When hiking in the Rockies in the Spring, you often have to descend to go higher. Looks like the markets may be doing the same.  Is a modest correction good for investors?  We think so.

  The S&P 500 hit an all time high on Tuesday, and then proceeded to close the week down 1.31%. We are in for some volatility as we enter earnings season. 

  At the beginning of 2013, Q1 earnings were expected to rise 4.3%. The outlook is now 1.5% as the consensus is that earnings will disappoint. The economy is fragile and revenues will be light, the test will be the firms abilities to deliver at the earnings level. We like the PE ratio of the S&P at 12 to 15 times. At almost 18 times, we feel the market is due for a little pullback.  Hopefully all that cash on the sidelines will go to work and we'll climb higher. It is not unrealistic that we will see a multiple expansion fueled by low interest rates.

  With several stops along the way, we'll continue to see the markets climb. The recent jobs report was horrible.  While the unemployment rate declined to 7.6%, the economy added only 88,000 jobs in March. We are not adding jobs at the clip expected and more people are dropping out of the labor force. The labor participation rate has fallen to its lowest rate since 1979, 63.3%.

  We have yet to see the impact of sequestration and austerity.  Government spending cuts will create a drag that will begin to be felt at the end of April through June.  Workers will begin to take days off without pay, things could get very ugly. The fiscal drag will keep unemployment high and job growth will remain slow.

  The economy is fragile and the Fed realizes that. They will continue to keep interest rates low and will not dial back bond purchases until things improve.  Monetary policy will be loose for the next 18 to 36 months. These markets do not match the economic picture, but we've know that all through this bull run. Retail investors don't trust it, there is no technology or business boom fueling it, it's purely a Fed driven run. So how long will it last? As long as the Fed is involved and unemployment remains high, we'll continue to experience pullbacks on our way to new highs.

  It's a catch 22 that will go on for sometime. Revenues will be tight, companies will not hire, earnings will be accomplished by bottom line growth.  No hiring, no economic growth. No hiring, no Fed easing. No Fed easing, more low interest rates.  Continued low interest rates, markets continue to rise. Where else are you going to go for returns? You can not sit on the sidelines for another 36 months. When hiking, are you willing to backtrack 250 VF to ascend for 1,000 VF?  Sua Sponte.

Bradford C. Bruner for Sua Sponte Wealth Management 

 My father-in-law, a world class carpenter and wood worker, could gauge the health of the economy by his 2 x 4 index.  In the course of daily business, his index would measure the price of a 2 x 4 at different lumber outlets and markets  Our friends at The Economist have something similar.

  The Big Mac Index is a measurement of purchasing power parity among currencies.  It is a great tool to help understand exchange rate theory and the relative value of currencies in different economies.  The basic premise is that identical goods and services, measured between economies, should be the same price when measured under the same currency.  A Big Mac in China should cost the same in the U.S. when measured in U.S. dollars.

  So, (Big Mac (Ca) / Big Mac (Cb)) -1 would tell us whether the related currency is undervalued or overvalued.   A positive result means the currency is over-valued; a negative return means the currency is under-valued. In January, the value of a Big Mac in America was $4.37.  A Big Mac purchased in China would cost you $2.57.  Plug those numbers into the formula and the result shows that the Chinese Yuan was under-valued by 41%.

 If you think that a Big Mac should be cheaper in poorer countries because labor and materials have a lower cost basis, you are correct.  For this reason, the Big Mac Index is adjusted for GDP per Person.

 The index is fun to play around with and The Economist has a really cool interactive tool to model different scenarios.  Let's not lose sight of the message here.  Cheap overseas goods are a benefit to U.S. consumers, but at the expense of American producers.

 When you hear terms such as trade war, currency wars, tariffs, import quotas, currency manipulator and trade imbalance, just substitute a Big Mac for the product or service in question.  You ready to begin importing your Big Macs from Beijing?  Sua Sponte

Bradford C. Bruner for Sua Sponte Wealth Management

 What a week it has been.  Eight straight days of advances in the S&P 500.  Curb your enthusiasm or maybe just tone it down a little?

  What’s happening?  Looks like retail investors, that abandoned the market in 2008, are jumping back in.  Those that were holding cash, and waiting for a correction, are entering back into the game.  $14.9 billion has moved into stocks and mutual funds in the past 3 weeks.  This is the best increase since 2001.  $6.8 billion moved into domestic stock based mutual funds since the 1st of this year.  We have not recovered the $416 billion that moved out of the markets in the period following the 2008 -2009 meltdown, but a significant reversal nonetheless.  It has taken some time but it appears the Fed’s plan is working.  Keeping interest rates at near zero until unemployment falls to below 6.5%, investors are moving into riskier assets for higher returns, stock prices are rising, the wealth effect comes into play, consumers and corporations will spend; the growth engine has its consumption fuel.

 Portfolios of individual investors have been idle for sometime.  Holding cash on the sidelines, waiting for a correction, we never seem to learn.  Small investor psychology shows us time and time again that we sell and buy at all the wrong times.  Selling when the market is spiraling to its murky demise and buying at the all time euphoric highs.  No one wants to lose it all, no one wants to miss the rally.  This current rally started after the credit lockup of 2008 & 2009, since March of 2009 the S&P has increased 120%.  Major indexes are up almost 5% since the beginning of January, breaking past the psychological barrier of 1,500 and on target to hit its all time high of 1,565 set back in 2007.  Market confidence appears to be rising.  If you’re holding bonds, you are missing out.  Where else are you going to go for returns that can outpace inflation?  This current trend to riskier assets could definitely hurt the bond investor.

 Why all the worldwide optimism?  At home there seems to be less doom and gloom.  Housing, jobs, and corporate profits appear to be improving.  Businesses are able to report solid profits despite flat revenue growth.  IBM reported robust earnings in Q4 2012.  Earnings per share increased 11%, net income up 6% and all this done while revenue declined by 1%.  How?  Relentless cost cutting and stock share repurchases.

 The government has implemented a short-term fix for the debt ceiling that will take it off the front page for at least a few weeks.  Housing appears to be gaining some traction.

 Overseas the Central Bank is buying bonds and it appears the single currency will be saved.  China’s growth appears to be accelerating with an increase in GDP from 7.4% to 7.9%.  Retail sales are up by 15% year over year.  Industrial production is up 10%.

 All roses?  We think not.  Our government has really not solved anything, just moved the pawn on the Parcheesi board.  Not realized yet is the rise in the payroll tax which could take 1% out of our fragile GDP number.  The aggressive bond buyer strategy may backfire.  Global austerity and recession, ever tightening credit and zero growth in Europe are still very real.

  The age old question of appearance versus reality.  How does it look from where you are, you enthusiastic and jumping in or curbing your enthusiasm.  Still pretty, pretty skeptical?  Sua Sponte.

Bradford C. Bruner for Sua Sponte Wealth Management

  We'll enter earnings season this week. Alcoa will kick it off on Tuesday. The analysis will be a welcome respit from the headline driven distraction of the fiscal cliff and the Washington debates. It will be nice to see how businesses are performing before we enter back into the debt ceiling harangue in late February or March.

  Earnings are expected to be a little better than Q3 results. Analysts forecasts are well down from those made in October of 2012 (see chart). 9.2% to 2.7%. The S&P is coming off its highest close since 12.31.2007. Europe will be back in focus and business leaders have indicated that weak macroeconomic conditions are a renewed area of great concern.  Expect continued volatility in the markets.

  We will see if Corporations can continue to boost profits despite weak revenue growth. Above, we saw that earnings growth is projected at 2.7%, revenue growth is forecasted at 1.9%. It will be interesting to see if earnings can expand at a greater clip than top line revenue. Through cost controls, technology,  and increased productivity, it has been happening.  Possibly at the expense of wages and jobs?  Sua Sponte.

Bradford C. Bruner for Sua Sponte Wealth Management

 If you go over a cliff, without a seatbelt, you'll hit the ceiling.  That's the way gravity works.  Our government leaders appear to have this same  Newtonian relationship.  Hang on, here we go, over the cliff and 'smack' up against the ceiling.

 The ceiling we are talking about is the debt ceiling.  We set the debt limit at $16.4 trillion back in 2011.  Guess where we are today, yes, $16.4 trillion.  This is the amount we owe to meet our expense obligations.  It is projected that the U.S will run out of cash, completely, in February or March.  You'll remember that the debt is the total amount we owe.  The deficit is how much in the red we are in a given year.  Our current budget deficit is $1.1 trillion.

  Indications would be that consumers are feeling pretty good.  Consumer confidence is up.  Those that have been able to hold on to their homes are seeing values increase and an overall recovery in the housing market appears to have legs.  The stock market has had a good year, all things considered.  If you have a job, you are still looking over your shoulder for a possible shoe to drop, but feeling a little more optimistic that things are getting better.  Not real sure how many consumers really understand the implications of the fiscal cliff, or for that matter, how many care.  The one basic understanding we should have is that any drastic action by congress could drive us into another recession.

  We need confident consumers, consumption is 70% of GDP.  Business confidence is the better economic barometer.  It remains down.  Stuck, waiting for any type of resolution.  It is estimated that companies have over $2 trillion in cash sitting in wait.  Don't look for that confidence to improve any time soon, but any turmoil in the market should be viewed as a buying opportunity.  And how will we know?

  Watch for markets to trend lower.  Watch for tomorrow (12.31), and the weeks to follow, to be volatile.  A market plunge will force the hand of congress.  Look for a buying opportunity on the dips.  The same thing happened with the debt downgrade in 2011.  In July, of 2011, the S&P 500 was trading at 1,340.  Our debt was downgraded to AA from a AAA rating.  In the six weeks following, the S&P fell by 16% to 1,124.  The market closed on 12.18.2012 at 1,447, up a whopping 28.8%.

  If you are not familiar with the VIX, it pays to get to know it.  Bookmark it on your financial tracker.  The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.  It's a nice tool and may help us through the next few weeks.  Volatility has increased from 15.87 on 11.30.2012 to today's close of 21.79, an increase of 37.3%.  Things are heating up.  15.57 on 12.18.2012, that is a 39.95% increase in less than two weeks.

  The VIX futures, by month, are a useful tool also.  This is the gauge of future volatility.  Watch the VIX for the pulse of shakiness in the market, use the VIX futures to get a view of future uneasiness.  "F" in the table to the right is for January and so on.

  The chart to the left would be an early indication that the S&P will open lower tomorrow (12.31) and head lower.  1,400 is a pretty important psychological benchmark.  If we open lower, we are headed down.  That 'swoosh' you hear will be the economy going over the cliff, listen for the 'clunk', that will be our heads hitting the ceiling.  The S&P is fairly valued at a PE of 15.69.  This is Sunday night and talks continue in Washington.  Any move lower could be a buying opportunity.  Think you have the stomach to profit from the volatility, uncertainty, and governmental anxiety?  Sua Sponte.

Bradford C. Bruner for Sua Sponte Wealth Management

 At my age, and especially this time of year, Dads can receive a lot of bad news.  What is the worst thing that a Dad can hear?  “Honey, I’m pregnant,” from your wife?  “Looks like you need a new furnace,” from the HVAC guy on Thanksgiving weekend?  “I need to refer you to a specialist,” from your doctor when a nagging cough will not go away?  Nope, worse than all of those?  “I think I’m going to change my major,” one of your children announces at the holiday table.

 Trying to get the best return on my investment, I drop my fork and start to do the numbers in my head.  Extending the expenses another year and a half.  The calculation tends to get a little complex and it’s necessary to adjust for the other two siblings who are 3 years apart.  I grab a piece of pie, I’ll work the spreadsheet later. These costs are out of control. It used to be a house that was the single biggest investment a person could make. Is college education still considered an investment?   

 Both the student debt, and that of institutions, is increasing. Tuition has increased at 5 times the rate of inflation since 1983 (chart 1).  As tuition becomes less affordable, there is a propensity to take on more debt.  Costs are taking a larger bite out of  our income.  Costs increased from 23% to 38% of median income between 2001 and 2010.  It only took 15 years for the debt per student to double in size.  The average debt of a 2011 graduate was $26,000.  When you look at investments, usually with increased risk comes increased chance of greater returns.  With the current education model, risk is going up, return is going down.  Chances of a 4 year degree being completed in 6 years is 57%. I don't like those odds. 

 Universities have debts too.  Balance sheets are declining as they spend beyond their means.  Similar to mortgage backed securities during the housing bubble, complex instruments have also been used to take advantage of this debt gravy train.  That train is running out of track.  Securitization of student loan debt declined from $20 billion in 2008 to just $6 billion in 2011.  Mostly sidelined by regulation and the fear of another collapse.

 If the toll way near your house increases rates, but you see new paving, increased safety measures, and efforts to keep costs contained, it’s a little easier to take a rate increase.  Not the same with education, no continuous improvements seen here.  There have been very few course/curriculum improvements.  Most of the money is spent ensuring good rankings on college survey tables.  It is impossible to rank the quality of the output (students).  Expenditure on curriculum and instruction is the slowest growing segment, despite the growth in student numbers (chart 2).

 While the government talks about the situation, don’t count on them to do anything soon.  State budgets are tight and we may see continued reductions in state funding, shifting an increased burden to students.  Look for enrollments to remain flat for at least the next 5 to 7 years, even as we recover from the depression like economic malaise.

 There just isn’t any value creation justification for the increase in tuition costs.  The quality of students and graduates is declining.  The literacy of college students has declined.  Only ¼, of enrolled, are deemed proficient.  1/3 of students do not take courses that require more than 40 pages of written material over the course of a term.  Students are looking for easy classes, easy teachers and spending more time on recreation rather than on studies.  43% of all grades at 4 year universities were As.  This represents an increase of 28% since 1960.  The average GPA in the ‘50s was 2.52 versus 3.11 in 2006.  Something smells fishy.

 I blame the institutions for their inability to innovate. This is broken.  Tear up the 200 year old playbook. We must find a way to extract the educational premium. To maximize our ROI. Embrace technology to reduce the costs.  Unbundling the costs of higher education may be the answer.  We are already seeing the impact of the Internet on education.  Perhaps the cloud offers the answer.  Have a buffet of accredited offerings at a standard rate.  Economics credits from Harvard, Finance from Brown, Philosophy from Rutgers; all resulting in a standardized test required to pass the course.  Taken when you want it, where you can.  Not subject to sabbatical schedules and extended professorial vacations.  Reduce the overhead, reduce the time and reduce the cost.  Miss the social aspect of campus?  We have Facebook. How was your Thanksgiving, your furnace working properly?  Sua Sponte.

Bradford C. Bruner for Sua Sponte Wealth Management

 A very important economic indicator is Housing Starts and Building Permits. If any one indicator is a possible precursor to recovery it could be this one.  Two aspects of Housing are important drivers.

  First, housing is very sensitive to interest rates.  Typically, when rates are low activity in home buying increases now that rates make it more affordable.  Interest rates have been at an all time low for some time and the Federal Reserve has indicated that they will work to keep rates low going into 2014.  Second, the homebuilding industry has a huge impact on the rest of the economy. The multiplier effect is a term used to refer to the increase in demand seen in steel, wood, electricity, glass, plastic, wiring, piping, concrete and labor as a result of an increase in housing demand.  Demand for furniture, carpet, electronics, and appliances are also seen increasing.

 Housing starts record how much groundbreaking occurred for residential real estate in the previous month. Housing permits are usually required for builders who are planning to construct new homes. Not only can one get a good sense of how many, but also where.  An indication of which areas are recovering faster than others.  

 Housing starts rose by 3.6% to 894,000 in October.  This is the highest in over four years.  GDP could get a much needed boost from Housing, the first time since 2005.   Building permits in October were almost 30% higher than last year at this time.

While the current trends in Housing Starts and Building permits look promising, U.S. housing still has a long way to go.   The challenge, the dynamic not seen before, is the huge debt burden that 11 million Americans (1/5th of homeowners) are deeply underwater and owe more on their properties than they are worth.  This needs to be resolved before the typical housing based economic recovery can begin. Consumers, deep in debt on mortgages, have tended to spend less on cars, groceries, appliances and furniture.  Others reduced spending because they lost their homes to foreclosure damaging their credit rating and ability to borrow.  The spicket that once was home equity has gone dry. The Federal Reserve has lowered rates to historic lows, but many institutions won’t refinance loans or extend new credit.

 While it is a good sign that Housing Starts and Permits are up, too many homes are underwater. Until homeowners are able to get out from underneath the housing debt, Housing Starts will continue to add encouragement that we have turned the corner. How are you feeling, have we turned the corner? Sua Sponte.

Bradford C. Bruner For Sua Sponte Wealth Management

We’ll, if the right thing is to manipulate the market so they profit from information that is not available to the general public. The answer is yes. It’s called Legislative Intelligence.  They have it, you don’t.

Whether we want to admit it or not, we all want to profit from information, trends, and data that others either do not see or do not have access to.   Get advanced information that would indicate a decline or increase in the value of the market and you can adjust your investment approach accordingly.  Profiting nicely.  Who exudes more greed and ego than we do? Congress.

Say you had information on legislation that had the ability to sink or soar the market. Congress has access to all the data, public and private, that drives the economy. Did you even know that, up until May of 2012, it was legal for members of Congress to trade on inside information (political intelligence)? Ethics legislation, ceremoniously attempting to outlaw insider trading by members of Congress, was adopted by unanimous consent in May. Very impressive. Great headline.  Well done boys.  You guys are awesome.

The Senate voted 96 to 3 and the House passed it by a vote of 417 to 2.  The bill has so many holes.  The Congressional intent was to appear to be doing the ethical thing; the goal, make no change to the way they use inside information or political intelligence to profit.  I want to thank the 5 guys who voted against the bill, they are the honest ones. As Nixon famously said, “well, when the President does it, it means it's not illegal.”  

From 60 Minutes, "Pelosi doesn’t deny that she profited in the Visa public offering; she merely contends that some tough credit card laws did, eventually, get passed. Perhaps that sort of twisted logic is what passes for absolution in Washington these days. The fundamental conflict of interest remains."

"Perhaps more disturbing than Pelosi’s profiteering were the actions of Spencer Bachus, the Republican running the House Financial Services Committee. In 2008, after attending private briefings by Federal Reserve Chairman Ben Bernanke and then Treasury Secretary Henry Paulson, who warned the financial system was on the brink of collapse, Bachus essentially shorted the U.S. economy, betting against the very system he should have been working to stabilize," also from CBS's 60 Minutes.

This is great.  Every time a politician gets in front of us, they project calculated mistruths and fascinatingly complex statements engineered to cover their asses should one be recovered from the archives and dissected. They are the carnies, we are the rubes on the financial and economic boardwalk.

The San Francisco Chronicle noted: Studies led by Georgia State University Professor Alan Ziobrowski found that stock portfolios of U.S. senators beat the market by 12 percent annually and House members by about 6 percent, returns he called abnormal.

“There is no law that says a congressman can’t go into the cloakroom, hear some information that is about to have an important impact on a company and then, before it becomes public, go right to his stockbroker and trade,” Ziobrowski said. “It is a tremendous temptation.”

What have been the great buying opportunities of the past? The Y2K bug, 1987 crash and name any bubble. Perhaps the best, and most recent, opportunity was the government manipulated debt ceiling debacle that caused the S&P 500 to lose 19% between the high in July 2011 and the low in August.  How many politicians bought in August?  With great fanfare, as the compromise deal was announced, the market recovered and mushroomed 31% from October to March.  How many Congressional leaders profited?

Watch the talking heads over the next 45 days.  Watch the VIX (volatility of the S&P) . Politicians indicate resolution, markets move up.  Politicians appear to be at odds, markets go down.  It will be a daily occurrence. Oh, and Congress has offered to give up their holiday recess.  How generous.  Wouldn’t you forgo your turkey for goose and golden eggs?

Would Congress let the country go over the Fiscal Cliff to boost their own portfolios? Never:). Remember, they passed that ethics bill.

My theory?  Congress will send us off the cliff, but there will be a trampoline at the bottom. First quarter 2013 will see a compromise between parties.  Each side saves face and gets rich(er). They will buy at the low and sell on the recovery.  This could be their last chance for huge financial gains. Prediction: S&P down 15%, rallies 30% +. You willing to jump with them? Do we have a choice? Sua Sponte.

Brafdford C. Bruner for Sua Sponte Wealth Management

What is going to get us out of this mess? One word - Growth, economic growth.  Economic growth is measured by the percent increase in GDP - Gross Domestic Product.  GDP is the sum of all goods and services produced by the U.S.

The formula for GDP is: = private consumption + gross investment + government spending + (exports − imports). We are a nation of consumers.  70% of our GDP is from personal consumption.  Business Investment is 3%, Government Spending accounts for 35% and we import more than we export, so that number is -9%.  Given this formula, you can see how important it is for consumers and businesses to feel confident about the future.  Why does Business Confidence remain flat while Consumer Confidence is improving?

My colleagues at Charles Schwab commented recently, "after surging at an 18% annual rate in the third quarter of 2011, investment in equipment and software was flat in this year's third quarter, and some economists are expecting business investment to post a decline in this year's fourth quarter thanks to ongoing uncertainty about the fiscal cliff. Weak third-quarter earnings have been a tie-in to this malaise as well, and earnings of multi-national/export-oriented companies have been hardest hit."

Regulatory policy and tax issues remain uncertain.  As long as that uncertainty remains, business investment will continue to decline or, at best, remain flat.  I expect it will be at least well into Q1 before we see what direction Business Confidence is headed and we have a good forecast for 2013.

Consumers appear to be gaining confidence in the economy.  We see spending increases in housing, autos and recreation.  Residential investment in housing surged by 14%, recently, and the stock market has made very nice gains in the past 12 months.  Consumer net worth is made up of financial components (stocks, savings, etc.) and housing.  What is puzzling is, why the confidence when wages appear flat, or falling.  Unemployment remains high and business spending is on hold.

I believe that consumers are back to our old habits, buying on credit and spending from dead 401Ks and saving's accounts. Is it the wealth effect?  Housing prices up, market up, so spending is up?  Consumers are feeling better.  Not me.  We have huge hurdles ahead, it will be business that gets us out of this.  An increase in hiring, business spending, and overall business confidence will spur this consumer's confidence.  And look again at how large the Government contribution is to GDP. What will it take to increase your confidence?  Sua Sponte.

 Action is a great restorer and builder of confidence. Inaction is not only the result, but the cause, of fear. Perhaps the action you take will be successful; perhaps different action or adjustments will have to follow. But any action is better than no action at all.  - Norman Vincent Peale  
 
Bradford C. Bruner for Sua Sponte Wealth Management  

 If you do have some money to save, where do you put it? A pass book savings account has an annual percentage yield of around 1%. A five year certificate of deposit can lock in 1.75% if you are lucky.  The current inflation rate is 2%, so any of those options will return (real yield) a loss on your investment. Thrifty, frugal savers are in the gulag.

 Interest rates reflect the price of money. Central banks want rates low in an effort to encourage corporate investment and consumer spending. Low rates reflect a weak economy. A strong economy calls for higher rates in an effort combat inflationary pressure from rising wages and prices.

 When it comes to stocks, and rates are low, the tendency is to move out of cash and into equities in search of a better return. The economy gets a boost when equities rise and the wealth effect comes into play. But if rates remain low and the perception is that future economic growth will be slow, investors may shy away from investing in equities. So, are low rates good or bad for equities?

 The answer: when real yields (adjusted for inflation) have been negative, equities have risen at a rate of 2.3%; when yields were positive, the average gain was 6.2%.

 In this graph, the "bottom" shows the return when real rates were negative, the market declined an average of 2.7%. The "top", shows the years with highest yields, equities gained 7.4% on average. That spread is 10% in favor of positive real yields.

 Inflation, in years when the rate has been falling, stocks have had a real return of 9.6%.  In years of rising inflation, equities have seen a real return of minus 1.1%. An upward movement of inflation will not be good for stocks. Has our monetary policy put too much money into the economy, fueling inflation? Or is the monetary action still too tight? Leading to continuing weakness in the economy and lower corporate forecasts that could drive equities lower.

 Do we think that continued low real rates will light a fire under equities and push them even higher, or are equities already overvalued and low rates are just setting them up for a correction?  Sua Sponte.

Bradford C. Bruner for Sua Sponte Wealth Management