Insights Summer 2014

Welcome to the newest edition of our quarterly newsletter, Insights. In this edition you will read about:

– A Message From the Managing Partner, Gary Ran
– Telemus Quarterly Market Update
– Equities Analysis
– Fixed Income Fund Spotlight
– Equity Fund Spotlight
– Telemus Wealth Advisors Summary
– Telemus In The News

Read the entire quarterly newsletter here

Alice in Bunderland

Alice: “One can’t believe impossible things.”

The White Queen: “I dare say you haven’t had much practice. Why, sometimes

I’ve believed as many as six impossible things before breakfast.”

  • Alice’s Adventures in Wonderland

 

In Lewis Carroll’s iconic Alice in Wonderland, we are told that believing the impossible takes some practice. The bond market has provided us plenty of practice recently and it appears it will continue to do so for a while to come. While I have mentioned the issues of mispriced risk and negative interest rates in previous communications, I thought it would be helpful to provide some further clarity to the unprecedented dynamic that is currently unfolding in the bond market.

You will recall that following the global financial crisis in 2008 a number of countries in the European Union (EU) were shown to have debt and deficits that were out of line with the terms of their EU membership. In fact, the financial circumstances of these countries were dire and getting worse. In April of 2009, the EU ordered the PIGS (Portugal, Spain, Ireland, and Greece) to reduce their budget deficits and to get “in-line” with EU member fiscal guidelines. By 2010 it was apparent that Greece’s debt to GDP was nearly double that allowed by the EU, and their budget deficit was four-times the EU maximum. Austerity was implemented, and soon there were riots in the streets. Greece has since elected an anti-austerity party and has all but defaulted on the bailout loans provide by the EU. The fate of Greece as an EU member now lies in the hands of the Mr. Draghi and Germany as they carefully consider the precedent-setting and/or potential domino effect of a decision on the fate of Greece. As of now Mr. Draghi and Greece have agreed to extend the time frame for any decisions. The following actual headline appeared in a European paper last Friday and puts things in unique perspective: “Greece – a deal was reached to comply with the old deal, which itself was not an actual deal.”

In 2011, it became apparent that the other three little PIGS (Portugal, Ireland, and Spain) had monumental debt of their own. In fact, without the assistance of the €500 billion European Stability Mechanism these financial-teetering sovereigns would have fallen. The yields on their 10-year debt reflected their precarious financial circumstance with some yields rising above 12%. While they all avoided demise, they all continue to struggle.

Since the days of 2011 when Ireland stood on the financial precipice and its 10-year sovereign yield peaked at above 11%, their GDP has grown at about 2% per year. Their annual deficit stands at 3.7% of GDP, and their government debt to GDP has increased 40% to 123%. In contrast, the US has grown GDP at about 2% per year, the annual budget deficit is at 2.8% of GDP, and government debt to GDP has grown about 7% to 101%. So, here is where we practice the impossible: Ireland’s 10-year bond now yields 0.78% and the 10-year US Treasury yields 1.95%! As we all know, there is no comparing the financial strength and risk profile of the US and Ireland – the above was just a superficial exercise. In fact, there are few sovereigns that come even close to the financial strength, economic diversification, government stability, and overall credit worthiness of the US, least of all the likes of Spain, Portugal, Italy and over a dozen other countries whose 10-year sovereign debt yields are now price-deemed less risky than the US. In the meantime, Janet Yellen’s Fed has removed “patience” from the Fed’s language which now opens the door to US interest rate hikes. Unfortunately, this will likely further distort the current risk-pricing dynamic of the bond market, which only makes sense down the rabbit hole in the land of the impossible.

The impossible doesn’t end with mispriced risk. The concept of negative interest rates is also consistent with the view through Alice’s looking glass. While negative interest rates became a topic of discussion and study in the early days and months of the 2008 financial crisis, the academic debate can actually be traced back to the late 19th century. At that time, Silvio Gesell, a German merchant, theoretical economist, anarchist and vegetarian, first proposed negative interest rates. While Gesell’s “deposit tax” was never widely accepted, it was given some regional consideration during the great depression. Moreover, in the 20th century Gesell’s concept was taken up by no less than John Maynard Keynes, the economist most noted for his belief in monetizing deficits (printing money), a strategy employed by the US for the past 30 years and a derivative of which is Quantitative Easing. While the concept of negative interest rates is very hard to wrap your head around, academics seem to dust off the concept when deflationary pressures become very real.[i]

Indeed, we have gone far beyond dusting off the concept of negative interest rates. In fact, the value of bonds trading at negative interest rates now exceeds €2 trillion and the ECB has just begun its €1 trillion sovereign bond purchase plan. With a mandate that includes buying negative yielding bonds, the ECB purchases will drive the euro value of negative yielding bonds considerably higher and yields even further below the zero bound. To be sure, we are not fighting our father’s inflation; we are fighting our grandfather’s deflation.

The extraordinary interest rate conditions that we see in the bond market today require special consideration. We continue to carefully monitor our fixed income holdings to make sure that our portfolios are well positioned relative to these changing dynamics. Please don’t hesitate to contact us with any questions.

David E. Post

Chief Investment Officer

March 8, 2015

 

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances.  Investment decisions should always be made based on the client’s specific financial needs and objectives, goals, time horizon and risk tolerance.  The statements contained herein are based solely upon the opinions of Telemus Capital, LLC. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.

How Sweet It Is To Be Paid Like You

In the five years after the financial crisis, CEOs at large U.S. companies collectively realized at least $6B more in compensation than initially estimated in annual disclosures according to a recent Reuters analysis. The reason for the windfall: the soaring value of their stock awards. The S&P 500’s total return (including dividends) of 166% – from the end of 2008 through Monday March 23 – has some investors re-evaluating how they judge compensation plans. In some cases, they say CEOs may be benefiting from the bull market even when their performance might be weak.1 Keep an eye out for increased shareholder activism over the coming months as more investors evaluate the merits of current CEO compensation plans.

Bracket Boom or Bust?

March Madness is officially upon us as the 2015 NCAA Basketball Tournament started yesterday evening in Dayton, OH.   With more than an estimated 40 million Americans filling out more than 70 million brackets, which resulted in more brackets than ballots cast for either President Obama or Mitt Romney in the 2012 election, most of America’s eyes will be focused on their standings within their respective office pools rather than on their portfolios.[1] According to market data provided by Kensho, over the past 10 years between March 17 and April 6, every single stock in the Dow Jones average has had a positive return. Broadening our scope to include the S&P 500 and only those companies that were around for the past 10 years, Kensho also found that only 12 of the 445 stocks included in the analysis experienced a negative average return.   Provided with this information, where will you spend more time focusing – on your brackets or on the markets?

Read more here

Bracket Boom or Bust?

March Madness is officially upon us as the 2015 NCAA Basketball Tournament started yesterday evening in Dayton, OH.   With more than an estimated 40 million Americans filling out more than 70 million brackets, which resulted in more brackets than ballots cast for either President Obama or Mitt Romney in the 2012 election, most of America’s eyes will be focused on their standings within their respective office pools rather than on their portfolios.[1] According to market data provided by Kensho, over the past 10 years between March 17 and April 6, every single stock in the Dow Jones average has had a positive return. Broadening our scope to include the S&P 500 and only those companies that were around for the past 10 years, Kensho also found that only 12 of the 445 stocks included in the analysis experienced a negative average return.   Provided with this information, where will you spend more time focusing – on your brackets or on the markets?

[1] http://www.americangaming.org/newsroom/press-releases/americans-to-bet-2-billion-on-70-million-march-madness-brackets-this-year

Voices: Lyle Wolberg, on Extending the Fiduciary Standard

President Obama backs DOJ plan to impose stricter standards on brokers who advise on retirement investments

 

Voices is an occasional column that allows wealth managers to address issues of interest to the advisory community. Lyle Wolberg is partner and senior adviser at Telemus Capital in Southfield, Mich.

Changes are afoot in the retirement account investment arena. President Obama has asked the Department of Labor to develop stricter standards for brokers and others who advise clients on retirement investments.

To Read the Full article click here.

 

Posted by Wall Street Journal, see the original article here.

March Market Commentary

“Nothing sedates rationality like large doses of effortless money.” – Warren Buffett

We are one day away from the sixth anniversary of the equity market bottom that came at the depth of the financial crisis and that brought an end to the previously venerable Lehman Brothers, Bear Stearns and the near end to many others. Since that time, the Fed has maintained not only a Zero Interest Rate Policy (ZIRP) but also quantitative easing programs one, two, and three. This policy and these programs have funneled hundreds of billions of dollars into the equity markets helping to re-inflate that which was lost in the market’s decline following the 2008 financial crisis. While the ascent of the equity markets following the crisis was briefly interrupted in April 2010 and April 2011 with 16% and 19% corrections respectively, the market’s climb has moved up relatively unabated.

 

As of last week, it has been 41 months since the last correction of 10% or more, which means that we are now experiencing one of the longest correction-free periods in US stock market history. That being said, much has been written about the absence of 10% equity market corrections since 2012. The underlying message has typically been that corrections are healthy for a bull market ascent and that without such corrections the market is increasingly susceptible to a larger “unhealthy” decline. The pull-back we have seen over the past few days leaves the market down just 2.3% from the all-time high set less than a month ago. If very recent history proves prescient, investors will buy the pull-back and the markets will move higher. However, we find that familiar scenario concerning considering current equity market valuations.

 

Assessing equity market valuations requires distilling many different fundamental data points down to a measure that can be compared historically so that one may have a reference point for determining whether an asset is under or over-valued. Corporate revenue, earnings, cash flow, earnings before interest, taxes, depreciation and book value are some of the many metrics to which valuation multiples are assigned. We have found that when evaluating the overall equity market, though, it is most appropriate to look at earnings-based metrics of which there are three that we consider:

 

  1. Forward Price Earnings Multiple – Also known as forward P/E, this measure allows one to value the market on its 12-month forward prospects which may be better or worse than the past year. The problem with this metric is that we can’t predict the future. The forward P/E of the S&P 500 is today at 16.9, a 24%, 20%, and 5% premium to the 5, 10, and 15-year averages, respectively. Note the 15-year average includes the 1999-2000 when the forward P/E was consistently above 20 and peaked at 25.

 

  1. Trailing Price Earnings Multiple – Also known as trailing P/E, this measure allows certainty as past earnings are facts not estimates. The problem with this measure is that it doesn’t give consideration to future improvements or problems. The trailing P/E of the S&P 500 is today at 19.6, a 26% and 35% premium to the historical mean and median, respectively.

 

  1. Cyclically Adjusted Price Earnings Multiple – Also known as CAPE, this measure is based on the average inflation-adjusted earnings from the previous 10 years. This allows for a “smoothing” of earnings over a period of time that takes into account a full business cycle. While a conservative measure, we give higher weight to this measure than the others. The CAPE of the S&P 500 is today at 27.3, a 64% and 70% premium to the historical mean and median, respectively.

 

In our view the equity markets are historically over-valued. Given current global economic conditions, in conjunction we have reduced equity allocations and increased allocations to strategies that are less correlated to the equity markets.

 

David E. Post

Chief Investment Officer

March 8, 2015

 

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances.  Investment decisions should always be made based on the client’s specific financial needs and objectives, goals, time horizon and risk tolerance.  The statements contained herein are based solely upon the opinions of Telemus Capital, LLC. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.

EUR/USD – Is Parity a Real Possibility?

The euro fell to a fresh 12-year low this morning which has extended a broad decline just day after the ECB launched its €1T bond-buying program. On the other hand, the dollar index soared to its highest in more than 11 years at 99.41, buoyed by expectations that the Fed could soon lift U.S. interest rates. Nearly all financial experts now believe the FOMC will remove the word “patient” from its policy statement after its March 17-18 meeting which will open the door for a rate increase in June. Today, the EUR/USD is currently at $1.0585,1 so keep an eye out over the coming months as a potential rate increase by the FOMC coupled with continuing ECB QE could make EUR/USD parity a real possibility.

Negative Interest Rates

There are now a total of $2 trillion of negative yielding notes and bonds in Euroland, a staggering number considering negative interest rates have never before really been contemplated, even in the halls of academia. To be clear, what this means is that investors are paying for the opportunity to lend money to Germany and several other countries in Euroland. Bill Gross keenly cutely described the dynamic as follows: “Modern day Oliver Twist investors have to pay to come to the dinner table and then sit there staring at an empty plate.”

The important thing to understand in this new world of negative interest rates is that it is a brand new financial circumstance without precedence and without any historical context of the interrelationship with other financial assets. We are playing a new game, on a new playing field, with new rules, many of which we are making up as we go along. The result of such a circumstance is uncertainty and heightens volatility, both of which scream caution to investor of all shapes and sizes. Be careful out there!

Europe’s Quantitative Easing Program

The European Central Bank (ECB) will begin its long awaited Quantitative Easing (QE) program this coming Monday. The ECB has pledged to buy 60 billion euros of EU member government bonds per month until September of 2016 in an effort to stimulate economic growth in the growth-stagnant Eurozone. Similar QE programs have been implemented in the US, the UK, and Japan, which have successfully purchased various types of government bonds. Whether these programs successfully stimulate economic growth is highly suspect, but they have been successful in terms of pushing interest rates down, forcing investors toward risk assets, and inflating equity markets.

The US, the UK, and Japan operate single-country financial systems, which facilitate much easier QE implementation than will be the case in the 19-member EU with 19 different financial systems. While the ECB has laid out a purchase plan that may theoretically navigate the complexities of buying in the different markets, practically speaking there may not be enough bonds available to purchase! There are a number of reasons for this dynamic, including the fact that German government bonds are in short supply and pensions and insurers may be unable or unwilling to sell such high quality bonds. Suffice it to say, the ECB’s QE program will be difficult to implement and its success is not ensured.