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vs. Opportunity By Mat Johnson 2007 has come to a close, and in the end there was little to write home about in the context of stock market performance. The broadest measure of equity market performance, the S&P 500, ended the year with only a modest gain. Unfortunately, the rolling of the calendar didn't erase 2007 concerns over the financial sector's sub-prime fiasco, easing real estate prices, escalating energy prices and the resulting concerns these issues have inflicted upon consumer spending and economic growth prospects. Thus far attention has been focused squarely on the possibility that the factors cited above will tip the U.S. economy into a recession. Some have even estimated that the U.S. may already be in a recession. As a result, through the first two weeks of 2008, all of the major market indices have moved lower, giving back most if not all of last year's modest gains. Compounding growing fears of a recession is the estimated decline in corporate earnings for the fourth quarter of 2007. Fourth quarter earnings are currently expected to decline by -11%, largely due to financial sector earnings which are mired in losses resulting from sub-prime mortgage defaults. (Earnings are expected to increase by 12% excluding the financial sector) Given this backdrop, it is no surprise that there has been a complete dearth of news suggesting anything but a lackluster investment outlook for the year ahead. We too have taken a look at what may be on the near-term horizon, in particular on the economic front. In fact, it turns out that a reasonable case can be made that the U.S. may have already entered a recession as far back as last September. How this plays out in financial markets can vary greatly however, owing in substantial part to why a recession might occur.  One of the focal points of today's recession fear is "the consumer," and how declining home values and record energy prices are poised to impact future consumer spending. However, the frequently overlooked aspect is that these two key factors have been relevant for the average consumer for over two years now, and quite unlike as portrayed in the media, are not now poised to send consumer spending over the cliff. Rather, these factors have been and simply continue to be exerting downward pressure on the willingness to spend at the same pace as previously. The fact of the matter is that in the U.S., consumers as a whole have been outspending their income for many years, owing in substantial part to the past runup in home equity and the ease of extracting this equity by borrowing against it. That this is now reversing, should now be as little of a surprise as the fact that home prices don't rise 10% a year indefinitely.
Also unlike in the media version of recession, determining whether the U.S. is experiencing one, or about to, is relatively easy to assess. While the most watched measure is quarterly Gross Domestic Product or GDP (released with a significant time lag), there are four monthly measures that make ascertaining the state of the economy a bit more real-time. Perhaps more important is that these same measures highlight why the economy is weak, and how a period of recession may unfold. It shouldn't be any surprise that the primary culprit appears to be the pace of past consumer spending and sharply higher consumer inflation. Given that consumer spending represents nearly 70% of GDP; the concern surrounding slower consumer spending is understandable. The impact on the broader (non-consumer) economy however, appears more limited. First off, GDP is not the entire economy, but a little more than half of it. GDP is simply a convenient way to look at end market demand (what the government views as important), but omits a sizable piece of the economy that is primarily made up of business investment. When consumer spending is measured against the total economy, or Gross Output (GO), consumers represent a much smaller 38%, while business investment accounts for 52% of economic activity. The second aspect of assessing recession risks is that recessions are a short-term phenomenon, and typically represent necessary adjustments to prior excesses. Whether due to faster reaction time on the part of businesses due to better information, globalization, or the off-shoring of the more volatile manufacturing sector employment abroad, the U.S. economy spends a smaller fraction of time in recession than has historically been the case. Today's modern economy spends just one out of every ten years in recession, while recessions have also become shallower and less damaging to businesses and consumers. Finally, while we are already hearing of plans in Washington D.C. to provide relief to consumers in the form of tax rebates — aimed to boost consumer spending — in the long-run, economic growth benefits more from consumer saving, not spending. This is because consumer savings provides businesses with a larger pool of funds from which to invest in their businesses for future growth, and notably, new business investment has been all but nonexistent over the past several years that coincided with the real estate boom and associated spending spree of consumers. All of this taken into consideration, our outlook for 2008 is a bit more balanced than one associated with yes, there will be a recession or no, there won't. While many market forecasts have been focused on one of these outcomes for the economy, we don't view GDP, earnings or interest rates as the principle driver for the equity market this year. Our view is that economic and earnings growth will continue to be muted, while market interest rates are likely to be higher in 2008. As for the equity market, we anticipate that the uncertainty that has carried over from last year will be around during the first half of 2008. Longer term however, we see what is current being cast as a concern, slower consumer spending, as a longer term benefit (consumer savings) that will ultimately be appreciated as stronger business investment. This in turn should promote renewed job growth and a more beneficial inflationary environment. Also of note, should the U.S. experience a recession this year, one of the key differences as it relates to the stock market between now and in prior recession periods is market valuation. By our S&P 500 valuation model, the market stands roughly -10% undervalued, whereas at the onset of the 1990 and 2001 recessions the market was overvalued by an estimated +19% and +32%, respectively. Accordingly, while the talk of recession is capturing the most attention, the consequences to the investment outlook may be quite different than feared. A key element to be considered is that outside of the financial sector, Corporate America appears to be in excellent financial health, as evidenced by strong cash flows and healthy balance sheets. Ultimately, while there are notable issues to be concerned with in 2008, it has always been the case that the perceived risks get more than their fair share of the weight when assessing the future. Perhaps it is because risks are predicated upon factors that are easily identifiable, whereas positive "surprises" are by definition, a surprise. In the world of equity investing, this is widely regarded as the "wall of worry" that investment sentiment is regularly up against, and yet consistently climbs. Back to TopEstate Organization By Scott Whittemore  The New Year is a time of resolutions. Along with dieting, getting organized is among the most popular resolutions. Advertisements from office supply stores and building supply stores tout organization tools, filing systems and closet systems. If one of your resolutions is to get organized, think beyond just what exists now. Think about what will happen if you were to pass away. While thinking about and planning for death is never something you want to spend much time doing, time spent preparing for one of the surest things in life can provide great benefits to your family and loved ones. The last thing a person in mourning wants to deal with is hassles and disputes around the legal requirements and paperwork of transferring a person's estate and filing estate tax forms. Every year Quantum works with families, trustees, executors, guardians and others who must sort out an estate. We know the frustrations and delays that can arise. We have learned that organization is critical. Estate organization does not require consultation with an estate attorney. You also derive immediate benefits from getting your finances and assets organized today. Here are three basic steps of estate organization.
The first step is to make a list of what you own (what you own will become your estate when you pass away) with details such as description of the asset, location, how it is titled or account or policy number, and contact name and estimated value. Letting other family members know where to find this information if you pass away or become incapacitated can save much time and frustration for your family. This list serves several purposes. Even if you have a will or trust with instructions on how to distribute your estate, if it unclear what is in the estate, confusion and disputes will result. An inventory of personal assets (furniture, art, jewelry, antiques, family keepsakes) can also be useful for making insurance claims if you suffer a fire, storm or theft. With this list of assets and estimated values, a financial planner or an estate attorney could see if there is potential for estate taxes to be due upon death. The second step is to determine the form of ownership of each asset. There are several ways property can be titled. Do you know how to distinguish between assets held as "joint tenants" (JTWROS) vs. "tenants in common" (TIC) vs. "individual" ownership and how they are treated upon death? In California, we have community property, which adds another wrinkle to the mix of titling possibilities. Often titling decisions made at the time of the purchase of the asset are made based on convenience or prior practice and with no discussion, explanation or thought of what the consequences are at death. The original choices made may not be aligned with your true desires for the property. If you have a living trust, you have to have the property titled in the name of the trust to get the benefit of the trust. Frequently a re-titling of some assets can keep them out of probate, reduce estate taxes and eliminate future family disputes. If you are unsure how your asset is titled or what the form of ownership you have means, please contact us for help. The third step is beneficiary verification on all retirement and bank accounts as well as life insurance policies and annuities. All these accounts and policies require beneficiaries. The advantage of having beneficiaries is that the account or policy proceeds pass through directly to the beneficiaries outside of probate. Transfers that can take months or years if the courts are involved can take just a few days if the beneficiary information is up-to-date. Up to date and accurate beneficiaries reduce potential disputes. The most common issue for legal counsel of mutual fund companies to be dealing with is disputes about beneficiaries on IRA accounts. Frequently ex-spouses or already deceased individuals are the named beneficiaries. Finally, on your regular taxable investment and bank accounts, if they are not already in a trust, you can set up transfer on death (TOD) instructions, which effectively mean you are naming a beneficiary like you can on life insurance policies and IRA accounts. It is not as widely known as it should be that the state of California enacted the Uniform TOD Security Registration Act in 1998. Instead of having to use a will to specify the heir to your account, you can have your account set up to transfer on death directly to a named beneficiary or beneficiaries. If you have a joint or community property account, and are not taking advantage of this transfer on death feature, you should do so. Back to TopAdvanced Estate Planning Issues By Scott Whittemore What is "advanced" estate planning? Advanced estate planning is generally something those with a high net worth should consider. If you are single and your net worth exceeds $2 million dollars, or if you are married and (as a couple) your net worth exceeds $4 million dollars, you should consider advanced estate planning. The main purpose of advanced estate planning is to reduce taxes. The use of the unified credit, gifting strategies, trusts and more can help your heirs receive the highest benefits possible under federal and state laws. What are trusts? They are the legal vehicles that enable you to have someone control, maintain and manage property for the benefit of someone else. In recognition of Leona Helmsley leaving $12 million for the upkeep of her dog, we can use the pet trust as a fairly straight forward demonstration of a trust. A pet trust allows you to designate a specific amount of money for your pet's care and name a trustee to carry out your wishes. There are five principal reasons for creating trusts: to provide for multiple beneficiaries, to manage the property if they become incapacitated, to protect beneficiaries from themselves and others, to avoid probate, and to avoid or reduce transfer taxes. Back to TopMaking Investment Decisions By Howard Aschwald Are choices based on evidence or emotion? Information vs. instinct. When it comes to investing, many people believe they have a "knack" for choosing good investments. But what exactly is that "knack" based on? The fact is, the choices individuals make with investment assets can be strongly influenced by factors, many of them emotional, that most people may not even be aware of. Deal du jour. You've heard the whispers, the "next greatest thing" is out there and YOU can get on board, but only if you hurry...sound familiar? The prospect of being on the ground floor of the next big thing can be thrilling. But while there really are great new opportunities out there once in a while, often those "hot new investments" can go south quickly. Jumping on board without all the information can be a bit like gambling in Vegas...the payoff could be huge, but so could the loss. Unlike individuals, professional investors turn away from spur-of-the-moment trends and seek out solid, proven investments with consistent returns. Risky business. Many people claim NOT to be risk-takers, but that is not always the case. Most proficient investors aren't reluctant to take a risk, they are reluctant to accept a loss. Yes, there's a difference. The first step is to establish what constitutes an acceptable risk by determining what you're willing to lose. The second step is to always bear in mind the final outcome. If taking a risk could help you retire five years sooner, would you take it? What if the loss involved working an extra ten years before retiring...is it still a good risk? By weighing both the potential gain AND the potential loss (while keeping final goals in mind), one can more wisely assess what constitutes an acceptable risk. The crystal-ball approach. Some investors attempt to predict the future based on the past. As everyone knows, just because a stock rose yesterday, that doesn't mean it will rise again today. People know this, but often individuals "shrug off" this knowledge in favor of hunches. When the hunch works out, they take credit for it and try again. When it doesn't work out (most of the time), the loss is attributed to bad luck, not a bad hunch. The gut-driven investor. Some investors tend to pull out of investments the moment they lose money, then invest again once they feel "driven" to do so. While they may do some research, they are ultimately acting on impulse. This method of investing can result in huge losses. For example, let's say you have $100 and are given 10 opportunities to bet $10 on a 50/50 chance event. If you lose the bet, you lose the $10. But if you win the bet, you make $25. What would you do? How many times would you bet? While the outcome is based on chance (and therefore impossible to predict), we do know this...if you were to bet at every single opportunity, you'd stand an 87% chance of ending up with more than $100. If you bet sometimes and not other times (based on your gut), the probability is that you would not do as well. So this is yet another argument for long-term investing. Eliminating emotion. Many investors "stir up" their investments when major events happen...including births, marriages or deaths...as well as the usual overreactions from the media. They seem to get a renewed interest in their investments and/or begin to second-guess the effectiveness of their long-term plans. It's a case of action-reaction: they invest in response to short-term needs, instead of their long-term financial goals. The more often this happens, the more incoherent their so-called "financial strategy" becomes. If the financial changes they make are really dramatic, it can lead to catastrophe. Many times, there is no need to fix what isn't broken, or make a U-turn away from what they've done right. This is why so many professional investment firms use a team approach in making investment decisions. It reduces emotions and creates a stable environment to make decisions that are most often better than what even a single professional investor could accomplish on their own. Back to Top Employee Spotlight: Adam Breech
Adam joined Quantum as an Associate Analyst back in 2006, with a focus on operations and trading. Adam graduated from the University of California, Berkeley with a degree in Economics. He is currently in the process of pursuing a Certified Financial Planner™ certification (CFP®). Adam spends most of his spare time enjoying his one-year-old daughter. His interests include soccer, literature, movies, all water sports, and snowboarding. Back to Top
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Home | About | Our Team | Services | Investment Strategies | Portfolio Strategies | Contact | Newsroom © 2008 Quantum Capital Management. All Rights Reserved. |
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