Investment Commentary, Q2 2012

Investor sentiment remains timid amid an early year market rally, European woes abroad and domestic policy debate compound the uncertainty.

Policy

In June, the Supreme Court upheld much of the Patient and Affordable Care Act of 2010.  The Department of Health and Human Services and the Internal Revenue Service are working diligently to draft regulations to implement the Act.

The Cato Institute reports that <a href=”http://www.cato-at-liberty.org/threat-to-obamacare-is-no-drafting-error/” target=”_blank”> some states are choosing not to set up healthcare exchanges as mandated by the Act.  As many as many as 30 states have not yet begun processes to set up the required exchanges.  Several states have simply stated that they will not comply with the law’s exchange requirement.

While it is unclear what effect, positive or negative, the legislation may have on our healthcare system, it is our opinion that it will not succeed in one of its primary goals: stemming the trend of higher costs in healthcare.  As such, we must work diligently with our clients to ensure that their financial plans include generous allowances for healthcare expenditures later in life.

Economy

The <a href=”http://www.bls.gov/” target=”_blank”>Bureau of Labor Statistics</a> reports that nationwide unemployment had declined from 8.3% to 8.2% as of June, and that the CPI Index (Inflation) remained flat.  Concerns remain about the resolution, or lack thereof, of the troubles plaguing the European community.  Domestically, Congress continues to avoid providing relief from uncertainty to US businesses and business owners as spending and tax policy remains up in the air.  Our opinion is that as long as fiscal policy remains fluid and Congress noncommittal, the broad economic recovery will remain tepid at best.

Bonds

The 10-year Treasury Bond rate <a href=”http://www.multpl.com/interest-rate/table” target=”_blank”>decreased</a>  dramatically from 2.3% to 1.54% as a further Fed action over the last month or so has “twisted” down long-term rates.  Dorsey Wright Money Management reports that net mutual fund flows into bond funds continued to be strong.  For the first time this year, the net outflows from domestic equity funds were flat in June.  We continue to believe investors may be best-served by allocating toward higher quality and shorter duration within their fixed income portfolios.

Real Estate

Publically traded REITS currently trade at a 16.7% premium to Net Asset Value, <a href=”http://www.greenstreetadvisors.com/” target=”_blank”>Greenstreet Advisors reports</a>, as investors continue to flock to assets providing superior yields compared to Treasuries and other fixed income securities. We continue to be diligent in searching for attractive non-traded opportunities.

In residential real estate, the Wall Street Journal <a href=”http://blogs.wsj.com/developments/2012/07/31/case-shiller-shows-strong-price-gains-in-may/” target=”_blank”>reports</a> the Case-Shiller Index is up 2.2% from April of this year, with home prices in Phoenix rising 11.5% in May 2012 compared to May 2011.  With Operation Twist in effect, however, borrowers saw mortgage rates decline to sub-4% levels.

We generally recommend that prudent investors allocate a portion of their investment portfolio in non-residential real estate, generally through the use of publically traded Real Estate Investment Trusts*.  Real estate has served as a great diversifying asset in good times and bad, and may serve as a hedge against both inflation (as a real asset) and deflation (given relatively high cash flow).

Equities

Equity valuations remained flat in the second quarter with the <a href=”http://www.multpl.com/table” target=”_blank”>Shiller CAPE10</a> (10-year Cyclically-Adjusted Price to Earnings Ratio published by Prof. Shiller of Yale University) remaining at about 22 as of this writing.  Retail fund flows continue to be biased positively towards fixed income and international equities, but flows to domestic equities have shown some improvement from negative to flat in the most recent data.  Our current 10-year forward-looking return estimate for equities remains 5-7% per annum.  Despite the market volatility of the last 10 or so years, we believe there are few attractive equity alternatives at this time.  Investors should continue to include a substantial diversified allocation to equities in their portfolios.

Gold and Commodities

Commodities rallied in quarter two as drought has persisted in much of the US.  Prices at the pump have relaxed somewhat.  Gold price volatility has lessened somewhat, and the price remains around <a href=”http://www.bloomberg.com/markets/commodities/futures/” target=”_blank”>$1620 per troy ounce</a>.  While commodities may enhance risk/return characteristics when included in a diversified, regularly rebalanced portfolio, we view the longer-term dynamics of an allocation to commodities as questionable and do not actively recommend inclusion of commodities in our client portfolios.

We continue to believe that prudent financial planning combined with a comprehensive approach to your financial situation is your best defense against unexpected market and economic events.  To be sufficiently vigilant, it is always a wise idea to revisit one’s plan no less often than once a year.  Feel free to contact our offices to set up a time to review your plan and portfolio.

Regards,

Jeremy S. Mitchell, CFP®

*Real estate may be owned through other ownership forms, but may involve additional risks than those typical with stock or bond investments.  Some of these other ownership forms may include illiquidity risk, which may prevent the investor from readily selling the holding(s).  The allocation to REIT and other real estate investments will vary based on an investor’s ability and inclination to assume the associated risks.

This information is provided for general purposes and is subject to change without notice.  The information does not represent, warranty or imply that services, strategies or methods of analysis offered can or will predict future results, identify market tops or bottoms or insulate investors from losses.  The information has been obtained from sources considered to be reliable, but it is not guaranteed.   Past performance is not a guarantee of future results. Investors should always seek individual financial advice based on their own personal circumstances before acting.

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