Reasons For Optimism

With 2011 now pretty much history, was there much to be happy about in 2011 from an investment perspective? Actually, despite all the turbulence, there were some reasons. While U.S. stocks went sideways (with a healthy dose of roller coaster volatility), on a relative basis sideways will have been pretty darn good performance when compared to most international markets, which are on track to decline anywhere from 10-30% this year. Bonds actually did a lot better than we thought in 2011, particularly U.S. Treasuries which benefitted from the “safe haven” status of the U.S. markets. But we have to wonder how much upside is left in bonds. We suspect much of that will depend on how things play out in Europe in the new year: if things deteriorate in Europe, the “flight to quality” into U.S. Treasuries could continue. Gold worked in 2011, but with prospects for a strengthening dollar and continued low inflation, our concern is gold may have reached an interim peak.

One important bright spot for the U.S. economy has been the strength of U.S. corporate earnings, which are on track to grow by an estimated 15% this year. Corporate profit margins and cash flows are at record highs and, barring some unforeseen disaster, we expect large U.S. companies will again generate healthy earnings and cash flow growth in 2012. We continue to see significant value in the earnings and cash flows of large U.S. multi-national companies and their ability to create rising cash flow streams via dividend increases. This is a bright spot for the U.S. economy and is part of the reason why we are cautiously optimistic about the outlook for U.S. equities in 2012.

Another potential positive for the U.S. market in 2012 is the now universal view that growth in the U.S. in 2012 will remain sluggish, in the range of 1-2%. That is the consensus now. As we know, the consensus is often wrong. We think the potential for surprises for the U.S. economy is to the upside due to continued employment gains, rising consumer confidence, rising corporate earnings and cash flow, continued healthy levels of business capital investment, and continued strong entrepreneurial activity and business formation, particularly in the tech sector.

From a financial planning standpoint, the fact that the stock market was flat in 2011 should not cause alarm. From a longer perspective, the stock market does appear to be in a long-term uptrend that began in March 2009. Also, there were a number of sectors that had significant moves. Many clients who were properly diversified actually saw increases in their portfolios for the year.

Even if one is retiring now, a properly diversified portfolio will capture future market growth and investments don’t end the day you retire. The most important questions from an investment planning standpoint are: Is one adequately diversified and, thereby, properly positioned to capture growth across a range of sectors ? Is the portfolio structured optimally with respect to risk vs. return?

Despite having lost some of their luster in the past decade, publicly traded equities are still one of the best ways for most people to capture growth, so as planners, we spend time thinking about this stuff and why and where client capital should be deployed to best accomplish client plan objectives. So, despite how 2011 may have seemed like another “lost year”, there were some positives and we have to remember that equities are still considered important elements of a sound financial plan and diversified investment portfolio.

Costco Discipline

A local company we all know and love, Costco Wholesale, announced its fiscal first quarter earnings on December 8. Earnings rose a healthy 13% compared with the year-ago quarter while same-store sales, the best measure of a retailer’s true (or “organic”) sales growth, grew a healthy 7%, above retail industry averages. Over the years, Costco has consistently delivered healthy growth throughout many varying economic conditions, a hallmark of a strong and well-managed company. This consistency of growth has benefitted both Costco customers and, obviously, its shareholders but it has not happened by accident. Over the years Costco has fostered a culture that has placed a high emphasis on discipline and sticking to that discipline: discipline in creating and implementing a sound business strategy; discipline and consistency in merchandising strategies; discipline in investments and store expansion; discipline in hiring and training; discipline in managing costs and passing those savings through to its customers.

The importance of discipline is no different when it comes to investing and financial planning. A good financial plan provides an important source of discipline that keeps one’s investments on track through the inevitable ups and downs of the financial markets. A plan provides not only a proper investment roadmap and asset allocation but also helps mitigate emotional reactions to the markets that can be so damaging to long-term wealth creation (i.e. buying and selling at exactly the wrong times). A cogent plan also helps to keep investors focused on long-term goals and not be tempted to “trade” or get sucked into the trend or hot sector of the day, also at exactly the wrong time. Yes, investors can take an important cue from a successful company like Costco: planning and the discipline of sticking with a sound plan can make a huge difference when it comes to long-term success in both business and investing. 

BT for S.R. Schill & Associates, Mercer Island, WA

Encouraging Economic News

We were encouraged by several pieces of economic news today: 1) Private employment, which excludes government jobs, climbed by 206,000 this month, according to data today from ADP Employer Services survey. This is the highest growth level so far this year. 2) The Institute for Supply Management-Chicago Inc.’s business barometer (PMI) increased to 62.6 in November from 58.4 in October led by strengthening industrial orders and production. The PMI new order index, an important leading indicator, rose to the highest level since March. 3) The German Federal Labor Agency reported that unemployment in Germany dropped more than forecast in November to 6.9%. Also, German business and consumer confidence rose in November. 4) The National Association of Realtors’ index of pending home sales increased 10.4%, the most since November 2010. 5) Today’s global central bank actions are positive for liquidity of the European banking system. This data supports a continued improved outlook for the U.S. economy and bodes well for acceleration in U.S. GDP growth in Q4 and 2012, in our view, and also supports the outlook for further growth in U.S. corporate earnings in 2012, a positive for U.S. equities.

What’s the downside? As it has been for some time: risk of a meltdown of the European financial system resulting in collapse of the Euro and implosion of the European economy. This has global financial and economic risk implications. Today’s actions by both Italy and global central banks are an encouraging sign that 1) European leaders understand the urgency of their situation, and 2) we are seeing more concrete measures being taken to address the problems in Europe. We remain concerned that the Eurozone countries continue to face massive headwinds in reaching a workable solution that will maintain both the integrity of the European Union and the Euro as viable currency.

Implications for financial planning: While today’s rise in the stock market is encouraging, we by no means believe volatility is going away. Western economies, including the U.S., are facing massive debt and fiscal problems that will take years to fully address and that will continue to present significant risk to the financial environment. From a portfolio perspective, we continue to advocate above average cash holdings and broad diversification with respect to asset class and geographic and sector allocation in order to mitigate portfolio volatility.  We would also add that today’s rise in the market is a perfect example of why we believe people need a sound financial plan and should stick to it, rather than trying to time the market.

BT for S.R. Schill & Associates, Mercer Island, WA

C’mon. Did anyone really expect an outcome other than what happened with the Super committee deliberations? Perhaps if you were on another planet. This was “political expediency” at its best: avoid tough decisions that could roil voters and seek political “cover” by pushing the issue on to the entire Congress. So now what? The President has said he will veto any attempts to avoid the automatic spending cuts that kick in in 2013, setting the stage for more DC high stakes political drama. You know it’s going to be an ugly process. Market implications? Continued news-driven volatility. The economy? It will most likely continue to muddle along as will corporate earnings, which offers support for equities, in our view. We are encouraged that recent U.S. economic data supports a moderately improving outlook. Outside the U.S., the ugly process of European debt restructuring will take more time and, of course, adds another element of uncertainty and volatility. So what does it mean for financial planning? While we think the long-term outlook for the U.S. is bright, the level of investment uncertainty near term remains high.  With higher market volatility expected to be around for awhile, we advocate having a financial plan that provides a long-term roadmap for your investments and portfolio strategy. It means keeping your eye on the long-term goal and not being overly influenced by short-term swings in the market, both up and down. A sound financial plan can help you stay on course for the long term. It’s like planning anything else in your life: would you start a business without a business plan? And a sound financial plan can address and mitigate portfolio volatility through appropriate asset allocation, sector diversification, and regular plan reviews.

 BT for S.R. Schill & Associates, Mercer Island, WA