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Inflation

By | 2015, Money Moxie, Newsletter | No Comments

Inflation

Inflation plays a part in our lives whether you are a new parent, seasoned grandparent, or the tooth fairy. Planning ahead will help to minimize your stress when inflation rears its ugly head.

• College savings accounts let you put money aside to cover the costs of higher education. Assets grow tax-deferred and can be used tax-free for allowed expenses.

• Cafeteria plans can be used to cover basic health care costs, glasses, dental work and braces, and even day care with tax-free money. If you know you are going to spend the money, do it before giving Uncle Sam a cut. Check with your employer to see if they offer cafeteria accounts.
At retirement, the shift to living on a fixed income can be harsh. At this stage, incomes are fixed and even compress over time.

Overall, inflation may be flat, but many services retirees need continue to rise; take for instance health care, long-term care, and housing.

One way to protect your income from the impact of inflation is through a retirement income plan. Understanding how and when each of your dollars will be used to provide income during retirement allows us to implement strategies to help protect your nest egg against inflation and other major factors.

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The Virtuous Cycle of Rising Prices

By | 2014, Newsletter, Viewpoint | No Comments

Imagine waking up tomorrow to discover gasoline prices have dropped in half. What if milk, eggs, and all your groceries cost less as well? Suddenly, your money would be worth more. Sounds great, right? It wouldn’t take long for the heavy weight of reality to hit you.

Consider how knowledge of tomorrow’s pricing might affect today’s behavior. Assuming no shortages, we would be crazy to buy today what would cost less in 24 hours. While falling prices (deflation) sound nice on the surface, they can have disastrous consequences.

Deflation's Destruction

Deflation has been present in most economic depressions in history, including the Great Depression. The initial causes may include productivity increases, oversupply of goods, or scarcity of money.
A rise in productivity has been occurring for centuries with greater education and technology. In fact, a U.S. worker today, on average, can produce twice as much as a worker in 1975 and 50 percent more than a worker in 1995! Outsourcing to cheaper foreign labor has a similar effect on productivity as technology.

Supply of goods fluctuates, especially with food and energy. For example, a drought in 2012 led to a rise in grain prices like corn, which made feed cattle more expensive in 2013, which led to higher dairy and beef prices in 2014 (see Price Changes table).

Price Changes

Scarcity of money is where the U.S. Federal Reserve (Fed) comes in. The Fed encourages low unemployment and low inflation by managing the money supply.

The Fed cannot control the weather in the Midwest, extract more oil from Saudi Arabia, or raise the minimum wage in China. But the Fed will do everything it can to avoid deflation. Since 2008, it has spent over three trillion dollars to stabilize falling prices.

Rising prices are normal in a healthy economy. The 50 year average for inflation is 4.1 percent. This reasonable rate encourages spending and creates a virtuous cycle of economic growth (see Inflation’s Value graphic).

Inflation's Value

All the current numbers in this cycle are good, but below average. Over the last twelve months inflation has been 1.7 percent, wage increases averaged 2.8 percent, and consumer spending grew 3.6 percent.
The most recent U.S. growth rate showed an increase of 4.2 percent. That is a great number. If it is followed by another increase in another category like wages the growth cycle could pick up speed. The result could help the current bull market continue.

Definitions

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Impact of War on Stock Markets

By | 2014, Money Moxie, Newsletter | No Comments

War Graphic

As the Sochi Olympics ended, many eyes turned to the other side of the Black Sea and the threat of war in Ukraine. With each successive turn of good or bad events, our U.S. stock markets1 seem to react in like manner. That begs the question, what impact do wars have on stock markets, and how should an individual react?

To see the impact of war, let’s first examine the most recent war that started on American soil. The impression that many people have is that the recession of the early 2000s started with the terror attacks on September 11, 2001. The reality is that stocks were already on a downward trend when September 11th happened. Yes stocks dropped sharply in the 10 days following that awful event, but once America grasped the reality of the situation, stocks rebounded, recovering the losses directly related to the shock of that event.2

There is a similar pattern for each conflict involving the United States. “In 14 shocks dating (back) to the attack on Pearl Harbor in December 1941, the median one-day decline has been 2.4%. The shocks, which also include the September 11th terror attacks and the 1962 Cuban missile crisis, lasted eight days, with total losses of 7.4%…The market recouped its losses 14 days later.”3

Similar patterns of decline occurred during several Middle Eastern conflicts such as Desert Storm in 1991, the Iraq War in 2003, and the Syrian Conflict in 2011. Leading up to each of these events, the market dropped, but recovery happened shortly thereafter.4

Mark Luschini, the Chief Investment Strategist for Janney Montgomery, put it this way, “It’s not that it’s welcome, but once it gets underway, you can quantify what the situation might look like. When you’re left in the dark about when it will start, what will be the result, it gives investors trepidation.”5

Short-term shocks to the system cause short-term consequences for the stock market and the economy. On the other hand, major periods of conflict can have more lasting effects on the economy and the stock market.

One of the most harmful economic effects of war is a supply shock. A major shock in the supply of goods or labor can severely impact economic productivity. Sources of these setbacks include economic sanctions, manufacturing destruction, infrastructure damage, etc. This has not been a factor of major concern within the United States as it has been a long time since there has been a war fought on American soil.

Public opinion supports the belief that war and its associated spending creates positive economic outcomes for the U.S. economy. This is mostly due to the higher GDP growth that was exhibited during conflict periods like World War II, the Korean War, the Vietnam War, and the Cold War. The only outliers have been the Iraq and the Afghanistan wars.6

While war tends to generate some positive economic benefits, it is more of a mixed bag for stock markets. “During WWII stock markets did initially fall but recovered before its end, during the Korean War there were no major corrections while during the Vietnam War and afterwards stock markets remained flat from the end of 1964 until 1982.”7

Another typical impact of major conflicts is inflation. This is due to the increase in government spending through various financing methods. “While inflation may be good for reducing debt burdens, high inflation has many harmful effects, such as wealth redistribution and erosion of international competitiveness.”8

Short-term conflicts typically have a short-lived impact on the stock market. As such they shouldn’t change an individual’s investment philosophy or cause one to “abandon ship.”

A more prolonged conflict may cause an individual to take a more judicious approach by reevaluating his or her goals and making adjustments based on the current market environment. As always, it is prudent to seek advice from an experienced investment professional that can help you plan for and navigate your own voyage through our uncertain world.

 

Learn more about Smedley Financial>

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1. Research by SFS. Please see stock market disclosure at the bottom of page three.

2. Adam Shell, “What Wall Street is Watching in Ukraine Crisis,” USA Today, 3/3/2014

3. Adam Shell, “What Wall Street is Watching in Ukraine Crisis,” USA Today, 3/3/2014

4. Chris Isidore, “Impact of War On Stocks and Oil,” CNN Money, 9/3/2013

5. Chris Isidore, “Impact of War On Stocks and Oil,” CNN Money, 9/3/2013

6. Michael Shank, “Economic Consequences of War on the U.S. Economy,” Institute for Economics & Peace, 2011

7. Michael Shank, “Economic Consequences of War on the U.S. Economy,” Institute for Economics & Peace, 2011

8.Michael Shank, “Economic Consequences of War on the U.S. Economy,” Institute for Economics & Peace, 2011

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Living in The Great Rotation

By | 2014, Money Moxie, Newsletter | No Comments

Picture a giant wheel moving ever so slowly up a hill. When you look at it from the side, you can see two dots on the edge that are directly opposite each other. As the wheel moves, those dots rotate. As one dot is on top the other is on the bottom. As the wheel continues to rotate, the dot that was on the bottom will eventually get back to the top and vice versa. This mental illustration that you have drawn demonstrates the relationship between stocks and bonds over time.

When the stock market1 dropped over 55 percent, from October 2007 to March of 2009, the giant wheel ended up with stocks on the bottom and bonds on top. This happened as people and institutions pulled some of their money out of stocks and put it into the relative safety of bonds.

Leadership in performance between stocks and bonds rotates like a rolling wheel.

Leadership in performance between
stocks and bonds rotates like a rolling wheel.

Fast forward almost five years and now that trend is reversing. 2013 saw some of the largest outflows from bonds with the money going into stocks.2 As CNBC writer Dhara Ranasinghe puts it, “A ‘Great Rotation’ out of bonds into stocks is only just underway and is setting up to be one of the major investment themes of 2014.”3

Great Rotation quote It is important to note that this great rotation takes time. It doesn’t just happen overnight. It has been almost five years since the stock market bottom of 2009 and it may take more time before stocks hit the top.

One of the drivers of the great rotation is inflation. Inflation is bad for bonds as it makes them worth less. Inflation could ensure that bonds stay on the bottom of the giant wheel for a while.
There are long-term signs that are positive for the economy and stocks. The housing market is coming back, U.S. oil and gas production is booming, and a manufacturing renaissance is taking place.4 This could lead to good long-term growth for stocks.

Along the way there will always be bumps in the road which result in short-lived reversals of the great rotation. However, the giant wheel keeps moving slowly. For now, that means that stocks are king of the mountain. Of course there are no guarantees.

1. The stock market defined as the S&P 500
2. Roben Farzad, “In Search of the Great Rotation,” Bloomberg Business Week, Aug 23,2013: http://www.businessweek.com/articles/2013-08-23/ in-search-of-the-great-rotation
3. Dhara Ranasinghe, “And We’re Off: the Great Rotation Gets Into Gear,” CNBC, Nov 20, 2013: http://www.cnbc.com/id/101212837
4. Fidelity, Investment Themes Quarterly Update, July 2013

Research by SFS. Data from public sources. This is not a recommendation to purchase any type of investment. Investing involves risk, including potential loss of principal. The Barclays U.S. Aggregate Bond Index, Dow, and S&P 500 are indexes considered to represent the U.S. market. One cannot invest directly in an index Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security or investment plan.

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Powerful Performance

By | 2014, Money Moxie, Newsletter, Viewpoint | No Comments

Economic growth in the United States was slow last year as the federal government dropped one potential bomb after another. However, none of these exploded and U.S. stocks had their best year since 1997. With all this positive momentum would it be too much to ask for an encore?

In January we escaped a close call with the fiscal cliff. Then came sequestration. By May, Ben Bernanke had dropped another bomb: tapering. Before the end of 2013 we endured a government shutdown.

Duds

Interest rates shot up last year with fear the Federal Reserve (Fed) would slow its bond-buying program. In 2014, this action is slated to become a reality.

Each month the Fed plans to slow its purchases by $10 billion. As it does, let’s keep in mind that any purchase is extra stimulus to the economy. The Fed is still flooding the economy with money. Some may compare this to pushing on a string, but the last few years have helped validate the phrase “Don’t fight the Fed!”

As the Fed becomes less involved as a driver of economic growth we may see more ups and downs in the stock market. In all likelihood, the coming year will be more volatile than last year.
When the next drop comes, let’s keep in mind that it is perfectly normal even in a healthy market to have some hiccups. A fall of 10 percent in stock markets occurs on average about once a year. These drops can even be healthy for long-term growth.

According to the Wall Street Journal, strategists believed the economy would slowly improve and the market would rise 8.2 percent in 2013. It rose 30.
This year, the economy is expected to grow faster, but predictions for stocks are more moderate.

The driving forces of growth should be similar. Domestic energy production is still rising. The housing recovery is underway. Employment is improving. Wages are expected to rise and changes in consumer spending are trending in a positive direction.

Improving economic growth does not necessarily mean more stellar stock returns. Sometimes the two can be out of sync as investors look to the future for something to get excited about. Nevertheless, stocks and the economy are closely related and the economy is still heading in the right direction for now.

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Elections Over. Fiscal Cliff in Focus.

By | 2013, Money Moxie, Newsletter | No Comments
Stocks started 2012 with solid gains and then added to them during the year. Most major asset classes made money during the year.
Despite being three years into the current economic recovery, stocks and many other risky assets started 2013 with a bang. Small cap stocks, international stocks, and high yield bonds have been particularly good thus far. Resolution of the Fiscal Cliff was clearly the initial factor, but there are other fundamental contributors to current optimism as well.  The following data points are available from the Federal Reserve Bank of St. Louis.
• Oil production continues to grow within the United States thanks to hydraulic fracturing or “fracking.” Natural gas production, which is growing from the same process, is also likely to continue at its elevated levels. This industry has provided jobs to approximately 50,000 workers in the last three years and is still increasing its employment numbers at a rate of 6.5 percent.
• The growth in the supply of natural gas and oil has also provided lower energy costs for consumers and manufacturing. After 10 straight years of job losses in manufacturing, this industry is now experiencing three years of employment growth around 2 percent.
• Consumers are in a better position to increase spending and saving. Household debt is 10.5% of disposable income, which is the best level since the early 1980s.
• The housing market is improving. Prices of existing homes rose over 4% (Case-Shiller 20 City Index) in the last year. Housing starts and permits are each up 20%.
• Even after the recovery began in 2009, state and local governments were reducing their work force. This placed a short-term drag on the economy by reducing consumer confidence and spending. Half a million workers lost their jobs. Now it appears that many of these governments have their fiscal house in order.
The hemorrhaging may have run its course. The negative factors may now turn positive.
• Inflation, measured by CPI, is just below 2 percent. This will provide the Federal Reserve the flexibility to continue to focus on stimulating the economy in order to create more jobs. The efforts of the Federal Reserve are certainly a large part of the current recovery and will likely continue to play a role in 2013.
Of course, all this opportunity for growth comes with a price. Investors don’t have to love risk, but they do have to live with it. It is a tool to be managed carefully in order to participate in the long-term benefits of investing.
Many of the positive factors that drove the market upward last year are still in place this year. Indeed, the current year started off with a similar jump as that in 2012. While history will not repeat itself exactly, hopefully it will rhyme.
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