Karp Capital Management Focus
1st Quarter Report
Written by Peter Karp
April, 2013

Is the Rally Here to Stay?

Wall Street Slugger

During the first quarter of 2013 markets continued to reach new recovery highs as global growth stabilized. This occurred in spite of concerns over payroll tax increases, the sequester and the Federal Reserve Open Market Committee’s decision to keep interest rate policy status quo. The rally has been driven by a combination of Fed Quantitative Easing and a healthier than expected U.S. economy. Many of the bulls tend to downplay the role of the Fed's easy money policies and instead believe that the market has entered a new rally phase – one that will soon take stocks far above their current level. Being overly optimistic at this stage holds risk for anyone that makes recent trends the foundation for business and investment strategies. Despite plenty of evidence that indicates the economic slide has ended, millions of people continue to think and act as if the conditions of 2008 and 2009 are still in place.

This mindset has blocked investors from participating in one of the strongest quarterly rallies in recent history. The asset purchases by the Federal Reserve stabilized the financial system and helped to turn what could have been a deflationary depression into a relatively anemic recovery. Fed quantitative easing has bolstered the stock market, but it’s impossible to quantify. We are concerned about the economic impact that the end of QE will have on the economy and the markets. One thing we know for sure is that a number of other factors have also driven the market higher. The market dipped for only a few days after the recent news of bank insolvency out of Cyprus. There have been a number of obstacles for the markets during the past few years. The Standard & Poor's downgrade of the U.S. debt rating in August 2011, the fiscal cliff of 2012 and the sequester of 2013 have been a few of the headwinds created by politicians in Washington.

Given the hurdles the market has had to overcome and fear driven by the media, it is hard to look beyond market gains and the real world risks to shift from a bearish to a bullish outlook. Population growth and pent-up demand have helped boost economic activity. Improvement in the employment situation is going to give the economy some breathing room if GDP slows from the sequester fallout. The problems in Europe could create a bump in the road. Unforeseen headwinds could be countered by the Federal Reserve providing the necessary liquidity to keep the economy well fueled with monies. The U.S. equity markets are looking strong next to European shares, while the devaluing Japanese yen and weak euro are keeping the U.S. dollar attractive. Add a relatively strong U.S. economy and it's a recipe for U.S. equity market out-performance. In this issue of Karp Capital Focus we will reflect on what the consensus estimates are for the economy, housing and the stock markets versus our expectations.

In This Issue:

Is the Rally Here to Stay?

Market Performance

Engineering Low Interest Rates

Portfolio Management – Speculation vs. Investing

Cyprus – A Turning Point?

Building Long-Term Wealth

Looking Ahead

Duration – What an Interest Rate Hike Could Do to Your Bond Portfolio

Understanding Medicare Fundamentals – A Healthcare Cost Planning Overview

Identity Theft Update

The Fruit of the Land

The Core of Estate Planning

Follow Us Online

 

_________________

Contact Peter

 

 

 

 



Market Performance

Here are the performance numbers for the major indices as of 3/31/2013 (Total Return):

March
2013

Latest
3 Months

Latest
6 Months
2012
Change
The
Close
Dow Jones Industrials
3.86%
11.90%
9.86%
7.26%
14,578.54
Standard & Poor’s 500
3.75%
10.61%
10.19%
13.41%
1,569.19
NASDAQ Composite
3.49%
8.51%
5.84%
15.91%
3,267.52
Russell 2000
4.62%
12.39%
14.48%
16.35%
951.54
MSCI EAFE
1.78%
9.78%
18.07%
17.32%
1,674.60
Long Term Treasury Bonds
-0.16%
-2.71%
-3.47%
3.54%
 
Gold
0.61%
-3.95%
-10.01%
5.68%
 
CBOE VIX (volatility index)
-29.52%
-19.26%
-18.10%
   
The first quarter ended at record highs as the S&P 500 closed at 1,569, higher than its previous record close of 1,565 on October 9, 2007. The Dow Jones Industrial Average also closed at a new high of 14,578.54 and the NASDAQ ended the quarter at 3,267.52. Market leadership was dominated by defensive sectors: Health Care (+15.2%), Staples (+13.8%) and Utilities (+11.8%). Cyclicals were mixed with Tech (+4.2%), Materials (+4.2%) and Energy (+9.6%) lagging the most and Discretionary (+11.8%) nearly tying Utilities as the third best sector.
Sources : Thomson Reuters; WSJ Market Data Group, Dow Jones & Co., BTN Research, BofA ML. Stock market indices do not include reinvested dividends. Data as of April 1 2013



Engineering Low Interest Rates

The Fed's 0% interest rate policy has been in place for almost four years and is officially scheduled to continue well into 2015. It will likely continue forever. The Fed can’t raise interest rates because it would create a huge burden on Uncle Sam. An average rate of 1% on Treasury securities costs $160 billion per year to service, but a ballooning of these rates to a 5% average would cost the Treasury $800 billion per year. The Fed has no choice other than to keep interest rates near 0% while continuing to buy $85 billion per month in securities. This will keep yields low and will eventually force yield-hungry investors back to the stock market.

Portfolio Management – Speculation vs. Investing

Investing is buying a security at a price that is associated with a reasonable expectation of acceptable long-term returns. Speculation is buying a security with the expectation that its price will advance substantially, but which also poses the risk of falling substantially, and is very volatile. Both benefit from solid valuation methods and reliable measures of market action and both play a part in the overall performance of our clients’ portfolios. To take a long term investment position in a security, we rely more heavily on valuation considerations. In the past, we have been reluctant to establish short-term speculative positions when such securities appear to be significantly overvalued. This has led us to miss some opportunities to add value. We recently modified our investment approach in this regard. We want to act sooner on momentum oriented moves in the market. These speculative positions are limited in scope and are taken for shorter time frames.

It's important to remember that the stock of most companies typically rise or fall based on earnings, generated by growth, rather than domestic political policies. At Karp Capital we are not calling for a raging bull market. Given our view that global economic growth is stabilizing, factors are in place for stocks to continue to perform in the high single digits. As market tension has eased, correlations have fallen, which means there are more opportunities to pick emerging sectors as economic conditions change. Fundamentals have once again become the driving force behind the stock market. Technology, industrials and healthcare look attractive compared to materials and commodities, which are underweighted in our clients’ portfolios. Outside of the U.S. we want to own China and Germany’s stock indices on any market weakness. We will continue to manage portfolio risk and trade within price ranges established by the market.

Cyprus – A Turning Point?

Cyprus Turning PointCyprus completed a plan to meet the terms of a European bailout because the sovereign government and the banks of Cyprus are insolvent. In exchange for a 10 billion euro bailout, the country agreed to shut down the second largest bank, Cyprus Popular Bank. The bank is 84% owned by the Cypriot government. Even after this bailout, the country remains at risk for a default because 50% of the country’s GDP is derived from the financial sector. For now the Mediterranean island has averted economic collapse. Devaluing the currency would be impossible as a member of the eurozone, hence the risk of a future exit from the union. The real questions are: What does this mean for the broader euro zone? Will there be contagion to other countries? Cyprus is on the map. This little island suddenly matters to all of Europe. Cyprus had a GDP of approximately 25 billion USD. Shreveport, LA and Portland, ME each have roughly the same ratio of GDP to the United States’ overall GDP. When you look back at the 2008 U.S. banking sector implosion—the real line in the sand was drawn when the U.S. government agreed to guarantee all bank loans—even beyond the prior FDIC threshold. What this did was contain the issue to those who owned the equity, debt or guaranteed financial products of various institutions. Unlike prior financial panics, depositors were protected and there were no lines outside of bank branches demanding their deposits back. With Cyprus the rules have changed. Who will pay the bill? The average person never had to think about such things. The depositors of the defunct Cyprus Popular Bank will be treated differently. Accounts with deposits below 100,000 euros will be shifted to the Bank of Cyprus. Depositors with more than 100,000 euros are now stuck with frozen accounts. They are going to sustain big losses. The message is, if your country’s banks are in trouble, your deposits are at risk. What do you think might happen in Spain or Italy? There could be a tidal wave of scared money looking for a new home. This could benefit the U.S. economy, causing the dollar to continue to strengthen and help the liquidity of domestic banks. We believe that Cyprus is indeed a unique case and not a template for bailouts of other nations. So far there has been little in the way of contagion, either in the form of depositors pulling money from Spanish or Italian banks or in rising government bond yields.

Building Long-Term Wealth

As we begin the second quarter we are meeting with clients to confirm goals and review investment strategy. It is important to understand and prepare for the fact that short-term underperformance is inevitable as we preserve capital. Clients find periods of short-term underperformance frustrating as major market indices are making new highs. Yet preserving capital is essential to building long-term wealth, and that was our primary concern in managing through what we expected to be a market downturn or pullback coming into 2013. Over the last few months our thesis of a stronger dollar, higher interest rates and better employment numbers have translated into a powerful market rally. We are currently modifying our asset allocation to help mitigate possible downside volatility from this recent run up. Adding investments that are not correlated to the broader stock market can reduce portfolio risk. Though we still like the broader stock market, the valuations are not as attractive as they were 12 months ago.

Looking Ahead

Dow JonesWhile investors have been justifiably worried that the combination of the big tax hikes of January and the sequester in March could lead to an economic slump, so far the numbers are reassuring. On the surface, the latest jobs report was mixed. We believe this is an anomaly and the long term trend is decreasing unemployment numbers with gains in both wages and the length of the workweek. We believe the wealth effects should not be underestimated as gasoline prices have been coming down and home prices continue to rise. This increase in wealth appears to be helping the economy weather significant fiscal drag and could set the stage for faster economic growth in the second half of the year. While higher home prices and stock prices are helping support consumer confidence, Americans still appear pretty gloomy. This is important for investors because there is a strong historical correlation between consumer confidence and stock valuations. If an improving economy boosts consumer confidence over the next year it could boost the price investors are willing to pay for a stream of corporate earnings. Equity mutual funds are seeing only modest inflows, albeit the outflows have stopped. Many institutions have allocations to equities that are well below the average of the last fifty years. Attitudes toward equities are characterized by relative disinterest and apathy. An upward move can be powered by a switch from the fear of losing money to the fear of missing an opportunity. When attitudes are moderate and allocations are low, it doesn’t take much to move the markets higher.

Duration – What an Interest Rate Hike Could Do to Your Bond Portfolio

How much could your bond portfolio go down if interest rates rise dramatically? Answer….a lot. Bonds are essential investments in any well-built portfolio. If you own bonds or have money in a bond fund, there is a number you should know. It’s called duration. Although stated in years, duration is not simply a measure of time. Duration estimates how much the price of your bond investment is likely to fluctuate when there is an up or down movement in interest rates. The higher the duration number, the more sensitive your bond investment will be to changes in interest rates. Many factors impact bond prices, one of which is interest rates. The main tenet of bond investing is that when interest rates rise, bond prices fall, and vice versa. This is known as interest rate risk. Some bonds are more sensitive to interest rate changes than others. Currently, interest rates are still near historic lows yet recently have been on the rise. Many economists and investment managers believe that interest rates are not likely to get much lower and will eventually rise. If that is true, then outstanding bonds, particularly those with a low coupon rate and high duration may experience significant price drops. If you have money in a bond fund that holds primarily long-term bonds, expect the value of that fund to decline significantly when interest rates rise, compared to a bond fund that holds short- or intermediate-term bonds. If you hold a bond to maturity, you can expect to receive the par (or face) value of the bond when the principal is repaid, unless the company or municipality goes bankrupt or otherwise fails to pay. If you sell before maturity, the price you receive will be affected by the prevailing interest rates and duration. Just because a bond or bond fund’s duration is low, it does not mean your investment is risk-free. In addition to duration risk, bonds and bond funds are subject to inflation risk, call risk, default risk and other risk factors. The main purpose of owning bonds is to create a predictable income stream. In our clients’ portfolios we do own some government backed bonds because they provide an offset to credit risk we are taking elsewhere in the portfolio to increase income. It is this balance that allows us to modulate interest rate risk while maintaining current income. Please call us to review the income portion of your portfolio.

Understanding Medicare Fundamentals – A Healthcare Cost Planning Overview

Choosing Medicare coverage is an important decision that can have significant benefits. Medicare is not one size fits all. There are important differences between the available plan combinations and consumers should be properly informed when considering their individual needs. Original Medicare, Parts A & B, when combined with Part D Drug coverage and a Medigap policy offer flexible hospital, medical, and drug insurance coverage. Medicare Advantage plans offer differing levels of comprehensive HMO and PPO group medical services and Prescription Drug coverage that replaces Medicare Parts A & B. There may be significant premium penalties for late enrollment unless an individual has a special enrollment exception, such as having been working and had insurance coverage through an employer or union group health plan. Individuals should plan to review their Medicare coverage once a year to see if it still meets their needs. During the Annual Election Period between October 15 and December 7, you can add, drop, change, or renew Medicare Part D prescription drug coverage and/or Medicare Advantage plan. A cost estimate and coverage comparison tool is available at the Medicare web site:http://www.medicare.gov

Identity Theft Update

Identity TheftWe are constantly on the lookout for the latest identity theft scams. Financial institutions are the number one target of this growing crime. We are constantly sending emails to our IT and Webmaster to see if an email, a link or a request is legitimate. Have you ever wondered what identity theft looks like or what it might involve? For the 13th consecutive year, identity theft was reported to the FTC more often than any other consumer complaint. The increase by approximately 90,000 complaints over last year’s number is likely a combination of more identity theft events and an increase in the number of entities filing complaints. Click here for top identity theft complaints.

The Fruit of the Land

Market and 401kThe statement by investment managers “past returns do not guarantee future results” is not just rhetoric. The Federal Reserve has made a pledge that low rates are here to stay with the support of the printing presses in Washington going day and night. We are now approaching a decade of historically low interest rates. In addition, the first baby boomers are in retirement and there is an emergence of countries that have higher savings rates as the populace becomes wealthier. The result is a capital glut that is having a depressing impact on fixed income yields in the U.S. Most savvy pre-retirees have heard that withdrawing 4% of retirement savings is safe, but that’s based on returns seen in the 20th century. What will interest rates look like in the future? Most planners take some comfort in knowing that a 4% inflation-adjusted withdrawal rate wouldn't cause a retiree to run out of money in a 30-year retirement. This sounds good if you think the future investment climate is going to look like the past. We try to estimate what would happen if bond yields and equity returns corrected for a low-yield risk-free rate of return well into the future. Most retirees want to withdraw a stream of monies from a variety of assets without the fear of running out of money. You can mitigate this risk, but the yields are very low. We have used tax deferred and immediate annuities in the past but compared with historical yields even the best annuities are not compelling. We want to help you understand the risk of overestimating returns in a retirement portfolio. We want to guide you toward a more conservative approach when estimating retirement income and open you to non-traditional methods of generating retirement income. If you want a certain level of retirement income you might have to work part time, delay retirement or perhaps readjust expectations about lifestyle during retirement. These are difficult discussions that take time to incorporate into a retirement income plan. Our focus is constructing a retirement income portfolio that includes safeguards to prevent you from running out of money when you need it the most. While deferred and immediate annuity products provide longevity protection and higher yields (compared to bonds), they reduce liquidity, which raises the problem of potential big ticket expenses such as healthcare and carries higher management costs. There must be a balance. If you need access to cash in the form of a lump sum you can always withdraw it from your retirement plan. If you annuitize, you need to make sure you can protect yourself by buying long-term care coverage. We take all of these potential risks and consumption needs into account when looking at your retirement planning picture.

The Core of Estate Planning

Estate PlanningRegardless of how well informed our clients are concerning their own estate planning issues or federal and state laws governing inheritance, some key aspects of estate planning are often neglected. Initiating a dialog with family members about death is extremely difficult on many levels. The most obvious reason for failing to create an estate plan, or complete a comprehensive one, is that no one likes to confront his or her own mortality. People tend to focus on getting their financial house in order only after they have been diagnosed with a disease, had a brush with death or have had a close family member pass on. In addition, there might be family issues that are either too emotional or difficult to deal with head on. Estate planning is for everyone, regardless of wealth. It is an endeavor that should bring people together. By incorporating estate planning into one’s wealth management plan, you not only address the risk of becoming incapacitated or dying prematurely, you also have a plan that can evolve and change as your situation and net worth changes. Today’s ever-changing estate tax law means that your plan may have to change from one year to the next, and no one plan can exist statically. To begin the process, start with the basic documents that will protect you and your family. Click here for the core of an estate plan. We have a program at Karp Capital that can foster these difficult discussions involving family members and trusted advisors. Click here for more information. If you do not have a clear understanding of what would happen in the case of your spouse or parents’ death, call us to discuss how we can help you and your family carry on a legacy with dignity and respect.

Follow Us Online

LinkedIn

Karp Capital is on LinkedIn

  Brightscope
Our profile is featured on Brightscope

Contact Peter

All of us at Karp Capital Management thank you for your continued support over the last year. It is a privilege to help you, your family and friends reach financial goals. Please remember that we appreciate your support and we’re flattered when you refer your family and friends. If you know someone that would enjoy our commentary on the market, please share the newsletter with them. If they would like to receive our quarterly commentary please direct them to sign up for the email edition at www.karpcapital.com.

If you have any questions on the analysis above, or would like to review your portfolio's performance, please call me at 877-900-Karp. Working with Karp Capital, there is only one boss, YOU!

Peter Karp
Peter Karp

Karp Capital Management Corporation
Registered Investment Advisor

Mailing Address: 2269 Chestnut St #308
San Francisco, CA 94123

Office Address: 188 The Embarcadero
San Francisco, CA 94105

P: (415) 345-8185 F:(415) 869-2832
peter@karpcapital.com
karpcapital.com

If you no longer wish to receive the Karp Capital Management Focus newsletter, please contact us to be removed from our mailing list . Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of this report and are subject to change without notice. Such options and estimates, including forecast returns involve a number of assumptions that may not prove valid. Further, investments in international markets can be affected by a host of factors, including political or social conditions, diplomatic relations, limitations or removal of funds or assets or imposition of (or change in) exchange control or tax regulation in such markets. The past performance of securities or other investments does not necessarily indicate or predict future performance, and the value of investments and income arising there from can fall as well as rise; the investor may get back less than what was invested; and no assurance can be given that any portfolio or investment described herein would yield favorable investment results. We or our associated persons may act upon or use material in this report prior to publication. This document may not be reproduced or circulated without our written authority.Securities offered though Financial Telesis Inc. member FINRA/SIPC. Karp Capital Management is not an affiliate of Financial Telesis Inc.