Permanent Value Inc. - Registered Investment Advisor

3rd Quarter Review

The word “volatile” has been so overused in the media, but it’s hard to find a better way to describe recent movements in the financial markets. On any given day, the markets can rise or fall based on the latest thinking about euro-zone sovereign debt problems, a possible U.S. or Chinese recession, weak banks, inflation, deflation, or poor job numbers.

In the just completed third quarter, uncertainty (there’s another overused word!) was in full bloom as the three major U.S. stock market indices posted double-digit declines, according to Barron’s. Was the market sniffing out a new recession? Possibly. Last week, the respected Economic Cycle Research Institute was quoted in MarketWatch as saying, “The U.S. economy is headed for another recession that government intervention cannot prevent.”
 
Along those same lines, Goldman Sachs said we may be moving from the 2007-2009 “Great Recession” to an upcoming “Great Stagnation.” As quoted by Bloomberg, Goldman Sachs said a “Great Stagnation” would be characterized by “‘high and sticky’ unemployment, an average 0.5 percent growth rate in per capita gross domestic product, and stock markets that underperform historical averages.”

But, not everyone agrees with that assessment. Warren Buffett told CNBC last week, “it’s very, very unlikely we’ll go back into a recession.”

So, who are you going to believe? The market’s jumpiness may reflect the fact that smart people have completely different views of the economy.

WHAT TO WATCH IN THE FOURTH QUARTER

Here are a few things that made the headlines in the third quarter and may affect the markets over the final three months of the year:

• The S&P 500 index dropped 14.3 percent in the third quarter and is now down 10.0 percent for the year. 

What to Watch: Third quarter corporate earnings will start rolling in soon and investors will scour them for any sign of weakness. For the past few quarters, strong earnings helped the market recover from the Great Recession. While some earnings weakness may already be priced in the market, we have to wait for the actual earnings to see how the market reacts.

• Commodities and precious metals experienced significant price movements during the quarter. Gold prices finished the quarter up 8 percent, while silver dropped 14 percent, according to MarketWatch. Oil prices declined 17 percent for the quarter, while copper dropped a stunning 26 percent. On the agricultural side, corn prices finished the quarter down 25 percent from their June 10 all-time high, according to The Wall Street Journal.

What to Watch: Recent declines in oil and copper prices are particularly noteworthy because they may presage a slowing worldwide economy. If the declines continue, it may not bode well for stock prices.

•  The housing market is still weak and that puts a significant drag on economic growth. According to the most recent S&P/Case-Shiller Home Price Indices, housing prices around the country are back to where they were in the summer of 2003.

What to Watch: Mortgage rates are at a record low yet the housing market is still in the doldrums, according to Bloomberg. Any sign that housing is turning the corner could bode well for the economy and the markets. 

• Interest rates on U.S. government securities dropped significantly in the third quarter as the flight to safety continued. The yield on the 10-year Treasury note recently hit a paltry 1.67 percent — the lowest yield since the 1940s. While low rates are good for businesses and our indebted government, it’s bad for savers who rely on interest income to support their living expenses.

What to Watch: If interest rates keep dropping in the fourth quarter, it may suggest investors are still in a fearful state. Ironically, it could be a good thing to see interest rates rise — as long as it’s due to economic growth and not due to money printing by the Federal Reserve.

• Sovereign debt woes in Europe and budget wrangling in the U.S. weighed on the financial markets in the third quarter.

What to Watch: Continued bad news here could be very problematic. However, if there’s any concrete resolution to the Euro-zone debt problems or a credible bi-partisan budget solution in Washington — look out. The financial markets could rally strongly on that kind of news.

With the above issues looming, you can see why the markets are a bit nervous. Yet, even if the market swoons in the fourth quarter, it could make valuations so compelling that it sets the stage for the next bull market.

President’s Message

UNCERTAINTY BREEDS VOLATILITY…

We are currently in a very uncertain economic environment.  Not many people would disagree with that statement.    While picking which way the market is going from day to day is next to impossible, we like to give you a long-term general sense of the market.   The recovery after the recession of 2007-2009 has been so slow in terms of economic and job growth,  and this is why it’s hard for investors to ascertain where markets are going so they can choose whether to participate in economic growth and or prepare for another recession (according to Warren Buffett, it is “very unlikely” the US economy will go back into a recession.)   That is why you keep seeing such volatility in stocks, bonds, gold, and currencies whenever there is another pronouncement from Europe or Washington.   

This past quarter the federal debt limit was a big part of the news.   There is a lot of misinformation about the debt out there so I wanted to give you a few facts about what is happening.  One of the issues that have to be addressed is not only the sheer size in dollar figures but also the debt as a percentage of our economy.   Authors Carmen Reinhart and Kenneth Rogoff have written a paper (“This Time is Different: Eight Centuries of Financial Folly”) on sovereign debt and its impact on a country’s ability to grow.  The authors conclude that a country’s growth slows substantially once the country’s level of public debt exceeds 90% of the size of its economy (source: Peterson Institute for International Economics, Harvard University).   The USA’s public debt is projected to be 71.2% of the size of our economy in 2012 (source: Congressional Budget Office) which led ulitmately to a downgrade of the Federal Government’s debt by Standard and Poors.   

So what impact does this have on our investments you might ask?   Since we invest in US Treasury bonds from time to time we thought we share a few numbers with you.  The yield on the 10-year Treasury note was 2.57% on 8/05/11, the day that S&P announced a downgrade of the USA from AAA to AA+.  Now 8 weeks later, the yield on the 10-year Treasury note closed last Friday (9/30/11) at 1.92% as funds around the world continue to buy US debt (source: Treasury Department).    Another result of the downgrade was a significant drop in the stock market over the past quarter and in fact the S&P 500* lost 7.0% (total return) in September 2011 [alone], its 5th consecutive down month.  The S&P 500 has experienced 5 consecutive down months only 3 times since 1990 including the negative stretch that ended last Friday (9/30/11).    This all took place in light of corporate profits being significantly higher than when the recession started in 2008.   In fact, the earnings projected to be generated by the companies in the S&P 500 stock index in calendar year 2012 are more than 6 times as large as the actual earnings of the 500 companies during calendar year 2008 (source: S&P).               

*The S&P 500 is an unmanaged index of 500 widely held stocks generally considered representative of the US stock market (source: BTN Research).   

What has a government that is set up to spend more than it saves (politicians don’t get elected on $ they save; they get elected on the $ they bring home to their districts/states) done about the federal debt you ask?    On 2/14/11 President Obama proposed $1.1 trillion of deficit reductions over the next 10 years.  On 4/13/11 he proposed $4.0 trillion of deficit reductions over the next 12 years.  On 9/19/11 he proposed $4.4 trillion of deficit reductions over the next 10 years (source: White House).  So forget about ten years, how is this year going to look?   Fiscal year 2012 (10/01/11 to 9/30/12) began a week ago Saturday.  The most recent projection (released on 8/24/11) for the fiscal year by the government anticipates $2.6 trillion of revenue, $3.6 trillion of spending, and a deficit of $973 billion (source: Congressional Budget Office).

All of this news requires us to be more vigilant than ever so that we can preserve, protect, and ultimately grow your money.  We look forward to meeting with you to discuss your strategy and make any year-end adjustments that will make your strategy more effective.

Planning Perspective

Multigenerational IRA

What is a Multi-Generational IRA plan?  A Multi-Generation IRA or “Stretch” IRA has administrative provisions allowing the non-spousal beneficiary or beneficiaries to continue tax-deferral of the account over the beneficiary’s life expectancy.

Recent IRA changes allow each beneficiary to establish a required minimum distribution plan based on his or her own life expectancy.  These distributions must begin by December 31 of the year following the participant’s death.  At any time, the beneficiary may elect to take a greater distribution than the minimum.  The technique of passing an IRA from one generation to another involves proper elections by the plan participant and proper identification of beneficiaries.  Beyond correctly identifying the beneficiaries, the trustee, custodian, or insurance company must have the systems for maintaining these accounts over long periods of time and the ability to administer this new opportunity in estate planning. 

The Multi-Generational IRA plan is designed to allow for a much greater time period of tax deferral and compounding of earnings.  Depending on the ages of the beneficiaries and/or rates of return, a stretch IRA can grow to many times the balance originally inherited.  With a Multi-Generational IRA plan you can truly create financial security for your children or grandchildren.  If you are interested in learning more about making your IRA a Multigenerational IRA, please call or email us.