Pacific Wealth Management Market Comment

by Jim Kuntz on January 7, 2014

With the holidays behind us, 2013 will likely go into the books as one of the most extraordinary years in the history of the capital markets.  Despite a tepidly growing U.S. economy and corporate profits increasing by only 3%, the stock market finished up around 30% last year.  Stock market appreciation of this magnitude usually coincides with an economy growing rapidly or on the verge of robust growth.   Unfortunately, this does not appear imminent.  Declining unemployment percentages have been illusory as more jobseekers have quit looking for work, not because they have found it.  The 2013 U.S. economy grew at around 2%, with slight improvement anticipated next year.

Since the banking crisis in 2008-2009, Ben Bernanke and his fellow central bankers around the world have been manipulating their respective bond markets to keep interest rates artificially low.  We believe this “zero interest rate policy” is inherently dysfunctional, in that it temporarily drives investment capital out of safer investments and into riskier investments, like stocks and real estate. As Mr. Bernanke keeps his finger firmly pressed on the United States Mint’s printing presses, buying $85 billion a month and over one trillion a year of government bonds, stock markets around the world have become dependent on this manipulation and inflated at a rapid pace. To put this in perspective, it has taken 237 years for the United States to accumulate a national debt of approximately $17 trillion, while this Fed policy has contributed over $3.2 trillion in just the last five years.

Going into 2013, we expected Bernanke to remove the punch bowl from the party, or at least start to reduce the level of monthly bond buying, before his term expires on the 31st of this month.  In late spring of last year, stock and bond markets experienced a period of volatility when the Fed comments merely suggested such a reduction might occur. However, Bernanke quickly backed away from this stance, and in September he formally announced the economy was not doing well enough to even begin to reduce or “taper” his monthly bond purchases. This was interpreted positively by stock markets, thus showing how dependent stocks have become to what we believe is an inherently unsustainable policy. When free market economies and their financial markets are no longer free to independently determine valuation levels, the process of hitting the reset button can be traumatic and market volatility is likely.  As economic commentator John Mauldin states; “Putting these bond buying policies into practice is easy, almost like squeezing toothpaste.  But unwinding them will be like putting the toothpaste back in the tube.

For these reasons we continue to have concerns stock market valuations remain especially vulnerable to higher than average volatility.  Pacific Wealth Management has kept our investment allocation in traditional stocks lower than normal to protect against this anticipated volatility.  We believe prudent diversification in these dysfunctional times will continue to control portfolio risk and effectively preserve wealth.

The strategic changes made over the last year to our portfolios are designed to increase growth. An array of sophisticated stock, bond and alternative investment additions have been made in markets around the world.  While our research suggests the economy will remain in an extended slow growth trajectory, 2014 is likely to be choppy.

James C. Kuntz, CIMA
Managing Director

Previous post:

Next post: