Big Macs, Gold, and Sugar

biggestBigMacBig Macs are a real bargain in China. On average, only $2.74 versus $4.79 in America. In Switzerland it will cost you $6.82, Norway $5.65, Euro area $4.02, Chile $3.27, Russia $1.88, and India $1.83. These values are from The Economist’s Big Mac Index, their annual survey to provide information on exchange rates.

The Big Mac Index was started in 1986 to provide a guide as to whether currencies are at their “correct level.” It is based on the theory of Purchasing Power Parity (PPP) which holds that in the long run exchange rates should move towards equalization of an identical basket of goods and services. Therefore, the Big Mac “raw” Index would suggest that the Chinese yuan was undervalued 43% to the dollar currently and will likely rise in the future.

However, the rise will likely be much less than 43%. This is because you would expect that a burger would be cheaper in poorer countries than in rich ones because labor costs are less. Hence, the Economist also compares the Big Mac price to GDP per person to get an adjusted index. When we use the adjusted index, the yuan is calculated to be 9% undervalued. India is estimated to be 34% undervalued and Switzerland 13% overvalued using the adjusted index.

The stronger U.S. dollar (USD) is very apparent in the raw and adjusted Big Mac Index. Over the last 12 months, the WSJ Dollar Index has risen 22%, mostly in anticipation of an interest rate increase by the Fed. The dollar’s gains are a burden for commodities, which are priced in USD and become more expensive for overseas buyers when the dollar gains in value. Gold and sugar are two commodities that have been dramatically impacted by the strong USD.

Gold hit a 5 year low last week propelled by a stronger USD, improving economic conditions, investor sentiment, and expectations the Fed will raise rates. Gold does well in response to unexpected crises (such as the financial crisis in 2008/2009), but not so for long-simmering troubles like the Greece situation. Furthermore, a diversified stock portfolio, as measured by a world index, has gone sideways (unchanged) for the last twelve months. And, with interest rates expected to rise and gold not paying any interest or dividends, investors have been moving out of gold. Furthermore, China and its citizens who have been big buyers of gold have tapered off their purchases. First, investors wanted to get into the roaring Chinese stock market instead, but as that market keeps sliding there is little liquidity to buy gold.

Of course, we think of gold as a kind of insurance policy. There’s a cost when things are good (markets are moving up) or moving sideways because gold is holding or losing value. But, when a crisis develops then this insurance helps mitigate the damage. A few percentage points of gold in your portfolio helps. Gold was up 2% in 2008 when stocks were down 35% or more.

In a similar way, sugar fell to a six year low last week. In the past year, sugar prices have fallen by 25%. Brazil has been supplying one quarter of the world’s 180 tons of sugar annually. The value of the Brazilian real has fallen 17% against the USD this year. As the value of the currency falls, it encourages producers and exporters to sell supplies on global markets, because it becomes more profitable for them when they convert the USD sales back into local currency.

Last week, Brazil’s cane growers announced they are in for an unusually large crop, increasing the worldwide supply. In addition, artificial sweetener production, including China’s Sucralose is expanding rapidly. As alternatives to natural sugar flood the global market, prices for real sugar declines.

I always look forward to the Big Mac Index. It is both fun and educational. The Big Mac Index has become a global standard, included in several economic textbooks and the subject of at least 20 academic studies. It helps explain, in part, why gold and sugar hit 5 and 6 year lows last week. And the Big Mac Index lesson is much more easily digested than many of the economics lectures and papers many of us have had to endure. Here’s to McD’s, In n’ Out Burger, Five Guys, Shake Shack, and more. Keep ‘em coming.

Homeowner’s Insurance: Covering Your Asset

Here in Charleston, the height of hurricane season is approaching and the weather reports around the country at times seem dire. Disasters, natural and otherwise, are vividly portrayed on the nightly news or in many of the entertaining insurance company commercials. Do we consider what would happen if we were the ones looking at the tree down on the roof or water pouring out our front door? Most people only think about their homeowner’s insurance policy when selling or buying a property. Even then, it is usually just a “to do” item to satisfy the lender or something to handle before the closing. There are many features in a policy that need careful consideration and it is good to understand the many options.

For example, you might be surprised to learn that opting for coverage at your home’s appraised value may, in some cases, leave you underinsured. Standard homeowner insurance policies use industry estimates to set their replacement coverage for rebuilding, replacing or repairing insured items. The cost to restore historic homes or homes with high-end customization or upgraded features may exceed what these standard policies will allow. As an article in the Wall Street Journal noted, “the cost of construction could be two, four or sometimes even 10 times the market value of the home”. Especially after a natural disaster when the price for materials and labor can skyrocket from the demand. Many insurance carriers, particularly those that specialize in high-value properties, will offer additional coverage above the industry standards for replacement costs. A knowledgeable agent can find the right amount of coverage for your property.

Also, you may have some very valuable items in your home that are worth much more than the replacement value. There are riders for particular high-value items like jewelry or art that you can insure for a specified value for replacement if lost, stolen or damaged. Usually the premium for the replacement of these valuables is well worth the cost and will allow them to be separately scheduled from the replacement coverage of your home.

In some cases, you may find you can save money by reducing your coverage, for example, on personal property or liability, especially if you already have a valuables rider or umbrella policy in place. You can also save on premiums by increasing your deductibles or self-insuring for some of the extras that a policy might cover. Installing security systems or safety features like storm shutters or sprinkler systems may qualify for discounts, as well. Be sure to let your agent know about any features like these or about any additional policies you have so you don’t duplicate coverage.

Some other things to consider:

  • There may be options in policies that offer coverages for lodging or other expenses in the event you must vacate your home during repairs.
  • Homeowners insurance does not cover damage caused by flooding, tsunamis, earthquakes or even some acts of war, like terrorism. Separate riders or policies may be needed if your property is at risk.
  • Many policies don’t cover for mold damage, sewage back-up or termite infestation. You can generally purchase additional coverage to protect against these or you may choose to self-insure.
  • Homeowners should note the liability coverage in their policy and make sure it is adequate to protect them or their guests. Additional umbrella policies can be used to cover your total net worth for extra protection.

It is always a good idea to know the details of your homeowner insurance policy. It is also smart to catalogue, videotape, or in some way record your property and the items inside. This will help you get your full value when faced with any insurance loss. At DWM, we hope you never have to face any type of insurance claim. Although we don’t sell any insurance or endorse any particular insurance products, we are happy to help you review and evaluate your insurance needs and make sure your assets are properly covered.

Systematic Investing and Dollar Cost Averaging

Systematic investing3You’ve probably heard the investment advice, “Buy low, sell high.” It would be nice if it were that easy, but no one can accurately predict when the market, let alone an individual security, will be at its high or low, making this advice extremely difficult to follow. Instead, many experts recommend staying fully invested, even during market downturns, to increase your chances of investment success. Historically, investors who stay fully invested fare better than their market-timing counterparts, because timing the market is nearly impossible. When an investor pulls assets out of the market in an effort to avoid losses, they will likely also miss some of the higher returning days. By remaining fully invested, you never miss the best performing days.

Many investors who stay invested use the systematic investing method to help achieve dollar cost averaging and meet long-term investment goals. Systematic investing is simply investing a specific amount on a regular basis, such as contributing a certain percentage of your pay to your 401k from each paycheck. When you invest systematically, you add to your investments regardless of market conditions. This is how you achieve dollar cost averaging (“DCA”). When prices are low, you will be able to purchase more shares for your money, and conversely, less shares when the price is higher. Rather than sitting in cash waiting for ideal market conditions, where your money is not working you, invest a set amount automatically and you will end up with an average price over time. If you establish an investment plan involving systematic monthly or semi-monthly investments, it is easier to stay the course when the market goes through rocky periods than it is when you invest without a plan. This helps you to stay committed to your long-term goals and takes the emotion out of investment decisions. The main reason to use DCA is that it reduces the timing risk of investing a large amount of cash at the wrong time.

DCA doesn’t always have to be used in combination with systematic investing. DWM typically employs DCA when a large infusion of cash comes in from a client. Rather than put it all into the market immediately, we may implement the money by investing equal portions over a few month’s time. I.e. 1/3 immediately, 1/3 a month later, and a 1/3 two months later. To limit transaction costs we don’t do this with smaller amounts. We also don’t typically use DCA when we receive a non-cash transfer, i.e. $400,000 worth of securities from an old broker. In this case, the money already has exposure to the market so there’s no reason to DCA back in.

Systematic and DCA investing are smart ways of putting cash to work and putting you on a disciplined, emotion-less investment schedule. If you’d like more information, we’re happy to help!

DWM 2Q15 Market Commentary

Sideways fireworksIt was a special year for me. Instead of just my normal one annual firework viewing, I was able to see a number of displays this season including one in Kentucky, one in Wisconsin, and one in my hometown of Glen Ellyn, IL. On top of that I was able to witness the market fireworks that came early in June. Usually we wait until the 4th of July for fireworks. But not this year as the second quarter was chugging along somewhat quietly until “bang goes the dynamite” in the last week of June. The Greek turmoil was the cause of these fireworks and it sent global markets tumbling and cut the year’s gains to almost nothing. It’s unfortunate as we think that “Grexit” is overblown – please see our recent blog for more on Greece.

Let’s take a closer look into each asset class:

Equities: The most popular index, but generally not the best one for proxy use, the S&P500 managed to eke out a small gain for 2Q15, +0.28%, and is now up only 1.23% for the year. The MSCI ACWI Investable Market Index, a benchmark capturing ~99% of the global equity markets, registered 0.35% for the quarter and has returned 2.66% Year-To-Date (“YTD”). International funds continue to outperform domestic ones in 2015.

Fixed Income: It was a difficult quarter in bond land as we saw the Barclays US Aggregate Bond Index fall 1.68% and 0.10%, 2Q15 and YTD, respectively; and the Barclays Global Aggregate Bond Index drop 1.18% and 3.08%, respectively. Corporate bonds really suffered as represented by the iBoxx USD Liquid Investment Grade Index, off 3.82% for the quarter and now down 1.31% for the year.

Alternatives: It wasn’t a great quarter for stocks or bonds and unfortunately not a good one for alternatives either. A lot of the areas that did well in the first quarter stumbled this time around, for example, managed futures and real estate. MLPs were also down but we believe MLPs are mistakenly getting lumped into the “sell-anything-related-to-oil” trade. There were some bright areas. For example, there are insurance-linked (“catastrophe”) funds that continue to chug along with positive returns. They have really no correlation whatsoever with the financial markets as they are tied to natural events instead. We love non-correlation like this!

So at the half way point of 2015, many investors are sitting with small, albeit positive net gains for the calendar year. We are cautiously optimistic about the second half as there are many positives out there including:

  • The US economy is definitely headed in the right direction – unemployment and wage data keep improving. We are expecting a modest pick-up of growth in the second half.
  • Even with the Fed poised to start raising rates later this year – a sign of US economy strength – comfortably low US inflation should continue and is good news for American businesses and consumers. It also lends support for stocks.
  • Outside of the US, central banks are easing which usually is a catalyst for global markets.

That being said, beyond Grexit, there are other headwinds including:

  • China’s stock markets have been in extreme whipsaw lately. Hopefully there is no spillover effect for the rest of the world.
  • Large cap domestic stocks as represented by the S&P500 are a little pricey. The S&P500 finished 2Q15 at 17.9 times Trailing Twelve Months (“TTM”) earnings. That’s higher than the 15.7 average for the last ten years and higher than the 17.1 at the start of the year. Frankly, US stocks have risen so fast since the financial crisis of 2008 that future gains are likely to be weaker than historical averages. (On the flip side, a lot of the international markets look relatively cheap.)
  • The Fed, via its unprecedented QE program, has created this artificial low rate environment which has led to recent major volatility in bonds. Not only should we expect this to continue, but it to lead to increased volatility in other asset classes. Furthermore, nervousness is abundant as the Fed tries to unwind this artificial un-natural setting.

In conclusion, the “fireworks” may continue and keep us on our toes. The market doesn’t always go up. We need to remember to be patient when quarters, and perhaps years, like this come along. It’s important to stay disciplined, to stay focused on the long-term, stay invested, and not let emotions drive irrational behavior based on short-term events.

In closing, the best firework display I saw this year was the one last week in Kentucky. It was amazing! Besides being kicked off by a 15 minute video that gave thanks to our troops, the fireworks were synchronized to music from AC/DC to the theme song from Frozen, “Let it go!” Unlike the other fireworks events I attended, only this one had a unique set of fireworks that actually go up, make a huge bang, and then go sideways. Yes, sideways, as in totally horizontal for some time. Frankly, I think it may be appropriate if our markets moved like these fireworks: up for a short while and a healthy move sideways…

Brett M. Detterbeck, CFA, CFP®