Karp Capital Management Focus
2nd Quarter Report
Written by Peter Karp
July, 2013

No Pain….No Gain

U.S. Economy and the Stock Market

After trending higher through the first quarter of 2013, equity markets have slowed, with prices stalling in the middle of the second quarter. A consistent improvement in economic data, which fueled the upward momentum earlier in the year, has given way to a potpourri of mixed messages. Optimism over better U.S. payrolls and strong Japanese growth data was tempered by weaker U.S. manufacturing, tepid Chinese activity data, and persistent sluggishness in Europe. Concerns were initially shrugged off as markets marched higher. Sentiment shifted when policy uncertainty resurfaced at Fed chairman Ben Bernanke’s suggestion that Quantitative Easing (QE) could be tapered in the next few meetings if numbers continue to improve. This coincided with a sharp rise in bond yields as investors re-priced fixed income assets. The result of this move was the loss of value of more than two years of interest payments in a single month. More important, consumers and the stock market weren't fazed by these challenges. In fact, at the end of the first half of 2013, the stock market was up 13% and consumer confidence is at a 5 year high. The policies over the last 5 years by the Federal Reserve have been extreme. A move toward more normal interest rates should help convince many businesses and consumers that the economic crisis is behind us. It should reduce the hesitancy to act which has permeated the economy during the last few years. Over the next few months equity markets should reflect the fact that the domestic economy is on strong footing. This is not to say there are no economic headwinds from sequester cuts, corporate and individual tax reform up in the air and a slow boiling European financial crisis exacerbated by a credit crunch in China. All of that may lead to great buying opportunities overseas, but for now U.S. markets remain the most attractive. In this installment of Karp Capital Focus we will outline our investment strategy and our view of the economic and political forces that shape our investment themes.

In This Issue:

No Pain….No Gain

Market Performance

The Only Thing to Fear is Fear Itself

All That Glitters

The Meaning of Rising Bond Yields

Exit Strategy

Are Bonds Still Worth Holding?

Social Security Benefits – What is your strategy?

Collectibles for a Lifetime

More than Money

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Market Performance

Here are the performance numbers for the major indices as of 6/28/2013:

Latest
3 Months

Latest
6 Months
2012
% Return
The
Close
Dow Jones Industrials
2.27%
13.78%
7.26%
14,909.60
Standard & Poor’s 500
2.36%
12.63%
13.41%
1,606.28
NASDAQ Composite
4.15%
12.71%
15.91%
3,403.25
Russell 2000
3.08%
15.86%
16.35%
977.48
MSCI EAFE
-0.98%
4.47%
17.32%
1,638.94
Long Term Treasury Bonds
-5.63%
-8.19%
3.54%
 
Gold
-25.42%
-28.37%
5.68%
 
The S&P 500’s YTD gain is the best start to the year since 1997. US equities extend the rally for the year despite -1.3% in June. In the first half of 2013 the S&P 500's gain far exceeding that of T-bonds (-8.2%) and Corp Bonds (-3.3%). Gold suffered a 28.4% loss ytd. Sector rotation has been all over the map with Financials and Industrials leading in May and in June Defensives leading the way: Telecom (+1.9%), Ulitilites (+.6) and consumer staples (-0.6%). YTD Health Care (19.1%), Discretionary (+18.9%) and Financials (+18.5%) lead while Materials (+1.7%), and Tech (+5.5%) lag. Five year high in consumer confidence as measured by the University of Michigan.
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 July 1, 2013



The Only Thing to Fear is Fear Itself

Fear and the MediaThe financial media always points to the latest headline to explain market moves. Sometimes there is a relationship, but often the reasons are more complex and by nature are a reflection on investor psychology playing out over a much broader range of issues and fundamentals. Recent stock market declines probably had more to do with events in emerging markets than a shift in the Fed’s policy. As a result, gold and commodity prices continued to tumble. Chinese equity prices dropped precipitously and interest rates spiked. Further market volatility is possible as China transitions from export led growth to growth driven by domestic consumption by the middle class. Weakness in China and emerging markets further supports the U.S. dollar and redirects investment into the United States. The political crisis in Egypt pushed oil prices up towards $102 a barrel during the early days of July. The good news is the U.S. is overstocked with gasoline reserves right now. Any pull back in the U.S. stock market because of global events is an opportunity to buy. Do not let the images propagated by the media scare you. The Federal Reserve’s talk of the possibility of reducing monetary stimulus has led to a further rally in the dollar. This forces the Chinese yuan higher against other foreign currencies because of its peg to the dollar. This puts downward pressure on Chinese exports. As the Chinese economy slows it affects the global economy. Sounds dismal…it is not. This is a positive revelation. As we stated in our last two newsletters global growth is stabilizing. This is an investment theme that should reward our clients’ globally diversified portfolios in the near future.

All That Glitters

Cyprus Turning PointMarkets do not go up without a correction. Speculators typically get ahead of themselves. Gold has tumbled to its lowest level in nearly three years, putting it on track for its biggest quarterly fall since the end of the gold standard (until 1971 the dollar was pegged to gold). Gold is currently in a bear market and there is no reason to buy it, at any price. Gold has been known as the fear metal and storage of value since the beginning of time. Other wealth is represented by paper – bonds, notes, bills, stocks, IOUs, etc. When an economy is growing it becomes more sophisticated... with relatively more wealth in paper form. The more faith people have in the system, the more faith they have that their pieces of paper can be exchanged, some time in the future, for real goods and services. When trust in the system slips, so too does faith in pieces of paper. Can the issuers of debt instruments really pay? Are corporations really as profitable as they state? When trust suddenly disappears, panic takes its place. Soon it manifests as a crash in asset (paper) prices. Often, tangible assets go down too – such as real estate, art and commodities. Gold’s precipitous drop is an indication of our investment theme…GLOBAL GROWTH IS STABILIZING and investor fear is dissipating. We relish the fact that we sold our client’s holdings in gold a year ago. Do not get bitten by the gold bug.

The Meaning of Rising Bond Yields

Uncertainty over interest rates remains a short-term problem for the financial markets. The Federal Open Market Committee (FOMC) statement failed to calm the nerves of traders after the last Fed meeting in June. Though investors were looking for more clarity, the meeting statement only contained two notable changes from the May statement. The committee altered its assessment of economic and labor market downside risks to “having diminished,” from “continuing to see” those risks. The second change was the dissension of St. Louis Fed president James Bullard. Bullard thought the committee needed a stronger defense of its inflation target. Stocks and interest rates do have a direct relationship. Interest rates are driven by a combination of growth and inflation, and we are experiencing slow growth and very moderate, if any, inflation in the United States. Some inflation is not necessarily bad for stocks if accompanied by sales growth of companies. Historically, stocks have re-rated, meaning their multiples have gone up. Ultimately stock prices will fall while multiples fall as investors anticipate that companies will not be able to raise prices fast enough to cover the rise in inflation. When inflation rises to anything above 4.5%, stock values tend to slide. By no means are we there yet, but there is a sweet spot for growth and inflation to find equilibrium. This higher return, combined with lower U.S. energy prices is attracting capital to the United States. The capital flow to the United States is driving the dollar higher. There is the inverse relationship between the dollar and commodities. In other words, as the dollar rises, commodity prices tend to fall. Where lower commodity prices cause economic weakness in Brazil and Australia, they result in a net boost to the U.S. economy. Lower commodity prices give the consumer, who has been somewhat constrained by moderate wage increases, more buying power. That is the virtuous circle that is keeping the American consumer and the U.S. stock market alive. Rising bond yields are a pro-growth signal backed by recovering consumption, employment, and housing growth. This is the type of environment we want to see when increasing our stock exposure and reducing the allocation of bonds and cash.

Exit Strategy

Dow JonesThe financial establishment is obsessed with Ben Bernanke and the Federal Reserve. That dynamic has been in place for a while now, but it’s reached new heights in recent weeks. The past three FOMC (Federal Open Market Committee) meetings have seen an increasing level of chatter amongst voting members regarding the timetable for halting the Fed's Quantitative Easing program. Improvements in the economy and future costs of QE justify the conversation. The Fed balance sheet is just getting too large. Though the timetable was never explicit, an end to QE should not come as a surprise. Some investors live in fear of a world where the Fed is not gobbling up tens of billions of dollars in Treasury debt and mortgage-backed securities every month. The Fed released three reports on FOMC minutes so far this year. In each case, the stock market suffered a brief mini correction. The latest one saw the S&P 500 fall by 1.2%. This is not a healthy relationship that the Federal Reserve should participate in. The focus shouldn’t be that the Fed is in the market every day, buying up assets supporting prices. The focus should be that it’s sitting on a large balance sheet. The recent statement by Ben Bernanke is actually creating an environment of certainty, but the markets are preparing for the worst. The fear currently permeating the markets should dissipate soon. This is where we expect to uncover opportunities as volatility increases and investments are mispriced.

Are Bonds Still Worth Holding?

Interest rates have been held artificially low, mainly because of Federal Reserve policies. At the same time, investors have been looking for stable income, and bonds became the place to go. However, yields got so low that they no longer made sense, and other asset classes, including real estate and equities, looked more attractive. We have been planning for a rise in interest rates by shortening the maturity or duration of bond holdings from 8 to 10 years to less than 5 years. Shorter duration bonds are less volatile. We've positioned portfolios in corporate and high yield bonds that are the least interest rate sensitive. We've had minimal exposure to longer maturity Treasuries, as well as 20-30 year corporate bonds because they are vulnerable to sharper price declines as interest rates rise. But when you have a company whose fundamentals are improving, bond prices can move higher even in an environment where interest rates are rising. The offerings are smaller than treasuries and other fixed income securities so the price you see on your statement is often a function of lack of liquidity more than the quality of the bond. Clients have asked… if rates are going up, why own bonds? The purpose of bonds in a portfolio is not to generate high returns, even though until this year we have been in a 20 year bull market for bonds, but to dampen total portfolio volatility by balancing out riskier holdings. Alternatively, we have been holding a larger allocation in cash since the end of May. An allocation of bonds and cash in a portfolio provides investors with more options if and when stocks fall. If you need income, you can liquidate the bonds, rather than having to sell stocks at a loss. If you're a total return oriented investor who depends on your portfolio to meet living expenses, essentially you're taking what the market gives you, harvesting gains from equities in good times and from bonds during equities' bad times. What has worked in the past will not necessarily work in the future with regard to sector focus. Defensive sectors like utilities, consumer staples and telecom that are bond proxies will not be as attractive if interest rates continue to climb. Given the dramatic move in interest rates over the last few weeks these sectors have dramatically sold off. We expect these sectors to bounce and we will lighten up any exposure into the market rebound. Even with our near term caution regarding stocks during most of 2013, we are long-term bullish. We believe we are entering a new stage in the economic recovery. New sectors will take the lead. It's valuable to look past the market's fear and reposition some holdings in sectors that are more likely to benefit in this next stage of the recovery, such as the financial and consumer discretionary sectors.

Social Security Benefits – What is your strategy?

Identity TheftSo you just turned 60 and you’re wondering how and when to take social security. You can claim social security retirement benefits as early as age 62 or as late as age 70. Should you opt to receive benefits at 62? full retirement age? later? Most individuals claim their social security benefits at the earliest opportunity because they need the money or they lack confidence that social security will be solvent over the course of their retirement years. If you take benefits on day one, there is a substantial reduction in income. If your full retirement age is 66, the reduction of your benefits at age 62 is 25 percent; at age 63 it’s about 20 percent; at age 64 it is about 13.3 percent; and at 65 it is about 6.7 percent. If you were born after 1954 and start your retirement benefits at 62, the reduction in your benefit amount can reach a maximum of 30 percent. Claiming benefits at your full retirement age entitles you to full retirement benefits, depending on your date of birth. (Click here for the most likely distribution scenarios). As you approach your golden years we can help you make the social security timing choice that best fits your financial picture.

Collectibles for a Lifetime

Collectibles can provide enjoyment and potential profits during a collector’s life. Generally they are less liquid, trickier to value and less divisible than other financial assets. Beneficiaries can have strong emotional attachment and disputes among heirs can develop. The key to having collectibles as part of a well thought out investment plan is to determine the investment characteristics and a buy/sell strategy. The first step is to make sure there is a beneficiary for each collectible. This can be accomplished by naming the collectible in a will and trust. We advise clients to discuss all valuable objects with their families, and decide together what should be done with them--whether selling at auction or distributing among the family. In addition, the collectibles should be appraised periodically by a third party that specializes in the collectible. The lesson here is that families must be involved in the estate planning process. If they don’t share your love of collectibles, you might decide it’s better to dispose of the collection in your lifetime. Regardless, your family should have a basic understanding of the collection, its value and how you want the proceeds distributed. Appraisals are required for insurance, estate taxes, charitable contributions and even gift tax purposes, but few people realize the IRS requires different types of appraisals depending on the value and use of the collection. Selecting a qualified appraiser is an important step and takes time. Collectors should pick appraisers who specifically conform to Uniform Standards of Professional Appraisal Practice. Just like a real estate appraisal, reliable certification can greatly increase a collection’s liquidity and value. (Click here for a list of collectibles and recommended designations).

More than Money

Each day the world of communication becomes increasingly virtual. Emails, texts, social media, voicemail and on it goes. While these tools can create efficiencies they can also be easily deleted, ignored or trivialized, and create an undesired disconnect. Ultimate communication goals are simple; get the attention of an engaged audience and make it memorable. It is with that in mind that we introduce the process called Share your Life. It is a unique exercise which uses a series of cards along with an open dialogue with your family, friends and close advisors. You will prioritize your cards and discuss why each question and corresponding answer is important to you. Each question on the card is intended to conjure a deep emotion or concern. Couples and families will each identify their own set of cards, giving each person a voice, which so often is not the case. We will review the process with you and help to identify if you are on course to meet your goals and map out a process to create experiences that resonate with you. It is not all about the money. It is about what your money means to you and the environment you create for you and your family.

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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.