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December 2012 Blogs
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There are a lot of things that could go right in 2013, and since you may not be hearing about them as much as you should, I want to make sure we give them adequate respect. Here they are, in no particular order:

The United States’ Housing Recovery, which has only just begun, takes firmer hold

The US housing market suffered a significant setback starting in 2007, and a virtual collapse of the global economy followed soon thereafter. Now, more than five years later, housing and its close cousin the US Banking sector are on the verge of something we never thought we’d see again – profitability. It feels like it’s been so long since they were anything but the punchline to a joke. Perhaps the very thing that led us into the morass could be what leads us out….

Low interest rates continue to accelerate the transition from debt to equity

Ben Bernanke has all but filled out your refinance paperwork for you and called you at home to steer you away from money markets, CDs and long-term bonds. Because these investments are no longer even covering the costs of inflation, there is very little left enticing retail or institutional investors into the bond market, especially US Treasuries. For at least two years investment professionals have warned of the “Great Rotation” – when hundreds of billions, if not trillions, of dollars migrate from bonds (debt) to stocks (equity) like birds flying south for the winter. It is my belief that this inevitable transition is already underway.

The chart above demonstrates graphically the thirty-year bull market that I feel is ending for US bonds, as interest rates have fallen steadily on our benchmark 10- and 30-Year Treasury. Remember, bond prices and yields are inversely correlated. Unlike Grover Norquist’s stance on tax rates, interest rates can move in either direction….

A wealthier consumer continues to increase spending

Another side effect of low interest rates is increased spending. Consumers don’t see much value in their savings accounts, and those fortunate enough to refinance have more disposable income due to lower mortgage payments. I was doing a little shopping this weekend and the local mall was employing extra temporary personnel to assist with parking overflow. I had to park on the roof of a mall for which, until this weekend, I had no idea there was rooftop parking. Coincidence? Maybe….

Freshly extinguished flames in Europe lead to stock market bounce on the other side of the pond

Like the Cleveland Indians in the movie Major League (one of my all-time favorites), European stocks are “threatening to climb out of the cellar.” Our own political sideshow has derailed the media from focusing on European turmoil for a few months, but let me assure you it has not gone away. That being said, I feel the bottom is behind us, and it may have been over a year ago. Remember that the stock market is a leading indicator, meaning the economy’s health generally tends to lag the stock market by anywhere from six to twelve months. Below is a chart of the European stock index over the past two years.

Even a partial deployment of the $Trillions sitting on US Corporations’ balance sheets leads to record stock buybacks and improved EPS (Earnings Per Share)

As we approach the almost certain end of 15% maximum dividend tax rates, we are seeing corporations like Costco, Wal-Mart, and Las Vegas Sands issuing special dividends, advancing shareholders a portion of their 2013 dividends at 2012’s more favorable tax rates. This move got a lot of attention but added little value, if any, for shareholders – remember that dividends reduce the per share price of the issuing company’s stock. A $100 stock paying a special dividend of $7 per share will trade “ex-dividend” on the day it makes the payment, for a resulting per share price of $93. More of a publicity stunt than anything, in my view.

When a company orchestrates a stock buyback they are effectively reducing the number of outstanding shares (by purchasing shares owned by the public). Fewer outstanding shares means higher EPS (Earnings Per Share) which, in turn, means a more favorable P/E (Price to Earnings-Per-Share) ratio. Additionally, buybacks are more tax-efficient for the investors/shareholders than when a company issues or raises its dividend. So, in theory, corporations may be waiting for dividends to become less attractive (due to the proposed increase in dividend tax rates) to initiate this alternate form of returning capital to shareholders.

United States Energy Independence

You may have heard a thing or two about this, but you probably treated it with a little “boy who cried wolf” disinterest. However, there is actual evidence to support this movement.  We are drilling and refining for oil and natural gas at record rates here in the United States, meeting an overwhelming majority of our own energy needs. In addition, we are producing natural gas at a per barrel rate that is far less expensive than the commodity costs in just about every other part of the world. There is a real economic opportunity here.

Investors recognize that, while we currently stand close to all-time highs on major benchmark stock indexes, investment returns over the previous 5-, 10-, and 15-year periods are well below historical averages

Do you know anyone who has “never made any money in the stock market?” I do. They are typically stubborn folks who insist that the market is rigged and/or they have terrible luck. They also tend to make very poor, overly emotional decisions. The US stock market has returned over 10% per year, on average, over the past 100 years. That time period has shown us wars, inflation, depression, recession, gas crises, amazing advances in transportation and technology, and many other important things. What has happened over the past five years has done nothing to disrupt that trend, in my view.

Over the past 5-, 10-, and 15-year periods the stock market (S&P500) has returned (-3.27%), 63.37%, and 52.72% respectively.* To put things in perspective, Apple’s stock is up more in the past two years than the S&P over the past fifteen. I believe that a reversion to the mean is nigh. I believe the US recovery has only started on paper, but is much stronger than we can see or feel yet. Like our housing market recovery, “The way I see it, we’ve only just begun….”

* Through market close on Friday, December 21, 2012

Have a great week and a Happy Holiday!!

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
310.772.2201 (Main)
310.496.2822 (Fax)

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