DWM 2Q12 Market Commentary

Detterbeck Wealth Management sherpaAfter the investor party that took place in the 1st quarter, 2q12 started like a bad hangover with most stock indices getting hit hard in May. Fortunately the best month of June (at least for the S&P500) since 1999 helped recoup some of the early losses. 

For the record, the average US diversified stock fund posted a -4.6% return for the second quarter yet remains up 7% so far this year! That’s pretty amazing given the soft economic conditions here in the U.S. and the turmoil overseas. And speaking of overseas, the international markets continued to lag the domestic markets in the second quarter as evidenced by diversified international stock funds dropping 7.1%, yet still up 3.8% Year-To-Date (“YTD”). It should be noted that international outperformed domestic in the month of June, a trend we expect to continue. Another note was value outperformed growth in 2Q12. 

With stocks trending down most of the quarter, investors gravitated to safety as expressed by the relatively strong showing in the bond world. The Barclays Capt’l US Aggregate Bond Index was up 2.1% for the quarter and now up 2.4% YTD. Yields on 10-year Treasury notes fell to 1.5% last week, near the lowest levels in generations, reflecting market dreariness about the economy and also possibly the anticipation of more action by the Fed. 

Turning toward alternatives, our DWM Liquid Alternatives portfolio did its primary job of protecting first, participating-in-upside second, up almost 1% for the quarter and now up almost 5% on the year. During the quarter, we successfully merged in alts like real estate, gold, and other commodities that were held in strategic models into the LA portfolios for more-focused strategy tracking moving forward.    

Going forward, there are many challenges: 5 of 17 Eurozone countries have received a financial bailout in the last 2½ years with more on the horizon. Let’s face it, its not just the PIGS (Portugal,Ireland,Greece, and Spain) that we need to worry about; the whole Eurozone faces recession. Move Far East, and even China is slowing down. Back in the homeland, our latest readings show slowing new orders, production, etc. Three years after the end of the nation’s most recent recession, the U.S.employs almost 4 million fewer Americans than when the recession began and 12.7 million people remain jobless. And the worst is that Joe Consumer is not spending as much as he did just last year. In the political arena, we are now in the Presidential Election wait-game with not much getting done in Washington D.C.before that wraps up. And frankly there’s a lot that needs attention politically… Did you know that Federal spending on Social Security, Medicare and Medicaid has risen from 16% of total government spending in 1967 to 41% of spending in 2011 and the percentage is only going to go higher unless serious changes are made?

The good news is that almost all of the major global central banks are taking steps to bolster economic output. U.S. Fed Head Bernanke said last month “We are prepared to do what’s necessary”. We think they’ll keep this attitude for the near future and hence don’t anticipate rates/inflation moving up any time soon. This should create an environment where stocks are volatile, bonds have modest returns, and alternatives are the key driver in your portfolio’s total return.  

In conclusion, here are a few more general comments on the stock market. Of course, stocks (equities) only represent a minority allocation for our clients’ portfolios. Diversification amongst stocks, bonds, and alternatives is the key to achieving a stable, long-term return. But equity is the asset class that gets the most headlines. So I thought it would be fun to remind people that as gloomy as the stock market may seem, the S&P500 is now entering its 41st month in the current bull market and has gained 115% (total return) since bottoming 3/09/09. Here’s another tidbit: The average bull market for the S&P500 since 1950 has lasted 58 months. It’ll be fun to see if this current run, even though it may not feel like one, can eclipse the average. As a reminder, if you haven’t already done so, please download the DWM Mobile App to your smartphone so you can see your portfolio at any time and take advantage of the many features within. Enjoy your summer and we hope to connect with you again soon! 



Obamacare Court Decision May Impact Roth Conversion

Roth Conversions and ObamacareOn June 28, the Supreme Court affirmed Obamacare. Numerous tax changes were included in the law. Some have already gone into effect and others are scheduled to kick in over the next several years. A new 3.8% surtax on investment income will start on January 1, 2013. Capital gains rates will increase from 15% to 18.8%. And, if Congress allows the Bush tax cuts to expire, the top rate would be 23.8% on capital gains and 43.4% on dividends.

Advisers and investors are now looking at ways to accelerate income into 2012 and considering other long-term strategies, such as converting a regular IRA into a Roth IRA.

Regular IRAs have been characterized as “deals with the devil” that taxpayers make with the IRS. Money invested is not taxed when contributed but later, after the amounts have grown over the years, and then the tax is based on the full amount of the IRA, including earnings, at the then current tax rates. 

With a conversion to a Roth, a taxpayer ends the “arrangement.” Taxes are paid on amounts not previously taxed. The taxpayer can continue to grow the Roth account from that point without tax and pay no tax at the time of distribution(s). Furthermore, the taxpayer and their spouse are not required to take regular minimum distributions starting at age 70 ½ as are required for traditional IRAs. Hence, a Roth account could grow tax free for decades without tax and could continue to grow tax-free during the beneficiaries’ lifetimes as well, though annual distributions are required once mom and dad die.

So, the question is, does it make sense to convert now, based on new taxes going into effect in 2013 and the likelihood that income taxes will increase in coming years? And, if so, when should the conversion be done? Here are a few rules of thumb:

  1. If you are likely to leave money to your heirs, then a Roth account is the best possible asset you could leave them. Investments within a Roth account grow tax-free. Hence, inheriting a Roth account is better than cash. Consider converting.
  2. If you are likely to spend your IRA(s) in your lifetime, conversion is probably not the best idea. In this case, your earnings in retirement will likely be less than your working years. Hence, even though tax rates are higher overall, your individual tax rate may be the same or lower.
  3. If you are not sure, then you should have your fee-only, independent Registered Investment Advisor run some scenarios for you of conversion or not, using hypothetical tax rates during working and retirement years. Taxpayers can get a real “bang for their buck” when using non-IRA funds to pay the income taxes on conversion to a Roth.

Check with your CPA before you make your final decision. If you do decide to convert, you may want to convert over time, perhaps 5-10 years, so that the income produced by the conversion doesn’t push you into a higher tax bracket. The special conversion election in 2010 to split the income and report it in 2011 and 2012 no longer applies. However, conversion still is available regardless of the income of the taxpayer(s).

Fourth of July-Be Happy and Safe!

4th of JulyEveryone at DWM hopes you and yours have a happy and safe Fourth of July.  In honor of our national holiday and courtesy of National Geographic, we’d like to share six memorable myths that turn out to be more fiction that fact.

1) Did Paul Revere ride solo? No, he didn’t. Yes, patriot Paul Revere really did ride the night of April 18, 1775 to warn the countryside that the British troops were on the move. He and two other riders, William Dawes and Samuel Prescott were, in fact, part of a highly effective, early warning system. Longfellow’s 1860 poem “Paul Revere’s Ride” fails to acknowledge the other two riders or that all three were, in fact, captured that night by the British.

2) Did a raucous Independence Day Party in Philly crack the Liberty Bell? No, the State House bell cracked soon after its arrival in 1752. The bell was recast and recracked several times but was intact during the Revolutionary War.

3) Did patriots flock to fight for freedom? Not really. There was a surge of initial enlistees. However, as it became clear that the struggle for independence would be long and difficult, the enthusiasm began to wane. Many colonies resorted to cash incentives as early as 1776 and states were drafting men by 1778.

4) Did John Adams die thinking of Thomas Jefferson? Incredibly both Adams and Jefferson died on the same day, July 4, 1826, exactly fifty years after the founding of America. However, Jefferson actually died a few hours before Adams and there is no evidence that supports the myth that Adams whispered these final words: “Thomas Jefferson survives.”

5) Did Betsy Ross Make the First American Flag? There is no proof that Betsy Ross played any part in designing or sewing the American flag that made its debut in 1777. Her participation was only revealed nearly a century after the fact by her grandson. There is no evidence, on the other hand, to prove she was not the seamstress.

6) Does the Declaration of Independence hold secret messages? The movie National Treasure was based upon a “coded map” on the back of the Declaration of Independence which would lead to the lost “national treasure” of precious metals, artwork and other artifacts accumulated over many millennia. Of course, that is not true. The National Archives acknowledges that there is something written on the back of the document. It is merely a label stating: “Original Declaration of Independence dated 4th July 1776.” 

Vacation Do-Overs in Europe

European VacationOn June 28th, Americans anxiously awaited as the Supreme Court ruled on Obama Care. In Europe, a week earlier, all eyes were on the European Court of Justice. Their case did not concern health care; rather it concerned vacation time, a topic near and dear to Europeans.

The European Court of Justice ruled last week that workers are entitled to additional paid vacation time if they don’t feel well during their original vacation. Amazing.

The question had originated in Spain, where trade unions sued for the vacation do-over allowance some years ago. The European court upheld the right throughout the EU, stating that “the entitlement to paid annual leave must be regarded as a particularly important principle of EU social law; a principle enshrined in the EU Charter of Fundamental Rights, and thus cannot be interpreted restrictively.”

Vacation do-overs add to the EU minimum of 20 paid days of vacation per year and this doesn’t include national holidays, EU mandated weekends, breaks and other additional time off. It’s even better in countries like France, where the minimum is 25 paid days per year and you get an extra 10 paid days if you work a 39 hour week instead of a 35 hour week. In addition, Europeans accrue vacation time while they are on sick leave. Hence, they could end a long recuperation period by going on paid vacation.

The EU Court decision comes at a time when the rate of unemployment in Spain is 25% and Europe is in the midst of an economic crisis. Perhaps the leaders of Europe need to take a look at the EU Charter of Fundamental Rights. Seems some changes might be needed there if Europe ever hopes to return to strong economic growth in the future.

The Big Mac Index: Tracking Worldwide Standards of Living

Big Mac indexA Big Mac has 540 calories and 29 grams of fat. It also contains important economic information that The Economist and others use to compare international prices and wages.

In January, a Big Mac cost $6.81 in Switzerland, $4.20 in the U.S., $2.44 in China, and $1.96 in India. The hourly wage at a McDonald’s (“McWages”) in each of those countries was $15.00, $9.24, $1.46 and 78 cents, respectively. Economists divide the cost of the Big Mac by the McWage to get “Big Macs per Hour” or BMPH in comparing countries. In the U.S., Canada and Western Europe, our BMPH is 2.2 (hourly earnings at a McDonald’s are 2.2 times the cost of Big Mac). In China the BMPH is .6 and in India only .4. So, in India, McDonald workers would have to work 2 ½ hours just to be able to buy a Maharaja Mac (made of chicken, not beef.) These numbers change over time and that’s what the economists are tracking.

The Big Mac Index was started in 1986 to attempt to track “purchasing power parity (“PPP”)” used to evaluate market exchange rates, currency valuations and cost of living changes across the globe. Mc Wages and Big Macs were selected because they are uniform and ubiquitous. Sandwiches are produced worldwide according to a rigidly uniform process detailed in a 600 page manual. Identical burgers are produced in every city. This produces an ideal environment for global productivity comparisons. BMPH represents a PPP-like calculation of the real wage, taking account the local cost of goods.

The Big Mac Index demonstrates the vast gulfs in worldwide productivity and standards of living. The gaps are in fact shrinking. In the U.S., our BMPH was 2.4 in 2007. Now, the McWage is up 26% in four years, but the cost of the Big Mac is up 38%, partially due to increases in food prices. The net 9% drop in our BMPH is one sign of a reduced overall standard of living. In Russia, the BMPH increased an astounding 152% from 2000 to 2007 and has increased another 42% from 2007 to 2011. China has had increases of 60% from 2000 to 2007 and another 22% from 2007 to 2011. India saw a large increase of 53% from 2000 to 2007 but their BMPH declined by 10% from 2007 to 2011. It’s no surprise that more progress in standards of living was made by the BRICs and other developing countries from 2000 to 2007 than from 2007 to 2011.

Yes, our BMPH has gone down slightly here in the U.S. over the last decade. Even so, we’re still the envy of the entire world, by far. Time to celebrate- with a Big Mac and fries.


Barron’s: “Investors Moving To Alternative Mutual Funds”

Alternative mutual fundsInvestors like hedge-fund strategies to manage portfolio risk. What they don’t like are the fees, lack of transparency, illiquidity, high minimums and lockup periods of hedge funds. Enter liquid alternative (“LA”) mutual funds. Assets in LA funds have grown three-fold in the last four years, while hedge fund assets have declined by 40%.

The Morningstar and Barron’s Alternative Investment Survey of U.S. Institutions and Financial Advisors identifies trends in alternative investing. Responses this year, as reported by Barron’s on May 26, 2012, show that “advisers are increasingly using mutual funds to get at alternative strategies and asset classes.” The report continued, “Investors are increasingly interested in anything not correlated with the stock and bond markets.These (LA) vehicles are viewed as a way to deliver additional, or even outsize, returns over conventional investment strategies.”

Barron’s report is no surprise to us. DWM was one of the early adopters of LA fund strategies. Back in early 2008, we encouraged clients to consider reducing their exposure to equities and substituting non-correlated, liquid alternatives. Many of these LAs held their ground in 2008 while equity funds suffered losses of 30% or more. We felt then as we do now- a traditional portfolio of stocks and bonds is not the answer alone. If your first goal is to protect your assets and the second to grow them, we suggest incorporating an appropriate mix of non-correlated LA investments to your portfolio.

The picture above represents a possible allocation for the DWM LA basket. It was established for the investor seeking less volatility and more absolute-type returns than the equity market. Holdings may include arbitrage funds, global tactical allocation funds, and market-neutral funds, among others. The model follows a “low beta” approach.  Low beta means returns that have little correlation to market risk and results. That being said, when there is a bull market, the performance of the model will most likely not be as great as a 100% stock portfolio. However, in a bear market, the model is geared to protect the downside.

The funds within the DWM LA portfolio are chosen to complement one another and together create a very powerful portfolio that can potentially excel in any market environment. We constantly monitor this dynamic LA area for offerings that may represent new opportunities for the DWM LA model and its investors.

Welcome aboard, Barron’s. It’s great to see a major, traditional investment publication recognizing the growth, value and importance of liquid alternatives.

Smartphones Are Changing Retailing

Smartphones: in store vs online shoppingAmazon began the current retailing revolution 17 years ago as an online bookseller. Today, hand-held devices are on the verge of disrupting what’s left of the in-store experience.

The Pew Research Center’s Internet & American Life Project is tracking how our habits are changing thanks to the powerful computers in our hands. During the last holiday season, Pew reported that 38% of cellphone users called a friend about a purchasing decision, 24% used their phone to review products and 25% used their phone to compare prices, all while they were shopping in a store. Ultimately, 37% of these shoppers decided not to buy, 19% bought online and 8% went elsewhere.

Cellphone users’ behavior goes beyond bargain hunting. Mara Devitt of retail consulting firm McMillan Doolittle says, “Consumers with cellphones don’t look up. They’ll be texting a friend (who may be next to them) or obtaining information and not looking around at traditional displays and signage.”

Amazon launched its new Price Check app in December with the tagline, “Ever wonder if the ‘deals’ you see while shopping in retail stores are really deals?”  In fact, Amazon offered customers $5 off their next Amazon purchase if they simply scan in the item of their choice at the store and get an immediate price comparison. This type of “e-tailing” caused Best Buy to close 50 of its largest stores in March.

Target, JCPenney and others are fighting back. They have created mobile apps that allow shoppers to download coupons right at checkout. In addition, they’ve put the squeeze on suppliers and are considering more membership-based pricing models to better compete.

Overseas, bricks and mortar shopping may be disappearing altogether. Tesco, a retailing giant in South Korea, is using subway ads that feature photos of dozen of products along with their bar codes. While waiting for their trains, shoppers can scan the barcode, make a purchase and have the item on its way to their house.

Even so, stores are not dead, says McMillan Doolittle’s Devitt. “People need to touch some merchandise, to get out of the house, and get something now. Stores with smart people can overcome apps.”  The Apple Store is a good example.  Shoppers go there to interact with the help. And grocery chain Trader Joe’s has some great checkout people, adding value to the shopper’s experience at the store. You don’t get that on a smartphone. At least, not yet.

Financial Planning for Family Members with Special Needs

From The Charleston Mercury May 30:

You may recall that back in March I invited y’all to my 100th birthday party. I received a number of nice responses, including suggestions for the menu at the party to include “soft items” not requiring much chewing for toothless attendees. I also received a few serious responses, one from my friend and fellow fee-only financial advisor Don Bailey. Click here to read the full article.

Rent or Buy?

Rent or Buy?Last week the Wall Street Journal ran an article where readers weighed in on the question: Is Now the Time to Buy Your First House? Actually, the question of renting or buying a house is a good question for all ages to consider.

Historically, for most people, the answer has been pretty simple. “Don’t waste money on renting- buy a house as soon as you can scrape together the down payment.” A house was more than a home. It was typically one’s largest investment and the leveraged appreciation over time was fantastic. 

Everything has changed in the last five to six years. The decision today is not so easy. 

Here are some of the reasons to buy a house:

  • Own your permanent dream home for years to come
  • Get a tax break for the interest and real estate taxes paid
  • Build equity with your principal payments
  • Hopefully obtain long-term appreciation

 Here are some of the reasons to rent:

  • Payments are fixed with the monthly cost often lower than buying
  • No repairs, grass cutting or painting to do and/or pay for
  • Opportunity to invest funds elsewhere; spreading your investment risk
  • More flexibility to move quickly for business or personal reasons
  • No closing costs during buying or selling

There are free, online rent-or-buy calculators available. One is www.nytimes.com/interactive/business/buy-rent-calculator.html. However, please be aware that there are major estimates that are required, including annual maintenance and appreciation. Even so, the site can help people focus on some key factors. As a generalization, I think it is fair to say in today’s market that renting may be better than buying for those people who might need or want to move within 3-5 years. Those who plan to stay in one spot for a longer time will likely do better to buy.

Of course, housing decisions are one of the major pieces of a complete financial plan. Every situation is different. What makes it even tougher is that the decision to buy or rent a house is typically three decisions all rolled into one; a lifestyle decision, an investment decision, and a risk management decision. Fun stuff. We love working through these decisions with our clients, of all ages.