-vs-Energy-123014

While the argument that declines in energy and gasoline prices should lead to stronger consumption sounds logical, the data suggests that this is not the case.

The reason is that falling oil prices are a bigger drag on economic growth than the incremental "savings" received by the consumer.

Oil and gas production makeup a hefty chunk of the "mining and manufacturing"component of the employment rolls. Since 2000, when the oil price boom gained traction, Texas has comprised more than 40% of all jobs in the country according to first quarter data from the Dallas Federal Reserve.

Employment-Texas-DallasFed-111814

(Read more here)

The obvious ramification of the plunge in oil prices is that eventually the loss of revenue will lead to cuts in production, declines in capital expenditure plans (which comprises almost 1/4th of all capex expenditures in the S&P 500), freezes and/or reductions in employment, and declines in revenue and profitability.

The majority of the jobs "created" since the financial crisis have been lower wage paying jobs in retail, healthcare and other service sectors of the economy. Conversely, the jobs created within the energy space are some of the highest wage paying opportunities available in engineering, technology, accounting, legal, etc. In fact, each job created in energy related areas has had a "ripple effect" of creating 2.8 jobs elsewhere in the economy from piping to coatings, trucking and transportation, restaurants and retail.

Simply put, lower oil and gasoline prices may have a bigger detraction on the economy that the "savings" provided to consumers.

Newton's third law of motion states:

"For every action there is an equal and opposite reaction."

In any economy, nothing works in isolation. For every dollar increase that occurs in one part of the economy, there is a dollars' worth of reduction somewhere else."

I live in Houston, and the face of fear in 2015 is that oil prices remain low. 

Lance Roberts

Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. 

© Streettalk Live

[description] => In the financial markets and economics it is a common occurrence that the media and commentators will latch on to a statement that supports a cognitive bias and then repeat that statement until it is a universally accepted truth. [author] => Lance Roberts [legacyinterface_firm_id] => 400 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 15:37:39 [created_by] => 948 [modified_on] => 2014-12-31 15:38:00 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2249 [hits] => 0 ) [2] => stdClass Object ( [legacyinterface_commentary_id] => 2184 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15422 [apv_conversation_id] => 3032 [content_type] => market-commentary [title] => Gold Beat All Other World Currencies in 2014 [slug] => global_123114 [fulltext] =>
Gold is money. Everything else is credit.
~J.P. Morgan in 1912

Loyal readers of our Investor Alert and my blog Frank Talk are no doubt aware that the U.S. dollar’s rising strength has put pressure on commodities such as oil and gold. I wrote about this as recently as my roundup of the top commodities stories of 2014, which you can read here.

Gold took a blow in the second half of 2014 as a result of the dollar’s ascent, and sentiment toward the yellow metal right now is less than ideal. But to keep things in perspective, its performance this year has far outpaced that of 2013, when it fell 28 percent—its worst showing since early into President Reagan’s first term.

Even though gold has lost 0.8 percent year-to-date as of this writing, it still leads all major world currencies except for the U.S. dollar.

Gold is Second Best Performing Currency of 2014
click to enlarge

The Case for Gold as Currency

In his most recent book, former Federal Reserve Chairman Alan Greenspan convincingly makes the case that gold is indeed money:

Yet gold has special properties that no other currency, with the possible exception of silver, can claim. For more than two millennia, gold has had virtually unquestioned acceptance as payment. It has never required the credit guarantee of a third party. No questions are raised when gold or direct claims to gold are offered in payment of an obligation; it was the only form of payment, for example, that exporters to Germany would accept as World War II was drawing to a close.

Greenspan goes on to make another astute point. If gold is nothing more than a commodity, then why do most developed countries’ central banks see the need to hold the stuff? Wouldn’t some other commodity suffice? Diamonds perhaps, or soybeans?  

During a Congressional monetary policy meeting in 2011, Texas Representative Ron Paul squared off against former Fed Chairman Ben Bernanke over this very topic. When asked why central banks still insist on holding the precious metal in their reserves, Bernanke responded that it was simply tradition.

Tradition, yes, but the reason goes so much deeper than that. Gold has an intrinsic value that transcends its commodity-ness, something that’s recognized by nations all over the globe.

For example, we’re seeing a trend among European central banks seeking to bring their gold reserves back under their jurisdiction. Although Switzerland recently voted down a referendum that would have done just that, there’s talk now that Austria, Belgium and France are interested in shoring up their own gold reserves. The Netherlands and Germany have already brought some of their gold home.

China and India’s central banks are in the buying mood. Russia is currently snapping up gold at an astounding rate: 130 tons this year alone, up 73 percent from 2013.

Of course, if you’re Russia, buying that much bullion makes perfect sense. When your currency is the worst-performing in the world, you sorely need something in your coffers with greater value, ample liquidity and no credit risk.

Diversify and Rebalance

For the rest of us, gold remains an exceptional instrument to diversify your portfolio with. Despite its decline midway through the year, its price has remained relatively stable, much more so than oil’s. What investors—especially the gold bears—need to remember is that bullion has a 12-month standard deviation of ±18 percent, meaning that its price action this year is well within normal behavior.

As always, I advocate a 10-percent weighting in gold: 5 percent in physical metal, 5 percent in equities, then rebalance every year.

Speaking of which, look out for my special New Year’s edition of the Investor Alert this Friday. I’ll be discussing what steps you can take to maximize your portfolio going into 2015! 

Past performance does not guarantee future results.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility. Diversification does not protect an investor from market risks and does not assure a profit. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

© U.S. Global Investors

[description] => Loyal readers of our Investor Alert and my blog Frank Talk are no doubt aware that the U.S. dollar’s rising strength has put pressure on commodities such as oil and gold. I wrote about this as recently as my roundup of the top commodities stories of 2014, which you can read here. [author] => Frank Holmes [legacyinterface_firm_id] => 464 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 15:46:54 [created_by] => 948 [modified_on] => 2014-12-31 15:47:19 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2250 [hits] => 0 ) [3] => stdClass Object ( [legacyinterface_commentary_id] => 2185 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15423 [apv_conversation_id] => [content_type] => market-commentary [title] => 2015 Investment Outlook: Europe—The Saga Continues [slug] => franklin_123114 [fulltext] =>

David Zahn, CFA, FRM
Head of European Fixed Income 
Senior Vice President
Franklin Templeton Fixed Income Group®

For the eurozone, 2015 offers the prospect of both significant change and continued inertia. Though the European Central Bank (ECB) refrained from announcing any further actions at its December 2014 meeting, a dovish speech by ECB President Mario Draghi a few weeks earlier did provide further backing for what markets have been signaling for many months, namely that the ECB might introduce full-blown quantitative easing (QE) at some point during the coming year. Should QE happen in 2015, we believe its onset could mark a step change in the ECB’s role and the region’s financing of debt, with potentially profound political implications for the monetary union.

And yet, regardless of whether QE is introduced or not, the secular stagnation that has gripped the eurozone seems unlikely to lift by the end of 2015. Although the region’s overall third-quarter growth in 2014 was better than expected, the weakness of the German economy, which managed an expansion of just 0.1% over this period, dented any optimism.

On top of the existing internal problems of “lowflation,” shorthand for ultra-low inflation, weak demand and anemic credit growth, the deterioration in the external backdrop over much of 2014—rising geopolitical tensions with Russia, and the slowdown of the Chinese economy and many other emerging markets—has made a rapid return to meaningful growth across the eurozone unlikely, in our view, despite some positive signs, including the stabilization of many peripheral economies and the boost in competitiveness from the weaker euro.

What Probably Will Change in the Eurozone in 2015?

Much has been made of the opposition of some German policymakers to QE, and politically its introduction, we think, could depend disproportionately on the course of future German economic data, rather than a more measured assessment of the overall course of the eurozone. If German industry’s slowdown continues beyond the second half of 2014 into 2015, then the resolve of the country’s officials to stick to their ideological knitting will likely be tested, and may create enough of a consensus for ECB President Draghi to move beyond the substantial raft of measures he has already announced.

In the event of a go-ahead for QE, its announcement might be of greater political than economic significance, potentially marking the first step on the road to closer fiscal integration of the eurozone. In terms of what QE could include, as well as purchases of member states’ sovereign and corporate debt, other options might include supranational institutions such as the European Investment Bank. A regional approach to debt financing would be a critical threshold for policymakers to cross, potentially opening the way for further transfers to ease intraregional imbalances. We anticipate an announcement confirming QE’s introduction could see further compression of spreads.1 between peripheral and core eurozone bonds, though as has been the case in other countries that have used it, the actual implementation of QE may trigger a modest selloff, in our view.

Ahead of any potential decision, we believe President Draghi will hope for signs that the ECB’s existing measures are having some effect. While the remedies announced so far have lacked sufficient magnitude individually to have a noticeable impact, in aggregate they could help to dispel some of the deflationary pressures weighing on the region. Perhaps the most important goal is to reinvigorate credit growth, and here the cheap funds provided by the ECB’s TLTRO (Targeted Longer-Term Refinancing Operation) program to the region’s banks, designed to stimulate lending to businesses, might yet prove effective. The initial auction for the TLTRO loans in September 2014 proved disappointing, as banks opted instead to repay the previous round of loans from the ECB at the height of the eurozone crisis.

What Probably Will Not Change in the Eurozone in 2015?

One of the main criticisms of QE when used by other central banks has been its ineffectiveness in injecting money into the “real” economy. Though the ECB has acknowledged that one of the main factors underlying the eurozone’s stagnation is a lack of credit growth, any potential use of QE seems unlikely to make much of an impact in this regard, even if an announcement of QE could drive yields down further, making it even less attractive for banks to hold government bonds.

Nor is there much prospect of relief for the eurozone economy from fiscal stimulus. We believe the precarious finances of the peripheral economies rule out such largesse, while core eurozone countries have only limited fiscal leeway, or in Germany’s case, insufficient political interest in such expansion.

Though current and future region-wide initiatives to boost expenditure are sure to be talked up by officials, in reality their impact on growth is likely to be marginal, in our view, rather than meaningful. It is important to emphasize that, despite the current headwinds, we do not foresee a full-blown recession for the eurozone in 2015. Growth across the region may turn slightly negative at some point, indeed lowflation may even change to slight deflation, but these indicators are more likely to oscillate around zero than sharply deteriorate. Our base-case scenario for the end of 2015 sees the eurozone economy remaining more or less where it is now, not really growing much or shrinking much either. Even if growth in the region did show signs of picking up in 2015—and recent sharp falls in energy prices should support growth, though put further pressure on lowflation—given structural constraints, ultimately growth is likely to be limited to the region’s trend rate, somewhere between 1% and 2%. So far, structural reforms that could lift this long-run average rate have been most evident in peripheral economies, with little sign in key core economies (such as France) of the necessary political will to grasp this nettle.

1231_ZahnInflation_Eurozone 

What Else Might Impact the Eurozone in 2015?

We see two other variables that could have a significant impact in 2015. If a worsening of the dispute over Ukraine caused a further deterioration in the European Union’s (EU’s) relationship with Russia, the dampening effect on growth in the eurozone (and even more so for the eastern EU member countries) would likely be negative while political relations remained strained. The other unknown is the UK general election in May 2015, in which a Conservative victory would raise the possibility of a referendum within a couple of years on the UK’s membership in the EU. How European markets might react to the possibility of “Brexit,” which is shorthand for “British exit from the European Union,” both in the run-up to the UK election and its aftermath, remains unclear, although given that UK assets suffered as the result of the referendum on Scottish independence became less predictable such volatility could conceivably reoccur.

While Eastern European countries may experience a slowdown if the Ukrainian crisis worsens further, we believe that their fundamentals—generally higher growth than the eurozone countries, and significantly more manageable debt burdens—remain attractive. For the United Kingdom, we do not anticipate that its currently superior rate of growth will be affected by the coming election, though with the eurozone’s weakness inhibiting UK inflation, the Bank of England might hold off raising interest rates for longer than many observers expect. The other key event that might occur in 2015 is a much-heralded increase in US interest rates, as the US economy continues to improve. While such a move would likely cause a spike in volatility in European markets, we would expect investors to quickly refocus on the eurozone’s weak fundamentals. Such sentiment, along with the possibility of further monetary stimulus from the ECB, should also see the euro likely continue to fall over 2015.

David Zahn’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

This information is intended for US residents only.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

What Are the Risks?

All investments involve risks, including the possible loss of principal. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency rate fluctuations, economic instability and political developments. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. Currency rates may fluctuate slightly over short periods of time, and can reduce returns. A non-diversified portfolio involves the risk of greater price fluctuation than a more diversified portfolio.

1. Spread is the percentage difference between the yields of different types of bonds.

[description] => Like television fans deciphering a season-finale cliffhanger, investors have been left with unanswered questions about the eurozone as 2014 draws to a close. Will the European Central Bank unleash full quantitative easing? Will the eurozone fall into a recession? David Zahn, head of European Fixed Income and portfolio manager, Franklin Templeton Fixed Income Group®, gives his perspective on what he thinks may lie ahead as the eurozone’s drama continues into 2015. [author] => David Zahn [legacyinterface_firm_id] => 163 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 15:49:39 [created_by] => 948 [modified_on] => 2014-12-31 15:55:19 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2251 [hits] => 0 ) [4] => stdClass Object ( [legacyinterface_commentary_id] => 2186 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15424 [apv_conversation_id] => [content_type] => market-commentary [title] => Structural Reforms in Asia [slug] => matthews_123114 [fulltext] =>

The global investment community continues to deliberate about the impact of quantitative easing stemming from Europe, and more recently from Japan, as a means to revive domestic demand. Meanwhile, several Asian economies are embarking on a different kind of stimulus, aimed at boosting long-term productivity and investment spending, through structural changes to the underlying economies. Last month’s Asia Insight focused on “Asia’s Deepening Capital Markets,” in which we highlighted that growth is being supported by financial market reforms designed to both deepen the markets and broaden its participant base. This month’s Asia Insight provides some context around wider economic reforms, how the imperatives may differ from the past and how Matthews Asia seeks to participate in these changes through our portfolios.

Countries in Asia are no strangers to reforms and many of us who have watched these markets for decades recall the solid recovery posted by these economies in the aftermath of the 1997 Asian Financial Crisis (AFC). In hindsight, the AFC proved to be short, albeit deep, because the regulators were forced to adopt tough measures, mainly prescribed by the International Monetary Fund (IMF). The intention was to rectify policy missteps and to clean up major faults in the financial system; and the results were very positive over the long-term. Two important factors helped Asia recover quickly. First, there had already been significant productivity gains within the agricultural and manufacturing sectors, leading into the AFC—particularly in North Asia. Second, the IMF's rescue led to relatively groundbreaking reforms prompted by a financial shock. 

This kind of radical change rarely occurs in the absence of a crisis. On the back of these reforms, Asia posted multiple years of impressive growth. More recently, progress has stemmed from better terms of trade or increasing leverage. But these factors are not sustainable, and slowing growth is strengthening the resolve of today’s policymakers to embark on much-needed reforms. But what distinguishes Asia from the West is that reforms are targeting the economy at its foundation—at the corporate and consumer level. This is contradictory to common practices that use fiscal spending or monetary policy to affect temporary improvements in top-line GDP growth. What we are seeing today is an effort to mobilize capital in parts of South Asia, and at the same time, an effort to better allocate capital and build an innovation-led economy in parts of North Asia. Reforms implemented during the post-AFC era were prompted from outside of Asia, while current reforms are being driven by local governments. 

Capital Accumulation: Still an Important Step for Parts of Asia


In the book, “The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else,” Peruvian economist Hernando de Soto Polar describes capital as "that part of a country's assets that initiates surplus production and increases productivity." Capital is not to be confused with money, which is one of the many forms in which it travels. Instead, capital is an asset that generates money when invested. 

In the initial stages of economic development in North Asia, countries gained ground by using all available labor in agriculture to build economies of scale and push output to the highest possible level. As yields increased, economic surpluses also increased, leading to capital accumulation. In the next stage, the surpluses in human capital and other resources were directed toward manufacturing. In this phase, a small number of entrepreneurs and technicians made an outsized impact on economic development by focusing on innovative-mechanized production by employing large cohorts of unskilled and semi-skilled labor.

In North Asia, agricultural industrialization led to productivity gains and allowed surplus labor to be absorbed into other parts of the economy. But in many other parts of Asia, the agricultural sector’s share of overall employment is still where Japan was in the 1950s and 1960s—where agriculture still accounts for 30% to 50% of all employment—including China, Indonesia, the Philippines, Thailand and Vietnam. 

South Korea and Taiwan, and more recently China, have demonstrated a ruthless and uncompromising focus on competition and productivity, and this has been crucial to developing robust manufacturing. Asia’s policy initiatives toward accumulating and mobilizing capital have included a host of measures to support economic development including deregulation in labor to provide more flexible cost structures; deregulation in ownership structures that can provide a greater role for the private sector; deregulation in natural resources; as well as liberalization of the financial markets.

The pace and sequencing of these initiatives can be critical; when changes occur too slowly, there is a risk of weak job creation and technological obsolescence, as there has been in India and Indonesia. When changes happen too quickly, countries run the risk of experiencing a speculative frenzy that can be counter-productive to long-term development. 

“Make in India”: A Push for Manufacturing


India's challenges in the manufacturing sector illustrate the complexities of implementation in real (versus theoretical) political and economic systems. Ownership barriers, rigid labor laws, complex land acquisition rules and weak infrastructure have conspired to stunt manufacturing growth. But whenever these barriers have been lifted, the response from the entrepreneurial community has been encouraging. The automobile industry, liberalized in 1991, was among the first segments of manufacturing to open up to private sector participation. Since then, output has grown 15-fold and, India is increasingly considered a destination for manufacturing and an export base for auto parts and automotive vehicles. 

India's newly elected Prime Minister Narendra Modi has made manufacturing a key agenda point. Specifically, his administration plans on building a globally competitive industrial sector that can steadily increase market share in exports. To support this, authorities have progressively lowered ownership barriers to foreign firms within manufacturing. Most recently, in the defense and railways sectors, it has increased the level of ownership permitted by foreigners to 49% and 100%, respectively. 

Labor laws in India are more vexing because they are legislated concurrently by both the central and state governments. The Northwestern state of Rajasthan has taken the lead in labor deregulation by reducing government-approval restrictions on hiring/firing workers. Other proposed measures aim to provide greater flexibility in running factories, and in complying with existing labor laws. If the efforts in Rajasthan lead to greater job creation, it will be difficult for other states not to follow suit. 

Formal job creation is surely a goal of Mr. Modi’s and the kinds of changes sought by the state of Rajasthan are certain to challenge some vested interests. But the recent elections have given a broad mandate of growth and governance over welfare entitlements to the incoming government. 

Diminishing Subsidies: Is this a Sign of Deepening Resolve?

 
In Indonesia, one of the first steps taken by the incoming administration of President Joko Widodo was to reduce energy subsidies in order to allow gasoline prices to move closer to market-determined rates. Subsidies often have unexpected consequences and lead to crowding out. In this case, the fiscal costs associated with energy subsidies had been twice as high as expenditures on infrastructure and three times as high as spending on health care. They had also been harmful because they disproportionately benefited the top 20% of Indonesians, adding to already-high tensions surrounding class and wealth in the country. 

India and Malaysia have taken similar steps to cut energy subsidies, which now account for 2.5% and 1.7% of GDP, respectively. If these policies continue to hold in an environment of rising oil prices, it will be a sure sign of leaderships’ determination to push ahead with structural reforms that may sacrifice the short term for the sake of the long term. 

The new governments in India and Indonesia are working to reduce dependence on individuals, and to strengthen the role of institutions by improving public service performance and coordination across ministries. Technological systems are also helping to improve work flow and reduce corruption through increased transparency. As an example, India’s public services administration’s transition to an e-governance platform has been credited with helping to launch an astonishing 33% of previously stalled investment projects, amounting to as much as 5% of GDP. These types of efficiency improvements are occurring behind the scenes, and are less controversial than bolder efforts to reduce subsidies and deregulate industries.

Capital Allocation: A Growing Priority


The macroeconomic policy settings in the capital allocation phase of development are often characterized by an environment of low interest rates, strict capital controls and low exchange rates. In recent times, China has been exemplary in its use of policies to promote capital accumulation. China has also been successful in directing savings and surpluses toward accelerated technological learning. 

Some have argued that the hectic pace of infrastructure creation in China is more indicative of capital misallocation. While we acknowledge that the rapid pace has its risks, it is also entirely possible that the massive infrastructure spend has been a key enabler of the Internet/e-commerce revolution now engulfing the country. Rapid capital mobilization may be a normal step in economic development, but perhaps the government realizes that the impetus has to shift toward better allocation of capital. As such, there has been a resolute commitment toward freeing-up interest rates, liberalizing exchange rates and slowly lifting the controls on the capital account. 

China’s authorities are embracing financial sector reform, but on their own terms. The steps toward internationalization of the renminbi (RMB) are at the leading edge of those efforts. At the national level, this gives China additional trade-settlement options and reduces dependence on the U.S. dollar; but that is only a part of the multi-year story. By using the RMB as a financing mechanism in international trade, Chinese exporters may gain share in higher value-added items, such as telecommunication routing equipment, capital goods and personal computers, et al.

For financial reform to be successful, it needs to promote competition from both private and foreign players. One of the key thrusts of Chinese authorities has been to provide private firms with access to a broader range of sectors. In support of this, there has been an attempt to improve access to funding for small- and medium-sized enterprises (SMEs). Many of these companies in China, and other parts of Asia, still have to rely on internally generated funds since capital availability remains constrained.



Most notable has been a general effort to deregulate parts of the services economy previously controlled by state-owned enterprises. One clear example is health care, where increasing competition is gearing up to meet the changing needs of average consumers. One perverse outcome of accelerating prosperity has been increased incidents of lifestyle diseases, such as diabetes and heart disease. In order to provide higher-quality health care, the government has allowed private companies to enter the hospital sector. 

In general, building a higher-quality services economy will test the mettle of authorities. Steps to level the playing field, between conglomerates and SMEs, can help. South Korean policymakers have picked up the gauntlet in this regard. Recent actions to encourage dividends, improve the use of cash and to refine ownership structures within conglomerates are steps in that direction. The development of the services sector can lead to greater balance and more inclusive growth in Asian economies, which is another step in the direction toward increasingly efficient economic structures. 

Sentiment can be Unpredictable over the Short Term


We have not seen a near-synchronous effort toward structural changes within Asian economies in quite a while. China has taken the lead and has been the most rapid and most consistent in its execution. By withdrawing from its role as director of a planned economy, the Chinese government is embracing a regulatory role in a more market-oriented economy. The government’s near single-mindedness comes with the realization that while the current reforms can be painful, the cost of missing out on greater global stature that will come from further growth will be even more painful. Yet the investment community seems to shrug off these developments in China, while the mere possibility of change in India is enough to send spasms of excitement across the capital markets. 

Arguably, the task at hand in India is different. Like many parts of South Asia, it focuses on overall growth prospects from a better supply-side response to freeing-up factors like land and labor. China, much like other parts of Asia, has to focus on a more rational organization of talent and push for greater quality of growth. The success in either of these endeavors is not guaranteed. And as history has shown, the path to future development has been traversed in multiple ways by Asian economies. 

How do we Capture Opportunities in our Portfolios?


One thing is increasingly clear—in the stages of economic development across Asia, greater diversity means there are greater numbers of businesses from which to choose. One way to participate in this dynamic is to stay nimble within the confines of a disciplined investment process. The other important goal is to remain focused on the long-term evolution of these economies, rather than getting drawn into short-term predictions. We analyze the financial information of companies, but it is sometimes useful to use a long-range lens to understand the intentions behind some of the initiatives affecting companies in Asia. Of all the above reform initiatives, two are crucial—to improve the quality of life for the household, and to boost economic productivity. If we can identify those businesses that are doing so, we believe this will be a powerful force for our shareholders. 

Sharat Shroff, CFA
Portfolio Manager
Matthews Asia

You should consider the investment objectives, risks, charges and expenses of the Matthews Asia Funds carefully before making an investment decision. This and other information about the Funds is contained in the prospectus or summary prospectus, which may also be obtained by calling 800-789-ASIA (2742). Please read the prospectus carefully before you invest or send money as it explains the risks associated with investing in international and emerging markets. These include risks related to social and political instability, market illiquidity and currency volatility. Investing in foreign securities may involve certain additional risks, exchange rate fluctuations, less liquidity, greater volatility and less regulation. Fixed income investments are subject to additional risks, including, but not limited to, interest rate, credit and inflation risks. Single-country and sector funds may be subject to a higher degree of market risk than diversified funds because of a concentration in a specific sector or geographic region.

Matthews Asia Funds are distributed in the United States by Foreside Funds Distributors LLC, Berwyn, PA
Matthews Asia Funds are distributed in Latin America by HMC Partners 
© 2014 Matthews International Capital Management, LLC

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For much of 2014, the financial press was filled with dire headlines warning of global stagnation and deflation. These demoralizing reports seemed to paralyze policy makers. The facts behind the headlines, however, suggested the reality was not nearly as gloomy or pessimistic as it seemed. This paper outlines a more optimistic outlook for 2015 where the world economy is expected to remain resilient and where the outlook for sustainable corporate returns remains strong.

2014 Market Review

Emerging market economies dominated financial markets in 2014. Figure 1 shows a list of the top ten equity and bond market returns through early December, heavily populated by emerging markets. This was particularly noteworthy in light of the U.S. Federal Reserve’s unwinding of quantitative easing operations. Returns are shown in U.S. dollar terms, thus fully reflecting the negative impact of USD strength. We believe the strong performance of emerging markets in spite of Fed policy headwinds is a testament to how far these countries have come as well as their future potential.

In the bond markets, global yields continued to compress in 2014. As recently as two years ago it would have been highly unlikely for a sovereign to make the top ten returns list with a yield of less than the mid-teens. But in 2014, yields of just under 4% represented some of the best returns available in fixed income. It was not surprising to see the search for yield spill into the equity space. This was evidenced by the fact that three of the top four performing global equity sectors were healthcare, real estate, and utilities.

Healthcare’s stellar performance was perhaps not surprising given the amount of mergers and acquisitions, both fulfilled and unfulfilled, occurring in the sector globally. With companies like Shire, Actelion, and Coloplast each up 40% – 60% in 2014, the market was showing its preference for security, high free cash flow, and good dividend yields.

The emphasis on yield and stable performance was also evident in the real estate sector, which was strong in 2014 across much of Continental Europe, the United Kingdom, and Sweden. Finally, compressing bond yields had a similar positive effect on utilities broadly, with particular strength in the European periphery markets as companies like Red Electrica and EDP-Energias de Portugal performed well. We believe that this focus on yield and free cash flow will continue to be an important driver of returns as we look ahead to 2015 and beyond.

Current Landscape: Low Growth and Pronounced Disinflation

How do we reconcile the disconnect between alarming financial headlines and actual market performance? We assert that it is all about falling inflation or “disinflation,” Figure 2 highlights the differentials between average growth rates in the years prior to the 2008 financial crisis and the last three years.

The total height of the bar is the nominal Gross Domestic Product (GDP) growth differential, which is composed of real growth and inflation. This clearly shows that most of the deceleration in growth was driven by lower or falling inflation. The notable exception was the Euro Area, where real growth decelerated dramatically. This disinflation trend has been a global phenomenon. In fact, the only major economy that registered significant acceleration in inflation over the last three years was Japan.

The pronounced and enduring disinflation across the globe is especially noteworthy in light of what has been a very aggressive monetary policy easing pursued by major central banks around the world. Figure 3 illustrates the growth of the U.S. monetary base as a percent of total global GDP. The amount of money supporting the U.S. economy has tripled in the last five years compared to the previous three decades.

The Fed has been joined in this effort by the Bank of England (BOE), and more recently by the Bank of Japan (BOJ), the People’s Bank of China (PBOC), and several smaller central banks. Despite this abundant liquidity injected into the world economy, the anticipated inflation has not ensued. Notably absent from this list is the European Central Bank (ECB), which remains embroiled in a heated debate with Germany, France and Italy on the issue of expanded powers and the fundamental role of the central bank. However, it is expected that Europe will be joining the BOE, BOJ, and PBOC in outright quantitative easing at some point in the spring of 2015.

Private sector growth in the U.S. has been quite robust and resilient for the past five years. Figure 4 shows the U.S. private sector has expanded at a rate of 2.25% – 2.50% quarterly (year-over-year) for an extended period.

In addition, industrial production volumes surpassed the 2007 peaks earlier in 2014, and industrial capacity is slowly working back to its pre-crisis levels.

Figure 5 shows that core consumer price inflation (CPI), excluding energy and food, is not accelerating. Likewise, hourly wage growth is not accelerating to anywhere near the levels seen before the 2008 crisis. In fact, the employment report released in early December 2014 was strong, showing the U.S. economy is adding quality private sector jobs at an ever-increasing rate, yet there are no signs that wages are increasing.

Figure 6 illustrates a similar disinflationary dynamic in the Euro area, especially when actual growth differences between the two sides of the Atlantic are taken into account. Core inflation has always been somewhat lower in Europe compared to the U.S., however, the more recent slowdown is largely due to weak growth. The headline inflation in the Euro Area is even weaker than the core, which has been the one beneficial effect of the rising tensions and sanctions on Russia. In the very short term, vast quantities of food exports destined for Russia were instead left in Europe, where a sizeable short-term oversupply meant lower food prices for many European consumers.

On a longer term note, change in the regional source of inflation within the Euro Area speaks to the ongoing significant structural adjustment taking place in Europe.

Figure 7 shows that, before 2008, core inflation in Spain was persistently at least one percentage point higher than the average for the Euro Area. At the same time, Germany was the “sick man of Europe” with correspondingly weak domestic consumption and inflation.  Today, this dynamic is completely reversed, as Spain is regaining competitiveness while the German consumer is enjoying good wage growth. 

The same disinflation trend is also evident in emerging markets. Figure 8 illustrates how core prices in China are growing faster now compared to the pre-2008 years. This is welcomed evidence of the ongoing rebalancing of the economy toward private domestic consumption. Much of the disinflation is coming from commodities prices, as producer prices in China follow commodities prices quite closely. China is not unique in this respect.

Figure 9 shows the same dynamic playing out across emerging markets broadly.

Commodities and Resources

China’s massive infrastructure overinvestment is clearly a factor in the pressure on commodities prices. In metals and certain forms of energy, most notably coal, China accounts for a large proportion of global demand (Figure 10). At the same time, the ongoing slowdown in residential real estate construction is applying downward pressure on the associated industrial metals and minerals prices. However, metals and coal account for only about 15% – 20% of commodities consumed by the emerging markets. The two principal contributors to inflation, food and energy, account for over 80%, and China is only one of many players. Specifically, China accounts for only about 20% of global fuel consumption, which is roughly in line with its share of global GDP. In agricultural markets, China barely plays any role at all. This supports the thesis that global disinflation has been driven by broader forces than China’s supposed overinvestment.

Over the past five years, commodities prices, as shown in Figure 11, have been broadly flat or declining slightly, showing no signs of inflation.

Oil prices fell sharply in the second half of 2014 due in part to the strong growth of shale production in the U.S. in recent years. At this point, the general expectation is that a dramatic reduction in oil prices will likely drive out some of the high cost producers in the U.S., with less additional supply resulting in higher oil prices by the end of 2015. While it is possible that this conventional argument will play out, we believe it is also equally possible that technological changes that are driving down the cost of fracking and shale production in the U.S. will continue to be underappreciated. Instead of leading to a significant decline in supply, current oil prices may only slow the growth of U.S. shale production. In this scenario, lower oil prices may not rebound as conventional wisdom suggests.

The drop in oil prices can be viewed as a tax cut on a global basis; some estimates are as high as $40 billion. This is clearly a positive for the consumer globally. On a country-by-country basis, the impact may be positive or negative depending on whether you are an importer or exporter of oil. From a Russian or Venezuelan perspective, this is almost a catastrophic development. On the positive side, countries that are dependent on imports are actually doing much better; for example India is a clear benefactor. For the U.S. and Europe, the pull-through from cheaper oil prices is a significant positive and clearly beneficial for the consumer.

Why Does Inflation Matter?

We believe that the prevailing environment of low inflation is particularly relevant to equity investors as it is a key source of corporate pricing power. The economy, as measured by GDP, effectively consists of wages and corporate profits. Both of these are partially driven by rising prices. Since the end of World War II, policy makers around the world have sought to ensure that the global economy operates in a low and stable inflationary environment. Company executives learned how to produce and sell products in such an environment, while financial markets participants designed tools to assess corporate performance in an inflationary setting. What are the implications for growth in a world without inflation? To the extent that inflation is seen as a manifestation of growth, is disinflation by extension a sign of stagnation?

Are growth and inflation really disappearing? We believe that the three key forces simultaneously driving growth and disinflation over the past four or five decades are globalization, technological innovation, and deregulation. Their importance over this time period is uncontested, and it is clear that they are not necessarily always forces for good – there are excesses and negatives associated with each. As we try to determine whether growth and inflation have permanently changed, we closely examine these themes.

From a globalization point of view, the expansion of trade and increased level of investment that have been seen post-World War II and post-Bretton Woods have led to integrated supply chains, cheaper products and even cheaper services on a global basis. Clearly economic growth has benefitted from globalization, but it has also been a significant contributor to disinflation as well.

Deregulation has enabled the opening of industries to private capital, the breaking down of monopolies, changes in workforce regulations, and the creation of wholly new industries. The resulting competition has driven growth, yet deregulation is not a panacea as the negatives associated with deregulation are also significant.

Technological innovation has unequivocally been a strong growth driver, but there is often capital misallocation associated with the hype of technology, as occurred most obviously amid the tech bubble period. The Moore’s Law curve, still very much intact today, has expanded processing power at ever cheaper rates and is leading to further disinflation while still producing growth. The conclusion drawn from these longer-term trends is that growth is intact but it is also important to understand the disinflation component.

The question remains: have these growth and disinflationary forces exhausted themselves? In the aftermath of the 2008 crisis, at least two of the three, globalization and deregulation, appear to have stalled. In Figure 12, global trade volumes are shown as a proxy for globalization. Following a decade of strong gains where global trade grew well in excess of global GDP, trade growth has slowed to a rate approximating global GDP growth.

Lack of progress on deregulation, which falls under the auspices of general economic policies, was well summarized by the International Monetary Fund’s José Viñals at a recent gathering in London. He accurately noted that, for the past five years, of the three major policy pillars, monetary policy has been the only game in town. This is true across much of the world, as most national governments focused on making sure that their domestic economies could weather the storm of demand destruction post the 2008 crisis.

But, five years after the financial crisis, things seem to be changing. Fiscal consolidation is over in both the U.S. and the Euro Area. As shown in Figures 13 and 14, government spending on both sides of the Atlantic declined sharply through 2011 and is now beginning to contribute positively to growth.

Globalization Trends

There are signs of reviving globalization, despite the fact that the last round of Doha negotiations at the World Trade Organization failed at the last moment in 2014. There are several transformational regional agreements in the final stages of negotiation following many years of work. Specifically, the Trans-Pacific Partnership (TPP) spans three continents and includes the U.S., Japan, Australia, Canada, Mexico, Peru, Chile, New Zealand, Malaysia, Singapore and Vietnam. Together, these economies account for 40% of global GDP. Further significant dismantling of trade barriers in goods and services, as well as intellectual property, will have a measurable boost to trade.

Less frequently discussed, but no less important in terms of its economic impact, is the Transatlantic Trade & Investment Partnership (TTIP), which is a regional agreement between the U.S. and the European Union. Taken together, these economies account for 45% of global GDP. Most negotiations on this have been completed and the lawyers are putting the finishing touches on the final text. If ratified, the benefits are estimated in the hundreds of billions of euros or dollars over the next 15 years. This would not only benefit the two economies in question, but the world at large.

Last month, China signed a free trade agreement with Australia that has been in the works for nearly a decade. It is a major step toward fully liberalizing bilateral trade between these two countries.

Globalization efforts do appear to be reviving. No fewer than a dozen bilateral and regional trade deals are currently in various stages of negotiations. While change is slow, structural changes are cumulative and we believe that these agreements in aggregate can have a meaningful impact over time.

Structural Reforms

The outlook on deregulation, or structural reforms, is also improving with several developments that promote growth and are disinflationary. Significant reforms are being seen in India, where the current Prime Minister Narendra Modi was elected in 2014 on a strong reform mandate. Modi appears to be delivering on his promise of less government “There are signs of reviving globalization...” and more governance. In an effort to lessen bureaucracy and streamline the provision of services, Modi’s government is prioritizing the digitization of permits requests and the centralization of subsidies distribution. We believe these microeconomic reforms will reduce the costs of doing business, as they limit opportunities for corruption and more efficiently deliver funds to end consumers without “bleeding” to endless layers of bureaucracy. In this way, these reforms are highly disinflationary.

In China, the current leadership consolidated power faster than most outside observers thought possible, taking concrete steps toward breaking up the triumvirate of state owned enterprises (SOEs), local governments, and large state-owned banks. If implemented, these reforms could pave the way for continued growth in China for years to come.

Reforms are not limited to emerging market economies as advanced economies are also making strides, perhaps most notably Japan. The key structural change that is a significant focus of Prime Minister Shinzo Abe’s efforts is inflation. There are early signs of success and we are already seeing positive signs of corporate performance in response.

Even the Euro Area is undertaking major initiatives. This is not limited to the recently announced infrastructure spending initiative in Europe, which so far has included few details and garnered little enthusiasm from the private sector. Fifteen years after the introduction of the single currency, there will finally be a banking union. As of November 2014, there is now a single, pan-European banking regulator, hastening the development of a fully integrated financial services market. All of these reforms are growth-promoting and disinflationary to the extent that they take costs out of the production of goods and services.

Investing in Growth in a Non-Inflationary World

How does one invest in growth in this noninflationary world? Our approach remains the same. Our philosophy has always been focused on seeking high quality growth companies that can deliver strong corporate performance. We remain focused on companies that we believe have the ability to generate free cash flow from both the top line and operational leverage on the margin side, which can then be reinvested back in the business or returned to shareholders.

Our continued focus on quality growth brings us to emerging markets (EMs). During the decade preceding the financial crisis, most major EMs undertook significant macroeconomic restructuring. Inflation and fiscal spending were brought under control, current account deficits were eliminated or reduced, and external debts were repaid. This paved the way for sustained rapid growth and has resulted in significant changes to the composition of the global high quality universe.

In 1997, as shown in Figure 15, our investable universe of high quality companies included just over 1,300 names, only 10% of which were from EMs. Today, not only has the universe doubled in size, but the number of high quality companies in EMs has risen seven-fold, and is now on par with the number of high quality companies in the U.S.

This macro restructuring and non-inflationary growth led to a rapid rise of the middle and lower middle class where the propensity to consume is many times greater than in developed economies. It is also where large groups of people are demanding continued non-inflationary growth. This was at the heart of the 2014 protests in Brazil. Political ramifications of the rise of the middle class in EMs are evident from India and Indonesia to Mexico, and perhaps less obviously, Brazil. As a result of their restructuring, many EMs are in a stronger position to control their economic development. In our view, the vigor with which they are able to implement reforms will largely determine the continued evolution of their economies and their growth trajectory.

Now more than ever the EMs are a heterogeneous lot of countries with very different economic and growth trajectories. For example, the prospects for India are significantly different than those for Russia. We believe the market now understands this as Figures 16 and 17 display the trends in the dispersion of returns and valuations. Whereas 10 – 15 years ago most of the EMs were traded or valued as a single asset class, the dispersion of the returns has expanded and the market is much more aggressively trying to differentiate between really true, sustainable quality companies and those that are not. The market appears to be paying for this as the differences in valuation are also notable.

Substantial dispersion can also be seen in Figure 18 by looking at the earnings trend/ valuation lens used by William Blair to evaluate stocks, sectors and countries. This illustrates how China, a market that was much more homogenous itself 10 – 15 years ago, now exhibits substantial dispersion across sectors in terms of valuation and earnings trends.

India

In the case of India, the goal of the near term reforms is to change the mix of economic growth and inflation. As shown in Figure 19, in the years preceding the financial crisis, India experienced strong growth and relatively low inflation. Over the past five years, the picture has completely reversed, with prices growing at or near a double-digit pace, while the economy grew at half the pace of the 2000s. Although inflation fell noticeably in the second half of 2014, Reserve Bank of India Governor Raghuram Rajan has yet to cut interest rates. Rajan’s actions suggest that the government is serious about reining in inflation to pave the way for productive investment and growth. For growth to accelerate, India needs massive private and public investment. Ultimately, the objective is to incentivize investments and to bring investment growth to generate further output gains.

As previously cited, India was the best performing market in 2014, in terms of both bonds and equities. Figure 20 shows that equity valuations are clearly above their 10 year average, but this does not necessarily mean they are overextended. Quality companies, as demonstrated through recent (or historic) corporate performance, are quite abundant in

India. It is not surprising for the technology sector to be a source of high quality companies, with well-known leaders in IT services, but we also see strong corporate performance in pharmaceuticals and the automotive industry.

Although valuations have increased, we believe there is potentially more opportunity from an equity investment perspective, as India is outperforming its emerging markets brethren with respect to earnings. While the spread is not huge we believe it is significant in that there is strong underlying fundamental performance. We will continue to review the fundamental earnings trends and progress on reform measures.

China

Deciphering China’s reform efforts is considerably more challenging. In the initial decades, China’s remarkable growth was based on an intertwined relationship between SOEs, local governments and large, state-owned banks. Such a system was very successful in rapidly mobilizing financial resources and developing infrastructure. At the same time, the private sector developed largely outside of this triumvirate, with little access to capital or resources. The private sector flourished despite these obstacles.

Today, private companies in China account for nearly 90% of employment and the vast majority of corporate profits. It is widely acknowledged that services and consumption are best delivered by market-based mechanisms. Chinese leaders have long recognized this, and efforts to open private sectors to capital more formally while dismantling SOE dominance are well underway.

The reforms over the next several years are complex and interrelated, but fall generally into three categories:

• SOE Restructuring: Provinces have published plans to restructure their SOEs, including asset sales, to the private sector. Several large companies, such as China Telecom and CNOOC, have already published their plans for mixed ownership and consolidation, and many local SOEs have already announced privatization plans. There are nearly 100,000 local SOEs in China, so the amount of assets and companies opening to the market will be significant in the coming years.

“If China is successful in implementing these reforms, we believe they will be strongly growth generative and ultimately disinflationary.”

• Fiscal Reform: In order to restructure and dispose of SOEs, local governments must have sources of financing other than SOE profits and land sales. Effective January 1, 2015, provincial level governments will be allowed to issue debt on behalf of towns and counties, subject to the provincial ceiling. This is the beginning of the municipal bond market in China, which we believe will also pave the way for greater transparency, and ultimately debt sustainability, in local government debt. At the same time, local governments are now expressly forbidden from setting up local government financing vehicles (LGFVs). There are also plans to address the existing stockpile of local government debt.

• Financial Liberalization: These reforms are accompanied by financial liberalization, as insurance companies and other financial intermediaries move in to collect savings and provide services previously reserved for state-owned banks.

This is a highly complex reform process that will take several years to materialize. If China is successful in implementing these reforms, we believe they will be strongly growth generative and ultimately disinflationary.

Japan

While various portions of the three arrows of Abenomics remain somewhat unfulfilled, the fundamental trends are encouraging. Using our earnings trend/valuation lens, the most interesting region globally remains Japan with strong earnings trends and supportive valuations across most sectors, as shown in Figure 21.

As seen in Figure 22, wages and core inflation are a key part of our positive view on Japan.

With regard to retail sales, efforts to move the buying public in Japan away from the caution previously exhibited were not helped by the sales tax increase in the spring of 2014. The result has been the postponement of the second tax increase, which could be positive for the economy more broadly.

Annualized share buybacks (Figure 23) illustrate how corporate performance has shown significant improvement in the past six months. The virtuous circle in Japan, in which higher return on equity is sought by management and rewarded by the market, is a significant change in the mental approach toward investment in Japan. Improved corporate performance evidenced by higher earnings, better dividends, and share buybacks that have been significantly ahead of market expectations, has given us confidence that reforms are already producing results. We are particularly encouraged by the recently launched JPX-Nikkei 400 Index targeting high ROE companies with good governance standards, and the Government Pension Investment Fund’s doubling of its target equities allocation in an effort to improve prospective returns.

United States

Finally, the U.S. enjoyed good performance in 2013 and 2014 driven by multiple expansion. While earnings have been catching up, U.S. valuations are extended versus the rest of the world. We believe that is fair since corporate performance has been much better in the U.S. than it has been in many other places. We are quite cognizant of the fact that reform, especially on the banking side, happened earlier and much more efficiently in the U.S. than it did anywhere else – most notably Europe. This is evident in the returns profile and GDP growth which is significantly ahead of what we have seen in other markets, particularly Europe.

With respect to the earnings outlook, there has also been considerable discussion that U.S. corporate profit margins will come under pressure. To the extent that we are not seeing wage growth being a significant impediment to corporate profit margins, we believe U.S. corporates will likely sustain their profitability profiles.

Summary

We anticipate the world economy in 2015 will remain resilient, but with a moderate growth profile overall. IMF data project global GDP growth around 3.3% – 3.5%; satisfactory in an historical context. The U.S. and Europe are expected to benefit from dissipating fiscal drag, while the Japanese tax increase postponement should have a positive impact. Emerging markets should benefit from lower commodity prices, stable developed market demand and domestic reform efforts.

Disinflation is likely to continue as we expect globalization, structural reform efforts, and technological changes to lead to lower prices. The emerging markets will continue to be important to investors, but differentiation among countries, sectors and companies will be critical to success. In our view the emerging markets are not a homogenous group: the prospects for India are significantly different than those for Russia.

As always, we will continue to seek sustainable corporate returns. We strongly believe that companies that demonstrate high returns on investment are better positioned to navigate this environment, and have better potential to provide a solid foundation for our portfolios.

Important Disclosures

This material is provided for information purposes only and is not intended as investment advice nor is it a recommendation to buy or sell any particular security. Any discussion of particular topics is not meant to be comprehensive and may be subject to change. Data shown does not represent the performance or characteristics of any William Blair product or strategy. Any investment or strategy mentioned herein may not be suitable for every investor. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Past performance is not indicative of future results. Information and opinions expressed are those of the author and may not reflect the opinions of other investment teams within William Blair & Company, L.L.C.’s Investment Management division. Information is current as of the date appearing in this material only and subject to change without notice.

© William Blair

 

[description] => For much of 2014, the financial press was filled with dire headlines warning of global stagnation and deflation. These demoralizing reports seemed to paralyze policy makers. The facts behind the headlines, however, suggested the reality was not nearly as gloomy or pessimistic as it seemed. This paper outlines a more optimistic outlook for 2015 where the world economy is expected to remain resilient and where the outlook for sustainable corporate returns remains strong. [author] => Simon Fennell, Olga Bitel [legacyinterface_firm_id] => 456 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 16:33:10 [created_by] => 948 [modified_on] => 2014-12-31 16:48:23 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2253 [hits] => 0 ) [6] => stdClass Object ( [legacyinterface_commentary_id] => 2179 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15417 [apv_conversation_id] => 3026 [content_type] => market-commentary [title] => 2015 Investment Outlook - Stay Tactical! [slug] => cmg_123014 [fulltext] =>

I wrote often throughout 2014 about the danger signals flashing from an excessive run up in debt and derivatives. We have a repeat of the scenario we suffered in 2008, only much worse (Watch Junks Bonds For Early Warnings Of New Financial Crisis, Forbes). The budget recently passed by Congress put taxpayers on the hook for a 2008-like derivatives failure. The potential losses could exceed the previous financial meltdown as other world market conditions exacerbate a bad situation.

As a risk manager, I need to acknowledge and plan to mitigate these big, macro risks. At the same time, as a tactical manager, I acknowledge that right now the weight of evidence points to a continued positive trend for this mega bull market.

In a world of excessive debt and unprecedented Central Bank intervention, where is a global investor to go? For now, the best place remains in U.S. equities.

Global debt continues to be the #1 concern going into 2015. A sovereign debt crisis looms on the horizon yet for now the creativity of global central bankers has kicked that can down the road. It is desperation time in Japan and the Eurozone is not far behind. A number of factors favor the U.S. dollar and U.S. equities through mid-2015.

My snapshot 2015 investment outlook:

The Fed & Interest Rates

  • Expect rates to be modestly higher in 2015.
  • In comparison to a historical average of 3.3 percent annual GDP growth, my expectation of 2.8 percent growth is enough to keep the Fed on track to raise rates for the first time in June 2015.
  • North America remains the primary growth engine to the world. Particularly the U.S.
  • The wind shifts in the second half of the year as the probability of the second Fed interest rate increase occurs. This could happen in September or October 2015. Bull markets tend to end after the second Fed rate increase.

U.S. Stocks & Bonds

  • Ultra low fixed income yields favor equities over fixed income. Despite today’s high valuations, the strong U.S. equity bull market continues through mid-2015.
  • The third year of the presidential election cycle is historically bullish for stocks (especially the first half).
  • Global capital flows favor U.S. equities and U.S. real estate.
  • There are a number of risks: Geopolitical. Crisis in high yield debt. Margin debt is at the highest level in history. U.S. stock valuations are high. At a median PE of 21.2, current valuation puts the probable forward 10-year S&P 500 Index return at just 4.28%. Historically, the lowest performing quintile (yellow line).

  • The chase for yield has flooded the high yield market with money to invest. Less credit worthy companies found it easy to borrow and at terms far less favorable to investors. A high yield bond market default wave begins in 2015 and lasts for several years (See Code Red In High Yield, Forbes, 7/25/2014).
  • We are 5.75 years into the bull market that began in 2009. Compared with bull markets from 1923 (5.83 years), 1994 (5.75 years) and 2002 (5.0 years), this bull is aged. Couple this with low probable 10-year forward returns and you have a higher risk environment.
  • For now, the U.S. economy is holding up the world but the U.S. is not immune to the deflationary pressures that grip much of the global economy. Debt is the problem.
  • A sovereign debt crisis likely drives the next financial crisis: a global economic crisis that rivals the 2008 global financial meltdown. My best guess? Beginning in late 2015 or 2016.

There is more than $700 trillion in bank created synthetic derivatives. It exists in an intricate web of entangled global counterparty risk. The concentration of such risk lies in the hands of just a few large banks. One has to wonder to what degree a sovereign debt crisis or other unknowing event might trigger another major financial crisis. It is unnerving that the banks were able to get Congress to pass a bill that puts the U.S. taxpayer on the hook for bank losses related to the banks’ derivatives holdings.

Global Macro Views

  • As QE ends in the U.S., interest rates here will rise while rates in Japan (recession and early QE) and the Eurozone (deflation and probable QE) will fall relative to U.S. rates. Additionally, it is widely expected that the Fed will begin to normalize interest rates in June 2015. Both the Yen and Euro offer less favorable interest rates and are early in their QE program. This favors the U.S. dollar over Yen and Euros.
  • The Eurozone is in decline economically and is dysfunctional politically. Global investors will continue to see U.S. real estate and equity markets as better investment options. Further, a sovereign debt crisis will cause capital to race into U.S. dollars and U.S. assets. Equities are favored over bonds.
  • Japan is now “all in” on QE, which is negative for the Yen but positive for Japanese equities. At 250 percent debt to GDP, Japan has reached a crisis phase. Their plan is to devalue the Yen. This is not viewed favorably by Korea, China or Europe. In 2015, the global trade and currency wars intensify.
  • Global pension plans are significantly underfunded and meaningfully exposed to low yielding sovereign debt. A debt reset (default/restructuring) is the probable outcome.
  • Underfunded pensions, with exposure to such debts, will be forced to restructure. A pension crisis follows the sovereign debt crisis.
  • Global banks are exposed to sovereign debt. EU regulators have made it attractive for banks to own sovereign debt as banks do not have to hold any capital against their holdings of government debt. A banking crisis follows the sovereign debt crisis.
  • Japan is center stage and the Eurozone is up next. Trade tensions and currency battles mount. None of this is favorable for global growth. Slow global growth and deflation are likely to continue.

The global central banks have embarked on a grand experiment of unimaginable proportion. But it is wise to remember too that bankers are human. Greenspan shared in his book that his problem as Fed chair was that he just didn’t know about the flood of junk mortgages that fueled the unprecedented risk in housing prices during the bubble years. He offered this reason to explain his lack of action about the risks posed by the bubble.

The Guardian explains, “Greenspan’s ‘I didn’t know’ excuse is so absurd as to be painful. The explosion of exotic mortgages in the bubble years was hardly a secret. It was frequently talked about in the media and showed up in a wide variety of data sources, including those produced by the Fed. In fact, there were widespread jokes at the time about ‘liar loans’ or ‘Ninja loans.’ The latter being an acronym for the phrase, ‘no income, no job, no assets’.”1

Japan is in desperation mode. Europe is following quickly behind. The Fed has printed trillions of dollars and has meaningfully participated in our markets. It has kept interest rates at near zero percent for six years. QE has become the global medicine of choice. There will be unintended consequences.

Here are some things you can do to participate in the market’s upside while protecting yourself from the next market crisis.

  1. Overweight equities but put a stop loss process in place to protect yourself from a -40 percent or more decline. Placing a stop loss just below an ETF’s 200-day simple moving average can help.
  2. The following graph looks at a 13-week over a 34-week exponential moving average. If you are invested in an S&P 500 index ETF such as “IVV”, “VOO” or “SPY”, when the 13-week (blue) line declines below the 34-week (red) line, sell NYSE “SPY” or “IVV”, switch to a lower volatile S&P 500 index like “HSPX” (it uses covered calls) or move more defensively to iShares 1-3 year Treasury ETF symbol “SHY”.
  3. Favor large caps over small caps. I like the following sectors: Technology via iShares, U.S. Technology ETF “IYW”, Healthcare “IYH” and Consumer Staples “KXI”.
  4. Look to include tactical all asset, tactical equity and tactical fixed income strategies in your portfolio. These strategies offer disciplined buy and sell processes that can help you further mitigate portfolio risk. Remember that broad diversification coupled with sound risk management remains the best path over time.

In summary, capital continues to flow into dollars, supporting a favorable view of U.S. equities. Trend evidence remains positive. A reasonable guess puts the S&P 500 index at 2350 by mid-2015 (a gain of approximately 15 percent). But it is really just a guess – much is dependent on capital flows and the timing of developing sovereign debt default worries. Markets move on supply and demand. I see more demand than supply for now.

Overweight U.S. equities, but keep in mind that valuations are high and the bull market is aged as is favorable Fed policy. Risk remains high. Corrections happen quickly and absent a plan, recall that a 50 percent decline can wipe out all the gains made over the last few years. Further, it will then take another 100 percent gain to get back to even and that takes time. As we well know, meaningful declines can happen.

As with all predictions, it is smart to remain balanced. I remember the 35 Wall Street analysts who, this time last year, on average predicted the yield on the 10-year Treasury would rise from then 2.99% to 3.25% by the end of 2015. Here we stand at 2.12%. Not one analyst thought the yield would be below 2.90%. They all missed.

One of the best performing assets of the year, the iShares 20+ Year Treasury Bond ETF “TLT” is up 24% through December 16. I too believed rates would rise; however, despite my fundamental view, our bond positioning process kept us invested in bonds. Keep this in mind when you look at expert opinions. They are probability based and come with no guarantees. It is best to broadly diversify your risks, overweight to areas that look most promising and incorporate a disciplined process that limits your downside and can keep you participating in the upside just in case your view or mine is wrong.

I see a strong first half for 2015 with a potential tipping point in late 2015. The trigger could be a sovereign debt crisis, successive Fed rate increases, an unexpected shock in oil prices or something we just don’t yet know. The point is that systemic risk is high and a 2008 crisis-like event is probable in the near future. If valuations were in quintiles 1 or 2 (as presented in the chart above) the story today would be entirely different. I believe we’ll see those quintiles within the next few years.

The good news is that market crisis creates outstanding opportunity. With a risk management plan in place, you will have the liquidity that will enable you to take advantage of the opportunity that the next crisis creates and it may just help you sleep more peacefully at night.

Here’s to a great 2015. Stay tactical!

© CMG Capital Management Group

[description] => I wrote often throughout 2014 about the danger signals flashing from an excessive run up in debt and derivatives. We have a repeat of the scenario we suffered in 2008, only much worse. The budget recently passed by Congress put taxpayers on the hook for a 2008-like derivatives failure. The potential losses could exceed the previous financial meltdown as other world market conditions exacerbate a bad situation. [author] => Stephen Blumenthal [legacyinterface_firm_id] => 483 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 15:39:02 [created_by] => 948 [modified_on] => 2014-12-30 15:39:28 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2245 [hits] => 0 ) [7] => stdClass Object ( [legacyinterface_commentary_id] => 2180 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15418 [apv_conversation_id] => 3027 [content_type] => market-commentary [title] => Can The Dollar Save Small Caps? [slug] => leuthold_123014 [fulltext] =>

The dollar’s moonshot in recent months has resuscitated a stock market leadership argument we haven’t heard for a long time—namely, that Small Cap stocks are better insulated than Large Caps from the loss of competitiveness and the currency translation impact of a stronger buck. Is there merit to this argument, or are Small Cap proponents grasping for straws after a flat year? It turns out there’s reasonable support for the Small Cap enthusiasts’ view, based on evidence from the U.S. (trade-weighted) Dollar Index. Isolating all dollar swings of 15% or greater since 1971 yielded the following performance results:

Small Caps have, on average, outperformed Large Caps during periods of sustained U.S. dollar strength, generating an annualized total return of +13.6% versus +10.7% for the S&P 500. This 2.9% performance spread is significantly higher than the +0.9% per annum performance edge earned by Small Caps over the full 44-year period. In contrast, Small Caps compounded at just +9.2% during periods of dollar weakness, below the S&P 500 figure of +10.4%.

While the full-period results support the fundamentalists’ argument, the late 1990s stand out as a costly counter-example—with Large Caps clocking Small Caps for five consecutive years (1995 to 1999) despite an historic dollar rally that “should” have favored more domestically-exposed companies (i.e., Small Caps). Recent experience also runs counter to the long-term results; the current U.S. dollar strength kicked off in April 2011—coinciding to the month with the cycle’s Small Cap relative strength peak. Overall, we’d grade dollar strength as a mild positive for Small Caps, but not enough to outweigh other factors that continue to point to Large Cap strength (including relative valuations, looming Fed tightening, and the continued narrowing of market breadth related to bull market age).

© Leuthold Weeden Capital Management

[description] => The dollar’s moonshot in recent months has resuscitated a stock market leadership argument we haven’t heard for a long time—namely, that Small Cap stocks are better insulated than Large Caps from the loss of competitiveness and the currency translation impact of a stronger buck. Is there merit to this argument, or are Small Cap proponents grasping for straws after a flat year? It turns out there’s reasonable support for the Small Cap enthusiasts’ view, based on evidence from the U.S. (trade-weighted) Dollar Index. [author] => Doug Ramsey [legacyinterface_firm_id] => 265 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 19:15:55 [created_by] => 948 [modified_on] => 2014-12-30 19:16:56 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2246 [hits] => 0 ) [8] => stdClass Object ( [legacyinterface_commentary_id] => 2181 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15419 [apv_conversation_id] => 3028 [content_type] => market-commentary [title] => U.S. Consumers: Spend More? Bah, Humbug [slug] => abbett_123014 [fulltext] =>

Sometimes, something says something good about the economy’s growth prospects. Two quarters of relatively strong advances in real gross domestic product (GDP) and more recently falling oil prices and strong November jobs numbers offer such signs. They are welcome. Still, reason remains to curb levels of enthusiasm. The employment figures have given plenty of false signals in the past, and many of the same forces dampening growth so far in this recovery remain in place. Especially for the consumer, fully 70% of the economy, seems unwilling to act as aggressively as in the past and so is less likely to propel the overall pace of growth.         

The most recent good news is a pickup in the pace of hiring. Recent reports for November indicate 321,000 new jobs created during the month and upward revisions in previous months’ estimates.While this is indeed news, it is important to keep in mind that individual months in the past have shown surges that have then petered out. In January 2012, for instance, payrolls rose by 360,000 only to slow to a disappointing 96,000 by April. What is more important, and as a consequence more encouraging, is the general improvement this year over 2013. Every month this year, except weather–depressed January, has reported payroll increases over 200,000. Only five months showed such gains in 2013 and a still smaller portion in 2012. The 2.0% growth in payrolls so far this year compares to only 1.7% in 2013 and a 1.6% yearly rate averaged between 2010 and 2012. The jobs picture still has many troubling weak spots, but the trend is encouraging.

Presumably, the additional jobs will increase household incomes, encourage more consumer spending, and so accelerate the pace of overall economic growth. If the percentage point increase in employment were to translate directly into income, it would raise wages and salaries growth from the 4.3% pace averaged during the last twelve months toward 5.1%. Since wages and salaries constitute about half of all income in this economy, overall income flows would accordingly rise from the 3.9% recorded during the past twelve months toward 4.6%. With taxes still rising as a percent of gross income, spendable income growth would then register about a 4.5% nominal annual rate of increase. And if households were then to spend the increase, the overall pace of nominal consumer spending would accelerate from the 3.9% rate averaged during the past twelve months to about 4.5%, or about 3.0% in real terms. That would accelerate the economy’s overall 2.3% rate of real growth averaged during the past four quarters up to about 2.8%, an improvement but still short of the economy’s long-term average growth rate of 3.2% and its average growth rate of closer to 3.8%.     

But these are big “ifs.” For one, it is not apparent that the recent accelerated pace of employment growth can persist. False starts in the past issue a warning, and all the factors that so far have kept back hiring remain in place. Managements certainly continue to carry scars from the great recession that temper their impulse to expand, what the great economist John Maynard Keynes referred to as their “animal spirits.” Continued uncertainty about costs and the ultimate requirements of the Affordable Care Act and even the Dodd-Frank financial reform legislation will continue to reinforce such hesitations. Meanwhile, households, too, have shown an atypical caution about spending. Compared to past recoveries and the past in general, they have spent less aggressively in this recovery and saved more. On average, households have saved well over 5.0% of their after-tax income in this cycle, low by international standards but high by past American standards. What is more impressive, and indicative of how they will likely behave going forward, is how households, whenever their savings rates have fallen below trend, have quickly corrected by slowing their rate of spending.   

On balance, then, the consumer should hold to a comparatively slow rate of expansion even if the improved hiring trend is durable. It should come in below a 3.0% yearly rate. The current quarter may prove an exception, however. The recent precipitous drop in oil and gasoline prices will leave the consumer at least temporarily better off. Because energy absorbs almost 10% of the average household budget, the recent drop in price amounts to about a 2.5%  jump in real spendable income, a good portion of which consumers will no doubt use to improve the holidays, making the fourth-quarter GDP look better than the fundamentals and longer-term prospects described above. But unless the oil price declines go deeper still (not especially likely), much less if oil prices bounce back up (entirely possible given the volatility in the Middle East), the pace of consumption growth and overall growth in the new year should continue at a still substandard rate.

1 Employment data from the U.S. Department of Labor
Data from the U.S. Department of Commerce

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

© Lord Abbett

[description] => Despite an improving labor market and lower oil prices, consumer outlays should continue to expand at a slow pace. Here’s why. [author] => Milton Ezrati [legacyinterface_firm_id] => 273 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 19:19:50 [created_by] => 948 [modified_on] => 2014-12-30 19:20:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2247 [hits] => 0 ) [9] => stdClass Object ( [legacyinterface_commentary_id] => 2182 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15420 [apv_conversation_id] => 3029 [content_type] => market-commentary [title] => MLPs Weren’t Supposed To Decline [slug] => advisorshares_123014 [fulltext] =>

By: Roger Nusbaum AdvisorShares ETF Strategist

Most income investors will know at least a little about Master Limited Partnerships more commonly referred to as MLPs. Most MLPs are tied to the transportation of energy products. They collect royalties as the energy product moves through their pipeline (this is a very common structure). Fundamentally, the movement of MLPs should not be vulnerable to price movements of the underlying energy product. The royalty collected is what it is.

This is the generally accepted truthism about MLPs and most of the time it is correct but not always. The following chart from Google Finance tracks a large MLP exchange traded product in blue versus a large energy sector ETF in Red, we’ll get to the yellow line in a moment.

The royalties may not change but the price action of the two look very similar. In past declines MLPs have many times been spared but not always as was the case over the last month. You might think of course they will snap back and while that will probably turn out to be correct, someone sold at the lows, perhaps in a state of heightened emotions and now likely regrets (another emotion) the sale.

Of course MLPs could be vulnerable to lower demand; less oil moving through the pipeline would result in less royalty income.

The yellow line is a relatively large Business Development Company (BDC) that had a similar even if not exact decline as the MLP fund during the essentially the same period of time. The charted BDC was not an island, one of the BDC ETPs was down in lockstep with the charted individual name. Again, there has been snapback in both but also again, someone sold at the lows.

We often see articles published in numerous places suggesting very large weightings to various income vehicles including MLPs and BDCs. Someone who put 15% in each increased their chances of being put in a position where they panic sell. It is much easier to be rational now after the worst of it (or maybe now is just a respite) than during the heat of the decline.

Look at the correlation of MLPs and BDCs as measured by the respective ETPs there seems to be no rhyme or reason here, sometimes they correlate closely and sometimes the correlation is negative so it is probably a coincidence that they both went down at the same time and it might be a rare event that MLPs go down under the weight of a drop in oil prices but both happened and both happened at the same time.

This sort of unfortunate coincidence can happen at any time with any market segment. REITs did not go down with the other two this time around but what if they did and in addition to 15% in the other two the same investor had another 15% in REITs?

MLPs, BDCs, REITs and any others are valid portfolio exposures, the point here is about weighting. Most of the time these things do what investors hope they do but that won’t matter if you give in to a panicked decline. Everyone has their own threshold for capitulation and as I have said many times before finding out you too much in fill-in-the-blank after it goes down a lot is a very bad place for an investor to be.

Any market segment can have some sort of event that even if unjustified fundamentally can still do permanent portfolio damage to the investor whose panic threshold is breached. This is why diversification and emotional control are both so important to long term investing success. 

© AdvisorShares

[description] => Most income investors will know at least a little about Master Limited Partnerships more commonly referred to as MLPs. Most MLPs are tied to the transportation of energy products. They collect royalties as the energy product moves through their pipeline (this is a very common structure). Fundamentally, the movement of MLPs should not be vulnerable to price movements of the underlying energy product. The royalty collected is what it is. [author] => Roger Nusbaum [legacyinterface_firm_id] => 14 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 19:27:42 [created_by] => 948 [modified_on] => 2014-12-30 19:29:58 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2248 [hits] => 0 ) [10] => stdClass Object ( [legacyinterface_commentary_id] => 2126 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15416 [apv_conversation_id] => 3015 [content_type] => market-commentary [title] => The Lessons of Oil [slug] => oaktree_122914 [fulltext] =>

Memo to:         Oaktree Clients

From:               Howard Marks

Re:                   The Lessons of Oil


I want to provide a memo on this topic before I – and hopefully many of my readers – head out for year-end holidays.  I’ll be writing not with regard to the right price for oil – about which I certainly have no unique insight – but rather, as indicated by the title, about what we can learn from recent experience.

  • Despite my protestations that I don’t know any more than others about future macro events – and thus that my opinions on the macro are unlikely to help anyone achieve above average performance – people insist on asking me about the future.  Over the last eighteen months (since Ben Bernanke’s initial mention that we were likely to see some “tapering” of bond buying), most of the macro questions I’ve gotten have been about whether the Fed would move to increase interest rates, and particularly when.  These are the questions that have been on everyone’s mind.

    Since mid-2013, the near-unanimous consensus (with credit to DoubleLine’s Jeffrey Gundlach for vocally departing from it) has been that rates would rise.  And, of course, the yield on the 10-year Treasury has fallen from roughly 3% at that time to 2.2% today.  This year many investing institutions are underperforming the passive benchmarks and attributing part of the shortfall to the fact that their fixed income holdings have been too short in duration to allow them to benefit from the decline of interest rates.  While this has nothing to do with oil, I mention it to provide a reminder that what “everyone knows” is usually unhelpful at best and wrong at worst.  

  • Not only did the investing herd have the outlook for rates wrong, but it was uniformly inquiring about the wrong thing.  In short, while everyone was asking whether the rate rise would begin in December 2014 or April 2015 (or might it be June?) – in response to which I consistently asked why the answer matters and how it might alter investment decisions – few people I know were talking about whether the price of oil was in for a significant change.

    Back in 2007, in It’s All Good, I provided a brief list of some possibilities for which I thought stock prices weren’t giving enough allowance.  I included “$100 oil” (since a barrel was selling in the $70s at the time) and ended with “the things I haven’t thought of.”  I suggested that it’s usually that last category – the things that haven’t been considered – we should worry about most.  Asset prices are often set to allow for the risks people are aware of.  It’s the ones they haven’t thought of that can knock the market for a loop.

  • In my book The Most Important Thing, I mentioned something I call “the failure of imagination.”  I defined it as “either being unable to conceive of the full range of possible outcomes or not understanding the consequences of the more extreme occurrences.”  Both aspects of the definition apply here.

    The usual starting point for forecasting something is its current level.  Most forecasts extrapolate, perhaps making modest adjustments up or down.  In other words, most forecasting is done incrementally, and few predictors contemplate order-of-magnitude changes.  Thus I imagine that with Brent crude around $110 six months ago, the bulls were probably predicting $115 or $120 and the bears $105 or $100.  Forecasters usually stick too closely to the current level, and on those rare occasions when they call for change, they often underestimate the potential magnitude.  Very few people predicted oil would decline significantly, and fewer still mentioned the possibility that we would see $60 within six months. 

    For several decades, Byron Wien of Blackstone (and formerly of Morgan Stanley, where he authored widely read strategy pieces) has organized summer lunches in the Hamptons for “serious,” prominent investors.  At the conclusion of the 2014 series in August, he reported as follows with regard to the consensus of the participants:

    Most believed that the price of oil would remain around present levels.  Several trillion dollars have been invested in drilling over the last few years and yet production is flat because Nigeria, Iraq and Libya are producing less.  The U.S. and Europe are reducing consumption, but that is being more than offset by increasing demand from the developing world, particularly China.  Five years from now the price of Brent is likely to be closer to $120 because of emerging market demand.

    I don’t mean to pick on Byron or his luncheon guests.  In fact, I think the sentiments he reported were highly representative of most investors’ thinking at the time.

    As a side note, it’s interesting to observe that growth in China already was widely understood to be slowing, but perhaps that recognition never made its way into the views on oil of those present at Byron’s lunches.  This is an example of how hard it can be to appropriately factor all of the relevant considerations into complex real-world analysis.

  • Turning to the second aspect of “the failure of imagination” and going beyond the inability of most people to imagine extreme outcomes, the current situation with oil also illustrates how difficult it is to understand the full range of potential ramifications.  Most people easily grasp the immediate impact of developments, but few understand the “second-order” consequences . . . as well as the third and fourth.  When these latter factors come to be reflected in asset prices, this is often referred to as “contagion.”  Everyone knew in 2007 that the sub-prime crisis would affect mortgage-backed securities and homebuilders, but it took until 2008 for them to worry equally about banks and the rest of the economy.

     

    The following list is designed to illustrate the wide range of possible implications of an oil price decline, both direct consequences and their ramifications: 

    • Lower prices mean reduced revenue for oil-producing nations such as Saudi Arabia, Russia and Brunei, causing GDP to contract and budget deficits to rise.

    • There’s a drop in the amounts sent abroad to purchase oil by oil-importing nations like the U.S., China, Japan and the United Kingdom.

    • Earnings decline at oil exploration and production companies but rise for airlines whose fuel costs decline.

    • Investment in oil drilling declines, causing the earnings of oil services companies to shrink, along with employment in the industry.

    • Consumers have more money to spend on things other than energy, benefitting consumer goods companies and retailers.

    • Cheaper gasoline causes driving to increase, bringing gains for the lodging and restaurant industries.

    • With the cost of driving lower, people buy bigger cars – perhaps sooner than they otherwise would have – benefitting the auto companies.  They also keep buying gasoline-powered cars, slowing the trend toward alternatives, to the benefit of the oil industry.

    • Likewise, increased travel stimulates airlines to order more planes – a plus for the aerospace companies – but at the same time the incentives decline to replace older planes with fuel-efficient ones.  (This is a good example of the analytical challenge: is the net impact on airplane orders positive or negative?)

    • By causing the demand for oil services to decline, reduced drilling leads the service companies to bid lower for business.  This improves the economics of drilling and thus helps the oil companies.

    • Ultimately, if things get bad enough for oil companies and oil service companies, banks and other lenders can be affected by their holdings of bad loans.

  • Further, it’s hard for most people to understand the self-correcting aspects of economic events.

    • A decline in the price of gasoline induces people to drive more, increasing the demand for oil.

    • A decline in the price of oil negatively impacts the economics of drilling, reducing additions to supply.

    • A decline in the price of oil causes producers to cut production and leave oil in the ground to be sold later at higher prices.

    In all these ways, lower prices either increase the demand for oil or reduce the supply, causing the price of oil to rise (all else being equal).  In other words, lower oil prices – in and of themselves – eventually make for higher oil prices.  This illustrates the dynamic nature of economics.

  • Finally, in addition to the logical but often hard-to-anticipate second-order consequences or knock-on effects, negative developments often morph in illogical ways.  Thus, in response to cascading oil prices, “I’m going to sell out of emerging markets that rely on oil exports” can turn into “I’m going to sell out of all emerging markets,” even oil importers that are aided by cheaper oil.

    In part the emotional reaction to negative developments is the product of surprise and disillusionment.  Part of this may stem from investors’ inability to understand the “fault lines” that run through their portfolios.  Investors knew changes in oil prices would affect oil companies, oil services companies, airlines and autos.  But they may not have anticipated the effects on currencies, emerging markets and below-investment grade credit broadly.  Among other things, they rarely understand that capital withdrawals and the resulting need for liquidity can lead to urgent selling of assets that are completely unrelated to oil.  People often fail to perceive that these fault lines exist, and that contagion can reach as far as it does.  And then, when that happens, investors turn out to be unprepared, both intellectually and emotionally. 

    A grain of truth underlies most big up and down moves in asset prices.  Not just “oil’s in oversupply” today, but also “the Internet will change the world” and “mortgage debt has historically been safe.”  Psychology and herd behavior make prices move too far in response to those underlying grains of truth, causing bubbles and crashes, but also leading to opportunities to make great sales of overpriced assets on the rise and bargain purchases in the subsequent fall.  If you think markets are logical and investors are objective and unemotional, you’re in for a lot of surprises.  In tough times, investors often fail to apply discipline and discernment; psychology takes over from fundamentals; and “all correlations go to one,” as things that should be distinguished from each other aren’t.

  • To give you an idea about how events in one part of the economy can have repercussions in other economic and market segments, I’ll quote from some of the analyses I’ve received this week from Oaktree investment professionals:

    • Energy is a very significant part of the high yield bond market.  In fact, it is the largest sector today (having taken over from media/telecom, which has traditionally been the largest).  This is the case because the exploration industry is highly capital-intensive, and the high yield bond market has been the‎ easiest place to raise capital.  The knock-on effects of a precipitous fall in bond prices in the biggest sector in the high yield bond market are potentially substantial: outflows of capital, and mutual fund and ETF selling.  It would be great for opportunistic buyers if the selling gets to sectors that are fundamentally in fine shape . . . because a number of them are.  And, in fact, low oil prices can even make them better.

    • An imperfect analogy might be instructive: capital market conditions for energy-related assets today are not unlike what we saw in the telecom sector in 2002.  As in telecom, you’ve had the confluence of really cheap financing, innovative technology, and prices for the product that were quite stable for a good while.  [To this list of contributing factors, I would add the not-uncommon myth of perpetually escalating demand for a product.]  These conditions resulted in the creation of an oversupply of capacity in oil, leading to a downdraft.  It’s historically unprecedented for the energy sector to witness this type of market downturn while the rest of the economy is operating normally.  Like in 2002, we could see a scenario where the effects of this sector dislocation spread wider in a general “contagion.”

    • Selling has been reasonably indiscriminate and panicky (much like telecom in 2002) as managers have realized (too late) how overexposed they are to the energy sector.  Trading desks do not have sufficient capital to make markets, and thus price swings have been predictably volatile.  The oil selloff has also caused deterioration in emerging market fundamentals and may force spreads to gap out there.  This ultimately may create a feedback loop that results in contagion to high yield bonds generally.
  • Over the last year or so, while continuing to feel that U.S. economic growth will be slow and unsteady in the next year or two, I came to the conclusion that any surprises were most likely to be to the upside.  And my best candidate for a favorable development has been the possibility that the U.S. would sharply increase its production of oil and gas.  This would make the U.S. oil-independent, making it a net exporter of oil and giving it a cost advantage in energy – based on cheap production from fracking and shale – and thus a cost advantage in manufacturing.  Now, the availability of cheap oil all around the world threatens those advantages.  So much for macro forecasting!

  • There’s a great deal to be said about the price change itself.  A well-known quote from economist Rudiger Dornbusch goes as follows: “In economics things take longer to happen than you think they will, and then they happen faster than you thought they could.”  I don’t know if many people were thinking about whether the price of oil would change, but the decline of 40%-plus must have happened much faster than anyone thought possible.

  • “Everyone knows” (now!) that the demand for oil turned soft (due to sluggish economic growth, increased fuel efficiency and the emergence of alternatives) at the same time that the supply was increasing (as new sources came on stream).  Equally, everyone knows that lower demand and higher supply imply lower prices.  Yet it seems few people recognized the ability of these changes to alter the price of oil.  A good part of this probably resulted from belief in the ability of OPEC (meaning largely the Saudis) to support prices by limiting production.

    A price that’s kept aloft by the operation of a cartel is, by definition, higher than it would be based on supply and demand alone.  Maybe the thing that matters is how far the cartelized price is from the free-market price; the bigger the gap, the shorter the period for which the cartel will be able to maintain control.  Initially a cartel or a few of its members may be willing to bear pain to support the price by limiting production even while others produce full-out.  But there may come a time when the pain becomes unacceptable and the price supporters quit.  The key lesson here may be that cartels and other anti-market mechanisms can’t hold forever.  As Herb Stein said, “If something cannot go on forever, it will stop.”  Maybe we’ve just proved that this extends to the effectiveness of cartels.

  • Anyway, on the base of 93 million barrels a day of world oil use, some softness in consumption combined with an increase in production to cut the price by more than 40% in just a few months.  What this proves – about most things – is that to Dornbusch’s quote above we should append the words “. . . and they go much further than you thought they could.” 

    The extent of the price decline seems much greater than the changes in supply and demand would call for.  Perhaps to understand it you have to factor in (a) Saudi Arabia’s ceasing to balance supply and demand in the oil market by cutting production, after having done so for many years, and (b) a large contribution to the decline on the part of psychology.  (In the “conspiracy theory” department, consider the rumor that Saudi Arabia is allowing or abetting the price drop in order to either punish Iran, Iraq and ISIL; put the U.S. shale oil industry out of business; or discipline the more profligate members of OPEC . . . take your pick.)

    The price of oil thus may have gone from too high (supported by OPEC and by Saudi Arabia in particular) to too low (depressed by negative psychology).  It seems to me with regard to the latter that the price fell too far for some market participants to maintain their equanimity.  I often imagine participants’ internal dialogues.  At $110, I picture them saying, “I’ll buy like mad if it ever gets to $100.”  Because of the way investor psychology works, at $90 they may say, “If it falls to $70, I’ll give serious thought to buying.”  But at $60 the tendency is to say, “It’s a falling knife and there’s no way to know where it’ll stop; I wouldn’t touch it at any price.” 

    It feels much better to buy assets while they’re rising.  But it’s usually smarter to buy after they’ve fallen for a while.  Bottom line, as noted above: there’s little logic in investor psychology.

  • I said it about gold in All That Glitters (November 2010), and it’s equally relevant to oil: it’s hard to analytically put a price on an asset that doesn’t produce income.  In principle, a non- perishable commodity won’t be priced below the variable production cost of the highest-cost producer whose output is needed to satisfy total demand.  But in reality and in the short run, strange things can happen.  It’s clear that today’s oil price is well below that standard.

    It’s hard to say what the right price is for a commodity like oil . . . and thus when the price is too high or too low.  Was it too high at $100-plus, an unsustainable blip?  History says no: it was there for 43 consecutive months through this past August.  And if it wasn’t too high then, isn’t it laughably low today?  The answer is that you just can’t say.  Ditto for whether the response of the price of oil to the changes in fundamentals has been appropriate, excessive or insufficient.  And if you can’t be confident about what the right price is, then you can’t be definite about financial decisions regarding oil.

In the last few years, as I said in The Role of Confidence (August 2013), investor sentiment has been riding high.  Or, as Doug Kass pointed out this past summer, there’s been “a bull market in complacency.”  Regardless, it seems that a market that was unconcerned about things like oil and its impact on economies and assets now has lost its composure.  Especially given the pervasive role of energy in economic life, uncertainty about oil introduces uncertainty into many aspects of investing. 

“Value investing” – the form of investing Oaktree practices – is supposed to be about buying based on the present value of assets, rather than conjecture about profit growth in the far-off future.  But you can’t assess present value without taking some position on what the future holds, even if it’s only assuming a continuation of present conditions or perhaps – for the sake of conservatism – a considerably lower level.  Recent events cast doubt on the ability to safely take any position.

One of the things that’s central to risk-conscious value investing is ascertaining the presence of a generous cushion in terms of “margin of safety.”  This margin comes from conviction that conditions will be stable, financial performance is predictable, and/or an entry price is low relative to the asset’s intrinsic value.  But when something as central as oil is totally up for grabs, as investors seem to think is the case today, it’s hard to know whether you have an adequate margin.  Referring to investing, Charlie Munger told me, “It’s not supposed to be easy.”  The recent events surrounding oil certainly prove that it isn’t.

On the other hand – and in investing there’s always another hand – high levels of confidence, complacency and composure on the part of investors have in good measure given way to disarray and doubt, making many markets much more to our liking.  For the last few years, interest rates on the safest securities – brought low by central banks – have been coercing investors to move out the risk curve.  Sometimes they’ve made that journey without cognizance of the risks they were taking, and without thoroughly understanding the investments they undertook.  Now they find themselves questioning many of their actions, and it feels like risk tolerance is being replaced by risk aversion.  This paragraph describes a process through which investors are made to feel pain, but also one that makes markets much safer and potentially more bargain-laden. 

In particular with regard to the distress cycle, confident and optimistic credit markets permit the unwise extension of credit to borrowers who are undeserving but allowed to become overlevered nevertheless.  Negative subsequent developments can render providers of capital less confident, making the capital market less accommodative.  This cycle of easy issuance followed by defrocking has been behind the three debt crises that delivered the best buying opportunities in our 26 years in distressed debt.  We think it also holds the key to the creation of superior opportunities in the future.

We’ve argued for a few years that credit standards were dropping as investors – chasing yield – became less disciplined and less discerning.  But we knew great buying opportunities wouldn’t arrive until a negative “igniter” caused the tide to go out, exposing the debt’s weaknesses.  The current oil crisis is an example of something with the potential to grow into that role.  We’ll see how far it goes.

For the last 3½ years, Oaktree’s mantra has been “move forward, but with caution.”  For the first time in that span, with the arrival of some disarray and heightened risk aversion, events tell us it’s appropriate to drop some of our caution and substitute a degree of aggressiveness.

December 18, 2014


Legal Information and Disclosures

This memorandum expresses the views of the author as of the date indicated and such views are subject to change without notice.  Oaktree has no duty or obligation to update the information contained herein.  Further, Oaktree makes no representation, and it should not be assumed, that past investment performance is an indication of future results.  Moreover, wherever there is the potential for profit there is also the possibility of loss.

This memorandum is being made available for educational purposes only and should not be used for any other purpose.  The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction.  Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources.  Oaktree Capital Management, L.P. (“Oaktree”) believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. 

This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Oaktree.

[description] => I want to provide a memo on this topic before I – and hopefully many of my readers – head out for year-end holidays. I’ll be writing not with regard to the right price for oil – about which I certainly have no unique insight – but rather, as indicated by the title, about what we can learn from recent experience. [author] => Howard Marks [legacyinterface_firm_id] => 323 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-20 04:38:18 [created_by] => 945 [modified_on] => 2014-12-29 22:12:43 [modified_by] => 945 [checked_out_time] => 2014-12-29 22:12:57 [checked_out] => 945 [asset_id] => 2192 [hits] => 0 ) [11] => stdClass Object ( [legacyinterface_commentary_id] => 2170 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15406 [apv_conversation_id] => [content_type] => market-commentary [title] => Unsettling Interplay of Leading Indicators [slug] => dynamika_122914 [fulltext] =>

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The information, tools and material presented herein are provided for informational purposes only and are not to be used or considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities, investment products or other financial instruments, nor to constitute any advice or recommendation with respect to such securities, investment products or other financial instruments. This research report is prepared for general circulation. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should independently evaluate particular investments and consult an independent financial adviser before making any investments. 

We review in details where we stand in terms of the US and World leading indicators and point to some of the unsettling recent developments which should be watched carefully over the coming months. Happy holidays and happy New Year!

The set of indicators we review comprises

- US shadow policy rate;

- US Treasury yield curve;

- US TIPS yield curve;

- Global business cycles interplay (OECD CLI);

- G7 growth and inflation (OECD MEI);

- World trade and industrial production;

- US conventional growth leading indicator;

- US coincident inflation indicator;

- US job creation;

- US growth and inflation based on Macro-Yield model, small and large datasets;

- US GDP-based leading indicator.

For the details on the methodology and explanations refer to the previous  Commentaries.[1][2][3]

US shadow policy rate

We use the proprietary methodology to construct the shadow Fed Funds rate implied by other economic and financial information (methodology is similar to the recent BIS work[4]). Below the Fed Funds rate and its shadow reconstruction over the last 45 years are presented

Here is the more recent snapshot

As one can see the Fed has been effectively tightening since May 2013 Taper announcement with some recent acceleration.

US Treasury yield curve

As we cautioned in February 2014[5][6] the yield curve level is going down and the curve is flattening to the levels not seen since the Global Financial Crisis

US TIPS yield curve

The level of the TIPS yield curve remained relatively flat post Taper Tantrum

but together with the Treasury yield curve the TIPS yield curve was flattening since December 2013 and reached some extreme historic flattening recently

This is of course also reflected in 5Y5Y forward rates

Global business cycles interplay (OECD CLI)

We use OECD CLI dataset (see the previous Dynamika Commentaries for explanation[7][8]).

Global Business Cycle Factor: what an unseen plateau! Where to now?

Europe Idiosyncratic Factor (outperformance of Europe versus Global Factor): Europe continues to underperform.

Asia Idiosyncratic Factor (underperformance of Asia versus Global Factor): China seems has turned the corner.

The US is the most interesting case as it seems to be doing well but for the wrong reasons.

Given recent plateau in the Global Factor the US was mostly uplifted by Europe deterioration and uplifted be recent asia deceleration. Here is how all three factors contributed to the US

You can see how the end of 2012 slowdown was avoided thanks to the uplifting Europe pain. Most recent European calamity also helps the US big time.

G7 growth and inflation (OECD MEI)

We use OECD MEI dataset to extract growth and inflation factors for each of the G7 countries (US, Japan, Germany, France, Italy, Canada, UK). Here are for example the US growth and inflation (sorry, inverted) factors (last data-point is October 2014):

Next we look what drives these 14 factors and come up with G7 growth factor

and G7 inflation factor

Not too optimistic though dataset and is very Euro-centric.

World trade and industrial production

World trade indicator based on common factor

World industrial production indicator based on common factor

US conventional growth leading indicator

Our conventional US growth leading indicator

Important to note that manufacturers new orders for non-defense capital goods have not been following suite recently and surprised to the downside

It is also noteworthy that decomposing leading indicators into two leading factors instead of one we see one surging leading indicator with higher lead (green) which is driven by PMI new orders and second factor which is now more of a coincident indicator and which continues to slowdown.

It is hard to say what is going on and we will be watching it carefully in the coming months.

US coincident inflation indicator

Our coincident inflation indicator shows no inflation in sight

US job creation

Our job creation indicator based on Establishment Survey data still looks solid (though it is lagging indicator):

US growth and inflation based on Macro-Yield model, small and large datasets

Our Macro-Yield model growth factor is not particularly optimistic

Our growth and inflation factors based on the small US dataset

Growth:

Inflation (sorry, inverted):

Similar results in our growth and inflation factors based on the large US dataset

Growth:

Inflation:

US GDP-based leading indicator

Finally GDP-based growth leading indicator[9] is not too optimistic

Happy Holidays and Happy New Year!

© Dynamika Capital L.L.C.



[1] Dynamika Commentary, “Lifted by Germany and China”, 16 August 2014

[2] Dynamika Commentary, “Monitoring the late cycle symptoms”, 1 June 2014

[3] Dynamika Commentary, “Watch out for the late cycle symptoms”, 30 March 2014

[4] BIS, “A shadow policy rate to calibrate US monetary policy at the zero lower bound”, June 2014

[5] Dynamika Commentary, “Where do the leading indicators lead?”, 28 February 2014

[6] Dynamika Commentary, “Watch out for the late cycle symptoms”, 30 March 2014

[7] Dynamika Commentary, “The global interplay of business cycles”, 31 May 2014

[8] Dynamika Commentary, “Lifted by Germany and China”, 16 August 2014

[9] Dynamika Commentary, “Watch out for the late cycle symptoms”, 30 March 2014

[description] => We review in details where we stand in terms of the US and World leading indicators and point to some of the unsettling recent developments which should be watched carefully over the coming months. [author] => Alexander Giryavets [legacyinterface_firm_id] => 503 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:02:50 [created_by] => 948 [modified_on] => 2014-12-29 16:03:13 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2236 [hits] => 0 ) [12] => stdClass Object ( [legacyinterface_commentary_id] => 2171 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15407 [apv_conversation_id] => [content_type] => market-commentary [title] => The Coming Crash in 2015: Why there will be no Happy New Year before we see QE Reloaded [slug] => franz_122914 [fulltext] =>
In September 2013 in my post How QE Alters Bond Yields (Or Rather How It Does Not) I wrote that historically the end of QE was associated with the following 4 events, which I expected to show up again after the end of the latest QE-programs (which in some cases was completely against the market consensus of that time):
1)      Falling inflation expectations
2)      As a result: falling Treasury yields (what basically no one believed at that time)
3)      Rising credit spreads
4)      A falling stock market
 
Now almost 2 months after the end of QE I thought it was time to look back on what has happened so far (the first 3 prediction were quite spot-on) and what it means for the part that has not yet happened (the 4th prediction).
Let’s get through it step by step.
1)      Inflation expectations: They completely crashed. While everyone blames it on the oil crash, it is exactly the same pattern as the last 2 times.
2)      Treasury Yields: Against an overwhelming consensus (what was suspicious anyway) Treasury yields fell, when the Fed reduced its purchases
This was something that most people got wrong. Here is a short run-down why: Most expected that when the Fed would stop its purchases, demand would therefore fall and yields would have to rise. Now what was wrong with that assumption was that the Fed, though the largest holder of Treasuries, does not yet control the market (as perhaps the BoJ does in the JGB market), nor is it just a marginal buyer that does not influence the behavior of all other participants. Just the opposite: The Fed vastly influences expectations of all other bond buyers. The Fed buying Treasuries increases the money supply which increases inflation expectations, which increases the expected path of future Fed Funds rates. And this is the main point: The long-end of the Treasury yield curve is basically nothing else than the average expected Fed Funds Rate over the lifespan of the bond (plus a small term premium, but this is in comparison a minor issue), no matter what the Fed is buying or not. Otherwise large arbitrage opportunities would be created. So what counts is not how much the Fed is buying in the Treasury market but what it means for expectations of future rate hikes. And that’s why yields rose substantially at the beginning of QE 1 and to a lesser degree after QE 2 and not at all after the beginning of Twist (as bond traders became sober about the less than expected effect of QE on inflation, gave up on betting on an early rate hike and took QE for granted). Yields only rose in spring of 2013 when the Fed did not only talk about tapering, but connected it indirectly to the next rate hike. Both events were then tied to the unemployment rate. QE should have ended at a rate of 7%, the first Fed Funds rate hike should have occurred at unemployment below 6.5%. With tapering ending and the Fed shifting its justification for rate hikes away from unemployment towards inflation, which remains very low, yields began to fall despite the end of QE.
By the way, if you think QE is responsible for low yields, think about the Eurozone, where yields are even much, much lower, despite the ECB backtracking on QE. Why? Because it is the lack of QE that has brought the  Eurozone towards the edge of deflation and with as a result no rate hike by the ECB to be seen in a long, long time, even rock-bottom yields get some kind of justification.
So QE did not decrease rates, therefore did not increase bond prices. That means, while the Fed bought Treasuries, everyone else sold. So where did the money actually go? Into risky assets. The Fed did not suppress yields with QE; instead it crowded out the Treasury market and pushed everyone towards the more risky stuff.
And this is the main point now and in coming months, as things are starting to reverse here as well. And leads me to prediction
3)      Rising credit spreads. What got rather little attention in the ongoing bull market in equities: Spreads have been constantly on the rise since the end of June when the Fed had cut the QE program to $35 billion.
Things are even much worse in the lowest rated space, the CCC and below rated stuff (while that once used to be more or less a no-go area, it now makes up a substantial part of many high yield funds):
While many blame the high yield sell-off on the low oil price that has caused troubles for HY issuers in the once booming fracking industry, the rise in spreads began much earlier than the crash in oil (see more on oil below). Further the spread widening is not just a thing of the high yield market. It’s the same story in investment grade (and much more stuff, see more on that below).
Now before I want to dig further into this risk-off story in a couple of markets I want to look at prediction
4)      Falling stock prices. This is the only prediction that so far has not yet come true.
Why? I “blame” it on the strong seasonality at the end of the year. Different to QE 1 and 2 this time around QE ended not right before or in the mid of the usually dull summer swoon, but right before the historically best time of the year.
But what does that mean for the next year? Nothing good. Once the strong seasonality wanes and liquidity tries up, things are bound to turn ugly. This could already happen in late January or in February, as February is historically one of the weakest months of the year and the big exception in the historically strong winter half-year (November to April).
I have nothing good to say about the US stock market for early 2015, especially as I look at a lot of other stories going on right now.
One interesting aspect to look at post-QE is how the last 2 major downturns had evolved compared to this time. In both cases the main trouble came from the Eurozone. Immediately after the end of QE1 things got completely out of hand in Greece:
And worsened even more after the end of QE2:
Though the end of QE2 in summer of 2011 actually was mostly the story of sharp spread widening in Spain and Italy, 2 countries too big to be saved by the rest. This marked a severe escalation of the Euro crisis (and actually the main story of the summer of 2011, though the rating downgrade of the US is now often regarded as the main event of these days):
But now? Nothing, despite rising political tensions in Greece. Except some spread widening in Greece itself, but only minor. And almost boring the situation in the rest of the periphery. The set-up of the Eurozone seems to be much healthier now. Well, actually personally I think it has more to do with current accounts, which were extremely negative in the periphery then, but are balanced now. But additionally you now have the ECB finally planning to expand its balance sheet after being for an eternity asleep at the wheel (which I blame on the constant interference by the German Bundesbank). As a result spreads in the Eurozone, also in the corporate space, are as low as they have been in years despite the global spread widening and an economy in trouble:
Instead the weakest spot has shifted to emerging markets. The crisis in Russia, Venezuela, Nigeria and others are blamed simply on oil, but the pattern is an all-too familiar one. Once QE ends, troubles emerge:
Russian Ruble in USD:
Emerging Market Credit Spreads (Embi+ is a major Emerging market debt benchmark):
It is always the weakest part of the chain that breaks. And while the place is different now the timing is not by chance. As Warren Buffet once famously said: “It's only when the tide goes out that you learn who's been swimming naked.” And the tide has now shifted.
Now one of the big stories lately has of course been oil. Some blame the crash on conspiracy, mainly coming from Saudi-Arabia. The trigger was OPEC’s decision to do nothing. But is this also the cause? No. Not at all. You can’t “blame” OPEC for the crash in the oil price. You can blame them for doing nothing to prevent it, but not for causing it.
There are rather 5 reasons for the crash in oil:
1)      The fracking boom (or bubble as some call it) of the last 3 years (that some say was caused by the Fed’s cheap money) …
2)      … met the deflationary environment of the global retirement wave (more below)…
3)      … while short-term the end of QE…
4)      …combined with a rise in the US-Dollar (itself a by-product of QE ending)…
5)      … was emphasized by the historically very negative seasonality at this particular time
From: Link
Now the last part is an interesting one: While QE ended at the best time of year for stocks (therefore postponing the negative effect of QE’s end) it was the worst time for oil. (Just as the end of QE and worsening seasonality for equities met in spring 2010 and summer 2011).
Now is the fall in the oil price good or bad for the US economy? Historically it was good, but nowadays with all the investments in US oil production the answer is not that clear-cut anymore.
Further, and this is an even bigger trouble, the problem is that the crash in oil is just part of a big deflation story. This summer I wrote a post about how the retirement wave in the US is causing low unemployment, but at the same time low inflation. Please see What the Baby Boomers turned Retirement Boomers mean for Growth, Jobs, Inflation and the Markets .
The oil crash would be great for the US economy and the stock market, if it would be accompanied by a more expansionary monetary policy. But to the contrary, it is caused by a much less accommodative Fed. For the same reason the troubles in (oil-producing) emerging markets means troubles for the US. They are all a sign that deflationary forces are getting stronger and money is getting tighter in the US. Some argue that we may see a replay of the tech-bubble of 1999. The idea is that we will see a full-blown emerging market crisis (which I think we will), which will then lead to a more expansionary US monetary policy. But exactly this is not the case right now. The Fed is now very reluctant to restart QE. This is not 2010 or 2011. The unemployment rate which was still sky-high then has now fallen to near full-employment. Further we have now a change in the leadership of the Fed. This is an often neglected issue. As I wrote in September 2013, briefly before Janet Yellen was appointed, in my post Whoever Becomes Fed Chair(wo)man, Historically Any Change Meant Trouble a shift in Fed leadership is usually associated with a more restrictive monetary policy for some time, leading to a crisis very early in the tenure of the new Fed leader. And this is exactly the situation now. Things will turn worse, but the Fed will be reluctant to act, as it fears to steer up new bubbles.
But how bad can the situation get for the US economy and the US stock market? Worse than you think. Remember the spread widening. There has been historically a clear connection between spreads and the economy (I use below the New Order component of the ISM as it is a good leading indicator for the US economy):
There have been 3 major drops in this indicator since the financial crisis, the last one was due to the severe winter in the 1st quarter of 2014, the other 2 were associated with rising credit spreads at the end of QE 1+2. The market is still cheering the strong economy in the 3rd quarter (5% growth), which still may be a bent-up of demand from the weather-related downturn in the 1st quarter, while the latest data was quite mixed. Especially durable goods orders were very weak so far in the 4th quarter and might be an early proof that rising credit spreads are causing a major slow-down in the US economy (as they did after QE 1 +2).
In the stock market there is a tight connection between spreads and stocks, which doesn’t bode well:
In the high yield space the lowest rated (and most equity like) issues have in the past a led stocks at major turning points, especially when the turn was to the downside (here shown is the index value of these issues):
Here a recalibrated short-term look with the QE timeline:
Another interesting similarity with prior QE programs: The VVIX, the volatility of volatility. Sounds a bit weird, but has some interesting implications (basically a high VVIX means that people – mostly hedgefunds – who want to run a constant risk portfolio, have to adjust their holdings very frequently, causing some wild market swings, as we have seen lately). Anyway, this index has now temporarily risen to the levels right after QE1 and 2 as well as the height of the financial crisis in October 2008 and its early beginning in August 2007. Not a good sign.
Now after a lot of charts and details, here a brief sum-up: There are a lot of similarities between the prior endings of QE and the current one. They might just be blurred by 2 major differences:
1)      The center the crisis is not the Eurozone this time, but (some) emerging markets
2)      Seasonality, which was very negative for stocks the other 2 times, has now held up the market so far
 
And there is a 3rd one that is important going forward: The Fed is much less inclined to act immediately this time, as unemployment is low and the fear of a bubble is high (just last summer in her speech before Congress Janet Yellen was talking about “stretched valuations” in high yields, bank loans and social media and biotech stocks).
What should that mean going forward? Markets are calm now, but that is natural in the last days of the year. Seasonality is extremely strong now:
Even the oil market has some seasonal support at the end of December (see before). That easily sweeps under the rug all the troubles lurking in the shadow. Once the year-end liquidity tries up, things are likely to get rough again. It will get worse until the Fed turns around and starts to print money again. Rising spreads are a harbinger for bad times in the US stock market and a downturn in the US economy, which the stock market is currently not prepared for. Trouble again is that the Fed will be reluctant to act. For that reasons, things will most likely turn worse than they did in 2010 and 2011. Not to mention that valuations are far worse now.
Nevertheless I would not predict a 2008 crisis. The epicenter of the crisis is in emerging markets where things will get worse again next year. The rise in the US-Dollar is causing troubles for everyone indebted in USD (and that are many there) and that means a new string of defaults like in the 2 prior USD-revaluation periods after the end of Bretton Woods.
Despite the doom and gloom I nevertheless would not predict that the S&P 500 would have a negative return in 2015. That sounds now really weird after all that I have written, but the point is that it is in the hands of the Fed to stop any slide in the market early on. As long as inflation expectations are rock-bottom, there is nothing that binds them from a macroeconomic perspective. I just don’t think that they will act anytime soon. Only after things get much worse, especially for the US economy. And that might be in the second half of 2015. So, yes, I partly think that the 1998 comparison has some merit. Then like this time (and different to 2008), the US is not the center of the crisis, just as it was not in 2010 and 2011. The S&P was actually up in 1998, as it was in 2010 and down in 2011 only by the smallest possible margin (-0.003%). But don’t forget that there was each time a major downturn in between. And this is what I have in mind. Only probably a bit worse. In any event it should be the largest downturn in US stocks since the financial crisis. Maybe it is like 1998, but then 2015 will be like 98, not yet 99.
So while everyone contemplates about the timing of the first rate hike, I contemplate about the timing of the return of QE, which I would expect before the end of 2015 and which then could turn things around again.
Actually there are markets that I am quite bullish on for next year (though only in local-currency terms),, namely those that are already seeing very accommodative monetary policy or are likely to early next year, i.e. Japan and the Eurozone. But I would expect gains there to occur mostly in late 2015 when I expect the Fed to make a U-turn.
But wouldn’t that in the end mean QE forever? Is this the future? Yes and no. The problem, as I wrote in What the Baby Boomers turned Retirement Boomers mean for Growth, Jobs, Inflation and the Markets are the deflationary forces coming from the retirement wave (in the US, but also from China, where the situation is much worse as the one-child policy is now starting to bite the labor force). Retirements mean less credit growth and less demand, as I result less inflation, even deflation. It’s the mirror image of the 70s, when the baby boomers started to work, which let to high unemployment and high inflation at the same time:
Now it is the opposite. Despite all the talk about rising wages, nothing to be seen here:
This is the problem going on right now. It’s not the aftermath of the financial crisis, as is widely believed. Now this development is bound to go on for another 10 years. Only then will the US labor force stabilize (and around that time the speed at which the Chinese labor force will shrink will at least stabilize, but not get worse). As I wrote in the mentioned post, it is all like Japan, just offset (by around 10-15 years). Sorry, this is the future going forward (at least for another decade): markets live and die from the hand of the Fed. You may hate it, but there is no way around a new QE program. The ECB, pressured by the German Bundesbank, has avoided QE so far. And where has it led? Deflation is hardly avoidable in the Eurozone now.
The Fed will have no option but to act again. In my opinion hopefully more subtle than the last time (and hopefully nothing like the BoJ is doing). Rather hopefully at a low speed that can be maintained without causing too many bubbles on the way. Even though I think there is no way to avoid QE, it was at times (especially in the last round of easing) a bit over the top. I never understood why the Fed started a new round of QE in September 2012 while Twist was still running and stocks were at a high and why they were running the printing press in 2013 at such a speed. I assume they were nervous about the low growth rate. But again it’s all about the retirement wave. 3% growth is a story of the past, last quarter was a short-term anomaly. Once that is recognized maybe we will see a more steady policy at the Fed instead of the ebbs and flows of QE. But for the meantime, get ready for the drought.
[description] => In September 2013 in my post How QE Alters Bond Yields (Or Rather How It Does Not) I wrote that historically the end of QE was associated with the following 4 events, which I expected to show up again after the end of the latest QE-programs (which in some cases was completely against the market consensus of that time). [author] => Franz Lischka [legacyinterface_firm_id] => 527 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:11:16 [created_by] => 948 [modified_on] => 2014-12-29 16:18:23 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2237 [hits] => 0 ) [13] => stdClass Object ( [legacyinterface_commentary_id] => 2172 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15408 [apv_conversation_id] => [content_type] => market-commentary [title] => Holiday Randoms [slug] => advisorshares_122914 [fulltext] =>

By: Roger Nusbaum, AdvisorShares ETF Strategist

Business Inside posted an article a few weeks ago that recapped the Black Swan concept using Nassim Taleb’s example of the Thanksgiving Day Turkey who is well fed and treated well until the day before Thanksgiving and then the ax falls…literally.

I won’t try to predict the next Black Swan as the definition says that is impossible but there will be Black Swans large and small that come along and the key to successfully navigating them is the awareness to recognize them in real time and not succumb to emotion when they do occur.

An example of a large Black Swan would be something like the financial crisis which very few people saw coming, had far reaching impact and likely (hopefully?) will be the biggest financial incident in most of our lifetimes. For a small Black Swan I would use the example of the large biotech company that recently fell 10% as an initial reaction to news that one of its drugs would not be covered by one of the larger health insurance companies. After the initial 10% it fell a little bit more. For such a big company to fall that much leads me to think the market didn’t see it coming and even if that is wrong, it is reasonable to conclude that this news was a small Black Swan to whoever sold it after that large drop. 

MarketWatch had a listy post about the habits of people who are debt-free. Most of the items on the list you have seen before but there was one that has been getting talked about a lot more lately which is valuing experiences over stuff which is obviously a don’t be materialistic argument.

One example that I think fits is the RV experience. RVs are neat, the bigger and fancier they are the neater they are and obviously the more expensive they are. The idea of taking an RV trip now and then holds a lot of appeal, something my wife and I would like to do to see the parts of the Mountain Time Zone we haven’t been to yet.

For some folks RVing is a way of life and that’s not who I am talking about here. I did some research at Cruise America’s website. A two week rental in May, 2015 that we would pick up in Flagstaff would cost $1106 for a Standard and $1246 for a Large plus $476 for miles and who knows what for gas.

Buying a new RV can range from $100,000 (maybe less, correct me if I am wrong) to unlimited. I found a used one on the Cruise America site for $20,485. Buying it plus whatever the cost for upkeep versus what is maybe $2500 all in for a two week rental. Obviously this is about a tradeoff between owning your own RV versus the experience of the road trip and even if this example doesn’t resonate there will be other examples that will.

Finally, the Tiny House Blog had a post with income ideas for tiny house dwellers related to their tiny-living experience including blogging about it. Most of the ideas in the article aren’t too unexpected although renting space to other tiny-housers if you own land is pretty good. At a higher level this about monetizing a hobby.

The interest here in tiny houses and smaller houses is about finding ways to relieve the burden that most of us will put on our investment portfolios at some point in our lives and lowering overhead, one way or another, seems like an obvious path.

© AdvisorShares

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Every December, economists are asked for their projections for the coming year. What’s GDP growth going to be? How many jobs will be added? What’s the Fed going to do? How will the financial markets react? We build models of the economy – models that we know are not precise. There are simply too many variables. Those who have studied forecasting in any detail know that a forecast is composed of a point estimate (a value at a certain point in time) and a level of uncertainty around that estimate. In economics, that uncertainty is usually very large, making the point estimate seem almost meaningless. For financial market participants, one should look at point estimates as a base-case scenario and focus on the risks surrounding that outlook. Some uncertainties are known, but there are others, currently unknown, that are sure to come up.

The Federal Reserve employs a lot of very smart people with considerable knowledge of forecasting. However, the Fed’s GDP projections of the last few years have been humbling. Growth estimates for 2011, 2012, and 2013 started out near 4%, only to be whittled down to more disappointing levels. Part of that reflects the nature of the recession. GDP growth projections for the next few years are more moderate.

Looking ahead to 2015, there are a number of key uncertainties. Oil prices are perhaps the most significant. After a sharp drop in the final months of 2014, most expect a new equilibrium in the months ahead – but where exactly? The answer matters a lot. The impact of lower oil prices on the consumer depends on how far prices decline and how long they stay low. The drop is a function of increased supply and decreased demand. However, lower prices will discourage new supply and encourage consumption, a combination which should (eventually) lead prices back up. The path of oil prices will have a significant impact on the economic outlook in 2015.

For Fed policymakers, the impact of lower oil prices on growth and inflation is seen as “transitory.” Overall inflation will be lower in the near term and we could see some small feed-through to core inflation. However, oil prices cannot fall forever. The impact will decrease over time. Lower gasoline prices are expected to help boost consumer spending growth, but that impact is also transitory, showing up mostly in the first half of 2015. Spending patterns will adjust to the new level of oil prices. We’ll need to see a pickup in average wages in the second half of the year to sustain strong growth in consumer spending. That may happen, but it’s hard to predict exactly.

Job growth was strong in 2014, but we didn’t see accompanying strength in areas that are normally associated with job gains, such as consumer spending and housing. Lackluster growth in average wages appears to be the most likely explanation. Average wages have barely kept pace with inflation. Wage growth should pick up as the job market tightens, but while slack is being taken up, a lot remains.

The job market outlook is a key uncertainty for Fed policymakers. While the December 19 monetary policy statement indicated that the Fed can “be patient”in beginning to normalize monetary policy, some Fed officials are more patient than others. Monetary policy affects the economy with a long and variable lag. The Fed sets policy with respect to where it thinks the economy will be 12 to 18 months from now. So, tightening does have to start at some point. However, the risks around the timing of tightening are not symmetric. If the Fed tightens too soon and growth is slower than expected, it will be harder for policymakers to change course. Short-term interest rates will still be low (even after the first couple of rate hikes) and nobody at the Fed wants another round of quantitative easing. If the Fed waits too long and inflation picks up more than intended, officials can then raise short-term rates more rapidly to get back on course. This is a strong argument for being patient and waiting longer to start tightening.

The Fed is focused primarily on the U.S., but it also has to pay attention to what’s going on in the rest of the world. That means anticipating the impact of overseas developments on the U.S. economy and financial markets. At this point, global growth is expected to be a bit soft in 2015, but the risks have been weighted to the downside. Yet, the amount of leverage in the global system is nowhere near where it was at the start of the financial crisis. That suggests that the downside risk to the financial system may be limited. Lower oil prices should have a mixed, but mostly positive impact on the rest of the world.

The 2015 economic outlook will evolve over time as the key issues, oil prices, the job market, and the global economy, become clearer. Best Wishes for a Prosperous New Year!

© Raymond James

[description] => Every December, economists are asked for their projections for the coming year. What’s GDP growth going to be? How many jobs will be added? What’s the Fed going to do? How will the financial markets react? We build models of the economy – models that we know are not precise. There are simply too many variables. [author] => Scott Brown [legacyinterface_firm_id] => 356 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:21:36 [created_by] => 948 [modified_on] => 2014-12-29 16:21:49 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2239 [hits] => 0 ) [15] => stdClass Object ( [legacyinterface_commentary_id] => 2174 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15410 [apv_conversation_id] => [content_type] => market-commentary [title] => Adam Smith or Jerry Goodman [slug] => rj_122914a [fulltext] =>

We are at a wonderful ball where the champagne sparkles in every glass, and soft laughter falls upon the summer air, we know at some moment the black horsemen will come shattering through the terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time, so everyone keeps asking, ‘What time is it?’ But none of the clocks have hands.

… The Money Game by Adam Smith

I met Jerry Goodman, whose nom de plume was Adam Smith, late in my career. He was working at my friend Craig Drill’s money management firm along with another icon in this business, from an era gone by, namely Al Wojnilower. I have had many conversations with all three of these Wall Street legends around the conference table at Drill Capital Management. Jerry wrote The Money Game(1968), Powers of Mind (1975), Paper Money (1981), and The Roaring ‘80s(1988), but unfortunately we lost his wisdom on January 3rd of this year (http://blogs.wsj.com/totalreturn/2014/02/17/remembering-adam-smith/). Well, that is not entirely true for as Terry Pratchett wrote, “Do you not know that a man is not dead while his name is still spoken?” More to the point is that much of Jerry’s wisdom can be gleaned from his books. Obviously, Jerry still lives in the minds of those who have read those books and continue to speak his name. This morning, I invoked his name with the aforementioned quote. I find the quip particularly timely following the 38-month upside skein we have experienced without a 10% correction on a closing basis. That’s a long time considering that a 10% correction comes along on average every 18 months! Of interest, it was the April through June of 2011 decline that lopped 19% off of the S&P 500 (SPX/2088.77), but since then we have not seen a true 10% pullback. Granted the April/June 2012 timeframe recorded a 9.9% slide, as did September/October 2014, but while they came close they were not true 10% declines based on closing prices. That makes this rally long of tooth, but not historic because, according to my notes, the longest run without a 10%+ correction came between October 1990 and October 1997.

I revisit the 10% correction theme as we approach the New Year because the timing models I use have again targeted the January/February timeframe as potentially a difficult period for the equity markets in the New Year. Recall, it was at this time last year those same models were calling for a 5% – 7% pullback in the first three months of 2014; and, we got a 6% decline. Of course the models also called for a 10% - 12% decline sometime in 2014, but, as stated, all we got was 9.84% on an intraday basis between mid-September and Mid-October. Still, I have come to respect my models over the decades and I am not going to ignore them this time. So what are investors to do?

Well, it was last July when I suggested that if you have stocks in your portfolio that have not participated in the 50%+ rally by the SPX we have seen since June 2012, you might want to consider selling some of them and raise some cash. I would use that same strategy as we head into 2015. In looking at which sectors are expensively valued, and therefore might be right for a rebalance in portfolios (read: trim back on select stocks), Healthcare is historically expensive with a price-to-earnings ratio (P/E) of 23.01x. Consumer Discretionary is next with a P/E of 21.50x followed by Consumer Staples (20.93x). The “cheapest” macro sectors on a P/E basis are Energy (13.41x), Telecommunications (13.66x), and Financials (14.76x).

Last week, however, raising cash was the last thing on investors’ minds as the Dow danced higher, and in the process breached 18000. Subsequently, my phone lit up with the ubiquitous question, “Jeff, you said earlier this month on various TV and radio shows that you thought the Santa rally would carry the D-J Industrials (INDU/18053.71) above 18000, and so what is the significance of 18000?” My response went like this, “I did expect 18000 to get exceeded before year end and I have been pretty adamant the Santa rally was going to accomplish that. But, 18000 is a non-event just like 11000, 12000, 13000, etc. The numbers that capture the public’s attention are numbers like 1000 (December 1972), 10000 (March 1999, where they broke out the hats on the NYSE), 20000, etc. If 18000 was a legion number, where are the hats?!” Speaking to Dow Theory, while the Industrials made new highs last week, the D-J Transports (TRAN/9199.65) did not, yet they are not very far away. For the Transports to confirm the Dow’s new high would require a closing price above the November 25, 2014 close of 9202.84. It will be interesting to see if that happens in a week where “champagne sparkles in every glass.”

Plainly, the drivers of last week’s “win” were the various reports. Consumer sentiment tagged a seven-year high, the Commerce Department reported consumer spending beat expectations at up 0.6%, and the third revision of 3Q14 Real GDP was a breathtaking +5%. The GDP report was the “cork popper” since expectations were clustered around +4.2%. It was the strongest quarterly reading in 11 years and has the U.S. economy growing at 3.5% in four of the past five quarters. On the negative side, the housing numbers disappointed and the durable goods report was terrible. The stock market, however, is turning a deaf ear to bad news and that’s good news. Hopefully, that trend will extend this week. But for those courageous enough to buy aggressive trading positions on our “fat lady sings” advice of December 17, 2014, I would either push up stop-loss points or shed those positions. One thing Andrew and I got right was the cup-and-handle formation in the Russell 2000 (RUT/1215.21), which we suggested was going to cause an upside breakout. That upside breakout occurred last week. As the eagled-eyed Jason Goepfert, of the insightful SentimenTrader, writes: “The Russell 2000 index of small-cap stocks closed at its first multi-year high in more than six months on Friday. The momentum that carries it to a new high has tended to continue over the next several weeks, as it added to its gains three weeks later all 15 times it has occurred (see chart).”

If Jason’s observations prove correct, this would foot with my timing work that shows the equity markets becoming increasingly vulnerable into mid-January.

The call for this week: While investors’ attentions were focused on last week’s economic reports, new highs in various indices and Christmas, the proverbial tree in the forest fell and was not heard. Verily to a cornered Vladimir Putin, who is feeling the pressure of a crude oil and Russian ruble collapse, last week’s Ukrainian parliament vote to become an “unaligned” nation is likely the first step toward becoming “aligned” with NATO. That may just prove to be the final straw that broke Premier Putin’s back. If so, things are getting ready to heat back up in the Ukraine, which may provide an unsettled news backdrop for the equity markets. Indeed, with the McClellan Oscillator overbought, as well as many other “finger to wallet ratios,” there is nearly a full charge of internal energy available in the equity markets to give us a move either on the upside or the downside. This week should be instrumental in determining the near-term direction. This morning Greece failed to elect a president, threatening the international bailout program. Russia has suffered its worst economic contraction since 2009. And Air Asia flight 8501 is still missing. All of this has the preopening futures flat at 6:00 a.m.

© Raymond James

[description] => I met Jerry Goodman, whose nom de plume was Adam Smith, late in my career. He was working at my friend Craig Drill’s money management firm along with another icon in this business, from an era gone by, namely Al Wojnilower. I have had many conversations with all three of these Wall Street legends around the conference table at Drill Capital Management. Jerry wrote The Money Game (1968), Powers of Mind (1975), Paper Money (1981), and The Roaring ‘80s (1988), but unfortunately we lost his wisdom on January 3rd of this year . [author] => Jeffrey Saut [legacyinterface_firm_id] => 356 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:29:19 [created_by] => 948 [modified_on] => 2014-12-29 16:33:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2240 [hits] => 0 ) [16] => stdClass Object ( [legacyinterface_commentary_id] => 2175 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15411 [apv_conversation_id] => [content_type] => market-commentary [title] => Intellectual Property Helps Boost 3Q GDP Growth To Highest Level Since 2003 [slug] => gavekal_122914 [fulltext] =>

As was widely reported yesterday, 3Q GDP growth was the strongest since 9/30/2003. However, less widely reported was the fact the intellectual property products contributed the most to real GDP in 32 quarters (9/30/2006). Fixed investment overall contributed 121 basis points to real GDP. Residential fixed investment contributed only 10 basis points and continues to hover around 3% of GDP. 

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© GaveKal Capital

[description] => As was widely reported yesterday, 3Q GDP growth was the strongest since 9/30/2003. However, less widely reported was the fact the intellectual property products contributed the most to real GDP in 32 quarters (9/30/2006). [author] => Team [legacyinterface_firm_id] => 173 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:42:34 [created_by] => 948 [modified_on] => 2014-12-29 16:42:48 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2241 [hits] => 0 ) [17] => stdClass Object ( [legacyinterface_commentary_id] => 2176 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15412 [apv_conversation_id] => [content_type] => market-commentary [title] => Oil and Emerging Markets: A Double-Edged Sword [slug] => franklin_122914 [fulltext] =>

The price of oil has plummeted this year as a result of increased volatility in most markets and a temporary imbalance of supply and demand. In view of continued long-term world growth, particularly in emerging- and frontier-market countries, we believe oil prices will probably not suffer from a prolonged price slump. As we see it, the demand for raw materials in general, including not only oil but also iron ore, copper, nickel and agricultural products, is still likely to increase over the long term with increased global growth. Much of the velocity of the recent oil price drop, we think, is based on speculation and short-term trading. In our view, the price of oil is likely to rebound in 2015 or 2016.

In the past two months, crude oil has experienced its biggest price slump since the 2007–2009 global financial crisis, with a number of reasons cited, including slowing demand growth from major economies and increased output from the United States in the past few years that hasn’t been met with decreased production among other major oil producers.

Certainly, too much supply, if it continues, will impact prices—that’s just basic economics. However, when we look at long-term demand patterns, we see the overall trend has been up, not down, and we can see how emerging-market economies have been driving this growth.

The Organisation for Economic Cooperation and Development (OECD) is a forum that facilitates cooperation among the governments of 34 member-democracies with market economies to promote economic growth, prosperity and sustainable development. Most emerging and frontier markets are non-OECD members, including China and India. The chart below shows how non-OECD countries have already surpassed the OECD countries in terms of crude oil consumption, and the gap is forecast to widen in future years.

 1214_MM_EnergyConsumptionOECD

China: Growing—or Slowing?

Slowing growth in China has been cited as a reason behind the drop in oil prices, but we look at the situation a little differently than many. Sure, its gross domestic product (GDP) growth is no longer in the double-digits of times past, and that’s to be expected because China’s economy is growing—it now has a higher baseline. I don’t think growth in China is a problem. In 2010, when China was growing at about 10%, US$844 billion was added to the economy. In 2013, growth had slowed to just under 8%, but more than US$900 billion was added to the economy. So, yes, GDP growth has been smaller percentage-wise, but you have to look at the overall economic impact—the US dollar figures.

Additionally, many people don’t think China needs more infrastructure, but from my personal experience traveling around the country on packed trains and heavily trafficked roads, it needs it badly! Urbanization is still underway; there is still a lot to be done in China, and it will still need natural resources to do it.

1214_MM_ChinaNomGDP

 1214_MM_ChinaRail

Impact of Lower Oil on Emerging Economies

Most consumers naturally cheer lower energy prices, but looking at overall economic impacts, lower oil prices can be a double-edged sword. In countries that are heavily dependent on oil exports, a prolonged oil price slump could be harmful.

Nigeria’s government, for example, depends on oil for a large part of its budget; the oil and gas sector accounts for about 35% of GDP, and petroleum export revenue represents over 90% of total export revenues.1 If these revenues drop, Nigeria’s leaders would either have to suffer through a lower oil price spell, or do something to revive the economy through diversification and reforms. Among the world’s top exporters, Russia’s GDP fell 8% in 2009 as the price of oil plunged below US$40 a barrel amid the global financial crisis. Russia remains heavily dependent on energy revenues today, and the country seems likely to be impacted greatly if prices don’t rebound quickly enough. Combined with Ukraine-related sanctions, Russian government officials have predicted a possible recession in 2015. Also highly dependent on oil revenues, Venezuela also seems particularly vulnerable, in our view. Saudi Arabia seems likely in a better position to weather the price downturn, as Saudi Arabia has enormous foreign reserves and investments that we believe should enable it to continue spending and growing even with low oil prices. On the flip side, China and India, as net importers, are likely to benefit from lower oil prices.

Part of the increased supply of oil has come from increased US shale production. At levels under US$60 a barrel, extracting oil becomes less profitable to shale producers. As it becomes unprofitable, some production will likely shut down, although it may take a number of months for fields to be abandoned. Meanwhile, the demand for oil in the two most populous countries in the world (China and India) is increasing as a result of more cars, buses and trucks on the roads. In addition, plastics and many other widely used products are derived from oil. The cost of finding and producing oil has not generally been declining. Therefore, over the longer term, we think oil prices will recover.

We see another side to the lower oil price story that is potentially positive for some emerging economies that had been subsidizing energy. These subsidies were a drag on government budgets, and lower market prices make removing such subsidies less painful for consumers residing in those countries. Indonesia has removed some subsidies, and we see signs that India and China are moving in that direction as well. An environment of lower energy prices has helped some emerging countries embark on much-needed reforms with less painful effects.

Right now, we think perhaps the biggest concern from an investment standpoint is volatility, not only in the price of oil but in related stocks in the sector—and in equity markets generally. We’ve seen some incredible swings. We look to use the downturns to find potential bargains for our portfolios, but many investors get spooked and lose out on opportunities. We, of course, will be looking at those countries, sectors and companies that we think could benefit from lower oil prices. We are not avoiding oil companies completely right now, however. Since many such companies are diversified, they may suffer in terms of their exploration and production activities, but could potentially benefit from their retail activities.

Mark Mobius’s comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding any country, region market or investment.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

What Are the Risks?

All investments involve risks, including possible loss of principal. Foreign securities involve special risks, including currency fluctuations and economic and political uncertainties. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Investments in the energy sector involve special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector.


1. Source: Organization of the Petroleum Oil Exporting Countries (OPEC), 2014.

© Franklin Templeton Investments

[description] => The price of oil has plummeted this year as a result of increased volatility in most markets and a temporary imbalance of supply and demand. In view of continued long-term world growth, particularly in emerging- and frontier-market countries, we believe oil prices will probably not suffer from a prolonged price slump. As we see it, the demand for raw materials in general, including not only oil but also iron ore, copper, nickel and agricultural products, is still likely to increase over the long term with increased global growth. [author] => Mark Mobius [legacyinterface_firm_id] => 163 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:45:57 [created_by] => 948 [modified_on] => 2014-12-29 16:46:14 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2242 [hits] => 0 ) [18] => stdClass Object ( [legacyinterface_commentary_id] => 2177 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15413 [apv_conversation_id] => [content_type] => market-commentary [title] => Chicken Little Economics [slug] => ft_122914 [fulltext] =>

It’s now been more than six years since the failure of Lehman Brothers – when the sky fell in and economic panic seized the land. Since then, Chicken Little Economics has inflicted fear and loathing on many investors.

Much of that fear has been caused by a misunderstanding of what actually happened. Conventional Wisdom has a bumper sticker mentality about the crisis – “Greedy Financiers Push World to Brink,” “Thank God the Government Saved Us” and “It Could Happen Again –Remember 1937.”

But this has it exactly backward. It was government mistakes that caused the crisis. It was government over-reaction that caused the recovery to be slower than it should have been. Most importantly, it was free market capitalism that saved us, not government.

While our readers understand our point of view, there are many who dismiss it because we were late in understanding how bad the crisis would become in 2008. We believed that government would figure out the role of mark-to-market accounting in making the crisis worse and we wrongly assumed this rule would be changed before things got worse.

But the Treasury and Federal Reserve refused to deal with the accounting problem, and instead invented Quantitative Easing (which started in September 2008) and the $700 billion TARP program, which passed Congress October 8, 2008.

What many don’t realize is that after TARP was passed, and after QE started, the stock market fell an additional 40%. In other words, there is absolutely no evidence that TARP or QE saved the economy.

Others say that it was “Stress Tests” that turned the market around. But the results of the first large bank stress tests were not released until May 7, 2009, which could not have caused the market to bottom on March 9, 2009, nearly two months earlier.

The only thing that happened on that exact day was that Congressman Barney Frank’s Financial Services Committee announced it was holding a hearing with FASB to force a change in mark-to-market accounting rules.

This is no coincidence. Forcing FASB to change overly strict accounting rules officially ended the crisis. No longer did illiquid markets and a really dumb accounting rule force banks to take losses that were not real.

Since then, the economy has consistently grown and the S&P 500, without dividends reinvested, has climbed by more than 210%.

Conventional wisdom just can’t deal with this. And politics has made things massively worse. Republicans who supported TARP still argue that it worked even though they supposedly believe in free markets. They also argue that as long as President Obama is in office, the economy cannot possibly grow. As a result, they join with the Fed in believing that QE has boosted stocks and the economy.

Democrats have treated the Financial Crisis of 2008 exactly as they did the Great Depression – as a reason to spend more, regulate more and redistribute more. The Democratic ideology is that government is always needed to keep markets in check and make things “fair.” This argument works best after a crisis. So, the political argument from the left is that the economy is growing because of government action as well.

In other words, investors have few friends that believe in free markets. “Arm chair economists” are everywhere, arguing that it’s simple to manage an economy. Just dial up some QE, redistribution and infrastructure spending, stress test the banks, too, and all will be well.

But these simple-minded remedies have run into an anecdotal and intellectual brick wall. The Fed has tapered its QE and is no longer buying bonds, yet GDP grew 5% last quarter and stock prices are at all-time highs. In Japan, massive new QE is not lifting economic activity or inflation. In Europe, with no QE, interest rates are lower than in the US. In addition, so many “end of the world” forecasters have been wrong that they are making “chicken little” look like an optimist.

Investors need to understand that the same things that boosted growth 150 years ago and 25 years ago are still the same things that boost growth today. What are those things? The answer: Entrepreneurship, innovation and creativity.

In spite of government mistakes, the U.S. entrepreneur has refused to be held back. Profits are at an all-time high and so are stocks. Chicken Little will be wrong again in 2015.

This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy. 

© First Trust Advisors

[description] => It’s now been more than six years since the failure of Lehman Brothers – when the sky fell in and economic panic seized the land. Since then, Chicken Little Economics has inflicted fear and loathing on many investors. [author] => Brian Wesbury, Robert Stein [legacyinterface_firm_id] => 154 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:53:40 [created_by] => 948 [modified_on] => 2014-12-29 16:54:54 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2243 [hits] => 0 ) [19] => stdClass Object ( [legacyinterface_commentary_id] => 2178 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15414 [apv_conversation_id] => [content_type] => market-commentary [title] => Three Potential Opportunities and Three Risks For 2015 [slug] => invesco_122914 [fulltext] =>

With my 2014 year-in-review now posted, Lessons from 2014, and my full 2015 outlook not arriving until January, I wanted to share a few of my thoughts and expectations for the coming year. Overall, I am bullish on global equities in 2015. That being said, volatility is likely to increase and investors may need to be more selective, as the US adjusts to life after QE, the US Federal Reserve begins raising interest rates, the US dollar strengthens, energy prices continue to decline and global growth moderates in my opinion.

Global equity performance may be less robust than in 2013 and 2014, but I still see room for gains driven by the US, Japanese and European markets. Emerging market equities, however, are likely to continue underperforming developed market equities in the coming year, in my opinion. Three major themes I expect to play out in 2015 are:

1. Money moves markets.

Quantitative easing (QE) policies have shown little benefit to the economies that have pursued them. But, the equity markets are a different story. Countries with the most aggressive monetary policy have shown the best equity performance.1 Japan and Europe could see the biggest moves, which may trump weak fundamentals.

2. The rising dollar.

In the US, a stronger dollar has historically correlated to lower energy prices.2 Reduced energy costs have tended to expand price-earnings (P/E) multiples and increase consumer disposable income, which in turn could bolster stock prices.3 This environment favors value stocks over growth, in my opinion. Multinationals in Europe and Japan may benefit, but investors may want to consider a currency hedge. Conversely, emerging markets may lag, as a stronger US dollar is likely to weigh on stock prices.

3. Range-bound interest rates.

Fundamentals argue for rising rates, as employment could reach the “full employment” rate in the first quarter of 2015 and quarter-over-quarter gross domestic product (GDP) growth may continue to run above 3%. However, strong demand for US Treasuries from global bank capital requirements, low global rates and a lack of inflation could help US rates stay lower for longer.4 In other words, even with a rate hike (possibly in June), I don’t see the Fed getting in the way of the equity markets.

On the flipside of this scenario are the risks that could fundamentally shift my outlook. As I see it, key risks could include:

1.    A prolonged or deep economic slowdown in China, which could drag down global growth and seriously undermine investor confidence.

2.    A spike in geopolitical risk, possibly from Russia or the Middle East, threatening Europe’s already fragile economy or causing a spike in volatility that drives money out of risk assets into “safe haven” assets, potentially creating bear markets.

3.    A cyber attack that becomes a “Black Swan” event, a rare, impossible-to-predict occurrence that significantly disrupts the financial markets.

As detailed in my December commentary, in 2014 investors who were patient and kept short-term volatility in perspective likely fared better than investors who got distracted. I believe the same lesson will apply in 2015, perhaps even more so.

1 Source: Bloomberg LP and Thomson Reuters DataStream, Nov. 30, 2014, based on the S&P 500 Index, MSCI Europe Index and Nikkei 225 Index.

2 Source: Thomson Reuters DataStream, Dec. 5, 2014

3 Source: Thomson Reuters DataStream, Dec. 5, 2014

4 Source: Bloomberg LP and Thomson Reuters DataStream, Dec. 10, 2014

Important Information

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The MSCI Europe Index is a free-float-adjusted market-capitalization-weighted index designed to measure the equity market performance of the developed markets in Europe.

The Nikkei 225 Index (or Nikkei Index) is a price-weighted index measuring the top 225 blue chip companies on the Tokyo Stock Exchange and is commonly considered representative of Japan’s stock market.

Price-earnings (P/E) ratio, also called multiple, is a common valuation metric for stocks that compares a stock’s share price to its per-share earnings.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

An investment in emerging market countries carries greater risks compared to more developed economies.

International markets may be less liquid and can be more volatile than US markets.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.

Growth stocks may be more susceptible to earnings disappointments, and value stocks may fail to rebound.

Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.

The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Before investing, investors should carefully read the prospectus and consider the investment objectives, risks, charges and expenses.

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.

©2014 Invesco Ltd. All rights reserved.

[description] => With my 2014 year-in-review now posted, Lessons from 2014, and my full 2015 outlook not arriving until January, I wanted to share a few of my thoughts and expectations for the coming year. Overall, I am bullish on global equities in 2015. That being said, volatility is likely to increase and investors may need to be more selective, as the US adjusts to life after QE, the US Federal Reserve begins raising interest rates, the US dollar strengthens, energy prices continue to decline and global growth moderates in my opinion. 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[slug] => sungarden_010215 [fulltext] =>

These past few weeks, with the year winding down and investment strategy decisions to think about (always), I spent a lot of time with my research team analyzing historical stock market index data as far back as 1871.  First conclusion: I am sick and tired of analyzing historical stock market index data!  We did this to see what today’s investor might learn from market history.

Why now?  Because we are at a precarious point in stock market history.  Given the strong market returns of the last half-decade or so, recent market index returns are in rarified air.  And while there is certainly historical evidence that when markets surge as they have since the S&P bottomed in early 2009, there is trouble ahead, there is plenty of evidence to say that this object (the market) that has been in motion since that time can stay in motion for a while.  As hedged investors, we are always trying to figure out how to do what we do better.  Historical analysis like this is a key part of that.

Rather than exhaust you (and lose your attention along the way) with the guts of our analysis, let me just start 2015 with a summary of our observations and conclusions.

 

S&P 500 INDEX (Total Return through 12/29/14) – RECENT PERFORMANCE HISTORY (Ycharts.com 2014)

  • Up 236% since 2/28/2009
  • Up 102% since 2/29/2000

HISTORICAL OBSERVATIONS

  • Depending on what time frame you look at, the stock market has either done very well or just OK in a historical context. Buried within this time period is a pair of 40%+ declines.  The S&P 500 Total Return has an annualized return of 5% in about the past 15 years but an annualized return of about 23% in about the last six years.
  • There is no definitive historical pattern we have found that says “do this” or “do that” to succeed after a 200% run-up in stock prices
  • Markets can go up a lot longer and lot higher than any of us imagines
  • Yet, major declines following major advances are inevitable…it is just a matter of how long it takes until the market peak occurs, and how deep the eventual drop will be
  • The threat of a major decline following a more than 200% rise in the S&P 500 Index since early 2009 is real. But who knows when it will come home to roost?  Certainly not us.  But our approach is not based on guessing, it is based on accounting for many different scenarios.
  • Whatever cushion bonds provided in the past is largely gone, due to interest rates which persist at levels well below normal for an economic recovery

IMPLICATIONS FOR INVESTMENT PLANNING

  • Enjoy the ride up, but it is essential to have as part of your investment process a clear-cut approach to combating major declines in stock prices
  • Rather than try to determine when a life-changing market decline will happen and what will cause it, make proactive risk-management a part of your ongoing strategy…not only when market turmoil occurs, but always
  • Investing to track a major market index like the S&P 500 has had a very good run the past half-decade and is now immensely popular. But do not be fooled into thinking that recent past is prologue.  The S&P 500 Index, after strong runs higher like this one, becomes a list of past winners. And with all the money now invested in index funds, when it goes the other way, the unraveling can be quick and thorough as we have seen twice in the past 15 years.
  • Instead, be prepared to diversify your equity portfolio along some additional dimensions, beyond sectors, market cap sizes, etc. such as:

1. Holding period diversification

2. Investment theme diversification

3. Dividend level diversification

 

THE SUNGARDEN TEAM WISHES YOU A VERY HAPPY AND PROSPEROUS 2015!!

© Sungarden Investment Research

www.sungardenresearch.com

 

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"If you repeat a falsehood long enough, it will eventually be accepted as fact."

In the financial markets and economics it is a common occurrence that the media and commentators will latch on to a statement that supports a cognitive bias and then repeat that statement until it is a universally accepted truth.

When such a statement becomes universally accepted and unquestioned, well, that is when I begin to question it.

One of those statements has been in regards to plunging oil prices. The majority of analysts and economists have been ratcheting up expectations for the economy and the markets on the back of lower energy costs. The argument is that lower oil prices lead to lower gasoline prices that give consumers more money to spend. The argument seems to be entirely logical since we know that roughly 80% of households in America effectively live paycheck-to-paycheck meaning they will spend, rather than save, any extra disposable income.

As an example, Steve LeVine recently wrote:

"US gasoline prices have dropped for more than 90 straight days. They now average $2.28 a gallon, which is remarkable considering that just a few months ago, some of us were routinely paying $4 and sometimes close to $5.

Not so coincidentally, the US economy surged by 5% last quarter, and does not appear to be slowing down. "

If you read the statement, how could one possibly disagree with such a premise? If I spend less money at the gas pump, I obviously have more money to spend elsewhere. Right?

The problem is that the economy is a ZERO-SUM game and gasoline prices are an excellent example of the mainstream fallacy of lower oil prices.

Example:

  • Gasoline Prices Fall By $1.00 Per Gallon
  • Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
  • Gas Station Revenue Falls By $16 For The Transaction (-16)
  • End Economic Result = $0

Now, the argument is that the $16 saved by the consumer will be spent elsewhere. This is the equivalent of "rearranging deck chairs on the Titanic."

Increased consumer spending is a function of increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend. Let's use another example:

Example:

Big John Has $100 To Spend Each Week On Retail Related Purchases

  • Big John Fills Up His Truck For $60 (Used To Cost $80) (+$20)
  • Big John Spends His Normal $20 Per Week On His Favorite Craft Beer
  • Big John Then Spends His Additional $20 Savings On Roses For His Wife (He Makes A Smart Investment)

-------------------------------------------------
Total Spending For The Week = $100

Now, economists quickly jump on the idea that because he spent $20 on roses, there has been an additional boost to the economy. However, this is false. John may have spent his money differently this past week but here is the net effect on the economy.

Gasoline Station Revenue = (-$20)
Flower Show Revenue = +$20
----------------------------------------------------
Net Effect To Economy = $0

Graphically, we can show this by analyzing real (inflation adjusted) gasoline prices compared to retail "control purchases." I am using "control purchases" as it removes retail gasoline sales, automobiles, and building materials from the retail sales number to focus more on what consumers are buying on a regular basis.

Gasoline-Prices-PCE-111814

The vertical orange line shows peaks in gasoline prices that should correspond (according to mainstream consensus) to a subsequent increase in retail sales.

Another way to show this graphically is to look at the annual changes in Personal Consumption Expenditures (PCE) in aggregate as compared to the subsection of PCE spent on energy and related products. This is shown in the chart below.

PCE-vs-Energy-123014

While the argument that declines in energy and gasoline prices should lead to stronger consumption sounds logical, the data suggests that this is not the case.

The reason is that falling oil prices are a bigger drag on economic growth than the incremental "savings" received by the consumer.

Oil and gas production makeup a hefty chunk of the "mining and manufacturing"component of the employment rolls. Since 2000, when the oil price boom gained traction, Texas has comprised more than 40% of all jobs in the country according to first quarter data from the Dallas Federal Reserve.

Employment-Texas-DallasFed-111814

(Read more here)

The obvious ramification of the plunge in oil prices is that eventually the loss of revenue will lead to cuts in production, declines in capital expenditure plans (which comprises almost 1/4th of all capex expenditures in the S&P 500), freezes and/or reductions in employment, and declines in revenue and profitability.

The majority of the jobs "created" since the financial crisis have been lower wage paying jobs in retail, healthcare and other service sectors of the economy. Conversely, the jobs created within the energy space are some of the highest wage paying opportunities available in engineering, technology, accounting, legal, etc. In fact, each job created in energy related areas has had a "ripple effect" of creating 2.8 jobs elsewhere in the economy from piping to coatings, trucking and transportation, restaurants and retail.

Simply put, lower oil and gasoline prices may have a bigger detraction on the economy that the "savings" provided to consumers.

Newton's third law of motion states:

"For every action there is an equal and opposite reaction."

In any economy, nothing works in isolation. For every dollar increase that occurs in one part of the economy, there is a dollars' worth of reduction somewhere else."

I live in Houston, and the face of fear in 2015 is that oil prices remain low. 

Lance Roberts

Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. 

© Streettalk Live

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Gold is money. Everything else is credit.
~J.P. Morgan in 1912

Loyal readers of our Investor Alert and my blog Frank Talk are no doubt aware that the U.S. dollar’s rising strength has put pressure on commodities such as oil and gold. I wrote about this as recently as my roundup of the top commodities stories of 2014, which you can read here.

Gold took a blow in the second half of 2014 as a result of the dollar’s ascent, and sentiment toward the yellow metal right now is less than ideal. But to keep things in perspective, its performance this year has far outpaced that of 2013, when it fell 28 percent—its worst showing since early into President Reagan’s first term.

Even though gold has lost 0.8 percent year-to-date as of this writing, it still leads all major world currencies except for the U.S. dollar.

Gold is Second Best Performing Currency of 2014
click to enlarge

The Case for Gold as Currency

In his most recent book, former Federal Reserve Chairman Alan Greenspan convincingly makes the case that gold is indeed money:

Yet gold has special properties that no other currency, with the possible exception of silver, can claim. For more than two millennia, gold has had virtually unquestioned acceptance as payment. It has never required the credit guarantee of a third party. No questions are raised when gold or direct claims to gold are offered in payment of an obligation; it was the only form of payment, for example, that exporters to Germany would accept as World War II was drawing to a close.

Greenspan goes on to make another astute point. If gold is nothing more than a commodity, then why do most developed countries’ central banks see the need to hold the stuff? Wouldn’t some other commodity suffice? Diamonds perhaps, or soybeans?  

During a Congressional monetary policy meeting in 2011, Texas Representative Ron Paul squared off against former Fed Chairman Ben Bernanke over this very topic. When asked why central banks still insist on holding the precious metal in their reserves, Bernanke responded that it was simply tradition.

Tradition, yes, but the reason goes so much deeper than that. Gold has an intrinsic value that transcends its commodity-ness, something that’s recognized by nations all over the globe.

For example, we’re seeing a trend among European central banks seeking to bring their gold reserves back under their jurisdiction. Although Switzerland recently voted down a referendum that would have done just that, there’s talk now that Austria, Belgium and France are interested in shoring up their own gold reserves. The Netherlands and Germany have already brought some of their gold home.

China and India’s central banks are in the buying mood. Russia is currently snapping up gold at an astounding rate: 130 tons this year alone, up 73 percent from 2013.

Of course, if you’re Russia, buying that much bullion makes perfect sense. When your currency is the worst-performing in the world, you sorely need something in your coffers with greater value, ample liquidity and no credit risk.

Diversify and Rebalance

For the rest of us, gold remains an exceptional instrument to diversify your portfolio with. Despite its decline midway through the year, its price has remained relatively stable, much more so than oil’s. What investors—especially the gold bears—need to remember is that bullion has a 12-month standard deviation of ±18 percent, meaning that its price action this year is well within normal behavior.

As always, I advocate a 10-percent weighting in gold: 5 percent in physical metal, 5 percent in equities, then rebalance every year.

Speaking of which, look out for my special New Year’s edition of the Investor Alert this Friday. I’ll be discussing what steps you can take to maximize your portfolio going into 2015! 

Past performance does not guarantee future results.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility. Diversification does not protect an investor from market risks and does not assure a profit. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

© U.S. Global Investors

[description] => Loyal readers of our Investor Alert and my blog Frank Talk are no doubt aware that the U.S. dollar’s rising strength has put pressure on commodities such as oil and gold. I wrote about this as recently as my roundup of the top commodities stories of 2014, which you can read here. [author] => Frank Holmes [legacyinterface_firm_id] => 464 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 15:46:54 [created_by] => 948 [modified_on] => 2014-12-31 15:47:19 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2250 [hits] => 0 ) [3] => stdClass Object ( [legacyinterface_commentary_id] => 2185 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15423 [apv_conversation_id] => [content_type] => market-commentary [title] => 2015 Investment Outlook: Europe—The Saga Continues [slug] => franklin_123114 [fulltext] =>

David Zahn, CFA, FRM
Head of European Fixed Income 
Senior Vice President
Franklin Templeton Fixed Income Group®

For the eurozone, 2015 offers the prospect of both significant change and continued inertia. Though the European Central Bank (ECB) refrained from announcing any further actions at its December 2014 meeting, a dovish speech by ECB President Mario Draghi a few weeks earlier did provide further backing for what markets have been signaling for many months, namely that the ECB might introduce full-blown quantitative easing (QE) at some point during the coming year. Should QE happen in 2015, we believe its onset could mark a step change in the ECB’s role and the region’s financing of debt, with potentially profound political implications for the monetary union.

And yet, regardless of whether QE is introduced or not, the secular stagnation that has gripped the eurozone seems unlikely to lift by the end of 2015. Although the region’s overall third-quarter growth in 2014 was better than expected, the weakness of the German economy, which managed an expansion of just 0.1% over this period, dented any optimism.

On top of the existing internal problems of “lowflation,” shorthand for ultra-low inflation, weak demand and anemic credit growth, the deterioration in the external backdrop over much of 2014—rising geopolitical tensions with Russia, and the slowdown of the Chinese economy and many other emerging markets—has made a rapid return to meaningful growth across the eurozone unlikely, in our view, despite some positive signs, including the stabilization of many peripheral economies and the boost in competitiveness from the weaker euro.

What Probably Will Change in the Eurozone in 2015?

Much has been made of the opposition of some German policymakers to QE, and politically its introduction, we think, could depend disproportionately on the course of future German economic data, rather than a more measured assessment of the overall course of the eurozone. If German industry’s slowdown continues beyond the second half of 2014 into 2015, then the resolve of the country’s officials to stick to their ideological knitting will likely be tested, and may create enough of a consensus for ECB President Draghi to move beyond the substantial raft of measures he has already announced.

In the event of a go-ahead for QE, its announcement might be of greater political than economic significance, potentially marking the first step on the road to closer fiscal integration of the eurozone. In terms of what QE could include, as well as purchases of member states’ sovereign and corporate debt, other options might include supranational institutions such as the European Investment Bank. A regional approach to debt financing would be a critical threshold for policymakers to cross, potentially opening the way for further transfers to ease intraregional imbalances. We anticipate an announcement confirming QE’s introduction could see further compression of spreads.1 between peripheral and core eurozone bonds, though as has been the case in other countries that have used it, the actual implementation of QE may trigger a modest selloff, in our view.

Ahead of any potential decision, we believe President Draghi will hope for signs that the ECB’s existing measures are having some effect. While the remedies announced so far have lacked sufficient magnitude individually to have a noticeable impact, in aggregate they could help to dispel some of the deflationary pressures weighing on the region. Perhaps the most important goal is to reinvigorate credit growth, and here the cheap funds provided by the ECB’s TLTRO (Targeted Longer-Term Refinancing Operation) program to the region’s banks, designed to stimulate lending to businesses, might yet prove effective. The initial auction for the TLTRO loans in September 2014 proved disappointing, as banks opted instead to repay the previous round of loans from the ECB at the height of the eurozone crisis.

What Probably Will Not Change in the Eurozone in 2015?

One of the main criticisms of QE when used by other central banks has been its ineffectiveness in injecting money into the “real” economy. Though the ECB has acknowledged that one of the main factors underlying the eurozone’s stagnation is a lack of credit growth, any potential use of QE seems unlikely to make much of an impact in this regard, even if an announcement of QE could drive yields down further, making it even less attractive for banks to hold government bonds.

Nor is there much prospect of relief for the eurozone economy from fiscal stimulus. We believe the precarious finances of the peripheral economies rule out such largesse, while core eurozone countries have only limited fiscal leeway, or in Germany’s case, insufficient political interest in such expansion.

Though current and future region-wide initiatives to boost expenditure are sure to be talked up by officials, in reality their impact on growth is likely to be marginal, in our view, rather than meaningful. It is important to emphasize that, despite the current headwinds, we do not foresee a full-blown recession for the eurozone in 2015. Growth across the region may turn slightly negative at some point, indeed lowflation may even change to slight deflation, but these indicators are more likely to oscillate around zero than sharply deteriorate. Our base-case scenario for the end of 2015 sees the eurozone economy remaining more or less where it is now, not really growing much or shrinking much either. Even if growth in the region did show signs of picking up in 2015—and recent sharp falls in energy prices should support growth, though put further pressure on lowflation—given structural constraints, ultimately growth is likely to be limited to the region’s trend rate, somewhere between 1% and 2%. So far, structural reforms that could lift this long-run average rate have been most evident in peripheral economies, with little sign in key core economies (such as France) of the necessary political will to grasp this nettle.

1231_ZahnInflation_Eurozone 

What Else Might Impact the Eurozone in 2015?

We see two other variables that could have a significant impact in 2015. If a worsening of the dispute over Ukraine caused a further deterioration in the European Union’s (EU’s) relationship with Russia, the dampening effect on growth in the eurozone (and even more so for the eastern EU member countries) would likely be negative while political relations remained strained. The other unknown is the UK general election in May 2015, in which a Conservative victory would raise the possibility of a referendum within a couple of years on the UK’s membership in the EU. How European markets might react to the possibility of “Brexit,” which is shorthand for “British exit from the European Union,” both in the run-up to the UK election and its aftermath, remains unclear, although given that UK assets suffered as the result of the referendum on Scottish independence became less predictable such volatility could conceivably reoccur.

While Eastern European countries may experience a slowdown if the Ukrainian crisis worsens further, we believe that their fundamentals—generally higher growth than the eurozone countries, and significantly more manageable debt burdens—remain attractive. For the United Kingdom, we do not anticipate that its currently superior rate of growth will be affected by the coming election, though with the eurozone’s weakness inhibiting UK inflation, the Bank of England might hold off raising interest rates for longer than many observers expect. The other key event that might occur in 2015 is a much-heralded increase in US interest rates, as the US economy continues to improve. While such a move would likely cause a spike in volatility in European markets, we would expect investors to quickly refocus on the eurozone’s weak fundamentals. Such sentiment, along with the possibility of further monetary stimulus from the ECB, should also see the euro likely continue to fall over 2015.

David Zahn’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

This information is intended for US residents only.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

What Are the Risks?

All investments involve risks, including the possible loss of principal. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Special risks are associated with foreign investing, including currency rate fluctuations, economic instability and political developments. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. Currency rates may fluctuate slightly over short periods of time, and can reduce returns. A non-diversified portfolio involves the risk of greater price fluctuation than a more diversified portfolio.

1. Spread is the percentage difference between the yields of different types of bonds.

[description] => Like television fans deciphering a season-finale cliffhanger, investors have been left with unanswered questions about the eurozone as 2014 draws to a close. Will the European Central Bank unleash full quantitative easing? Will the eurozone fall into a recession? David Zahn, head of European Fixed Income and portfolio manager, Franklin Templeton Fixed Income Group®, gives his perspective on what he thinks may lie ahead as the eurozone’s drama continues into 2015. [author] => David Zahn [legacyinterface_firm_id] => 163 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 15:49:39 [created_by] => 948 [modified_on] => 2014-12-31 15:55:19 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2251 [hits] => 0 ) [4] => stdClass Object ( [legacyinterface_commentary_id] => 2186 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15424 [apv_conversation_id] => [content_type] => market-commentary [title] => Structural Reforms in Asia [slug] => matthews_123114 [fulltext] =>

The global investment community continues to deliberate about the impact of quantitative easing stemming from Europe, and more recently from Japan, as a means to revive domestic demand. Meanwhile, several Asian economies are embarking on a different kind of stimulus, aimed at boosting long-term productivity and investment spending, through structural changes to the underlying economies. Last month’s Asia Insight focused on “Asia’s Deepening Capital Markets,” in which we highlighted that growth is being supported by financial market reforms designed to both deepen the markets and broaden its participant base. This month’s Asia Insight provides some context around wider economic reforms, how the imperatives may differ from the past and how Matthews Asia seeks to participate in these changes through our portfolios.

Countries in Asia are no strangers to reforms and many of us who have watched these markets for decades recall the solid recovery posted by these economies in the aftermath of the 1997 Asian Financial Crisis (AFC). In hindsight, the AFC proved to be short, albeit deep, because the regulators were forced to adopt tough measures, mainly prescribed by the International Monetary Fund (IMF). The intention was to rectify policy missteps and to clean up major faults in the financial system; and the results were very positive over the long-term. Two important factors helped Asia recover quickly. First, there had already been significant productivity gains within the agricultural and manufacturing sectors, leading into the AFC—particularly in North Asia. Second, the IMF's rescue led to relatively groundbreaking reforms prompted by a financial shock. 

This kind of radical change rarely occurs in the absence of a crisis. On the back of these reforms, Asia posted multiple years of impressive growth. More recently, progress has stemmed from better terms of trade or increasing leverage. But these factors are not sustainable, and slowing growth is strengthening the resolve of today’s policymakers to embark on much-needed reforms. But what distinguishes Asia from the West is that reforms are targeting the economy at its foundation—at the corporate and consumer level. This is contradictory to common practices that use fiscal spending or monetary policy to affect temporary improvements in top-line GDP growth. What we are seeing today is an effort to mobilize capital in parts of South Asia, and at the same time, an effort to better allocate capital and build an innovation-led economy in parts of North Asia. Reforms implemented during the post-AFC era were prompted from outside of Asia, while current reforms are being driven by local governments. 

Capital Accumulation: Still an Important Step for Parts of Asia


In the book, “The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else,” Peruvian economist Hernando de Soto Polar describes capital as "that part of a country's assets that initiates surplus production and increases productivity." Capital is not to be confused with money, which is one of the many forms in which it travels. Instead, capital is an asset that generates money when invested. 

In the initial stages of economic development in North Asia, countries gained ground by using all available labor in agriculture to build economies of scale and push output to the highest possible level. As yields increased, economic surpluses also increased, leading to capital accumulation. In the next stage, the surpluses in human capital and other resources were directed toward manufacturing. In this phase, a small number of entrepreneurs and technicians made an outsized impact on economic development by focusing on innovative-mechanized production by employing large cohorts of unskilled and semi-skilled labor.

In North Asia, agricultural industrialization led to productivity gains and allowed surplus labor to be absorbed into other parts of the economy. But in many other parts of Asia, the agricultural sector’s share of overall employment is still where Japan was in the 1950s and 1960s—where agriculture still accounts for 30% to 50% of all employment—including China, Indonesia, the Philippines, Thailand and Vietnam. 

South Korea and Taiwan, and more recently China, have demonstrated a ruthless and uncompromising focus on competition and productivity, and this has been crucial to developing robust manufacturing. Asia’s policy initiatives toward accumulating and mobilizing capital have included a host of measures to support economic development including deregulation in labor to provide more flexible cost structures; deregulation in ownership structures that can provide a greater role for the private sector; deregulation in natural resources; as well as liberalization of the financial markets.

The pace and sequencing of these initiatives can be critical; when changes occur too slowly, there is a risk of weak job creation and technological obsolescence, as there has been in India and Indonesia. When changes happen too quickly, countries run the risk of experiencing a speculative frenzy that can be counter-productive to long-term development. 

“Make in India”: A Push for Manufacturing


India's challenges in the manufacturing sector illustrate the complexities of implementation in real (versus theoretical) political and economic systems. Ownership barriers, rigid labor laws, complex land acquisition rules and weak infrastructure have conspired to stunt manufacturing growth. But whenever these barriers have been lifted, the response from the entrepreneurial community has been encouraging. The automobile industry, liberalized in 1991, was among the first segments of manufacturing to open up to private sector participation. Since then, output has grown 15-fold and, India is increasingly considered a destination for manufacturing and an export base for auto parts and automotive vehicles. 

India's newly elected Prime Minister Narendra Modi has made manufacturing a key agenda point. Specifically, his administration plans on building a globally competitive industrial sector that can steadily increase market share in exports. To support this, authorities have progressively lowered ownership barriers to foreign firms within manufacturing. Most recently, in the defense and railways sectors, it has increased the level of ownership permitted by foreigners to 49% and 100%, respectively. 

Labor laws in India are more vexing because they are legislated concurrently by both the central and state governments. The Northwestern state of Rajasthan has taken the lead in labor deregulation by reducing government-approval restrictions on hiring/firing workers. Other proposed measures aim to provide greater flexibility in running factories, and in complying with existing labor laws. If the efforts in Rajasthan lead to greater job creation, it will be difficult for other states not to follow suit. 

Formal job creation is surely a goal of Mr. Modi’s and the kinds of changes sought by the state of Rajasthan are certain to challenge some vested interests. But the recent elections have given a broad mandate of growth and governance over welfare entitlements to the incoming government. 

Diminishing Subsidies: Is this a Sign of Deepening Resolve?

 
In Indonesia, one of the first steps taken by the incoming administration of President Joko Widodo was to reduce energy subsidies in order to allow gasoline prices to move closer to market-determined rates. Subsidies often have unexpected consequences and lead to crowding out. In this case, the fiscal costs associated with energy subsidies had been twice as high as expenditures on infrastructure and three times as high as spending on health care. They had also been harmful because they disproportionately benefited the top 20% of Indonesians, adding to already-high tensions surrounding class and wealth in the country. 

India and Malaysia have taken similar steps to cut energy subsidies, which now account for 2.5% and 1.7% of GDP, respectively. If these policies continue to hold in an environment of rising oil prices, it will be a sure sign of leaderships’ determination to push ahead with structural reforms that may sacrifice the short term for the sake of the long term. 

The new governments in India and Indonesia are working to reduce dependence on individuals, and to strengthen the role of institutions by improving public service performance and coordination across ministries. Technological systems are also helping to improve work flow and reduce corruption through increased transparency. As an example, India’s public services administration’s transition to an e-governance platform has been credited with helping to launch an astonishing 33% of previously stalled investment projects, amounting to as much as 5% of GDP. These types of efficiency improvements are occurring behind the scenes, and are less controversial than bolder efforts to reduce subsidies and deregulate industries.

Capital Allocation: A Growing Priority


The macroeconomic policy settings in the capital allocation phase of development are often characterized by an environment of low interest rates, strict capital controls and low exchange rates. In recent times, China has been exemplary in its use of policies to promote capital accumulation. China has also been successful in directing savings and surpluses toward accelerated technological learning. 

Some have argued that the hectic pace of infrastructure creation in China is more indicative of capital misallocation. While we acknowledge that the rapid pace has its risks, it is also entirely possible that the massive infrastructure spend has been a key enabler of the Internet/e-commerce revolution now engulfing the country. Rapid capital mobilization may be a normal step in economic development, but perhaps the government realizes that the impetus has to shift toward better allocation of capital. As such, there has been a resolute commitment toward freeing-up interest rates, liberalizing exchange rates and slowly lifting the controls on the capital account. 

China’s authorities are embracing financial sector reform, but on their own terms. The steps toward internationalization of the renminbi (RMB) are at the leading edge of those efforts. At the national level, this gives China additional trade-settlement options and reduces dependence on the U.S. dollar; but that is only a part of the multi-year story. By using the RMB as a financing mechanism in international trade, Chinese exporters may gain share in higher value-added items, such as telecommunication routing equipment, capital goods and personal computers, et al.

For financial reform to be successful, it needs to promote competition from both private and foreign players. One of the key thrusts of Chinese authorities has been to provide private firms with access to a broader range of sectors. In support of this, there has been an attempt to improve access to funding for small- and medium-sized enterprises (SMEs). Many of these companies in China, and other parts of Asia, still have to rely on internally generated funds since capital availability remains constrained.



Most notable has been a general effort to deregulate parts of the services economy previously controlled by state-owned enterprises. One clear example is health care, where increasing competition is gearing up to meet the changing needs of average consumers. One perverse outcome of accelerating prosperity has been increased incidents of lifestyle diseases, such as diabetes and heart disease. In order to provide higher-quality health care, the government has allowed private companies to enter the hospital sector. 

In general, building a higher-quality services economy will test the mettle of authorities. Steps to level the playing field, between conglomerates and SMEs, can help. South Korean policymakers have picked up the gauntlet in this regard. Recent actions to encourage dividends, improve the use of cash and to refine ownership structures within conglomerates are steps in that direction. The development of the services sector can lead to greater balance and more inclusive growth in Asian economies, which is another step in the direction toward increasingly efficient economic structures. 

Sentiment can be Unpredictable over the Short Term


We have not seen a near-synchronous effort toward structural changes within Asian economies in quite a while. China has taken the lead and has been the most rapid and most consistent in its execution. By withdrawing from its role as director of a planned economy, the Chinese government is embracing a regulatory role in a more market-oriented economy. The government’s near single-mindedness comes with the realization that while the current reforms can be painful, the cost of missing out on greater global stature that will come from further growth will be even more painful. Yet the investment community seems to shrug off these developments in China, while the mere possibility of change in India is enough to send spasms of excitement across the capital markets. 

Arguably, the task at hand in India is different. Like many parts of South Asia, it focuses on overall growth prospects from a better supply-side response to freeing-up factors like land and labor. China, much like other parts of Asia, has to focus on a more rational organization of talent and push for greater quality of growth. The success in either of these endeavors is not guaranteed. And as history has shown, the path to future development has been traversed in multiple ways by Asian economies. 

How do we Capture Opportunities in our Portfolios?


One thing is increasingly clear—in the stages of economic development across Asia, greater diversity means there are greater numbers of businesses from which to choose. One way to participate in this dynamic is to stay nimble within the confines of a disciplined investment process. The other important goal is to remain focused on the long-term evolution of these economies, rather than getting drawn into short-term predictions. We analyze the financial information of companies, but it is sometimes useful to use a long-range lens to understand the intentions behind some of the initiatives affecting companies in Asia. Of all the above reform initiatives, two are crucial—to improve the quality of life for the household, and to boost economic productivity. If we can identify those businesses that are doing so, we believe this will be a powerful force for our shareholders. 

Sharat Shroff, CFA
Portfolio Manager
Matthews Asia

You should consider the investment objectives, risks, charges and expenses of the Matthews Asia Funds carefully before making an investment decision. This and other information about the Funds is contained in the prospectus or summary prospectus, which may also be obtained by calling 800-789-ASIA (2742). Please read the prospectus carefully before you invest or send money as it explains the risks associated with investing in international and emerging markets. These include risks related to social and political instability, market illiquidity and currency volatility. Investing in foreign securities may involve certain additional risks, exchange rate fluctuations, less liquidity, greater volatility and less regulation. Fixed income investments are subject to additional risks, including, but not limited to, interest rate, credit and inflation risks. Single-country and sector funds may be subject to a higher degree of market risk than diversified funds because of a concentration in a specific sector or geographic region.

Matthews Asia Funds are distributed in the United States by Foreside Funds Distributors LLC, Berwyn, PA
Matthews Asia Funds are distributed in Latin America by HMC Partners 
© 2014 Matthews International Capital Management, LLC

[description] => The global investment community continues to deliberate about the impact of quantitative easing stemming from Europe, and more recently from Japan, as a means to revive domestic demand. Meanwhile, several Asian economies are embarking on a different kind of stimulus, aimed at boosting long-term productivity and investment spending, through structural changes to the underlying economies. [author] => Sharat Shroff [legacyinterface_firm_id] => 286 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 16:08:48 [created_by] => 948 [modified_on] => 2014-12-31 16:08:58 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2252 [hits] => 0 ) [5] => stdClass Object ( [legacyinterface_commentary_id] => 2187 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15425 [apv_conversation_id] => 3033 [content_type] => market-commentary [title] => 2015 Global Market Outlook: Exploring the Growth Landscape [slug] => williamblair_123114 [fulltext] =>

For much of 2014, the financial press was filled with dire headlines warning of global stagnation and deflation. These demoralizing reports seemed to paralyze policy makers. The facts behind the headlines, however, suggested the reality was not nearly as gloomy or pessimistic as it seemed. This paper outlines a more optimistic outlook for 2015 where the world economy is expected to remain resilient and where the outlook for sustainable corporate returns remains strong.

2014 Market Review

Emerging market economies dominated financial markets in 2014. Figure 1 shows a list of the top ten equity and bond market returns through early December, heavily populated by emerging markets. This was particularly noteworthy in light of the U.S. Federal Reserve’s unwinding of quantitative easing operations. Returns are shown in U.S. dollar terms, thus fully reflecting the negative impact of USD strength. We believe the strong performance of emerging markets in spite of Fed policy headwinds is a testament to how far these countries have come as well as their future potential.

In the bond markets, global yields continued to compress in 2014. As recently as two years ago it would have been highly unlikely for a sovereign to make the top ten returns list with a yield of less than the mid-teens. But in 2014, yields of just under 4% represented some of the best returns available in fixed income. It was not surprising to see the search for yield spill into the equity space. This was evidenced by the fact that three of the top four performing global equity sectors were healthcare, real estate, and utilities.

Healthcare’s stellar performance was perhaps not surprising given the amount of mergers and acquisitions, both fulfilled and unfulfilled, occurring in the sector globally. With companies like Shire, Actelion, and Coloplast each up 40% – 60% in 2014, the market was showing its preference for security, high free cash flow, and good dividend yields.

The emphasis on yield and stable performance was also evident in the real estate sector, which was strong in 2014 across much of Continental Europe, the United Kingdom, and Sweden. Finally, compressing bond yields had a similar positive effect on utilities broadly, with particular strength in the European periphery markets as companies like Red Electrica and EDP-Energias de Portugal performed well. We believe that this focus on yield and free cash flow will continue to be an important driver of returns as we look ahead to 2015 and beyond.

Current Landscape: Low Growth and Pronounced Disinflation

How do we reconcile the disconnect between alarming financial headlines and actual market performance? We assert that it is all about falling inflation or “disinflation,” Figure 2 highlights the differentials between average growth rates in the years prior to the 2008 financial crisis and the last three years.

The total height of the bar is the nominal Gross Domestic Product (GDP) growth differential, which is composed of real growth and inflation. This clearly shows that most of the deceleration in growth was driven by lower or falling inflation. The notable exception was the Euro Area, where real growth decelerated dramatically. This disinflation trend has been a global phenomenon. In fact, the only major economy that registered significant acceleration in inflation over the last three years was Japan.

The pronounced and enduring disinflation across the globe is especially noteworthy in light of what has been a very aggressive monetary policy easing pursued by major central banks around the world. Figure 3 illustrates the growth of the U.S. monetary base as a percent of total global GDP. The amount of money supporting the U.S. economy has tripled in the last five years compared to the previous three decades.

The Fed has been joined in this effort by the Bank of England (BOE), and more recently by the Bank of Japan (BOJ), the People’s Bank of China (PBOC), and several smaller central banks. Despite this abundant liquidity injected into the world economy, the anticipated inflation has not ensued. Notably absent from this list is the European Central Bank (ECB), which remains embroiled in a heated debate with Germany, France and Italy on the issue of expanded powers and the fundamental role of the central bank. However, it is expected that Europe will be joining the BOE, BOJ, and PBOC in outright quantitative easing at some point in the spring of 2015.

Private sector growth in the U.S. has been quite robust and resilient for the past five years. Figure 4 shows the U.S. private sector has expanded at a rate of 2.25% – 2.50% quarterly (year-over-year) for an extended period.

In addition, industrial production volumes surpassed the 2007 peaks earlier in 2014, and industrial capacity is slowly working back to its pre-crisis levels.

Figure 5 shows that core consumer price inflation (CPI), excluding energy and food, is not accelerating. Likewise, hourly wage growth is not accelerating to anywhere near the levels seen before the 2008 crisis. In fact, the employment report released in early December 2014 was strong, showing the U.S. economy is adding quality private sector jobs at an ever-increasing rate, yet there are no signs that wages are increasing.

Figure 6 illustrates a similar disinflationary dynamic in the Euro area, especially when actual growth differences between the two sides of the Atlantic are taken into account. Core inflation has always been somewhat lower in Europe compared to the U.S., however, the more recent slowdown is largely due to weak growth. The headline inflation in the Euro Area is even weaker than the core, which has been the one beneficial effect of the rising tensions and sanctions on Russia. In the very short term, vast quantities of food exports destined for Russia were instead left in Europe, where a sizeable short-term oversupply meant lower food prices for many European consumers.

On a longer term note, change in the regional source of inflation within the Euro Area speaks to the ongoing significant structural adjustment taking place in Europe.

Figure 7 shows that, before 2008, core inflation in Spain was persistently at least one percentage point higher than the average for the Euro Area. At the same time, Germany was the “sick man of Europe” with correspondingly weak domestic consumption and inflation.  Today, this dynamic is completely reversed, as Spain is regaining competitiveness while the German consumer is enjoying good wage growth. 

The same disinflation trend is also evident in emerging markets. Figure 8 illustrates how core prices in China are growing faster now compared to the pre-2008 years. This is welcomed evidence of the ongoing rebalancing of the economy toward private domestic consumption. Much of the disinflation is coming from commodities prices, as producer prices in China follow commodities prices quite closely. China is not unique in this respect.

Figure 9 shows the same dynamic playing out across emerging markets broadly.

Commodities and Resources

China’s massive infrastructure overinvestment is clearly a factor in the pressure on commodities prices. In metals and certain forms of energy, most notably coal, China accounts for a large proportion of global demand (Figure 10). At the same time, the ongoing slowdown in residential real estate construction is applying downward pressure on the associated industrial metals and minerals prices. However, metals and coal account for only about 15% – 20% of commodities consumed by the emerging markets. The two principal contributors to inflation, food and energy, account for over 80%, and China is only one of many players. Specifically, China accounts for only about 20% of global fuel consumption, which is roughly in line with its share of global GDP. In agricultural markets, China barely plays any role at all. This supports the thesis that global disinflation has been driven by broader forces than China’s supposed overinvestment.

Over the past five years, commodities prices, as shown in Figure 11, have been broadly flat or declining slightly, showing no signs of inflation.

Oil prices fell sharply in the second half of 2014 due in part to the strong growth of shale production in the U.S. in recent years. At this point, the general expectation is that a dramatic reduction in oil prices will likely drive out some of the high cost producers in the U.S., with less additional supply resulting in higher oil prices by the end of 2015. While it is possible that this conventional argument will play out, we believe it is also equally possible that technological changes that are driving down the cost of fracking and shale production in the U.S. will continue to be underappreciated. Instead of leading to a significant decline in supply, current oil prices may only slow the growth of U.S. shale production. In this scenario, lower oil prices may not rebound as conventional wisdom suggests.

The drop in oil prices can be viewed as a tax cut on a global basis; some estimates are as high as $40 billion. This is clearly a positive for the consumer globally. On a country-by-country basis, the impact may be positive or negative depending on whether you are an importer or exporter of oil. From a Russian or Venezuelan perspective, this is almost a catastrophic development. On the positive side, countries that are dependent on imports are actually doing much better; for example India is a clear benefactor. For the U.S. and Europe, the pull-through from cheaper oil prices is a significant positive and clearly beneficial for the consumer.

Why Does Inflation Matter?

We believe that the prevailing environment of low inflation is particularly relevant to equity investors as it is a key source of corporate pricing power. The economy, as measured by GDP, effectively consists of wages and corporate profits. Both of these are partially driven by rising prices. Since the end of World War II, policy makers around the world have sought to ensure that the global economy operates in a low and stable inflationary environment. Company executives learned how to produce and sell products in such an environment, while financial markets participants designed tools to assess corporate performance in an inflationary setting. What are the implications for growth in a world without inflation? To the extent that inflation is seen as a manifestation of growth, is disinflation by extension a sign of stagnation?

Are growth and inflation really disappearing? We believe that the three key forces simultaneously driving growth and disinflation over the past four or five decades are globalization, technological innovation, and deregulation. Their importance over this time period is uncontested, and it is clear that they are not necessarily always forces for good – there are excesses and negatives associated with each. As we try to determine whether growth and inflation have permanently changed, we closely examine these themes.

From a globalization point of view, the expansion of trade and increased level of investment that have been seen post-World War II and post-Bretton Woods have led to integrated supply chains, cheaper products and even cheaper services on a global basis. Clearly economic growth has benefitted from globalization, but it has also been a significant contributor to disinflation as well.

Deregulation has enabled the opening of industries to private capital, the breaking down of monopolies, changes in workforce regulations, and the creation of wholly new industries. The resulting competition has driven growth, yet deregulation is not a panacea as the negatives associated with deregulation are also significant.

Technological innovation has unequivocally been a strong growth driver, but there is often capital misallocation associated with the hype of technology, as occurred most obviously amid the tech bubble period. The Moore’s Law curve, still very much intact today, has expanded processing power at ever cheaper rates and is leading to further disinflation while still producing growth. The conclusion drawn from these longer-term trends is that growth is intact but it is also important to understand the disinflation component.

The question remains: have these growth and disinflationary forces exhausted themselves? In the aftermath of the 2008 crisis, at least two of the three, globalization and deregulation, appear to have stalled. In Figure 12, global trade volumes are shown as a proxy for globalization. Following a decade of strong gains where global trade grew well in excess of global GDP, trade growth has slowed to a rate approximating global GDP growth.

Lack of progress on deregulation, which falls under the auspices of general economic policies, was well summarized by the International Monetary Fund’s José Viñals at a recent gathering in London. He accurately noted that, for the past five years, of the three major policy pillars, monetary policy has been the only game in town. This is true across much of the world, as most national governments focused on making sure that their domestic economies could weather the storm of demand destruction post the 2008 crisis.

But, five years after the financial crisis, things seem to be changing. Fiscal consolidation is over in both the U.S. and the Euro Area. As shown in Figures 13 and 14, government spending on both sides of the Atlantic declined sharply through 2011 and is now beginning to contribute positively to growth.

Globalization Trends

There are signs of reviving globalization, despite the fact that the last round of Doha negotiations at the World Trade Organization failed at the last moment in 2014. There are several transformational regional agreements in the final stages of negotiation following many years of work. Specifically, the Trans-Pacific Partnership (TPP) spans three continents and includes the U.S., Japan, Australia, Canada, Mexico, Peru, Chile, New Zealand, Malaysia, Singapore and Vietnam. Together, these economies account for 40% of global GDP. Further significant dismantling of trade barriers in goods and services, as well as intellectual property, will have a measurable boost to trade.

Less frequently discussed, but no less important in terms of its economic impact, is the Transatlantic Trade & Investment Partnership (TTIP), which is a regional agreement between the U.S. and the European Union. Taken together, these economies account for 45% of global GDP. Most negotiations on this have been completed and the lawyers are putting the finishing touches on the final text. If ratified, the benefits are estimated in the hundreds of billions of euros or dollars over the next 15 years. This would not only benefit the two economies in question, but the world at large.

Last month, China signed a free trade agreement with Australia that has been in the works for nearly a decade. It is a major step toward fully liberalizing bilateral trade between these two countries.

Globalization efforts do appear to be reviving. No fewer than a dozen bilateral and regional trade deals are currently in various stages of negotiations. While change is slow, structural changes are cumulative and we believe that these agreements in aggregate can have a meaningful impact over time.

Structural Reforms

The outlook on deregulation, or structural reforms, is also improving with several developments that promote growth and are disinflationary. Significant reforms are being seen in India, where the current Prime Minister Narendra Modi was elected in 2014 on a strong reform mandate. Modi appears to be delivering on his promise of less government “There are signs of reviving globalization...” and more governance. In an effort to lessen bureaucracy and streamline the provision of services, Modi’s government is prioritizing the digitization of permits requests and the centralization of subsidies distribution. We believe these microeconomic reforms will reduce the costs of doing business, as they limit opportunities for corruption and more efficiently deliver funds to end consumers without “bleeding” to endless layers of bureaucracy. In this way, these reforms are highly disinflationary.

In China, the current leadership consolidated power faster than most outside observers thought possible, taking concrete steps toward breaking up the triumvirate of state owned enterprises (SOEs), local governments, and large state-owned banks. If implemented, these reforms could pave the way for continued growth in China for years to come.

Reforms are not limited to emerging market economies as advanced economies are also making strides, perhaps most notably Japan. The key structural change that is a significant focus of Prime Minister Shinzo Abe’s efforts is inflation. There are early signs of success and we are already seeing positive signs of corporate performance in response.

Even the Euro Area is undertaking major initiatives. This is not limited to the recently announced infrastructure spending initiative in Europe, which so far has included few details and garnered little enthusiasm from the private sector. Fifteen years after the introduction of the single currency, there will finally be a banking union. As of November 2014, there is now a single, pan-European banking regulator, hastening the development of a fully integrated financial services market. All of these reforms are growth-promoting and disinflationary to the extent that they take costs out of the production of goods and services.

Investing in Growth in a Non-Inflationary World

How does one invest in growth in this noninflationary world? Our approach remains the same. Our philosophy has always been focused on seeking high quality growth companies that can deliver strong corporate performance. We remain focused on companies that we believe have the ability to generate free cash flow from both the top line and operational leverage on the margin side, which can then be reinvested back in the business or returned to shareholders.

Our continued focus on quality growth brings us to emerging markets (EMs). During the decade preceding the financial crisis, most major EMs undertook significant macroeconomic restructuring. Inflation and fiscal spending were brought under control, current account deficits were eliminated or reduced, and external debts were repaid. This paved the way for sustained rapid growth and has resulted in significant changes to the composition of the global high quality universe.

In 1997, as shown in Figure 15, our investable universe of high quality companies included just over 1,300 names, only 10% of which were from EMs. Today, not only has the universe doubled in size, but the number of high quality companies in EMs has risen seven-fold, and is now on par with the number of high quality companies in the U.S.

This macro restructuring and non-inflationary growth led to a rapid rise of the middle and lower middle class where the propensity to consume is many times greater than in developed economies. It is also where large groups of people are demanding continued non-inflationary growth. This was at the heart of the 2014 protests in Brazil. Political ramifications of the rise of the middle class in EMs are evident from India and Indonesia to Mexico, and perhaps less obviously, Brazil. As a result of their restructuring, many EMs are in a stronger position to control their economic development. In our view, the vigor with which they are able to implement reforms will largely determine the continued evolution of their economies and their growth trajectory.

Now more than ever the EMs are a heterogeneous lot of countries with very different economic and growth trajectories. For example, the prospects for India are significantly different than those for Russia. We believe the market now understands this as Figures 16 and 17 display the trends in the dispersion of returns and valuations. Whereas 10 – 15 years ago most of the EMs were traded or valued as a single asset class, the dispersion of the returns has expanded and the market is much more aggressively trying to differentiate between really true, sustainable quality companies and those that are not. The market appears to be paying for this as the differences in valuation are also notable.

Substantial dispersion can also be seen in Figure 18 by looking at the earnings trend/ valuation lens used by William Blair to evaluate stocks, sectors and countries. This illustrates how China, a market that was much more homogenous itself 10 – 15 years ago, now exhibits substantial dispersion across sectors in terms of valuation and earnings trends.

India

In the case of India, the goal of the near term reforms is to change the mix of economic growth and inflation. As shown in Figure 19, in the years preceding the financial crisis, India experienced strong growth and relatively low inflation. Over the past five years, the picture has completely reversed, with prices growing at or near a double-digit pace, while the economy grew at half the pace of the 2000s. Although inflation fell noticeably in the second half of 2014, Reserve Bank of India Governor Raghuram Rajan has yet to cut interest rates. Rajan’s actions suggest that the government is serious about reining in inflation to pave the way for productive investment and growth. For growth to accelerate, India needs massive private and public investment. Ultimately, the objective is to incentivize investments and to bring investment growth to generate further output gains.

As previously cited, India was the best performing market in 2014, in terms of both bonds and equities. Figure 20 shows that equity valuations are clearly above their 10 year average, but this does not necessarily mean they are overextended. Quality companies, as demonstrated through recent (or historic) corporate performance, are quite abundant in

India. It is not surprising for the technology sector to be a source of high quality companies, with well-known leaders in IT services, but we also see strong corporate performance in pharmaceuticals and the automotive industry.

Although valuations have increased, we believe there is potentially more opportunity from an equity investment perspective, as India is outperforming its emerging markets brethren with respect to earnings. While the spread is not huge we believe it is significant in that there is strong underlying fundamental performance. We will continue to review the fundamental earnings trends and progress on reform measures.

China

Deciphering China’s reform efforts is considerably more challenging. In the initial decades, China’s remarkable growth was based on an intertwined relationship between SOEs, local governments and large, state-owned banks. Such a system was very successful in rapidly mobilizing financial resources and developing infrastructure. At the same time, the private sector developed largely outside of this triumvirate, with little access to capital or resources. The private sector flourished despite these obstacles.

Today, private companies in China account for nearly 90% of employment and the vast majority of corporate profits. It is widely acknowledged that services and consumption are best delivered by market-based mechanisms. Chinese leaders have long recognized this, and efforts to open private sectors to capital more formally while dismantling SOE dominance are well underway.

The reforms over the next several years are complex and interrelated, but fall generally into three categories:

• SOE Restructuring: Provinces have published plans to restructure their SOEs, including asset sales, to the private sector. Several large companies, such as China Telecom and CNOOC, have already published their plans for mixed ownership and consolidation, and many local SOEs have already announced privatization plans. There are nearly 100,000 local SOEs in China, so the amount of assets and companies opening to the market will be significant in the coming years.

“If China is successful in implementing these reforms, we believe they will be strongly growth generative and ultimately disinflationary.”

• Fiscal Reform: In order to restructure and dispose of SOEs, local governments must have sources of financing other than SOE profits and land sales. Effective January 1, 2015, provincial level governments will be allowed to issue debt on behalf of towns and counties, subject to the provincial ceiling. This is the beginning of the municipal bond market in China, which we believe will also pave the way for greater transparency, and ultimately debt sustainability, in local government debt. At the same time, local governments are now expressly forbidden from setting up local government financing vehicles (LGFVs). There are also plans to address the existing stockpile of local government debt.

• Financial Liberalization: These reforms are accompanied by financial liberalization, as insurance companies and other financial intermediaries move in to collect savings and provide services previously reserved for state-owned banks.

This is a highly complex reform process that will take several years to materialize. If China is successful in implementing these reforms, we believe they will be strongly growth generative and ultimately disinflationary.

Japan

While various portions of the three arrows of Abenomics remain somewhat unfulfilled, the fundamental trends are encouraging. Using our earnings trend/valuation lens, the most interesting region globally remains Japan with strong earnings trends and supportive valuations across most sectors, as shown in Figure 21.

As seen in Figure 22, wages and core inflation are a key part of our positive view on Japan.

With regard to retail sales, efforts to move the buying public in Japan away from the caution previously exhibited were not helped by the sales tax increase in the spring of 2014. The result has been the postponement of the second tax increase, which could be positive for the economy more broadly.

Annualized share buybacks (Figure 23) illustrate how corporate performance has shown significant improvement in the past six months. The virtuous circle in Japan, in which higher return on equity is sought by management and rewarded by the market, is a significant change in the mental approach toward investment in Japan. Improved corporate performance evidenced by higher earnings, better dividends, and share buybacks that have been significantly ahead of market expectations, has given us confidence that reforms are already producing results. We are particularly encouraged by the recently launched JPX-Nikkei 400 Index targeting high ROE companies with good governance standards, and the Government Pension Investment Fund’s doubling of its target equities allocation in an effort to improve prospective returns.

United States

Finally, the U.S. enjoyed good performance in 2013 and 2014 driven by multiple expansion. While earnings have been catching up, U.S. valuations are extended versus the rest of the world. We believe that is fair since corporate performance has been much better in the U.S. than it has been in many other places. We are quite cognizant of the fact that reform, especially on the banking side, happened earlier and much more efficiently in the U.S. than it did anywhere else – most notably Europe. This is evident in the returns profile and GDP growth which is significantly ahead of what we have seen in other markets, particularly Europe.

With respect to the earnings outlook, there has also been considerable discussion that U.S. corporate profit margins will come under pressure. To the extent that we are not seeing wage growth being a significant impediment to corporate profit margins, we believe U.S. corporates will likely sustain their profitability profiles.

Summary

We anticipate the world economy in 2015 will remain resilient, but with a moderate growth profile overall. IMF data project global GDP growth around 3.3% – 3.5%; satisfactory in an historical context. The U.S. and Europe are expected to benefit from dissipating fiscal drag, while the Japanese tax increase postponement should have a positive impact. Emerging markets should benefit from lower commodity prices, stable developed market demand and domestic reform efforts.

Disinflation is likely to continue as we expect globalization, structural reform efforts, and technological changes to lead to lower prices. The emerging markets will continue to be important to investors, but differentiation among countries, sectors and companies will be critical to success. In our view the emerging markets are not a homogenous group: the prospects for India are significantly different than those for Russia.

As always, we will continue to seek sustainable corporate returns. We strongly believe that companies that demonstrate high returns on investment are better positioned to navigate this environment, and have better potential to provide a solid foundation for our portfolios.

Important Disclosures

This material is provided for information purposes only and is not intended as investment advice nor is it a recommendation to buy or sell any particular security. Any discussion of particular topics is not meant to be comprehensive and may be subject to change. Data shown does not represent the performance or characteristics of any William Blair product or strategy. Any investment or strategy mentioned herein may not be suitable for every investor. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Past performance is not indicative of future results. Information and opinions expressed are those of the author and may not reflect the opinions of other investment teams within William Blair & Company, L.L.C.’s Investment Management division. Information is current as of the date appearing in this material only and subject to change without notice.

© William Blair

 

[description] => For much of 2014, the financial press was filled with dire headlines warning of global stagnation and deflation. These demoralizing reports seemed to paralyze policy makers. The facts behind the headlines, however, suggested the reality was not nearly as gloomy or pessimistic as it seemed. This paper outlines a more optimistic outlook for 2015 where the world economy is expected to remain resilient and where the outlook for sustainable corporate returns remains strong. [author] => Simon Fennell, Olga Bitel [legacyinterface_firm_id] => 456 [published_on] => 2014-12-31 [digest_date] => 2014-12-31 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-31 16:33:10 [created_by] => 948 [modified_on] => 2014-12-31 16:48:23 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2253 [hits] => 0 ) [6] => stdClass Object ( [legacyinterface_commentary_id] => 2179 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15417 [apv_conversation_id] => 3026 [content_type] => market-commentary [title] => 2015 Investment Outlook - Stay Tactical! [slug] => cmg_123014 [fulltext] =>

I wrote often throughout 2014 about the danger signals flashing from an excessive run up in debt and derivatives. We have a repeat of the scenario we suffered in 2008, only much worse (Watch Junks Bonds For Early Warnings Of New Financial Crisis, Forbes). The budget recently passed by Congress put taxpayers on the hook for a 2008-like derivatives failure. The potential losses could exceed the previous financial meltdown as other world market conditions exacerbate a bad situation.

As a risk manager, I need to acknowledge and plan to mitigate these big, macro risks. At the same time, as a tactical manager, I acknowledge that right now the weight of evidence points to a continued positive trend for this mega bull market.

In a world of excessive debt and unprecedented Central Bank intervention, where is a global investor to go? For now, the best place remains in U.S. equities.

Global debt continues to be the #1 concern going into 2015. A sovereign debt crisis looms on the horizon yet for now the creativity of global central bankers has kicked that can down the road. It is desperation time in Japan and the Eurozone is not far behind. A number of factors favor the U.S. dollar and U.S. equities through mid-2015.

My snapshot 2015 investment outlook:

The Fed & Interest Rates

  • Expect rates to be modestly higher in 2015.
  • In comparison to a historical average of 3.3 percent annual GDP growth, my expectation of 2.8 percent growth is enough to keep the Fed on track to raise rates for the first time in June 2015.
  • North America remains the primary growth engine to the world. Particularly the U.S.
  • The wind shifts in the second half of the year as the probability of the second Fed interest rate increase occurs. This could happen in September or October 2015. Bull markets tend to end after the second Fed rate increase.

U.S. Stocks & Bonds

  • Ultra low fixed income yields favor equities over fixed income. Despite today’s high valuations, the strong U.S. equity bull market continues through mid-2015.
  • The third year of the presidential election cycle is historically bullish for stocks (especially the first half).
  • Global capital flows favor U.S. equities and U.S. real estate.
  • There are a number of risks: Geopolitical. Crisis in high yield debt. Margin debt is at the highest level in history. U.S. stock valuations are high. At a median PE of 21.2, current valuation puts the probable forward 10-year S&P 500 Index return at just 4.28%. Historically, the lowest performing quintile (yellow line).

  • The chase for yield has flooded the high yield market with money to invest. Less credit worthy companies found it easy to borrow and at terms far less favorable to investors. A high yield bond market default wave begins in 2015 and lasts for several years (See Code Red In High Yield, Forbes, 7/25/2014).
  • We are 5.75 years into the bull market that began in 2009. Compared with bull markets from 1923 (5.83 years), 1994 (5.75 years) and 2002 (5.0 years), this bull is aged. Couple this with low probable 10-year forward returns and you have a higher risk environment.
  • For now, the U.S. economy is holding up the world but the U.S. is not immune to the deflationary pressures that grip much of the global economy. Debt is the problem.
  • A sovereign debt crisis likely drives the next financial crisis: a global economic crisis that rivals the 2008 global financial meltdown. My best guess? Beginning in late 2015 or 2016.

There is more than $700 trillion in bank created synthetic derivatives. It exists in an intricate web of entangled global counterparty risk. The concentration of such risk lies in the hands of just a few large banks. One has to wonder to what degree a sovereign debt crisis or other unknowing event might trigger another major financial crisis. It is unnerving that the banks were able to get Congress to pass a bill that puts the U.S. taxpayer on the hook for bank losses related to the banks’ derivatives holdings.

Global Macro Views

  • As QE ends in the U.S., interest rates here will rise while rates in Japan (recession and early QE) and the Eurozone (deflation and probable QE) will fall relative to U.S. rates. Additionally, it is widely expected that the Fed will begin to normalize interest rates in June 2015. Both the Yen and Euro offer less favorable interest rates and are early in their QE program. This favors the U.S. dollar over Yen and Euros.
  • The Eurozone is in decline economically and is dysfunctional politically. Global investors will continue to see U.S. real estate and equity markets as better investment options. Further, a sovereign debt crisis will cause capital to race into U.S. dollars and U.S. assets. Equities are favored over bonds.
  • Japan is now “all in” on QE, which is negative for the Yen but positive for Japanese equities. At 250 percent debt to GDP, Japan has reached a crisis phase. Their plan is to devalue the Yen. This is not viewed favorably by Korea, China or Europe. In 2015, the global trade and currency wars intensify.
  • Global pension plans are significantly underfunded and meaningfully exposed to low yielding sovereign debt. A debt reset (default/restructuring) is the probable outcome.
  • Underfunded pensions, with exposure to such debts, will be forced to restructure. A pension crisis follows the sovereign debt crisis.
  • Global banks are exposed to sovereign debt. EU regulators have made it attractive for banks to own sovereign debt as banks do not have to hold any capital against their holdings of government debt. A banking crisis follows the sovereign debt crisis.
  • Japan is center stage and the Eurozone is up next. Trade tensions and currency battles mount. None of this is favorable for global growth. Slow global growth and deflation are likely to continue.

The global central banks have embarked on a grand experiment of unimaginable proportion. But it is wise to remember too that bankers are human. Greenspan shared in his book that his problem as Fed chair was that he just didn’t know about the flood of junk mortgages that fueled the unprecedented risk in housing prices during the bubble years. He offered this reason to explain his lack of action about the risks posed by the bubble.

The Guardian explains, “Greenspan’s ‘I didn’t know’ excuse is so absurd as to be painful. The explosion of exotic mortgages in the bubble years was hardly a secret. It was frequently talked about in the media and showed up in a wide variety of data sources, including those produced by the Fed. In fact, there were widespread jokes at the time about ‘liar loans’ or ‘Ninja loans.’ The latter being an acronym for the phrase, ‘no income, no job, no assets’.”1

Japan is in desperation mode. Europe is following quickly behind. The Fed has printed trillions of dollars and has meaningfully participated in our markets. It has kept interest rates at near zero percent for six years. QE has become the global medicine of choice. There will be unintended consequences.

Here are some things you can do to participate in the market’s upside while protecting yourself from the next market crisis.

  1. Overweight equities but put a stop loss process in place to protect yourself from a -40 percent or more decline. Placing a stop loss just below an ETF’s 200-day simple moving average can help.
  2. The following graph looks at a 13-week over a 34-week exponential moving average. If you are invested in an S&P 500 index ETF such as “IVV”, “VOO” or “SPY”, when the 13-week (blue) line declines below the 34-week (red) line, sell NYSE “SPY” or “IVV”, switch to a lower volatile S&P 500 index like “HSPX” (it uses covered calls) or move more defensively to iShares 1-3 year Treasury ETF symbol “SHY”.
  3. Favor large caps over small caps. I like the following sectors: Technology via iShares, U.S. Technology ETF “IYW”, Healthcare “IYH” and Consumer Staples “KXI”.
  4. Look to include tactical all asset, tactical equity and tactical fixed income strategies in your portfolio. These strategies offer disciplined buy and sell processes that can help you further mitigate portfolio risk. Remember that broad diversification coupled with sound risk management remains the best path over time.

In summary, capital continues to flow into dollars, supporting a favorable view of U.S. equities. Trend evidence remains positive. A reasonable guess puts the S&P 500 index at 2350 by mid-2015 (a gain of approximately 15 percent). But it is really just a guess – much is dependent on capital flows and the timing of developing sovereign debt default worries. Markets move on supply and demand. I see more demand than supply for now.

Overweight U.S. equities, but keep in mind that valuations are high and the bull market is aged as is favorable Fed policy. Risk remains high. Corrections happen quickly and absent a plan, recall that a 50 percent decline can wipe out all the gains made over the last few years. Further, it will then take another 100 percent gain to get back to even and that takes time. As we well know, meaningful declines can happen.

As with all predictions, it is smart to remain balanced. I remember the 35 Wall Street analysts who, this time last year, on average predicted the yield on the 10-year Treasury would rise from then 2.99% to 3.25% by the end of 2015. Here we stand at 2.12%. Not one analyst thought the yield would be below 2.90%. They all missed.

One of the best performing assets of the year, the iShares 20+ Year Treasury Bond ETF “TLT” is up 24% through December 16. I too believed rates would rise; however, despite my fundamental view, our bond positioning process kept us invested in bonds. Keep this in mind when you look at expert opinions. They are probability based and come with no guarantees. It is best to broadly diversify your risks, overweight to areas that look most promising and incorporate a disciplined process that limits your downside and can keep you participating in the upside just in case your view or mine is wrong.

I see a strong first half for 2015 with a potential tipping point in late 2015. The trigger could be a sovereign debt crisis, successive Fed rate increases, an unexpected shock in oil prices or something we just don’t yet know. The point is that systemic risk is high and a 2008 crisis-like event is probable in the near future. If valuations were in quintiles 1 or 2 (as presented in the chart above) the story today would be entirely different. I believe we’ll see those quintiles within the next few years.

The good news is that market crisis creates outstanding opportunity. With a risk management plan in place, you will have the liquidity that will enable you to take advantage of the opportunity that the next crisis creates and it may just help you sleep more peacefully at night.

Here’s to a great 2015. Stay tactical!

© CMG Capital Management Group

[description] => I wrote often throughout 2014 about the danger signals flashing from an excessive run up in debt and derivatives. We have a repeat of the scenario we suffered in 2008, only much worse. The budget recently passed by Congress put taxpayers on the hook for a 2008-like derivatives failure. The potential losses could exceed the previous financial meltdown as other world market conditions exacerbate a bad situation. [author] => Stephen Blumenthal [legacyinterface_firm_id] => 483 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 15:39:02 [created_by] => 948 [modified_on] => 2014-12-30 15:39:28 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2245 [hits] => 0 ) [7] => stdClass Object ( [legacyinterface_commentary_id] => 2180 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15418 [apv_conversation_id] => 3027 [content_type] => market-commentary [title] => Can The Dollar Save Small Caps? [slug] => leuthold_123014 [fulltext] =>

The dollar’s moonshot in recent months has resuscitated a stock market leadership argument we haven’t heard for a long time—namely, that Small Cap stocks are better insulated than Large Caps from the loss of competitiveness and the currency translation impact of a stronger buck. Is there merit to this argument, or are Small Cap proponents grasping for straws after a flat year? It turns out there’s reasonable support for the Small Cap enthusiasts’ view, based on evidence from the U.S. (trade-weighted) Dollar Index. Isolating all dollar swings of 15% or greater since 1971 yielded the following performance results:

Small Caps have, on average, outperformed Large Caps during periods of sustained U.S. dollar strength, generating an annualized total return of +13.6% versus +10.7% for the S&P 500. This 2.9% performance spread is significantly higher than the +0.9% per annum performance edge earned by Small Caps over the full 44-year period. In contrast, Small Caps compounded at just +9.2% during periods of dollar weakness, below the S&P 500 figure of +10.4%.

While the full-period results support the fundamentalists’ argument, the late 1990s stand out as a costly counter-example—with Large Caps clocking Small Caps for five consecutive years (1995 to 1999) despite an historic dollar rally that “should” have favored more domestically-exposed companies (i.e., Small Caps). Recent experience also runs counter to the long-term results; the current U.S. dollar strength kicked off in April 2011—coinciding to the month with the cycle’s Small Cap relative strength peak. Overall, we’d grade dollar strength as a mild positive for Small Caps, but not enough to outweigh other factors that continue to point to Large Cap strength (including relative valuations, looming Fed tightening, and the continued narrowing of market breadth related to bull market age).

© Leuthold Weeden Capital Management

[description] => The dollar’s moonshot in recent months has resuscitated a stock market leadership argument we haven’t heard for a long time—namely, that Small Cap stocks are better insulated than Large Caps from the loss of competitiveness and the currency translation impact of a stronger buck. Is there merit to this argument, or are Small Cap proponents grasping for straws after a flat year? It turns out there’s reasonable support for the Small Cap enthusiasts’ view, based on evidence from the U.S. (trade-weighted) Dollar Index. [author] => Doug Ramsey [legacyinterface_firm_id] => 265 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 19:15:55 [created_by] => 948 [modified_on] => 2014-12-30 19:16:56 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2246 [hits] => 0 ) [8] => stdClass Object ( [legacyinterface_commentary_id] => 2181 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15419 [apv_conversation_id] => 3028 [content_type] => market-commentary [title] => U.S. Consumers: Spend More? Bah, Humbug [slug] => abbett_123014 [fulltext] =>

Sometimes, something says something good about the economy’s growth prospects. Two quarters of relatively strong advances in real gross domestic product (GDP) and more recently falling oil prices and strong November jobs numbers offer such signs. They are welcome. Still, reason remains to curb levels of enthusiasm. The employment figures have given plenty of false signals in the past, and many of the same forces dampening growth so far in this recovery remain in place. Especially for the consumer, fully 70% of the economy, seems unwilling to act as aggressively as in the past and so is less likely to propel the overall pace of growth.         

The most recent good news is a pickup in the pace of hiring. Recent reports for November indicate 321,000 new jobs created during the month and upward revisions in previous months’ estimates.While this is indeed news, it is important to keep in mind that individual months in the past have shown surges that have then petered out. In January 2012, for instance, payrolls rose by 360,000 only to slow to a disappointing 96,000 by April. What is more important, and as a consequence more encouraging, is the general improvement this year over 2013. Every month this year, except weather–depressed January, has reported payroll increases over 200,000. Only five months showed such gains in 2013 and a still smaller portion in 2012. The 2.0% growth in payrolls so far this year compares to only 1.7% in 2013 and a 1.6% yearly rate averaged between 2010 and 2012. The jobs picture still has many troubling weak spots, but the trend is encouraging.

Presumably, the additional jobs will increase household incomes, encourage more consumer spending, and so accelerate the pace of overall economic growth. If the percentage point increase in employment were to translate directly into income, it would raise wages and salaries growth from the 4.3% pace averaged during the last twelve months toward 5.1%. Since wages and salaries constitute about half of all income in this economy, overall income flows would accordingly rise from the 3.9% recorded during the past twelve months toward 4.6%. With taxes still rising as a percent of gross income, spendable income growth would then register about a 4.5% nominal annual rate of increase. And if households were then to spend the increase, the overall pace of nominal consumer spending would accelerate from the 3.9% rate averaged during the past twelve months to about 4.5%, or about 3.0% in real terms. That would accelerate the economy’s overall 2.3% rate of real growth averaged during the past four quarters up to about 2.8%, an improvement but still short of the economy’s long-term average growth rate of 3.2% and its average growth rate of closer to 3.8%.     

But these are big “ifs.” For one, it is not apparent that the recent accelerated pace of employment growth can persist. False starts in the past issue a warning, and all the factors that so far have kept back hiring remain in place. Managements certainly continue to carry scars from the great recession that temper their impulse to expand, what the great economist John Maynard Keynes referred to as their “animal spirits.” Continued uncertainty about costs and the ultimate requirements of the Affordable Care Act and even the Dodd-Frank financial reform legislation will continue to reinforce such hesitations. Meanwhile, households, too, have shown an atypical caution about spending. Compared to past recoveries and the past in general, they have spent less aggressively in this recovery and saved more. On average, households have saved well over 5.0% of their after-tax income in this cycle, low by international standards but high by past American standards. What is more impressive, and indicative of how they will likely behave going forward, is how households, whenever their savings rates have fallen below trend, have quickly corrected by slowing their rate of spending.   

On balance, then, the consumer should hold to a comparatively slow rate of expansion even if the improved hiring trend is durable. It should come in below a 3.0% yearly rate. The current quarter may prove an exception, however. The recent precipitous drop in oil and gasoline prices will leave the consumer at least temporarily better off. Because energy absorbs almost 10% of the average household budget, the recent drop in price amounts to about a 2.5%  jump in real spendable income, a good portion of which consumers will no doubt use to improve the holidays, making the fourth-quarter GDP look better than the fundamentals and longer-term prospects described above. But unless the oil price declines go deeper still (not especially likely), much less if oil prices bounce back up (entirely possible given the volatility in the Middle East), the pace of consumption growth and overall growth in the new year should continue at a still substandard rate.

1 Employment data from the U.S. Department of Labor
Data from the U.S. Department of Commerce

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

© Lord Abbett

[description] => Despite an improving labor market and lower oil prices, consumer outlays should continue to expand at a slow pace. Here’s why. [author] => Milton Ezrati [legacyinterface_firm_id] => 273 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 19:19:50 [created_by] => 948 [modified_on] => 2014-12-30 19:20:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2247 [hits] => 0 ) [9] => stdClass Object ( [legacyinterface_commentary_id] => 2182 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15420 [apv_conversation_id] => 3029 [content_type] => market-commentary [title] => MLPs Weren’t Supposed To Decline [slug] => advisorshares_123014 [fulltext] =>

By: Roger Nusbaum AdvisorShares ETF Strategist

Most income investors will know at least a little about Master Limited Partnerships more commonly referred to as MLPs. Most MLPs are tied to the transportation of energy products. They collect royalties as the energy product moves through their pipeline (this is a very common structure). Fundamentally, the movement of MLPs should not be vulnerable to price movements of the underlying energy product. The royalty collected is what it is.

This is the generally accepted truthism about MLPs and most of the time it is correct but not always. The following chart from Google Finance tracks a large MLP exchange traded product in blue versus a large energy sector ETF in Red, we’ll get to the yellow line in a moment.

The royalties may not change but the price action of the two look very similar. In past declines MLPs have many times been spared but not always as was the case over the last month. You might think of course they will snap back and while that will probably turn out to be correct, someone sold at the lows, perhaps in a state of heightened emotions and now likely regrets (another emotion) the sale.

Of course MLPs could be vulnerable to lower demand; less oil moving through the pipeline would result in less royalty income.

The yellow line is a relatively large Business Development Company (BDC) that had a similar even if not exact decline as the MLP fund during the essentially the same period of time. The charted BDC was not an island, one of the BDC ETPs was down in lockstep with the charted individual name. Again, there has been snapback in both but also again, someone sold at the lows.

We often see articles published in numerous places suggesting very large weightings to various income vehicles including MLPs and BDCs. Someone who put 15% in each increased their chances of being put in a position where they panic sell. It is much easier to be rational now after the worst of it (or maybe now is just a respite) than during the heat of the decline.

Look at the correlation of MLPs and BDCs as measured by the respective ETPs there seems to be no rhyme or reason here, sometimes they correlate closely and sometimes the correlation is negative so it is probably a coincidence that they both went down at the same time and it might be a rare event that MLPs go down under the weight of a drop in oil prices but both happened and both happened at the same time.

This sort of unfortunate coincidence can happen at any time with any market segment. REITs did not go down with the other two this time around but what if they did and in addition to 15% in the other two the same investor had another 15% in REITs?

MLPs, BDCs, REITs and any others are valid portfolio exposures, the point here is about weighting. Most of the time these things do what investors hope they do but that won’t matter if you give in to a panicked decline. Everyone has their own threshold for capitulation and as I have said many times before finding out you too much in fill-in-the-blank after it goes down a lot is a very bad place for an investor to be.

Any market segment can have some sort of event that even if unjustified fundamentally can still do permanent portfolio damage to the investor whose panic threshold is breached. This is why diversification and emotional control are both so important to long term investing success. 

© AdvisorShares

[description] => Most income investors will know at least a little about Master Limited Partnerships more commonly referred to as MLPs. Most MLPs are tied to the transportation of energy products. They collect royalties as the energy product moves through their pipeline (this is a very common structure). Fundamentally, the movement of MLPs should not be vulnerable to price movements of the underlying energy product. The royalty collected is what it is. [author] => Roger Nusbaum [legacyinterface_firm_id] => 14 [published_on] => 2014-12-30 [digest_date] => 2014-12-30 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-30 19:27:42 [created_by] => 948 [modified_on] => 2014-12-30 19:29:58 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2248 [hits] => 0 ) [10] => stdClass Object ( [legacyinterface_commentary_id] => 2126 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15416 [apv_conversation_id] => 3015 [content_type] => market-commentary [title] => The Lessons of Oil [slug] => oaktree_122914 [fulltext] =>

Memo to:         Oaktree Clients

From:               Howard Marks

Re:                   The Lessons of Oil


I want to provide a memo on this topic before I – and hopefully many of my readers – head out for year-end holidays.  I’ll be writing not with regard to the right price for oil – about which I certainly have no unique insight – but rather, as indicated by the title, about what we can learn from recent experience.

  • Despite my protestations that I don’t know any more than others about future macro events – and thus that my opinions on the macro are unlikely to help anyone achieve above average performance – people insist on asking me about the future.  Over the last eighteen months (since Ben Bernanke’s initial mention that we were likely to see some “tapering” of bond buying), most of the macro questions I’ve gotten have been about whether the Fed would move to increase interest rates, and particularly when.  These are the questions that have been on everyone’s mind.

    Since mid-2013, the near-unanimous consensus (with credit to DoubleLine’s Jeffrey Gundlach for vocally departing from it) has been that rates would rise.  And, of course, the yield on the 10-year Treasury has fallen from roughly 3% at that time to 2.2% today.  This year many investing institutions are underperforming the passive benchmarks and attributing part of the shortfall to the fact that their fixed income holdings have been too short in duration to allow them to benefit from the decline of interest rates.  While this has nothing to do with oil, I mention it to provide a reminder that what “everyone knows” is usually unhelpful at best and wrong at worst.  

  • Not only did the investing herd have the outlook for rates wrong, but it was uniformly inquiring about the wrong thing.  In short, while everyone was asking whether the rate rise would begin in December 2014 or April 2015 (or might it be June?) – in response to which I consistently asked why the answer matters and how it might alter investment decisions – few people I know were talking about whether the price of oil was in for a significant change.

    Back in 2007, in It’s All Good, I provided a brief list of some possibilities for which I thought stock prices weren’t giving enough allowance.  I included “$100 oil” (since a barrel was selling in the $70s at the time) and ended with “the things I haven’t thought of.”  I suggested that it’s usually that last category – the things that haven’t been considered – we should worry about most.  Asset prices are often set to allow for the risks people are aware of.  It’s the ones they haven’t thought of that can knock the market for a loop.

  • In my book The Most Important Thing, I mentioned something I call “the failure of imagination.”  I defined it as “either being unable to conceive of the full range of possible outcomes or not understanding the consequences of the more extreme occurrences.”  Both aspects of the definition apply here.

    The usual starting point for forecasting something is its current level.  Most forecasts extrapolate, perhaps making modest adjustments up or down.  In other words, most forecasting is done incrementally, and few predictors contemplate order-of-magnitude changes.  Thus I imagine that with Brent crude around $110 six months ago, the bulls were probably predicting $115 or $120 and the bears $105 or $100.  Forecasters usually stick too closely to the current level, and on those rare occasions when they call for change, they often underestimate the potential magnitude.  Very few people predicted oil would decline significantly, and fewer still mentioned the possibility that we would see $60 within six months. 

    For several decades, Byron Wien of Blackstone (and formerly of Morgan Stanley, where he authored widely read strategy pieces) has organized summer lunches in the Hamptons for “serious,” prominent investors.  At the conclusion of the 2014 series in August, he reported as follows with regard to the consensus of the participants:

    Most believed that the price of oil would remain around present levels.  Several trillion dollars have been invested in drilling over the last few years and yet production is flat because Nigeria, Iraq and Libya are producing less.  The U.S. and Europe are reducing consumption, but that is being more than offset by increasing demand from the developing world, particularly China.  Five years from now the price of Brent is likely to be closer to $120 because of emerging market demand.

    I don’t mean to pick on Byron or his luncheon guests.  In fact, I think the sentiments he reported were highly representative of most investors’ thinking at the time.

    As a side note, it’s interesting to observe that growth in China already was widely understood to be slowing, but perhaps that recognition never made its way into the views on oil of those present at Byron’s lunches.  This is an example of how hard it can be to appropriately factor all of the relevant considerations into complex real-world analysis.

  • Turning to the second aspect of “the failure of imagination” and going beyond the inability of most people to imagine extreme outcomes, the current situation with oil also illustrates how difficult it is to understand the full range of potential ramifications.  Most people easily grasp the immediate impact of developments, but few understand the “second-order” consequences . . . as well as the third and fourth.  When these latter factors come to be reflected in asset prices, this is often referred to as “contagion.”  Everyone knew in 2007 that the sub-prime crisis would affect mortgage-backed securities and homebuilders, but it took until 2008 for them to worry equally about banks and the rest of the economy.

     

    The following list is designed to illustrate the wide range of possible implications of an oil price decline, both direct consequences and their ramifications: 

    • Lower prices mean reduced revenue for oil-producing nations such as Saudi Arabia, Russia and Brunei, causing GDP to contract and budget deficits to rise.

    • There’s a drop in the amounts sent abroad to purchase oil by oil-importing nations like the U.S., China, Japan and the United Kingdom.

    • Earnings decline at oil exploration and production companies but rise for airlines whose fuel costs decline.

    • Investment in oil drilling declines, causing the earnings of oil services companies to shrink, along with employment in the industry.

    • Consumers have more money to spend on things other than energy, benefitting consumer goods companies and retailers.

    • Cheaper gasoline causes driving to increase, bringing gains for the lodging and restaurant industries.

    • With the cost of driving lower, people buy bigger cars – perhaps sooner than they otherwise would have – benefitting the auto companies.  They also keep buying gasoline-powered cars, slowing the trend toward alternatives, to the benefit of the oil industry.

    • Likewise, increased travel stimulates airlines to order more planes – a plus for the aerospace companies – but at the same time the incentives decline to replace older planes with fuel-efficient ones.  (This is a good example of the analytical challenge: is the net impact on airplane orders positive or negative?)

    • By causing the demand for oil services to decline, reduced drilling leads the service companies to bid lower for business.  This improves the economics of drilling and thus helps the oil companies.

    • Ultimately, if things get bad enough for oil companies and oil service companies, banks and other lenders can be affected by their holdings of bad loans.

  • Further, it’s hard for most people to understand the self-correcting aspects of economic events.

    • A decline in the price of gasoline induces people to drive more, increasing the demand for oil.

    • A decline in the price of oil negatively impacts the economics of drilling, reducing additions to supply.

    • A decline in the price of oil causes producers to cut production and leave oil in the ground to be sold later at higher prices.

    In all these ways, lower prices either increase the demand for oil or reduce the supply, causing the price of oil to rise (all else being equal).  In other words, lower oil prices – in and of themselves – eventually make for higher oil prices.  This illustrates the dynamic nature of economics.

  • Finally, in addition to the logical but often hard-to-anticipate second-order consequences or knock-on effects, negative developments often morph in illogical ways.  Thus, in response to cascading oil prices, “I’m going to sell out of emerging markets that rely on oil exports” can turn into “I’m going to sell out of all emerging markets,” even oil importers that are aided by cheaper oil.

    In part the emotional reaction to negative developments is the product of surprise and disillusionment.  Part of this may stem from investors’ inability to understand the “fault lines” that run through their portfolios.  Investors knew changes in oil prices would affect oil companies, oil services companies, airlines and autos.  But they may not have anticipated the effects on currencies, emerging markets and below-investment grade credit broadly.  Among other things, they rarely understand that capital withdrawals and the resulting need for liquidity can lead to urgent selling of assets that are completely unrelated to oil.  People often fail to perceive that these fault lines exist, and that contagion can reach as far as it does.  And then, when that happens, investors turn out to be unprepared, both intellectually and emotionally. 

    A grain of truth underlies most big up and down moves in asset prices.  Not just “oil’s in oversupply” today, but also “the Internet will change the world” and “mortgage debt has historically been safe.”  Psychology and herd behavior make prices move too far in response to those underlying grains of truth, causing bubbles and crashes, but also leading to opportunities to make great sales of overpriced assets on the rise and bargain purchases in the subsequent fall.  If you think markets are logical and investors are objective and unemotional, you’re in for a lot of surprises.  In tough times, investors often fail to apply discipline and discernment; psychology takes over from fundamentals; and “all correlations go to one,” as things that should be distinguished from each other aren’t.

  • To give you an idea about how events in one part of the economy can have repercussions in other economic and market segments, I’ll quote from some of the analyses I’ve received this week from Oaktree investment professionals:

    • Energy is a very significant part of the high yield bond market.  In fact, it is the largest sector today (having taken over from media/telecom, which has traditionally been the largest).  This is the case because the exploration industry is highly capital-intensive, and the high yield bond market has been the‎ easiest place to raise capital.  The knock-on effects of a precipitous fall in bond prices in the biggest sector in the high yield bond market are potentially substantial: outflows of capital, and mutual fund and ETF selling.  It would be great for opportunistic buyers if the selling gets to sectors that are fundamentally in fine shape . . . because a number of them are.  And, in fact, low oil prices can even make them better.

    • An imperfect analogy might be instructive: capital market conditions for energy-related assets today are not unlike what we saw in the telecom sector in 2002.  As in telecom, you’ve had the confluence of really cheap financing, innovative technology, and prices for the product that were quite stable for a good while.  [To this list of contributing factors, I would add the not-uncommon myth of perpetually escalating demand for a product.]  These conditions resulted in the creation of an oversupply of capacity in oil, leading to a downdraft.  It’s historically unprecedented for the energy sector to witness this type of market downturn while the rest of the economy is operating normally.  Like in 2002, we could see a scenario where the effects of this sector dislocation spread wider in a general “contagion.”

    • Selling has been reasonably indiscriminate and panicky (much like telecom in 2002) as managers have realized (too late) how overexposed they are to the energy sector.  Trading desks do not have sufficient capital to make markets, and thus price swings have been predictably volatile.  The oil selloff has also caused deterioration in emerging market fundamentals and may force spreads to gap out there.  This ultimately may create a feedback loop that results in contagion to high yield bonds generally.
  • Over the last year or so, while continuing to feel that U.S. economic growth will be slow and unsteady in the next year or two, I came to the conclusion that any surprises were most likely to be to the upside.  And my best candidate for a favorable development has been the possibility that the U.S. would sharply increase its production of oil and gas.  This would make the U.S. oil-independent, making it a net exporter of oil and giving it a cost advantage in energy – based on cheap production from fracking and shale – and thus a cost advantage in manufacturing.  Now, the availability of cheap oil all around the world threatens those advantages.  So much for macro forecasting!

  • There’s a great deal to be said about the price change itself.  A well-known quote from economist Rudiger Dornbusch goes as follows: “In economics things take longer to happen than you think they will, and then they happen faster than you thought they could.”  I don’t know if many people were thinking about whether the price of oil would change, but the decline of 40%-plus must have happened much faster than anyone thought possible.

  • “Everyone knows” (now!) that the demand for oil turned soft (due to sluggish economic growth, increased fuel efficiency and the emergence of alternatives) at the same time that the supply was increasing (as new sources came on stream).  Equally, everyone knows that lower demand and higher supply imply lower prices.  Yet it seems few people recognized the ability of these changes to alter the price of oil.  A good part of this probably resulted from belief in the ability of OPEC (meaning largely the Saudis) to support prices by limiting production.

    A price that’s kept aloft by the operation of a cartel is, by definition, higher than it would be based on supply and demand alone.  Maybe the thing that matters is how far the cartelized price is from the free-market price; the bigger the gap, the shorter the period for which the cartel will be able to maintain control.  Initially a cartel or a few of its members may be willing to bear pain to support the price by limiting production even while others produce full-out.  But there may come a time when the pain becomes unacceptable and the price supporters quit.  The key lesson here may be that cartels and other anti-market mechanisms can’t hold forever.  As Herb Stein said, “If something cannot go on forever, it will stop.”  Maybe we’ve just proved that this extends to the effectiveness of cartels.

  • Anyway, on the base of 93 million barrels a day of world oil use, some softness in consumption combined with an increase in production to cut the price by more than 40% in just a few months.  What this proves – about most things – is that to Dornbusch’s quote above we should append the words “. . . and they go much further than you thought they could.” 

    The extent of the price decline seems much greater than the changes in supply and demand would call for.  Perhaps to understand it you have to factor in (a) Saudi Arabia’s ceasing to balance supply and demand in the oil market by cutting production, after having done so for many years, and (b) a large contribution to the decline on the part of psychology.  (In the “conspiracy theory” department, consider the rumor that Saudi Arabia is allowing or abetting the price drop in order to either punish Iran, Iraq and ISIL; put the U.S. shale oil industry out of business; or discipline the more profligate members of OPEC . . . take your pick.)

    The price of oil thus may have gone from too high (supported by OPEC and by Saudi Arabia in particular) to too low (depressed by negative psychology).  It seems to me with regard to the latter that the price fell too far for some market participants to maintain their equanimity.  I often imagine participants’ internal dialogues.  At $110, I picture them saying, “I’ll buy like mad if it ever gets to $100.”  Because of the way investor psychology works, at $90 they may say, “If it falls to $70, I’ll give serious thought to buying.”  But at $60 the tendency is to say, “It’s a falling knife and there’s no way to know where it’ll stop; I wouldn’t touch it at any price.” 

    It feels much better to buy assets while they’re rising.  But it’s usually smarter to buy after they’ve fallen for a while.  Bottom line, as noted above: there’s little logic in investor psychology.

  • I said it about gold in All That Glitters (November 2010), and it’s equally relevant to oil: it’s hard to analytically put a price on an asset that doesn’t produce income.  In principle, a non- perishable commodity won’t be priced below the variable production cost of the highest-cost producer whose output is needed to satisfy total demand.  But in reality and in the short run, strange things can happen.  It’s clear that today’s oil price is well below that standard.

    It’s hard to say what the right price is for a commodity like oil . . . and thus when the price is too high or too low.  Was it too high at $100-plus, an unsustainable blip?  History says no: it was there for 43 consecutive months through this past August.  And if it wasn’t too high then, isn’t it laughably low today?  The answer is that you just can’t say.  Ditto for whether the response of the price of oil to the changes in fundamentals has been appropriate, excessive or insufficient.  And if you can’t be confident about what the right price is, then you can’t be definite about financial decisions regarding oil.

In the last few years, as I said in The Role of Confidence (August 2013), investor sentiment has been riding high.  Or, as Doug Kass pointed out this past summer, there’s been “a bull market in complacency.”  Regardless, it seems that a market that was unconcerned about things like oil and its impact on economies and assets now has lost its composure.  Especially given the pervasive role of energy in economic life, uncertainty about oil introduces uncertainty into many aspects of investing. 

“Value investing” – the form of investing Oaktree practices – is supposed to be about buying based on the present value of assets, rather than conjecture about profit growth in the far-off future.  But you can’t assess present value without taking some position on what the future holds, even if it’s only assuming a continuation of present conditions or perhaps – for the sake of conservatism – a considerably lower level.  Recent events cast doubt on the ability to safely take any position.

One of the things that’s central to risk-conscious value investing is ascertaining the presence of a generous cushion in terms of “margin of safety.”  This margin comes from conviction that conditions will be stable, financial performance is predictable, and/or an entry price is low relative to the asset’s intrinsic value.  But when something as central as oil is totally up for grabs, as investors seem to think is the case today, it’s hard to know whether you have an adequate margin.  Referring to investing, Charlie Munger told me, “It’s not supposed to be easy.”  The recent events surrounding oil certainly prove that it isn’t.

On the other hand – and in investing there’s always another hand – high levels of confidence, complacency and composure on the part of investors have in good measure given way to disarray and doubt, making many markets much more to our liking.  For the last few years, interest rates on the safest securities – brought low by central banks – have been coercing investors to move out the risk curve.  Sometimes they’ve made that journey without cognizance of the risks they were taking, and without thoroughly understanding the investments they undertook.  Now they find themselves questioning many of their actions, and it feels like risk tolerance is being replaced by risk aversion.  This paragraph describes a process through which investors are made to feel pain, but also one that makes markets much safer and potentially more bargain-laden. 

In particular with regard to the distress cycle, confident and optimistic credit markets permit the unwise extension of credit to borrowers who are undeserving but allowed to become overlevered nevertheless.  Negative subsequent developments can render providers of capital less confident, making the capital market less accommodative.  This cycle of easy issuance followed by defrocking has been behind the three debt crises that delivered the best buying opportunities in our 26 years in distressed debt.  We think it also holds the key to the creation of superior opportunities in the future.

We’ve argued for a few years that credit standards were dropping as investors – chasing yield – became less disciplined and less discerning.  But we knew great buying opportunities wouldn’t arrive until a negative “igniter” caused the tide to go out, exposing the debt’s weaknesses.  The current oil crisis is an example of something with the potential to grow into that role.  We’ll see how far it goes.

For the last 3½ years, Oaktree’s mantra has been “move forward, but with caution.”  For the first time in that span, with the arrival of some disarray and heightened risk aversion, events tell us it’s appropriate to drop some of our caution and substitute a degree of aggressiveness.

December 18, 2014


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[description] => I want to provide a memo on this topic before I – and hopefully many of my readers – head out for year-end holidays. I’ll be writing not with regard to the right price for oil – about which I certainly have no unique insight – but rather, as indicated by the title, about what we can learn from recent experience. [author] => Howard Marks [legacyinterface_firm_id] => 323 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 1 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-20 04:38:18 [created_by] => 945 [modified_on] => 2014-12-29 22:12:43 [modified_by] => 945 [checked_out_time] => 2014-12-29 22:12:57 [checked_out] => 945 [asset_id] => 2192 [hits] => 0 ) [11] => stdClass Object ( [legacyinterface_commentary_id] => 2170 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15406 [apv_conversation_id] => [content_type] => market-commentary [title] => Unsettling Interplay of Leading Indicators [slug] => dynamika_122914 [fulltext] =>

Disclaimer

The information, tools and material presented herein are provided for informational purposes only and are not to be used or considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities, investment products or other financial instruments, nor to constitute any advice or recommendation with respect to such securities, investment products or other financial instruments. This research report is prepared for general circulation. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should independently evaluate particular investments and consult an independent financial adviser before making any investments. 

We review in details where we stand in terms of the US and World leading indicators and point to some of the unsettling recent developments which should be watched carefully over the coming months. Happy holidays and happy New Year!

The set of indicators we review comprises

- US shadow policy rate;

- US Treasury yield curve;

- US TIPS yield curve;

- Global business cycles interplay (OECD CLI);

- G7 growth and inflation (OECD MEI);

- World trade and industrial production;

- US conventional growth leading indicator;

- US coincident inflation indicator;

- US job creation;

- US growth and inflation based on Macro-Yield model, small and large datasets;

- US GDP-based leading indicator.

For the details on the methodology and explanations refer to the previous  Commentaries.[1][2][3]

US shadow policy rate

We use the proprietary methodology to construct the shadow Fed Funds rate implied by other economic and financial information (methodology is similar to the recent BIS work[4]). Below the Fed Funds rate and its shadow reconstruction over the last 45 years are presented

Here is the more recent snapshot

As one can see the Fed has been effectively tightening since May 2013 Taper announcement with some recent acceleration.

US Treasury yield curve

As we cautioned in February 2014[5][6] the yield curve level is going down and the curve is flattening to the levels not seen since the Global Financial Crisis

US TIPS yield curve

The level of the TIPS yield curve remained relatively flat post Taper Tantrum

but together with the Treasury yield curve the TIPS yield curve was flattening since December 2013 and reached some extreme historic flattening recently

This is of course also reflected in 5Y5Y forward rates

Global business cycles interplay (OECD CLI)

We use OECD CLI dataset (see the previous Dynamika Commentaries for explanation[7][8]).

Global Business Cycle Factor: what an unseen plateau! Where to now?

Europe Idiosyncratic Factor (outperformance of Europe versus Global Factor): Europe continues to underperform.

Asia Idiosyncratic Factor (underperformance of Asia versus Global Factor): China seems has turned the corner.

The US is the most interesting case as it seems to be doing well but for the wrong reasons.

Given recent plateau in the Global Factor the US was mostly uplifted by Europe deterioration and uplifted be recent asia deceleration. Here is how all three factors contributed to the US

You can see how the end of 2012 slowdown was avoided thanks to the uplifting Europe pain. Most recent European calamity also helps the US big time.

G7 growth and inflation (OECD MEI)

We use OECD MEI dataset to extract growth and inflation factors for each of the G7 countries (US, Japan, Germany, France, Italy, Canada, UK). Here are for example the US growth and inflation (sorry, inverted) factors (last data-point is October 2014):

Next we look what drives these 14 factors and come up with G7 growth factor

and G7 inflation factor

Not too optimistic though dataset and is very Euro-centric.

World trade and industrial production

World trade indicator based on common factor

World industrial production indicator based on common factor

US conventional growth leading indicator

Our conventional US growth leading indicator

Important to note that manufacturers new orders for non-defense capital goods have not been following suite recently and surprised to the downside

It is also noteworthy that decomposing leading indicators into two leading factors instead of one we see one surging leading indicator with higher lead (green) which is driven by PMI new orders and second factor which is now more of a coincident indicator and which continues to slowdown.

It is hard to say what is going on and we will be watching it carefully in the coming months.

US coincident inflation indicator

Our coincident inflation indicator shows no inflation in sight

US job creation

Our job creation indicator based on Establishment Survey data still looks solid (though it is lagging indicator):

US growth and inflation based on Macro-Yield model, small and large datasets

Our Macro-Yield model growth factor is not particularly optimistic

Our growth and inflation factors based on the small US dataset

Growth:

Inflation (sorry, inverted):

Similar results in our growth and inflation factors based on the large US dataset

Growth:

Inflation:

US GDP-based leading indicator

Finally GDP-based growth leading indicator[9] is not too optimistic

Happy Holidays and Happy New Year!

© Dynamika Capital L.L.C.



[1] Dynamika Commentary, “Lifted by Germany and China”, 16 August 2014

[2] Dynamika Commentary, “Monitoring the late cycle symptoms”, 1 June 2014

[3] Dynamika Commentary, “Watch out for the late cycle symptoms”, 30 March 2014

[4] BIS, “A shadow policy rate to calibrate US monetary policy at the zero lower bound”, June 2014

[5] Dynamika Commentary, “Where do the leading indicators lead?”, 28 February 2014

[6] Dynamika Commentary, “Watch out for the late cycle symptoms”, 30 March 2014

[7] Dynamika Commentary, “The global interplay of business cycles”, 31 May 2014

[8] Dynamika Commentary, “Lifted by Germany and China”, 16 August 2014

[9] Dynamika Commentary, “Watch out for the late cycle symptoms”, 30 March 2014

[description] => We review in details where we stand in terms of the US and World leading indicators and point to some of the unsettling recent developments which should be watched carefully over the coming months. [author] => Alexander Giryavets [legacyinterface_firm_id] => 503 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:02:50 [created_by] => 948 [modified_on] => 2014-12-29 16:03:13 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2236 [hits] => 0 ) [12] => stdClass Object ( [legacyinterface_commentary_id] => 2171 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15407 [apv_conversation_id] => [content_type] => market-commentary [title] => The Coming Crash in 2015: Why there will be no Happy New Year before we see QE Reloaded [slug] => franz_122914 [fulltext] =>
In September 2013 in my post How QE Alters Bond Yields (Or Rather How It Does Not) I wrote that historically the end of QE was associated with the following 4 events, which I expected to show up again after the end of the latest QE-programs (which in some cases was completely against the market consensus of that time):
1)      Falling inflation expectations
2)      As a result: falling Treasury yields (what basically no one believed at that time)
3)      Rising credit spreads
4)      A falling stock market
 
Now almost 2 months after the end of QE I thought it was time to look back on what has happened so far (the first 3 prediction were quite spot-on) and what it means for the part that has not yet happened (the 4th prediction).
Let’s get through it step by step.
1)      Inflation expectations: They completely crashed. While everyone blames it on the oil crash, it is exactly the same pattern as the last 2 times.
2)      Treasury Yields: Against an overwhelming consensus (what was suspicious anyway) Treasury yields fell, when the Fed reduced its purchases
This was something that most people got wrong. Here is a short run-down why: Most expected that when the Fed would stop its purchases, demand would therefore fall and yields would have to rise. Now what was wrong with that assumption was that the Fed, though the largest holder of Treasuries, does not yet control the market (as perhaps the BoJ does in the JGB market), nor is it just a marginal buyer that does not influence the behavior of all other participants. Just the opposite: The Fed vastly influences expectations of all other bond buyers. The Fed buying Treasuries increases the money supply which increases inflation expectations, which increases the expected path of future Fed Funds rates. And this is the main point: The long-end of the Treasury yield curve is basically nothing else than the average expected Fed Funds Rate over the lifespan of the bond (plus a small term premium, but this is in comparison a minor issue), no matter what the Fed is buying or not. Otherwise large arbitrage opportunities would be created. So what counts is not how much the Fed is buying in the Treasury market but what it means for expectations of future rate hikes. And that’s why yields rose substantially at the beginning of QE 1 and to a lesser degree after QE 2 and not at all after the beginning of Twist (as bond traders became sober about the less than expected effect of QE on inflation, gave up on betting on an early rate hike and took QE for granted). Yields only rose in spring of 2013 when the Fed did not only talk about tapering, but connected it indirectly to the next rate hike. Both events were then tied to the unemployment rate. QE should have ended at a rate of 7%, the first Fed Funds rate hike should have occurred at unemployment below 6.5%. With tapering ending and the Fed shifting its justification for rate hikes away from unemployment towards inflation, which remains very low, yields began to fall despite the end of QE.
By the way, if you think QE is responsible for low yields, think about the Eurozone, where yields are even much, much lower, despite the ECB backtracking on QE. Why? Because it is the lack of QE that has brought the  Eurozone towards the edge of deflation and with as a result no rate hike by the ECB to be seen in a long, long time, even rock-bottom yields get some kind of justification.
So QE did not decrease rates, therefore did not increase bond prices. That means, while the Fed bought Treasuries, everyone else sold. So where did the money actually go? Into risky assets. The Fed did not suppress yields with QE; instead it crowded out the Treasury market and pushed everyone towards the more risky stuff.
And this is the main point now and in coming months, as things are starting to reverse here as well. And leads me to prediction
3)      Rising credit spreads. What got rather little attention in the ongoing bull market in equities: Spreads have been constantly on the rise since the end of June when the Fed had cut the QE program to $35 billion.
Things are even much worse in the lowest rated space, the CCC and below rated stuff (while that once used to be more or less a no-go area, it now makes up a substantial part of many high yield funds):
While many blame the high yield sell-off on the low oil price that has caused troubles for HY issuers in the once booming fracking industry, the rise in spreads began much earlier than the crash in oil (see more on oil below). Further the spread widening is not just a thing of the high yield market. It’s the same story in investment grade (and much more stuff, see more on that below).
Now before I want to dig further into this risk-off story in a couple of markets I want to look at prediction
4)      Falling stock prices. This is the only prediction that so far has not yet come true.
Why? I “blame” it on the strong seasonality at the end of the year. Different to QE 1 and 2 this time around QE ended not right before or in the mid of the usually dull summer swoon, but right before the historically best time of the year.
But what does that mean for the next year? Nothing good. Once the strong seasonality wanes and liquidity tries up, things are bound to turn ugly. This could already happen in late January or in February, as February is historically one of the weakest months of the year and the big exception in the historically strong winter half-year (November to April).
I have nothing good to say about the US stock market for early 2015, especially as I look at a lot of other stories going on right now.
One interesting aspect to look at post-QE is how the last 2 major downturns had evolved compared to this time. In both cases the main trouble came from the Eurozone. Immediately after the end of QE1 things got completely out of hand in Greece:
And worsened even more after the end of QE2:
Though the end of QE2 in summer of 2011 actually was mostly the story of sharp spread widening in Spain and Italy, 2 countries too big to be saved by the rest. This marked a severe escalation of the Euro crisis (and actually the main story of the summer of 2011, though the rating downgrade of the US is now often regarded as the main event of these days):
But now? Nothing, despite rising political tensions in Greece. Except some spread widening in Greece itself, but only minor. And almost boring the situation in the rest of the periphery. The set-up of the Eurozone seems to be much healthier now. Well, actually personally I think it has more to do with current accounts, which were extremely negative in the periphery then, but are balanced now. But additionally you now have the ECB finally planning to expand its balance sheet after being for an eternity asleep at the wheel (which I blame on the constant interference by the German Bundesbank). As a result spreads in the Eurozone, also in the corporate space, are as low as they have been in years despite the global spread widening and an economy in trouble:
Instead the weakest spot has shifted to emerging markets. The crisis in Russia, Venezuela, Nigeria and others are blamed simply on oil, but the pattern is an all-too familiar one. Once QE ends, troubles emerge:
Russian Ruble in USD:
Emerging Market Credit Spreads (Embi+ is a major Emerging market debt benchmark):
It is always the weakest part of the chain that breaks. And while the place is different now the timing is not by chance. As Warren Buffet once famously said: “It's only when the tide goes out that you learn who's been swimming naked.” And the tide has now shifted.
Now one of the big stories lately has of course been oil. Some blame the crash on conspiracy, mainly coming from Saudi-Arabia. The trigger was OPEC’s decision to do nothing. But is this also the cause? No. Not at all. You can’t “blame” OPEC for the crash in the oil price. You can blame them for doing nothing to prevent it, but not for causing it.
There are rather 5 reasons for the crash in oil:
1)      The fracking boom (or bubble as some call it) of the last 3 years (that some say was caused by the Fed’s cheap money) …
2)      … met the deflationary environment of the global retirement wave (more below)…
3)      … while short-term the end of QE…
4)      …combined with a rise in the US-Dollar (itself a by-product of QE ending)…
5)      … was emphasized by the historically very negative seasonality at this particular time
From: Link
Now the last part is an interesting one: While QE ended at the best time of year for stocks (therefore postponing the negative effect of QE’s end) it was the worst time for oil. (Just as the end of QE and worsening seasonality for equities met in spring 2010 and summer 2011).
Now is the fall in the oil price good or bad for the US economy? Historically it was good, but nowadays with all the investments in US oil production the answer is not that clear-cut anymore.
Further, and this is an even bigger trouble, the problem is that the crash in oil is just part of a big deflation story. This summer I wrote a post about how the retirement wave in the US is causing low unemployment, but at the same time low inflation. Please see What the Baby Boomers turned Retirement Boomers mean for Growth, Jobs, Inflation and the Markets .
The oil crash would be great for the US economy and the stock market, if it would be accompanied by a more expansionary monetary policy. But to the contrary, it is caused by a much less accommodative Fed. For the same reason the troubles in (oil-producing) emerging markets means troubles for the US. They are all a sign that deflationary forces are getting stronger and money is getting tighter in the US. Some argue that we may see a replay of the tech-bubble of 1999. The idea is that we will see a full-blown emerging market crisis (which I think we will), which will then lead to a more expansionary US monetary policy. But exactly this is not the case right now. The Fed is now very reluctant to restart QE. This is not 2010 or 2011. The unemployment rate which was still sky-high then has now fallen to near full-employment. Further we have now a change in the leadership of the Fed. This is an often neglected issue. As I wrote in September 2013, briefly before Janet Yellen was appointed, in my post Whoever Becomes Fed Chair(wo)man, Historically Any Change Meant Trouble a shift in Fed leadership is usually associated with a more restrictive monetary policy for some time, leading to a crisis very early in the tenure of the new Fed leader. And this is exactly the situation now. Things will turn worse, but the Fed will be reluctant to act, as it fears to steer up new bubbles.
But how bad can the situation get for the US economy and the US stock market? Worse than you think. Remember the spread widening. There has been historically a clear connection between spreads and the economy (I use below the New Order component of the ISM as it is a good leading indicator for the US economy):
There have been 3 major drops in this indicator since the financial crisis, the last one was due to the severe winter in the 1st quarter of 2014, the other 2 were associated with rising credit spreads at the end of QE 1+2. The market is still cheering the strong economy in the 3rd quarter (5% growth), which still may be a bent-up of demand from the weather-related downturn in the 1st quarter, while the latest data was quite mixed. Especially durable goods orders were very weak so far in the 4th quarter and might be an early proof that rising credit spreads are causing a major slow-down in the US economy (as they did after QE 1 +2).
In the stock market there is a tight connection between spreads and stocks, which doesn’t bode well:
In the high yield space the lowest rated (and most equity like) issues have in the past a led stocks at major turning points, especially when the turn was to the downside (here shown is the index value of these issues):
Here a recalibrated short-term look with the QE timeline:
Another interesting similarity with prior QE programs: The VVIX, the volatility of volatility. Sounds a bit weird, but has some interesting implications (basically a high VVIX means that people – mostly hedgefunds – who want to run a constant risk portfolio, have to adjust their holdings very frequently, causing some wild market swings, as we have seen lately). Anyway, this index has now temporarily risen to the levels right after QE1 and 2 as well as the height of the financial crisis in October 2008 and its early beginning in August 2007. Not a good sign.
Now after a lot of charts and details, here a brief sum-up: There are a lot of similarities between the prior endings of QE and the current one. They might just be blurred by 2 major differences:
1)      The center the crisis is not the Eurozone this time, but (some) emerging markets
2)      Seasonality, which was very negative for stocks the other 2 times, has now held up the market so far
 
And there is a 3rd one that is important going forward: The Fed is much less inclined to act immediately this time, as unemployment is low and the fear of a bubble is high (just last summer in her speech before Congress Janet Yellen was talking about “stretched valuations” in high yields, bank loans and social media and biotech stocks).
What should that mean going forward? Markets are calm now, but that is natural in the last days of the year. Seasonality is extremely strong now:
Even the oil market has some seasonal support at the end of December (see before). That easily sweeps under the rug all the troubles lurking in the shadow. Once the year-end liquidity tries up, things are likely to get rough again. It will get worse until the Fed turns around and starts to print money again. Rising spreads are a harbinger for bad times in the US stock market and a downturn in the US economy, which the stock market is currently not prepared for. Trouble again is that the Fed will be reluctant to act. For that reasons, things will most likely turn worse than they did in 2010 and 2011. Not to mention that valuations are far worse now.
Nevertheless I would not predict a 2008 crisis. The epicenter of the crisis is in emerging markets where things will get worse again next year. The rise in the US-Dollar is causing troubles for everyone indebted in USD (and that are many there) and that means a new string of defaults like in the 2 prior USD-revaluation periods after the end of Bretton Woods.
Despite the doom and gloom I nevertheless would not predict that the S&P 500 would have a negative return in 2015. That sounds now really weird after all that I have written, but the point is that it is in the hands of the Fed to stop any slide in the market early on. As long as inflation expectations are rock-bottom, there is nothing that binds them from a macroeconomic perspective. I just don’t think that they will act anytime soon. Only after things get much worse, especially for the US economy. And that might be in the second half of 2015. So, yes, I partly think that the 1998 comparison has some merit. Then like this time (and different to 2008), the US is not the center of the crisis, just as it was not in 2010 and 2011. The S&P was actually up in 1998, as it was in 2010 and down in 2011 only by the smallest possible margin (-0.003%). But don’t forget that there was each time a major downturn in between. And this is what I have in mind. Only probably a bit worse. In any event it should be the largest downturn in US stocks since the financial crisis. Maybe it is like 1998, but then 2015 will be like 98, not yet 99.
So while everyone contemplates about the timing of the first rate hike, I contemplate about the timing of the return of QE, which I would expect before the end of 2015 and which then could turn things around again.
Actually there are markets that I am quite bullish on for next year (though only in local-currency terms),, namely those that are already seeing very accommodative monetary policy or are likely to early next year, i.e. Japan and the Eurozone. But I would expect gains there to occur mostly in late 2015 when I expect the Fed to make a U-turn.
But wouldn’t that in the end mean QE forever? Is this the future? Yes and no. The problem, as I wrote in What the Baby Boomers turned Retirement Boomers mean for Growth, Jobs, Inflation and the Markets are the deflationary forces coming from the retirement wave (in the US, but also from China, where the situation is much worse as the one-child policy is now starting to bite the labor force). Retirements mean less credit growth and less demand, as I result less inflation, even deflation. It’s the mirror image of the 70s, when the baby boomers started to work, which let to high unemployment and high inflation at the same time:
Now it is the opposite. Despite all the talk about rising wages, nothing to be seen here:
This is the problem going on right now. It’s not the aftermath of the financial crisis, as is widely believed. Now this development is bound to go on for another 10 years. Only then will the US labor force stabilize (and around that time the speed at which the Chinese labor force will shrink will at least stabilize, but not get worse). As I wrote in the mentioned post, it is all like Japan, just offset (by around 10-15 years). Sorry, this is the future going forward (at least for another decade): markets live and die from the hand of the Fed. You may hate it, but there is no way around a new QE program. The ECB, pressured by the German Bundesbank, has avoided QE so far. And where has it led? Deflation is hardly avoidable in the Eurozone now.
The Fed will have no option but to act again. In my opinion hopefully more subtle than the last time (and hopefully nothing like the BoJ is doing). Rather hopefully at a low speed that can be maintained without causing too many bubbles on the way. Even though I think there is no way to avoid QE, it was at times (especially in the last round of easing) a bit over the top. I never understood why the Fed started a new round of QE in September 2012 while Twist was still running and stocks were at a high and why they were running the printing press in 2013 at such a speed. I assume they were nervous about the low growth rate. But again it’s all about the retirement wave. 3% growth is a story of the past, last quarter was a short-term anomaly. Once that is recognized maybe we will see a more steady policy at the Fed instead of the ebbs and flows of QE. But for the meantime, get ready for the drought.
[description] => In September 2013 in my post How QE Alters Bond Yields (Or Rather How It Does Not) I wrote that historically the end of QE was associated with the following 4 events, which I expected to show up again after the end of the latest QE-programs (which in some cases was completely against the market consensus of that time). [author] => Franz Lischka [legacyinterface_firm_id] => 527 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:11:16 [created_by] => 948 [modified_on] => 2014-12-29 16:18:23 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2237 [hits] => 0 ) [13] => stdClass Object ( [legacyinterface_commentary_id] => 2172 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15408 [apv_conversation_id] => [content_type] => market-commentary [title] => Holiday Randoms [slug] => advisorshares_122914 [fulltext] =>

By: Roger Nusbaum, AdvisorShares ETF Strategist

Business Inside posted an article a few weeks ago that recapped the Black Swan concept using Nassim Taleb’s example of the Thanksgiving Day Turkey who is well fed and treated well until the day before Thanksgiving and then the ax falls…literally.

I won’t try to predict the next Black Swan as the definition says that is impossible but there will be Black Swans large and small that come along and the key to successfully navigating them is the awareness to recognize them in real time and not succumb to emotion when they do occur.

An example of a large Black Swan would be something like the financial crisis which very few people saw coming, had far reaching impact and likely (hopefully?) will be the biggest financial incident in most of our lifetimes. For a small Black Swan I would use the example of the large biotech company that recently fell 10% as an initial reaction to news that one of its drugs would not be covered by one of the larger health insurance companies. After the initial 10% it fell a little bit more. For such a big company to fall that much leads me to think the market didn’t see it coming and even if that is wrong, it is reasonable to conclude that this news was a small Black Swan to whoever sold it after that large drop. 

MarketWatch had a listy post about the habits of people who are debt-free. Most of the items on the list you have seen before but there was one that has been getting talked about a lot more lately which is valuing experiences over stuff which is obviously a don’t be materialistic argument.

One example that I think fits is the RV experience. RVs are neat, the bigger and fancier they are the neater they are and obviously the more expensive they are. The idea of taking an RV trip now and then holds a lot of appeal, something my wife and I would like to do to see the parts of the Mountain Time Zone we haven’t been to yet.

For some folks RVing is a way of life and that’s not who I am talking about here. I did some research at Cruise America’s website. A two week rental in May, 2015 that we would pick up in Flagstaff would cost $1106 for a Standard and $1246 for a Large plus $476 for miles and who knows what for gas.

Buying a new RV can range from $100,000 (maybe less, correct me if I am wrong) to unlimited. I found a used one on the Cruise America site for $20,485. Buying it plus whatever the cost for upkeep versus what is maybe $2500 all in for a two week rental. Obviously this is about a tradeoff between owning your own RV versus the experience of the road trip and even if this example doesn’t resonate there will be other examples that will.

Finally, the Tiny House Blog had a post with income ideas for tiny house dwellers related to their tiny-living experience including blogging about it. Most of the ideas in the article aren’t too unexpected although renting space to other tiny-housers if you own land is pretty good. At a higher level this about monetizing a hobby.

The interest here in tiny houses and smaller houses is about finding ways to relieve the burden that most of us will put on our investment portfolios at some point in our lives and lowering overhead, one way or another, seems like an obvious path.

© AdvisorShares

[description] => Business Inside posted an article a few weeks ago that recapped the Black Swan concept using Nassim Taleb’s example of the Thanksgiving Day Turkey who is well fed and treated well until the day before Thanksgiving and then the ax falls…literally. [author] => Roger Nusbaum [legacyinterface_firm_id] => 14 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:19:47 [created_by] => 948 [modified_on] => 2014-12-29 16:20:07 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2238 [hits] => 0 ) [14] => stdClass Object ( [legacyinterface_commentary_id] => 2173 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15409 [apv_conversation_id] => [content_type] => market-commentary [title] => Adventures in Forecasting [slug] => rj_122914 [fulltext] =>

Every December, economists are asked for their projections for the coming year. What’s GDP growth going to be? How many jobs will be added? What’s the Fed going to do? How will the financial markets react? We build models of the economy – models that we know are not precise. There are simply too many variables. Those who have studied forecasting in any detail know that a forecast is composed of a point estimate (a value at a certain point in time) and a level of uncertainty around that estimate. In economics, that uncertainty is usually very large, making the point estimate seem almost meaningless. For financial market participants, one should look at point estimates as a base-case scenario and focus on the risks surrounding that outlook. Some uncertainties are known, but there are others, currently unknown, that are sure to come up.

The Federal Reserve employs a lot of very smart people with considerable knowledge of forecasting. However, the Fed’s GDP projections of the last few years have been humbling. Growth estimates for 2011, 2012, and 2013 started out near 4%, only to be whittled down to more disappointing levels. Part of that reflects the nature of the recession. GDP growth projections for the next few years are more moderate.

Looking ahead to 2015, there are a number of key uncertainties. Oil prices are perhaps the most significant. After a sharp drop in the final months of 2014, most expect a new equilibrium in the months ahead – but where exactly? The answer matters a lot. The impact of lower oil prices on the consumer depends on how far prices decline and how long they stay low. The drop is a function of increased supply and decreased demand. However, lower prices will discourage new supply and encourage consumption, a combination which should (eventually) lead prices back up. The path of oil prices will have a significant impact on the economic outlook in 2015.

For Fed policymakers, the impact of lower oil prices on growth and inflation is seen as “transitory.” Overall inflation will be lower in the near term and we could see some small feed-through to core inflation. However, oil prices cannot fall forever. The impact will decrease over time. Lower gasoline prices are expected to help boost consumer spending growth, but that impact is also transitory, showing up mostly in the first half of 2015. Spending patterns will adjust to the new level of oil prices. We’ll need to see a pickup in average wages in the second half of the year to sustain strong growth in consumer spending. That may happen, but it’s hard to predict exactly.

Job growth was strong in 2014, but we didn’t see accompanying strength in areas that are normally associated with job gains, such as consumer spending and housing. Lackluster growth in average wages appears to be the most likely explanation. Average wages have barely kept pace with inflation. Wage growth should pick up as the job market tightens, but while slack is being taken up, a lot remains.

The job market outlook is a key uncertainty for Fed policymakers. While the December 19 monetary policy statement indicated that the Fed can “be patient”in beginning to normalize monetary policy, some Fed officials are more patient than others. Monetary policy affects the economy with a long and variable lag. The Fed sets policy with respect to where it thinks the economy will be 12 to 18 months from now. So, tightening does have to start at some point. However, the risks around the timing of tightening are not symmetric. If the Fed tightens too soon and growth is slower than expected, it will be harder for policymakers to change course. Short-term interest rates will still be low (even after the first couple of rate hikes) and nobody at the Fed wants another round of quantitative easing. If the Fed waits too long and inflation picks up more than intended, officials can then raise short-term rates more rapidly to get back on course. This is a strong argument for being patient and waiting longer to start tightening.

The Fed is focused primarily on the U.S., but it also has to pay attention to what’s going on in the rest of the world. That means anticipating the impact of overseas developments on the U.S. economy and financial markets. At this point, global growth is expected to be a bit soft in 2015, but the risks have been weighted to the downside. Yet, the amount of leverage in the global system is nowhere near where it was at the start of the financial crisis. That suggests that the downside risk to the financial system may be limited. Lower oil prices should have a mixed, but mostly positive impact on the rest of the world.

The 2015 economic outlook will evolve over time as the key issues, oil prices, the job market, and the global economy, become clearer. Best Wishes for a Prosperous New Year!

© Raymond James

[description] => Every December, economists are asked for their projections for the coming year. What’s GDP growth going to be? How many jobs will be added? What’s the Fed going to do? How will the financial markets react? We build models of the economy – models that we know are not precise. There are simply too many variables. [author] => Scott Brown [legacyinterface_firm_id] => 356 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:21:36 [created_by] => 948 [modified_on] => 2014-12-29 16:21:49 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2239 [hits] => 0 ) [15] => stdClass Object ( [legacyinterface_commentary_id] => 2174 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15410 [apv_conversation_id] => [content_type] => market-commentary [title] => Adam Smith or Jerry Goodman [slug] => rj_122914a [fulltext] =>

We are at a wonderful ball where the champagne sparkles in every glass, and soft laughter falls upon the summer air, we know at some moment the black horsemen will come shattering through the terrace doors, wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time, so everyone keeps asking, ‘What time is it?’ But none of the clocks have hands.

… The Money Game by Adam Smith

I met Jerry Goodman, whose nom de plume was Adam Smith, late in my career. He was working at my friend Craig Drill’s money management firm along with another icon in this business, from an era gone by, namely Al Wojnilower. I have had many conversations with all three of these Wall Street legends around the conference table at Drill Capital Management. Jerry wrote The Money Game(1968), Powers of Mind (1975), Paper Money (1981), and The Roaring ‘80s(1988), but unfortunately we lost his wisdom on January 3rd of this year (http://blogs.wsj.com/totalreturn/2014/02/17/remembering-adam-smith/). Well, that is not entirely true for as Terry Pratchett wrote, “Do you not know that a man is not dead while his name is still spoken?” More to the point is that much of Jerry’s wisdom can be gleaned from his books. Obviously, Jerry still lives in the minds of those who have read those books and continue to speak his name. This morning, I invoked his name with the aforementioned quote. I find the quip particularly timely following the 38-month upside skein we have experienced without a 10% correction on a closing basis. That’s a long time considering that a 10% correction comes along on average every 18 months! Of interest, it was the April through June of 2011 decline that lopped 19% off of the S&P 500 (SPX/2088.77), but since then we have not seen a true 10% pullback. Granted the April/June 2012 timeframe recorded a 9.9% slide, as did September/October 2014, but while they came close they were not true 10% declines based on closing prices. That makes this rally long of tooth, but not historic because, according to my notes, the longest run without a 10%+ correction came between October 1990 and October 1997.

I revisit the 10% correction theme as we approach the New Year because the timing models I use have again targeted the January/February timeframe as potentially a difficult period for the equity markets in the New Year. Recall, it was at this time last year those same models were calling for a 5% – 7% pullback in the first three months of 2014; and, we got a 6% decline. Of course the models also called for a 10% - 12% decline sometime in 2014, but, as stated, all we got was 9.84% on an intraday basis between mid-September and Mid-October. Still, I have come to respect my models over the decades and I am not going to ignore them this time. So what are investors to do?

Well, it was last July when I suggested that if you have stocks in your portfolio that have not participated in the 50%+ rally by the SPX we have seen since June 2012, you might want to consider selling some of them and raise some cash. I would use that same strategy as we head into 2015. In looking at which sectors are expensively valued, and therefore might be right for a rebalance in portfolios (read: trim back on select stocks), Healthcare is historically expensive with a price-to-earnings ratio (P/E) of 23.01x. Consumer Discretionary is next with a P/E of 21.50x followed by Consumer Staples (20.93x). The “cheapest” macro sectors on a P/E basis are Energy (13.41x), Telecommunications (13.66x), and Financials (14.76x).

Last week, however, raising cash was the last thing on investors’ minds as the Dow danced higher, and in the process breached 18000. Subsequently, my phone lit up with the ubiquitous question, “Jeff, you said earlier this month on various TV and radio shows that you thought the Santa rally would carry the D-J Industrials (INDU/18053.71) above 18000, and so what is the significance of 18000?” My response went like this, “I did expect 18000 to get exceeded before year end and I have been pretty adamant the Santa rally was going to accomplish that. But, 18000 is a non-event just like 11000, 12000, 13000, etc. The numbers that capture the public’s attention are numbers like 1000 (December 1972), 10000 (March 1999, where they broke out the hats on the NYSE), 20000, etc. If 18000 was a legion number, where are the hats?!” Speaking to Dow Theory, while the Industrials made new highs last week, the D-J Transports (TRAN/9199.65) did not, yet they are not very far away. For the Transports to confirm the Dow’s new high would require a closing price above the November 25, 2014 close of 9202.84. It will be interesting to see if that happens in a week where “champagne sparkles in every glass.”

Plainly, the drivers of last week’s “win” were the various reports. Consumer sentiment tagged a seven-year high, the Commerce Department reported consumer spending beat expectations at up 0.6%, and the third revision of 3Q14 Real GDP was a breathtaking +5%. The GDP report was the “cork popper” since expectations were clustered around +4.2%. It was the strongest quarterly reading in 11 years and has the U.S. economy growing at 3.5% in four of the past five quarters. On the negative side, the housing numbers disappointed and the durable goods report was terrible. The stock market, however, is turning a deaf ear to bad news and that’s good news. Hopefully, that trend will extend this week. But for those courageous enough to buy aggressive trading positions on our “fat lady sings” advice of December 17, 2014, I would either push up stop-loss points or shed those positions. One thing Andrew and I got right was the cup-and-handle formation in the Russell 2000 (RUT/1215.21), which we suggested was going to cause an upside breakout. That upside breakout occurred last week. As the eagled-eyed Jason Goepfert, of the insightful SentimenTrader, writes: “The Russell 2000 index of small-cap stocks closed at its first multi-year high in more than six months on Friday. The momentum that carries it to a new high has tended to continue over the next several weeks, as it added to its gains three weeks later all 15 times it has occurred (see chart).”

If Jason’s observations prove correct, this would foot with my timing work that shows the equity markets becoming increasingly vulnerable into mid-January.

The call for this week: While investors’ attentions were focused on last week’s economic reports, new highs in various indices and Christmas, the proverbial tree in the forest fell and was not heard. Verily to a cornered Vladimir Putin, who is feeling the pressure of a crude oil and Russian ruble collapse, last week’s Ukrainian parliament vote to become an “unaligned” nation is likely the first step toward becoming “aligned” with NATO. That may just prove to be the final straw that broke Premier Putin’s back. If so, things are getting ready to heat back up in the Ukraine, which may provide an unsettled news backdrop for the equity markets. Indeed, with the McClellan Oscillator overbought, as well as many other “finger to wallet ratios,” there is nearly a full charge of internal energy available in the equity markets to give us a move either on the upside or the downside. This week should be instrumental in determining the near-term direction. This morning Greece failed to elect a president, threatening the international bailout program. Russia has suffered its worst economic contraction since 2009. And Air Asia flight 8501 is still missing. All of this has the preopening futures flat at 6:00 a.m.

© Raymond James

[description] => I met Jerry Goodman, whose nom de plume was Adam Smith, late in my career. He was working at my friend Craig Drill’s money management firm along with another icon in this business, from an era gone by, namely Al Wojnilower. I have had many conversations with all three of these Wall Street legends around the conference table at Drill Capital Management. Jerry wrote The Money Game (1968), Powers of Mind (1975), Paper Money (1981), and The Roaring ‘80s (1988), but unfortunately we lost his wisdom on January 3rd of this year . [author] => Jeffrey Saut [legacyinterface_firm_id] => 356 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:29:19 [created_by] => 948 [modified_on] => 2014-12-29 16:33:03 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2240 [hits] => 0 ) [16] => stdClass Object ( [legacyinterface_commentary_id] => 2175 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15411 [apv_conversation_id] => [content_type] => market-commentary [title] => Intellectual Property Helps Boost 3Q GDP Growth To Highest Level Since 2003 [slug] => gavekal_122914 [fulltext] =>

As was widely reported yesterday, 3Q GDP growth was the strongest since 9/30/2003. However, less widely reported was the fact the intellectual property products contributed the most to real GDP in 32 quarters (9/30/2006). Fixed investment overall contributed 121 basis points to real GDP. Residential fixed investment contributed only 10 basis points and continues to hover around 3% of GDP. 

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© GaveKal Capital

[description] => As was widely reported yesterday, 3Q GDP growth was the strongest since 9/30/2003. However, less widely reported was the fact the intellectual property products contributed the most to real GDP in 32 quarters (9/30/2006). [author] => Team [legacyinterface_firm_id] => 173 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:42:34 [created_by] => 948 [modified_on] => 2014-12-29 16:42:48 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2241 [hits] => 0 ) [17] => stdClass Object ( [legacyinterface_commentary_id] => 2176 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15412 [apv_conversation_id] => [content_type] => market-commentary [title] => Oil and Emerging Markets: A Double-Edged Sword [slug] => franklin_122914 [fulltext] =>

The price of oil has plummeted this year as a result of increased volatility in most markets and a temporary imbalance of supply and demand. In view of continued long-term world growth, particularly in emerging- and frontier-market countries, we believe oil prices will probably not suffer from a prolonged price slump. As we see it, the demand for raw materials in general, including not only oil but also iron ore, copper, nickel and agricultural products, is still likely to increase over the long term with increased global growth. Much of the velocity of the recent oil price drop, we think, is based on speculation and short-term trading. In our view, the price of oil is likely to rebound in 2015 or 2016.

In the past two months, crude oil has experienced its biggest price slump since the 2007–2009 global financial crisis, with a number of reasons cited, including slowing demand growth from major economies and increased output from the United States in the past few years that hasn’t been met with decreased production among other major oil producers.

Certainly, too much supply, if it continues, will impact prices—that’s just basic economics. However, when we look at long-term demand patterns, we see the overall trend has been up, not down, and we can see how emerging-market economies have been driving this growth.

The Organisation for Economic Cooperation and Development (OECD) is a forum that facilitates cooperation among the governments of 34 member-democracies with market economies to promote economic growth, prosperity and sustainable development. Most emerging and frontier markets are non-OECD members, including China and India. The chart below shows how non-OECD countries have already surpassed the OECD countries in terms of crude oil consumption, and the gap is forecast to widen in future years.

 1214_MM_EnergyConsumptionOECD

China: Growing—or Slowing?

Slowing growth in China has been cited as a reason behind the drop in oil prices, but we look at the situation a little differently than many. Sure, its gross domestic product (GDP) growth is no longer in the double-digits of times past, and that’s to be expected because China’s economy is growing—it now has a higher baseline. I don’t think growth in China is a problem. In 2010, when China was growing at about 10%, US$844 billion was added to the economy. In 2013, growth had slowed to just under 8%, but more than US$900 billion was added to the economy. So, yes, GDP growth has been smaller percentage-wise, but you have to look at the overall economic impact—the US dollar figures.

Additionally, many people don’t think China needs more infrastructure, but from my personal experience traveling around the country on packed trains and heavily trafficked roads, it needs it badly! Urbanization is still underway; there is still a lot to be done in China, and it will still need natural resources to do it.

1214_MM_ChinaNomGDP

 1214_MM_ChinaRail

Impact of Lower Oil on Emerging Economies

Most consumers naturally cheer lower energy prices, but looking at overall economic impacts, lower oil prices can be a double-edged sword. In countries that are heavily dependent on oil exports, a prolonged oil price slump could be harmful.

Nigeria’s government, for example, depends on oil for a large part of its budget; the oil and gas sector accounts for about 35% of GDP, and petroleum export revenue represents over 90% of total export revenues.1 If these revenues drop, Nigeria’s leaders would either have to suffer through a lower oil price spell, or do something to revive the economy through diversification and reforms. Among the world’s top exporters, Russia’s GDP fell 8% in 2009 as the price of oil plunged below US$40 a barrel amid the global financial crisis. Russia remains heavily dependent on energy revenues today, and the country seems likely to be impacted greatly if prices don’t rebound quickly enough. Combined with Ukraine-related sanctions, Russian government officials have predicted a possible recession in 2015. Also highly dependent on oil revenues, Venezuela also seems particularly vulnerable, in our view. Saudi Arabia seems likely in a better position to weather the price downturn, as Saudi Arabia has enormous foreign reserves and investments that we believe should enable it to continue spending and growing even with low oil prices. On the flip side, China and India, as net importers, are likely to benefit from lower oil prices.

Part of the increased supply of oil has come from increased US shale production. At levels under US$60 a barrel, extracting oil becomes less profitable to shale producers. As it becomes unprofitable, some production will likely shut down, although it may take a number of months for fields to be abandoned. Meanwhile, the demand for oil in the two most populous countries in the world (China and India) is increasing as a result of more cars, buses and trucks on the roads. In addition, plastics and many other widely used products are derived from oil. The cost of finding and producing oil has not generally been declining. Therefore, over the longer term, we think oil prices will recover.

We see another side to the lower oil price story that is potentially positive for some emerging economies that had been subsidizing energy. These subsidies were a drag on government budgets, and lower market prices make removing such subsidies less painful for consumers residing in those countries. Indonesia has removed some subsidies, and we see signs that India and China are moving in that direction as well. An environment of lower energy prices has helped some emerging countries embark on much-needed reforms with less painful effects.

Right now, we think perhaps the biggest concern from an investment standpoint is volatility, not only in the price of oil but in related stocks in the sector—and in equity markets generally. We’ve seen some incredible swings. We look to use the downturns to find potential bargains for our portfolios, but many investors get spooked and lose out on opportunities. We, of course, will be looking at those countries, sectors and companies that we think could benefit from lower oil prices. We are not avoiding oil companies completely right now, however. Since many such companies are diversified, they may suffer in terms of their exploration and production activities, but could potentially benefit from their retail activities.

Mark Mobius’s comments, opinions and analyses are personal views and are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding any country, region market or investment.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.

What Are the Risks?

All investments involve risks, including possible loss of principal. Foreign securities involve special risks, including currency fluctuations and economic and political uncertainties. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Investments in the energy sector involve special risks, including increased susceptibility to adverse economic and regulatory developments affecting the sector.


1. Source: Organization of the Petroleum Oil Exporting Countries (OPEC), 2014.

© Franklin Templeton Investments

[description] => The price of oil has plummeted this year as a result of increased volatility in most markets and a temporary imbalance of supply and demand. In view of continued long-term world growth, particularly in emerging- and frontier-market countries, we believe oil prices will probably not suffer from a prolonged price slump. As we see it, the demand for raw materials in general, including not only oil but also iron ore, copper, nickel and agricultural products, is still likely to increase over the long term with increased global growth. [author] => Mark Mobius [legacyinterface_firm_id] => 163 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:45:57 [created_by] => 948 [modified_on] => 2014-12-29 16:46:14 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2242 [hits] => 0 ) [18] => stdClass Object ( [legacyinterface_commentary_id] => 2177 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15413 [apv_conversation_id] => [content_type] => market-commentary [title] => Chicken Little Economics [slug] => ft_122914 [fulltext] =>

It’s now been more than six years since the failure of Lehman Brothers – when the sky fell in and economic panic seized the land. Since then, Chicken Little Economics has inflicted fear and loathing on many investors.

Much of that fear has been caused by a misunderstanding of what actually happened. Conventional Wisdom has a bumper sticker mentality about the crisis – “Greedy Financiers Push World to Brink,” “Thank God the Government Saved Us” and “It Could Happen Again –Remember 1937.”

But this has it exactly backward. It was government mistakes that caused the crisis. It was government over-reaction that caused the recovery to be slower than it should have been. Most importantly, it was free market capitalism that saved us, not government.

While our readers understand our point of view, there are many who dismiss it because we were late in understanding how bad the crisis would become in 2008. We believed that government would figure out the role of mark-to-market accounting in making the crisis worse and we wrongly assumed this rule would be changed before things got worse.

But the Treasury and Federal Reserve refused to deal with the accounting problem, and instead invented Quantitative Easing (which started in September 2008) and the $700 billion TARP program, which passed Congress October 8, 2008.

What many don’t realize is that after TARP was passed, and after QE started, the stock market fell an additional 40%. In other words, there is absolutely no evidence that TARP or QE saved the economy.

Others say that it was “Stress Tests” that turned the market around. But the results of the first large bank stress tests were not released until May 7, 2009, which could not have caused the market to bottom on March 9, 2009, nearly two months earlier.

The only thing that happened on that exact day was that Congressman Barney Frank’s Financial Services Committee announced it was holding a hearing with FASB to force a change in mark-to-market accounting rules.

This is no coincidence. Forcing FASB to change overly strict accounting rules officially ended the crisis. No longer did illiquid markets and a really dumb accounting rule force banks to take losses that were not real.

Since then, the economy has consistently grown and the S&P 500, without dividends reinvested, has climbed by more than 210%.

Conventional wisdom just can’t deal with this. And politics has made things massively worse. Republicans who supported TARP still argue that it worked even though they supposedly believe in free markets. They also argue that as long as President Obama is in office, the economy cannot possibly grow. As a result, they join with the Fed in believing that QE has boosted stocks and the economy.

Democrats have treated the Financial Crisis of 2008 exactly as they did the Great Depression – as a reason to spend more, regulate more and redistribute more. The Democratic ideology is that government is always needed to keep markets in check and make things “fair.” This argument works best after a crisis. So, the political argument from the left is that the economy is growing because of government action as well.

In other words, investors have few friends that believe in free markets. “Arm chair economists” are everywhere, arguing that it’s simple to manage an economy. Just dial up some QE, redistribution and infrastructure spending, stress test the banks, too, and all will be well.

But these simple-minded remedies have run into an anecdotal and intellectual brick wall. The Fed has tapered its QE and is no longer buying bonds, yet GDP grew 5% last quarter and stock prices are at all-time highs. In Japan, massive new QE is not lifting economic activity or inflation. In Europe, with no QE, interest rates are lower than in the US. In addition, so many “end of the world” forecasters have been wrong that they are making “chicken little” look like an optimist.

Investors need to understand that the same things that boosted growth 150 years ago and 25 years ago are still the same things that boost growth today. What are those things? The answer: Entrepreneurship, innovation and creativity.

In spite of government mistakes, the U.S. entrepreneur has refused to be held back. Profits are at an all-time high and so are stocks. Chicken Little will be wrong again in 2015.

This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy. 

© First Trust Advisors

[description] => It’s now been more than six years since the failure of Lehman Brothers – when the sky fell in and economic panic seized the land. Since then, Chicken Little Economics has inflicted fear and loathing on many investors. [author] => Brian Wesbury, Robert Stein [legacyinterface_firm_id] => 154 [published_on] => 2014-12-29 [digest_date] => 2014-12-29 [access] => 1 [ordering] => 0 [post_to_apviewpoint] => 0 [post_to_rss] => 1 [post_to_legacy_database] => 1 [enabled] => 1 [created_on] => 2014-12-29 16:53:40 [created_by] => 948 [modified_on] => 2014-12-29 16:54:54 [modified_by] => 948 [checked_out_time] => 0000-00-00 00:00:00 [checked_out] => 0 [asset_id] => 2243 [hits] => 0 ) [19] => stdClass Object ( [legacyinterface_commentary_id] => 2178 [legacyinterface_template_id] => 9 [legacyinterface_record_id] => 15414 [apv_conversation_id] => [content_type] => market-commentary [title] => Three Potential Opportunities and Three Risks For 2015 [slug] => invesco_122914 [fulltext] =>

With my 2014 year-in-review now posted, Lessons from 2014, and my full 2015 outlook not arriving until January, I wanted to share a few of my thoughts and expectations for the coming year. Overall, I am bullish on global equities in 2015. That being said, volatility is likely to increase and investors may need to be more selective, as the US adjusts to life after QE, the US Federal Reserve begins raising interest rates, the US dollar strengthens, energy prices continue to decline and global growth moderates in my opinion.

Global equity performance may be less robust than in 2013 and 2014, but I still see room for gains driven by the US, Japanese and European markets. Emerging market equities, however, are likely to continue underperforming developed market equities in the coming year, in my opinion. Three major themes I expect to play out in 2015 are:

1. Money moves markets.

Quantitative easing (QE) policies have shown little benefit to the economies that have pursued them. But, the equity markets are a different story. Countries with the most aggressive monetary policy have shown the best equity performance.1 Japan and Europe could see the biggest moves, which may trump weak fundamentals.

2. The rising dollar.

In the US, a stronger dollar has historically correlated to lower energy prices.2 Reduced energy costs have tended to expand price-earnings (P/E) multiples and increase consumer disposable income, which in turn could bolster stock prices.3 This environment favors value stocks over growth, in my opinion. Multinationals in Europe and Japan may benefit, but investors may want to consider a currency hedge. Conversely, emerging markets may lag, as a stronger US dollar is likely to weigh on stock prices.

3. Range-bound interest rates.

Fundamentals argue for rising rates, as employment could reach the “full employment” rate in the first quarter of 2015 and quarter-over-quarter gross domestic product (GDP) growth may continue to run above 3%. However, strong demand for US Treasuries from global bank capital requirements, low global rates and a lack of inflation could help US rates stay lower for longer.4 In other words, even with a rate hike (possibly in June), I don’t see the Fed getting in the way of the equity markets.

On the flipside of this scenario are the risks that could fundamentally shift my outlook. As I see it, key risks could include:

1.    A prolonged or deep economic slowdown in China, which could drag down global growth and seriously undermine investor confidence.

2.    A spike in geopolitical risk, possibly from Russia or the Middle East, threatening Europe’s already fragile economy or causing a spike in volatility that drives money out of risk assets into “safe haven” assets, potentially creating bear markets.

3.    A cyber attack that becomes a “Black Swan” event, a rare, impossible-to-predict occurrence that significantly disrupts the financial markets.

As detailed in my December commentary, in 2014 investors who were patient and kept short-term volatility in perspective likely fared better than investors who got distracted. I believe the same lesson will apply in 2015, perhaps even more so.

1 Source: Bloomberg LP and Thomson Reuters DataStream, Nov. 30, 2014, based on the S&P 500 Index, MSCI Europe Index and Nikkei 225 Index.

2 Source: Thomson Reuters DataStream, Dec. 5, 2014

3 Source: Thomson Reuters DataStream, Dec. 5, 2014

4 Source: Bloomberg LP and Thomson Reuters DataStream, Dec. 10, 2014

Important Information

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The MSCI Europe Index is a free-float-adjusted market-capitalization-weighted index designed to measure the equity market performance of the developed markets in Europe.

The Nikkei 225 Index (or Nikkei Index) is a price-weighted index measuring the top 225 blue chip companies on the Tokyo Stock Exchange and is commonly considered representative of Japan’s stock market.

Price-earnings (P/E) ratio, also called multiple, is a common valuation metric for stocks that compares a stock’s share price to its per-share earnings.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

An investment in emerging market countries carries greater risks compared to more developed economies.

International markets may be less liquid and can be more volatile than US markets.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.

Growth stocks may be more susceptible to earnings disappointments, and value stocks may fail to rebound.

Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.

The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Before investing, investors should carefully read the prospectus and consider the investment objectives, risks, charges and expenses.

All data provided by Invesco unless otherwise noted.

Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.

©2014 Invesco Ltd. All rights reserved.

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