C.A.R.E. Asset Management
and Strategies, Inc.
Our Current Investment Strategy November 9, 2011
Summary of Strategy
We believe that the world economies will continue to grow, but not enough to support significant upside in equity markets. We expressed a similar opinion in a recent Economic and Market Outlook letter dated August 15, 2011. Accordingly, for many portfolios, especially for clients nearing or in retirement, our model asset allocation for retirement putting emphasis on income may be preferable.
As this is written, we think this is the situation.
Ageing
The percentage of the population that is over 65 is increasing. The number of those over 65 are living longer. This segment will require a greater percentage of the national income to cover social security payments.
Healthcare
The U.S. has not yet found a satisfactory strategy to impliment cost containment of healthcare costs. The riots in Greece could happen here if our government attempts to make draconian cuts in Medicare, Medicaid, and Obama's Universal Health Care law, or whatever is left of it after the Supreme Court rules on it. Accordingly, we believe that healthcare will take an ever-increasing percentage of the national income.
Servicing the National Debt
The U.S. outstanding public debt was$14,602,724,198,753, ie. $14.6 trillion, as of August 15, 2011, and growing at a rate of 4% to 5% growth every year. It equals 92.7% of the gross national product. If interest rates rise, as they are expected to do beyond 2013, the interest cost will take an ever-increasing share of national income. In addition, if rating agencies downgrade the U.S. debt further, interest costs will rise before 2013. That might happen if the Congress and the President are unable to come up with a plan to reduce spending.
Tax Reform
We anticipate the U.S. global companies will continue to be at a disadvantage due to high corporate tax rates. This will continue to be a short-term drag on export-driven growth and gross domestic product.
Monetary Policy
The Federal Reserve announced on August 9 that they would keep the Federal Funds Rate, the rate at which the Fed and banks lend to each other, at the 0.25% rate, basically zero through mid-2013. However, the Fed's policies have not directly led to growth in the economy because banks and corporations are hoarding cash. We don't know for sure why. A number of uncertainities and lack of customer demand are certainly two big reasons. In the final analysis, economic growth has not happened.
Household Debt and Consumer Spending
With high unemployment and higher food and gas costs, consumers have been paying down loans. Consequently, the amount of discretionary spending has not significantly increased and will not support a 4% to 5% economic growth rate needed to bring prosperity back.
Home Prices
Prices can be expected to decline in the fall and winter. Housing demand as measured by housing starts has seen no significant growth during 2011.
S&P 500 Corporate Profits
Company profits have been doing well, but revenues are not breaking records, to say the least. End demand by consumers continues to be weak.
Job Growth
The economy is simply not growing enough to give us the kind of job growth needed to drive consumer spending and the stock market significantly higher. The lack of net new job growth continues to act as a drag on the economy.
Gross Domestic Product Growth
Predictions of future economic growth in the U.S. range from 1% to 2.5%. Predictions for growth in the rest of the world indicate a decline. Some believe Europe is on the verge of a recession. The vision of many knowledgeable advisors is that slow growth is baked into the world structure for at least a decade.
Inflation
The forecast through July 2012 is for 2.4% inflation. This does not appear to be a drag on the economy nor on decreasing interest rates. We do not see it causing a rise in bond yields and a decline in bond values.
Personal Income
Personal income is not increasing significantly, and whatever increase there is, inflation is wiping it out.
Economic Cycle Research Institute
The ECRI is telling us the economy is slowing.
Our Current Investment Strategy
We have constructed a model asset allocation for retirement minded clients that takes the current slow growth economic and market environment in account. I list the allocation and then I will explain them.
Total Long Equity Positions
| | 20.00%
| Net Long Equity Positions
| | | 20.00%
| Bond mutual funds
| | | 48.00%
| Alternatives, REITS, Income Securities
| 12.00%
| High-Yielding Dividend Stocks
| | 11.00%
| Commodities
| | | 5.00%
| Cash
| | | 4.00%
| Totals
| | | 100.00%
|
The 20% allocation to equities is designed to provide some growth, some inflation protection, while reducing equity risk commensurate with the slow growth economy and client's reduced risk tolerance. The percentage can vary, based on individual risk tolerances. Twenty is the low end of the equity asset allocation for retirees. A number of clients have expressed confidence in this level of equity exposure.
The 48% allocation to bonds is high because retirees need income and high allocation to bonds is one way to achieve this goal. We have seven different bond mutual funds with varying durations, yields, and holdings. The overall average yield was 5.93% as of September 30, 2011. Yields have gone down a little since then. We hope and believe that inflation will stay low, maintaining the value of the bond portion of the retirement portfolio.
The 12% allocation to alternative investments represents a further attempt to grab yield from such investments as real estate investment trusts, oil royalty trusts, and master limited partnerships. Our overall average yield from this allocation was 8.11% as of September 30, 2011. Yields have gone down a little since then.
The 5% allocation to commodities consists of a gold miners mutual fund and a single stock industrial metal company. Both have appreciated over 23% in the last 10 years. Many current portfolios have a 10% allocation to commodities. The allocation can be adjusted.
Finally, we have a 11% allocation to high-dividend paying common stocks. I'll give you a few examples. Mesabi Trust pays an 8.8% dividend and has appreciated 21% annually over the last 10 years. Southern Cooper pays a 7.3% dividend and has appreciated 10% annually over the last 10 years. Johnson and Johnson pays a 3.5% dividend and has appreciated 0.8% over the last 10 years, but the dividend has increased at an annual rate of 12%. Southern Company pays a 4.6% dividend and has appreciated 4.8% over the last 10 years.
Sooner or later, we expect another recession. Business cycles happen. They are just part of a capitalistic system. The 20% allocation to growth equities can be reduced, risk can be taken off the table, and a Grizzly Bear Mutual Fund can be purchased to mitigate but not eliminate declines in the portfolio.
What this model portfolio does is increase annual income. The overall yield was 4.62% as of September 30, 2011, and the overall annual historical appreciation rate of return was 7.25%. Yields have gone down a little since then, but when the market corrects, the yields will come back.
This model does not eliminate risk or volatility. No portfolio can eliminate risk of one kind or another. Only after a significant market correction would we implement this allocation, to give a little margin of safety.
This white paper is general in nature, does not constitute investment, legal or tax advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. Economic and market forecasts presented herein reflect our judgment as of the date of this white paper and are subject to change without notice. These forecasts are subject to high levels of uncertainty that may affect actual performance. Accordingly, these forecasts should be viewed as merely representative of a broad range of possible outcomes. C.A.R.E has no obligation to provide updates or changes to these forecasts. Although certain information has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. The information has been provided without taking into account the investment objective, financial situation or needs of any particular person. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than your original investment. While the information in this document is not intended to be investment advice, it may be deemed a financial promotion in non-U.S. jurisdictions. Accordingly, where this document is used or distributed in any non-U.S. jurisdiction, the information provided is for use by professional investors only and not for onward distribution to, or to be relied upon by, any jurisdiction or in any circumstances that is otherwise unlawful or unauthorized. This document should not be published in hardcopy, electronic form, via the web or in any other medium accessible to the public, unless authorized by C.A.R.E. Asset Management and Strategies, Inc.
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