Investment Commentary, Q1 2012

After a volatile year for international stocks, the world equity markets have rallied in the first quarter, and the election year ahead for investors is off to a strong start.


In the last week of March, the Supreme Court held everyone’s attention as the justices took up the Patient Protection and Affordable Care Act, holding an unprecedented six hours of oral arguments over three days. The controversial act, drafted behind closed doors and rushed through Congress before its contents were well disclosed, will no doubt frame the election landscape in 2012. The court is due to publish its opinion on whether the law, with its individual mandate for the purchase of health insurance, is constitutional by the end of June. It is our opinion that the additional taxes contained in the law, if not struck down by the court or eliminated by Congress, may have a detrimental effect on the overall economic landscape for years to come. Irrespective, it is our hope that Congress will act to pass a law that fixes what we believe to be the root cause of the healthcare crisis in the United States today: the rising cost of care.


The big news in Q1 of 2012 was a rosy jobs report from the Department of Labor. The New York Times reported on March 9th that the economy added 227,000 new jobs and that the unemployment rate “held steady” at 8.3%.


In Q1, the 10-year Treasury Bond rate increased from 2.0% to 2.3% as a sell-off in Treasuries increased yields. However, we do not believe that the apparent “bubble” in Treasuries has yet burst. Economic uncertainty along with another decision in the European Union to delay real progress in the sovereign debt crisis has not yet caused a wholesale flight to risk assets. Dorsey Wright Money Management reports that net mutual fund flows into bond funds continued to be dramatically robust compared to the modest inflows of international equity funds, not to mention the continued net outflows from domestic equity funds. We recommend investors stay with shorter duration securities in their fixed income portfolios, while holding both nominal fixed income securities, along with Treasury Inflation Protected Securities (TIPS) as a prudent long-term inflation hedge.

Real Estate

Greenstreet Advisors reports that publicly traded REITs are currently trading at about a 12% premium to net asset value. This places them inline cost-wise with many public, non-traded REITs. However, we believe that the deep value environment that created attractive opportunities for non-traded REIT investment has largely subsided. We continue to be diligent in searching for attractive non-traded opportunities. Also, we continue to recommend that clients maintain at least a 10% exposure to REITs in their investment portfolios, both as a diversifying asset, and as a dual-hedge against deflation (due to high current cashflow) and inflation (Real Estate is considered a real asset).


Equities rallied in Q1, and valuations richened with the Shiller CAPE10 (10-year Cycically-Adjusted Price to Earnings Ratio published by Prof. Shiller of Yale University) rising from around 21.6 at the beginning of the year to 23.5 as of this writing. Retail fund flows continue to be biased positively towards fixed income and international equities, while flows remain negative year-to-date for domestic equity funds. We generally take these flows as a positive contrarian indicator for the domestic equity market. However, due to these conflicting signals (negative flows vs. historical overvaluations), we recommend that clients stay well diversified in their equity exposure among domestic and foreign developed markets and emerging market stocks. Our current 10-year forward-looking return estimate for equities remains conservative, at around 6-7% in nominal terms.

Gold and Commodities

After gold’s dramatic -20% (approximate) correction in late 2011, the metal has rebounded slightly in the new year. In a recent article, the Wall Street Journal reports that Goldman Sachs has indicated a 12-month price target of $1940 per troy ounce, about 10% above the current price.

While, as you are aware, we do not actively recommend gold as an investment, we do concur with Goldman’s reasoning for further support in the market price of gold. Historically, demand for gold is predicated on the availability of a perceived “safe” instrument for maintaining real value of money. Short-term US Treasury Securities, T-Bills, are generally held as the safest store of value in the world. However, when real yields on these “safe” assets turn south, investors tend to flock toward gold as an alternative store of value. In our research, we perceive that an equilibrium point exists for the desired real-yield of a “safe” asset–somewhere between 1-3%. Currently, the real yield on short-term T-Bills is less than -2%. Thus, while real yields continue to be disappointing, capital will likely gravitate towards gold as an alternative store of value, supporting its price or potentially driving it upwards. The caveat, of course, is that the Federal Open Market Committee directs interest rates, and although they are unlikely to raise rates in the near future, gold’s price is likely to anticipate any move ahead of time, making timing the gold market based on interest rates difficult at best.

We continue to encourage clients to enhance their diversified asset exposure and to stay the course, even in these turbulent times. We value each one of our clients and wish to help you make the most of your wealth. Feel free to contact us at any time with any questions you may have about the markets, economy, or your investments with our firm.


Jeremy S. Mitchell, CFP®

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