The Quarter in Brief

The third quarter of 2011 was a frustrating one for investors and non-investors alike; indeed for almost all Americans. If certain things would happen, then the fourth quarter could potentially be demonstrably better. The problem is that there remains a great deal of uncertainty and there are far too many “if this, then that” scenarios. Nevertheless, let’s review the events of the past three months.

• The growing debt crisis in the Eurozone and the fear of contagion kept U.S. markets lower, probably even more so than a whole host of lackluster domestic economic indicators. Confidence waned on Wall Street and Main Street, and analysts who had begun to second guess the recovery began vocalizing their concern.
• The U.S. economy crawled forward with occasional flashes of vigor, which were, unfortunately, too few and far between. Take for example, consumer spending which saw slight rises in July and August of 0.7% and 0.2%, respectively. To some extent, those increases reflected rises in food and energy costs, not necessarily true increases in spending. Americans, in general, held tight to their purse strings, too wary of the future
• The U.S. unemployment rate remained firmly anchored at 9.1% for the entire quarter, and consumer confidence, as measured by the Conference Board’s report, plunged.
• Frustration over the ongoing political posturing among Washington’s elected officials was a key driver of the markets’ volatility. After the long cantankerous debate regarding the nation’s debt ceiling, it was inevitable that Standard and Poor’s would downgrade America’s credit rating. And so they did, dropping it a notch from AAA to AA+; S&P also downgraded those federal agencies reliant on the U.S. government, i.e. Fannie Mae and Freddie Mac. While not unexpected, global equity markets took the downgrade badly.
• President Obama called for bipartisan unity as he introduced the $447 billion American Jobs Act late in the quarter, a program being likened by some to FDR’s New Deal, but the passage of the bill remains in limbo as Republicans are loathe to support a measure that would be funded by tax hikes.
• Under significant pressure to do something to stimulate the sluggish economy, the Federal Reserve did not haul out QE3 as some analysts had expected, but brought back 1961’s “Operation Twist” strategy of shifting $400 billion into longer-term Treasuries to foster growth. Equity markets didn’t look too kindly on Operation Twist, nor did analysts for that matter, who don’t believe that it will make any significant difference in the long run. 
• Asian economies, especially China, which is viewed as the driver of global growth, contended with a clear drop in export demand, a result primarily of the world-wide economic slowdown. The silver lining is that slowing global demand could slow down persistent inflation in India and China, seen as a priority by the respective governments.
• The real estate sector is far from healed, though there was some annualized improvement. Mortgages became cheaper with lower interest rates, but bank lending restrictions are still making it difficult for potential homebuyers, though there are fewer of those as a rule. Home sales are lower, as are home prices and building starts, because the majority of potential homebuyers are bargain hunting and looking for a deal among bank foreclosures.

So, how could things be better? First and foremost, the Eurozone’s policymakers need to have a decisive and truly unified response to the debt crisis there, and they must consider and arrange for an orderly default for Greece. A growing number of world-renowned economists believe that a default is in the cards for Greece, and at this point, the only true salvation for the Greek economy. Second, a strong corporate earnings season with some upside surprises would be nice. Third, markets need to get some clear data indicating that the economy is still growing.

Outlook and Commentary

The sad fact is that markets do not like uncertainty but there is a lot of it in the world today. Continuing concerns include the European sovereign debt crisis, likewise the ongoing one in the Federal government (and not a few state and municipal governments) and of course, in American households. Residual real estate challenges, partisan politics, and slowing growth in the Asian economies are also ongoing worries. The Federal government, through its central bank, has effectively used monetary policy to maintain low interest rates and keep inflation in check. Lacking, however, is the political will and cooperation needed to effectively use fiscal policy and other much-needed government programs such as an infrastructural bank reforms, and those which would support regulatory easing to fast track projects.

Fareed Zakaria, an interested observer, has noted in his reports that the key issue for America is jobs. I agree with his concerns. Low work force participation is driving income disparities in the U.S. and setting the stage for political turmoil. Americans are clearly frustrated that their own economic outlook is darkening; witness the recent Occupy Wall Street campaign which is spreading across the country. I encourage you to read his blog in which he calls for President Obama to declare a National Jobs Emergency that would enable a fast track to rebuilding the country’s infrastructure and putting Americans back to work.

Our Focus

As your financial advisors, we understand that you trust us to do more than manage your money: you rely on us to protect and grow the resources that you depend upon to live your life. Our focus continues to be to help you make smart choices about the aspects of money that you can control. And to anticipate and to react appropriately to the uncontrollable; market fluctuations, personal life changes, geopolitics and economic cycles. Our focus is you: living the best life as you were meant to live it.

On a Personal Note 

 As a Californian, the changing seasons mean shorter days, cooler mornings and even some rain. I know you Texans are grateful for the recent rain on your parched, burning state—Mother Nature has been kinder. With the long hot summer behind us we look forward to Thanksgiving and the holiday season. Time passes too quickly, I am sure you’ll agree. As I hit the “send” button I today, I head to the airport and will fly to St. Louis to visit Adam and his family. My bridge lessons are keeping me busy with the added bonus of having new “bridge friends” to enjoy. The year end is also time to put our financial house back in order and to reconsider how to live well, despite the continuing recession (and yes, this is a recession, regardless of what the pundits are calling it)…and we know that the key to living well is to get back to basics – take up new hobbies and treasure your friends and families.

“He changed the way each of us sees the world.” How many CEOs leave that kind of legacy? How many get that kind of compliment (from President Obama, no less)? Steve Jobs’ death on October 5 drew myriad tributes to his sustained brilliance. It also led to questions keying on one of Jobs’ favorite topics: what comes next.

Will Apple continue to set the curve? As Forbes contributor Carmine Gallo noted, “I often get the question, ‘Can anyone innovate like Apple?’ The simple answer: While anyone can learn the principles that drive Apple’s innovation, few businesses have the courage to do so.” Jobs and Apple spread that courage and vision into a trifecta that few firms (and few of its rivals in the tech sector) could have hoped to achieve.

• Apple created its own orbit of revenue from a culture of raving fans. Instead of rigidly defining Apple as a computer manufacturer, Jobs saw Apple as a digital products company whose revenue streams could come from many forms of media: music, books, movies, and more.
• Apple sells much of its product from its own online and brick-and-mortar stores. It laps up retail gross profit and manufacturing gross profit.
• Apple has created its own iPhone/iPad apps, which generate yet more profit

So with this trifecta in place, it is hard to imagine any firm dislodging Apple from the lead in the tech sector in the near future. Amazon’s Fire tablet has grabbed plenty of headline space as a low-end alternative to the iPad, and it may well be that Amazon claims the low-end tablet market for the near future while Apple gets the high end. (Of course, Apple owns the OS for its tablet; Amazon doesn’t.)

Does anyone possess the Jobs magic? As Blast Radius senior creative director Jason Theodor remarked, Jobs dreamed up Apple products that were “beautiful, friendly, and often indistinguishable from magic … he never gave people what they wanted, but chose instead to give them what they never knew they needed.”

Apple has a capable CEO in Tim Cook and an innovative designer in Jonathan Ive, so there is every reason to think it will remain the pacesetter into the middle of the decade.

 I feel a personal loss with the passing of Steve Jobs…he changed my life in a very personal way.

Lauren

After hinting in May that there would be no mid-year change in standard mileage rates, this morning the IRS announced significant increases in both the business mileage rate and the medical or moving expense rate. (Announcement 2011-40)

Effective July 1, 2011, the business rate increases from 51 cents per mile to 55.5 cents. The medical or moving expense rate increases from 19 cents to 23.5 cents. The charitable rate remains at 14 cents.

You are probably asking: What happened this week? What is Klein Financial Advisors planning to do? And what, if anything do I need to do? The fight or flight animal in all of us wants to react. Remember that panic is not a strategy.

Unprecedented and unsettling. Standard & Poor’s issued a historic downgrade of U.S. debt on August 5, sensibly waiting until the market week had concluded to send a shock wave toward global investors. It reduced America’s long-term debt rating – which had been AAA since 1941 – to AA+.

S&P felt Congress did too little too late. The credit rating agency had threatened the downgrade if Congress passed any deficit reduction plan smaller than $4 trillion in scope. The Budget Control Act of 2011 “falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” an S&P statement noted. It also retained its “negative” credit outlook on the U.S.

S&P is also skeptical that the federal government can collect more money from taxpayers. Its analysts do not think the Bush-era tax cuts will sunset at the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”

The other ratings agencies – Fitch and Moody’s have not downgraded the United States. Fitch has said a downgrade remains a possibility. Moody’s “thought a downgrade would be premature given that they [Congress] have come up with a plan for deficit reduction. Analysts are monitoring to see if lawmakers are able to agree on $1.5 trillion in further cuts.

China’s comments. The world’s largest holder of U.S. debt issued a withering critique of Congress through Xinhua, its official news agency. The state commentary stressed that the U.S. has a “debt addiction” only curable via major cuts to defense spending and entitlement programs. It also said that the option of a “new, stable and secured global reserve currency” should be explored.

 The Treasury’s claim.Friday evening, the Treasury argued that S&P’s analysis contained an accounting error that unnecessarily added $2 trillion to its projection of U.S. debt. S&P admitted the error but stuck with the downgrade.

 So what happens now?The markets that were open over the weekend, including Israel, have been volatile and nervous. The Asian markets that opened this morning with declines. The initial global response aside, analysts are divided as to what the short-term impact might be for the American economy. Could it cripple the recovery, or just prove inconvenient to it?

Demand was big for Treasury notes even before the threatened downgrade and Treasuries still symbolize comparative safety to institutional investors, so an August selloff might be short-lived. If this turns out to be the case, the effect on interest rates might be less significant than feared.

Could the Fed launch QE3*?The possibility exists, particularly if foreign investors ditch dollar assets. The Fed’s Open Market Committee will make an announcement on August 9, and few analysts expect another wave of bond buying – but it is an option.

 When might the U.S. recapture its AAA rating?It might take years for that to happen. S&P has cited political gridlock on Capitol Hill as a major reason for the downgrade, and it doesn’t see that going away in upcoming months. On top of that, the U.S. economy expanded just 1.3% in the first half of 2011 – about half the pace needed to dispel the lingering effects of recession.

Wall Street might sail through this.Does that sound far-fetched? Look at some historical examples. S&P downgraded Canada’s AAA credit rating in the spring of 1993, yet Canadian stocks gained 15% in 1994 and our northern neighbor had its AAA rating back by 1997. Moody’s Investors Service downgraded Japan in November 1998 and its stock market advanced more than 25% in the next 12 months. Italy, Canada, Ireland, Japan, Belgium and Spain have all suffered S&P downgrades from AAA, and most of these cuts had little sustained impact on government bond yields.

 What’s our outlook?Whatever happens in Congress, in Europe and in the daily market activity, Klein Financial Advisors will act prudently with your long term financial security in mind. Still feeling jittery? This may be a good time to revisit your risk profile – your ability, need and willingness to accept risk – and consider updating your investment policy.

Don’t hesitate to call to discuss your personal financial security.

And yes…stay confident and stay the course….especially on days like this.

Lauren