ProVise Management Group
January 31, 2012
- Gold has certainly been in the news for the past couple of years, and it’s fair to say that it has had a fairly substantial run up. It has fallen from its all-time high of $1,889 per ounce, a peak it reached on August 22, 2011. That peak was just a few weeks after S&P downgraded U.S. government bonds. While gold has hit a nominal high, it has yet to touch its inflation-adjusted high price. That all-time record was at $850 per ounce back in mid January of 1980. If that same price were simply adjusted for inflation, it would be $2,472 per ounce today. (Source: Department of Labor)
- If you don’t think there is a huge disconnect between government spending and government revenues, perhaps some of the following facts will convince you. This information is particularly important given discussions in Congress during the month of February regarding extending the payroll tax holiday to the end of the year, and how that will be paid for. For the fiscal year ending September 30, 2011, government spending equaled 24% of gross domestic product (GDP), which was the third highest percentage in the last 40 years. This situation is exacerbated by the fact that the taxes collected were 15% of GDP, which is the third lowest percentage in the past 40 years. Combine the two and you can understand why the country is moving in the wrong direction. This cannot be sustained and it will require sacrifice at all levels. There is no easy way out of the problem. Historically, in a healthy economy, the revenue percentage should be approximately 18-20%. (Source: Congressional Budget Office)
- Let’s take a few moments to talk about Europe and the euro, as it will certainly be in the headlines over the next couple of months. It’s been almost three years since Greece first became a topic of conversation. In the beginning, it was hard to believe that such a small nation really mattered in the grand context of what was happening on a global basis. So what if Greece defaulted? The problem is that the Greek contagion spread to other countries in Europe, including Ireland, Spain, Italy, Portugal, and now perhaps even to France to a more limited extent. Without question, the Germans and French have been the leaders in trying to work Europe of the crisis. On top of everything else going on, the French have elections coming up in the spring, and it is quite possible that Sarkozy will be voted out of office, which would add even more turmoil at a very crucial time. Europe got into the mess because they did not enforce (arguably they could not enforce) the rules that were laid down at the time the euro was born. They use a common currency, but spending and taxing are left up to the individual governments with no real punishment for doing the wrong thing. When you spend more than you have over a sustained period of time and when a large percentage of the population is employed at various levels by the government (does any of this sound familiar?), it is not surprising that a country such as Greece would see a decline in their standard of living.
It is unlikely that Europe would ever become, at a political level, the “United Countries of Europe”. There’s just too much history for anything like that to occur in the near term. However, there is nothing wrong with the formation of a monetary federation with real rules which can actually be enforced. Yes, countries do need to raise taxes (Ugh!) and cut back on spending (Yea!). It won’t be pretty in the short run, but it will be even uglier in the long run if they don’t do this, rather than simply talk about it. This is a position that Germany has adopted up to this point in time, and, from a commonsense point of view, it’s hard to blame them.
But this alone is simply not enough. Our friends at GaveKal, based in Hong Kong, make a strong case that without Germany finally agreeing to two points that they have refused to embrace up to this point, it could cause the euro to experience a serious decline. The first point is that there must be a “collective European responsibility for national government debts and bank guarantees”. In essence, each European country must become a guarantor of every other country’s debts. But, without any teeth, this is completely unpalatable. Therefore, the second step that must take place is essentially a monetary federation agreement where the European Community Bank (ECB) can essentially provide monetary support for all of the government debt. This is similar to the ECB having the same power that our Federal Reserve has. Neither of these points was addressed in a treaty that was agreed to in December. If that document is not modified before the actual vote in March, our fear is that Europe will remain in the news for an extended period of time.
- The U.S. government actually spent less money in the first quarter of fiscal 2012 than it did in the first quarter of fiscal 2011. In fact, it was $47 billon less. That’s the good news. The bad news is that the deficit was $86 billion for the month of December, bringing the total for the quarter to $322 billion. At least it’s a start, but it appears that we are headed for another trillion dollar deficit this year, which will cause some interesting discussions during the Presidential election. Total debt as of 12/31/11 was $15.2 trillion. (Source: Treasury Department)
- There is an old theory about the stock market that says that if you do the opposite of whatever the small investor does that you will be right. Today, the small investor is still pulling money out of stocks. The outflows have been occurring since last September, although they did slow down a little in the latter part of January. Where is this money going? It continues to flow into bond funds of all types. In fact, money is going into bond funds so quickly that some of the fund managers are finding it hard to put all the money to work. Unfortunately, a lot of this money is going into long-term funds where investors are chasing a higher interest rate. At some point, interest rates will begin to rise. When this happens, bond prices will decline and the decline could be swift and steep. We remain concerned for those investors which is why, for the most part, we have kept our clients on the shorter end of the yield curve. We are giving up potential interest in an effort to preserve capital when interest rates do rise.
- There are several theories concerning the market which are worth exploring at this time. The first is a theory that if the market is up during the first five trading days – which it was – it will be up for the year. The second is known as the “January effect”, which says that if the market is up in the month of January, it will be up for the year. Not only was the market up in January, but it was the best January since 1997, or the last 15 years. Then, of course, there is the “Super Bowl Theory” which says that if a team from the NFC or a former team of the old NFL wins the Super Bowl, the market will have an up year. Not that we are superstitious, but all we can say is, “Go Giants!”
(c) ProVise Management Group