Karp Capital Management Focus
3rd Quarter Report
Written by Peter Karp
October, 2013

Uncertainty is Certain

New Terror Alerts

Investors do not like surprises or uncertainty but that’s precisely what shaped the investment landscape in the third quarter. The potential for military action in Syria dominated the discussion in Washington. Attention was then turned toward budget and debt ceiling issues at the end of September when Ben Bernanke and the Fed governors decided to throw the markets a curveball. They did not pull back on their $85 billion monthly asset purchases. The tapering (reduction of the Fed’s bond buying program) was delayed but not ruled out pending the release of more economic data. This is a reminder to investors that daily market gyrations have remained policy dependent since the fall of Lehman Brothers and the ensuing financial crisis 5 years ago. Washington's debt and budget deadlines are a growing concern.

Obamascare

The second round of sequester cuts and unease over the implementation of the Affordable Care Act (ACA) created an uncomfortable investment environment that made it easy to sit on the sidelines. Keep in mind, the U.S. economy continues to improve. Outside the U.S., economic conditions are improving too. The global manufacturing index (PMI) hit its highest level in two years. Despite the potential for further Fed-induced volatility and slower growth, long term investors need to remain focused on economic and company fundamentals. We remain optimistic beyond any short term volatility and let’s not forget that U.S. individual wealth is up 6 trillion dollars this year on top of the 6 trillion for last year. In this installment of Karp Capital Financial Focus we will address the opportunities we see and why we believe risk control in portfolios will be paramount as we head into the end of the year. We will also discuss the imperatives of getting your financial house in order with a well-defined estate and business plan.

In This Issue:

Uncertainty is Certain

Market Performance

Is the Federal Reserve’s Policy of Quantitative Easing Helping my Portfolio?

Where do we go From Here?

Debt Ceiling - A Sad Truth

Housing Market Part II

Why We Like Germany & Japan

Why Pay More Taxes than Necessary?

Doing the Right Thing

Attention Retirement Plan Sponsors

Family Values

America's Cup

Follow Us Online

 

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Contact Peter

 

 

 

 



Market Performance

Here are the performance numbers for the major indices as of 9/30/2013:

Latest
3 Months

Latest
9 Months
2012
% Change
The
Close
Dow Jones Industrials
1.48%
15.46%
10.23%
15,129.67
Standard & Poor’s 500
4.69%
17.91%
16.00%
1,681.55
NASDAQ Composite
10.82%
24.90%
17.74%
3,771.48
Russell 2000
9.85%
27.69%
16.35%
1,073.79
MSCI EAFE
10.94%
13.36%
17.89%
1,818.23
Long Term Treasury Bonds
-2.50%
-10.49%
3.54%
 
Gold
-11.28%
-20.28%
5.68%
 
Despite losing more than 2% following the Fed meeting, the S&P gained 3% for the month. Industrials was the best performing sector in September (+5.5%) and Materials were the best for the quarter (+9.7%). Defensives were weak over the last quarter with Telecom (-5.5%), Utlities (-.8%) and Consumer Staples (+.1%) the biggest laggards. Consumer Discretionary Posted the strongest gains so far this year (27.7%). Lower quality stocks have edged out high quality stocks in Q3 and YTD. The key thing to remember is that the government has shut down in the past—in fact, 18 times over the 20-year period from 1976 to 1996—and the markets have not melted down in response.
Sources : Thomson Reuters; WSJ Market Data Group, Dow Jones & Co., BTN Research, BofA ML, Ned Davis Research. Stock market indices do not include reinvested dividends.



Is the Federal Reserve’s Policy of Quantitative Easing Helping my Portfolio?

Summers LovingThe Fed's negative outlook for the economy and the decision not to reduce its asset purchases (tapering) has rattled investors. A lack of market follow through after the Fed’s decision is positive; it indicates that traders and investors weren’t relying on monetary policy to fuel the next stock rally. For those of you keeping score at home, the Fed purchased $1.725 trillion of bonds during QE1 (November 2008 through March 2010). The Fed purchased $600 billion of bonds during QE2 (November 2010 through June 2011). The Fed began QE3 with monthly purchases of $40 billion of mortgage-backed securities in September 2012 and added purchases of $45 billion a month of long-term Treasuries in January 2013. Fed Chairman Ben Bernanke confirmed at the last Open Market Meeting (9/18/13) that the $85 billion of combined monthly purchases will continue for now, making the acquisitions from QE3 equal to $1.1 trillion through 12/31/13. Most people would be hard pressed to explain exactly how the monthly purchase of U.S. Treasury debt paper and mortgage-backed securities are helping the economy. Rates are kept low but that’s only a small part of the equation. The debtor (individuals and businesses) and the creditor (banks) must be confident before shaking hands on any deal. Keeping rates artificially low mutes the effect. In the past, the bulls and the bears have come to rely heavily on Quantitative Easing to explain much of the good news regarding the economy and the financial markets. While stocks may move higher in the coming months, it should be characterized as a higher-risk and more dangerous liquidity-driven move. If rates are moving higher it would follow that economic conditions are improving and starting to strengthen. This translates to stronger more profitable companies. The odds of continuity at the Fed increased a notch with the withdrawal of Larry Summers’ candidacy to replace Bernanke for the role of Chairman. This reduced uncertainty associated with the impending Fed leadership transition, as current Fed Vice-Chair Janet Yellen is now widely expected to get the job. This provides additional confidence that the Fed’s long term forward interest rate guidance will stay intact and the Fed’s continued monetary policies will likely continue. (Click here for Fed Reserve Estimates and Guidelines) Ben Bernanke has stated numerous times how he is a champion of transparency at the Fed but his actions have propagated uncertainty and confusion in the minds of investors.

Where do we go From Here?

Bond yields have stopped climbing and the U.S. dollar has pulled back, partially reversing this summer’s tightening in monetary conditions. This has hampered the stock market valuation expansion. Despite a lack of confidence the Fed displayed in the economic outlook, we believe corporate profit growth will expand. Hidden beneath rising stock indices is a rotation among stock sectors and an unsettling rise in high valuation companies. Until third quarter corporate earnings announcements begin this month, the markets will mark time. High dividend stocks were hot through April, but many turned cold when interest rates rose. Homebuilding stocks were cold through mid-May, but many have bounced back dramatically since then. In early September, President Obama sought Congressional authorization to attack Syria, but he postponed his request when Russian President Vladimir Putin introduced a deal requiring Syria to turn over its chemical weapons. Subsequently Putin offered to supply Iran with sophisticated air defense systems, as well as a second reactor at Iran’s Bushehr nuclear plant.  Whether on the political or economic front the twists and turns are unsettling. We've seen a surge in merger and acquisition activity, indicating rising confidence by executives. This in turn leads to business investment which has been lagging over the last few years of the recovery. On the consumer side of the economy, August auto sales rose to an annualized level of roughly 16 million vehicles, a rate not seen since before the financial crisis.  We believe this will be a major catalyst for the next leg up in stocks. We view this environment as the perfect time to build positions in our focus sectors … small cap industrials, financials and homebuilders. Short term events such as the debt ceiling ramblings in Washington and global political posturing also create purchase opportunities.

Debt Ceiling - A Sad Truth

Congress lifts a finger...As tends to happen with politicians, the hard decisions have been delayed again and again. Last February Congress agreed to deal with the debt ceiling by suspending it for 3-1/2 months (until May 21st). On that date, the debt ceiling was automatically raised to match the government's borrowing needs ($16.699 trillion). Over the last 4 1/2 months the Treasury has been using what it refers to as "extraordinary measures" to meet its obligations and keep the Federal government from defaulting on its debt. Both political parties have known that such measures would run out of maneuvering room this fall and by most estimates, the debt ceiling will have to be raised (or suspended again) by the middle of October in order to avoid a disastrous outcome. The last time Washington pushed the debt ceiling to the last minute, Standard & Poor's downgraded America's debt rating. It fostered a crisis in confidence for Americans and investors around the world. The collateral damage was slowed economic growth and punishing stock investors with the largest correction (about 20%) of the current bull market. Before the Republicans and the Democrats are forced to deal with the debt ceiling deadline in mid-October, they will have to address an even more pressing need. The new fiscal year is already underway. The House of Representatives, Senate and White House still need to come up with a compromise that will fund the government moving forward. The House passed a short-term funding bill in late September. However, it contained language that would defund the Affordable Care Act, better known as ObamaCare. The Senate wants to fund that existing law and naturally the White House is in favor of pushing forward with healthcare reform as well. That means the latest effort by Republicans to defund the program is a fruitless strategy. Obama sees healthcare reform as a crucial part of his legacy. There is no chance that the White House will budge on the matter. Washington is once again a headwind on the recovery. The talk of a default if the debt ceiling isn’t raised is an embarrassment in the midst of real economic issues. Tax revenues far exceed interest costs on the debt and existing debt can be rolled over, so there is zero chance of default. The budget and debt ceiling debates will very likely be meaningless in the long run health of the economy and at most, merely high drama. This is also an internal battle between conservative activists and the party establishment for control of the Republican Party. This is great political theater, but for long-term investors, it is a sideshow. The market has gone through this before and typically does not react as strongly the second time around. The list of positives for the market is favorable and growing. We expect the market to remain on hold until budget talks are behind us and we’re well into a new earnings season.

Housing Market Part II

In the last newsletter we discussed the reasons we’re bullish on the housing recovery. As we started to build a real estate sector position for our clients we hit an air-pocket of lackluster data and stocks dropped. Before the higher interest rates, housing data had begun to top out as home construction waned. The slow down in housing was more a supply issue than a demand issue. This has caused many analysts to scale back their housing growth rate for 2013. We think this is a mistake and have been buying accordingly. Higher interest rates, higher prices, inventory shortages, and labor shortages have all held back the housing market over the last quarter. However, some of those factors look to dissipate in the fourth quarter and beyond. The Fed's decision not to scale back on its tapering program just yet could cause at least a temporary drop in rates that should pull in buyers who missed the lower interest rates this past spring. It finally appears that banks are easing up on their tight credit policies. New home sales were up in August, even if the rate wasn’t as fast as analysts had forecast. Lennar (LEN) and KB Home (KBH) both reported solid earnings. These positive data points have homebuilders excited; their official sentiment data remains at a recovery high, despite the fact that housing starts are down more than 10% from its spring highs.

Why We Like Germany & Japan

GermanyThere were a number of unexpected surprises out of Germany and the rest of Europe over the last three months. Europe appears to be moving from recession into recovery, as the second-quarter GDP rate announced in July turned positive for the first time since 2011. Also in the positive column, Chinese and European manufacturing appeared to pick up steam in the quarter. Better auto sales and production rates contributed to the improvement, as did some inventory rebuilding and general improvements in consumption from more confident European consumers. We have begun to buy into the European recovery story, but most investors remain fearful of the region’s fragility. We disagree. A few bits of upbeat economic data recently provided grounds for optimism, and the European Central Bank’s (ECB) continued commitment to holding the Eurozone together has boosted confidence. We believe the recent election result in Germany was the best possible outcome for Chancellor Angela Merkel and is a positive catalyst for the European markets. With Merkel staying in power, center-right voters in Germany will remain relatively confident that targeted stimulus programs and easing by the ECB are not being used to write a blank check to Southern Europe. Before the elections, Merkel warned that a new debt cut for Greece could unleash a risky domino effect. Post election she has left the door open to such a debt cut. The German stock index, the DAX, established a recent all-time high in September. Two months ago we started a position for our clients’ portfolios buying the exchange traded fund (DBGR) that focuses on the DAX. In Japan we have been buying the currency hedged ETF (DBJP) because the yen should continue to weaken given the stimulus programs orchestrated by Prime Minister Abe. Japan's economy is likely to receive the largest injection of liquidity over the next year among large developed economies. The DBJP will give us exposure to the Japanese equity market for which we have a positive outlook without the inherent currency risk (that is, the risk of losing any stock gains when we sell and need to convert from yen back to dollars). We will continue to add to these investments during any market pull back.

Why Pay More Taxes than Necessary?

We believe the purpose of an employer starting and maintaining a retirement plan is to help employees save for retirement and reduce the tax burden for the employer. Through careful plan design, an employer can maximize contributions for their highly compensated employees while offering a benefit to their lower paid staff. Poor plan design can be costly to the employer through unnecessary contributions, taxable refunds to highly compensated employees, or inefficient use of plan features. That’s why it’s important for employers to have a knowledgeable retirement plan advisor help them navigate through the many different types of retirement plans and plan features. Now is the time to use all aspects of the retirement plan rules and regulations to your benefit. Plan sponsors can help employees make contributions well beyond the 401k annual deferral limits of $51,000 for 2013. It can put more money in the pockets of their highly compensated employees and less money in the pockets of government. Many professional service firms, such as law firms, have made use of Karp Capital’s retirement plan consulting in tandem with a safe harbor 401(k) plan. These plans do not maintain hypothetical individual employee account balances like the traditional defined benefit plans. In addition, the balances are protected from creditors and are portable like 401k/ profit sharing plans. Typically they’re more flexible than the old defined benefit plan with less demand for required contributions. Plans need to be in place by the end of the year. Do not wait until it’s too late: call us for consultation to see if this strategy is right for you and your business. (Click here for retirement plan limits.)

Doing the Right Thing

Although we spend a lifetime building up an array of emotional responses to help us cope with uncomfortable feelings, those same normal emotional responses are exactly the opposite of what is needed to succeed in reaching investment goals. Investing requires that you do the unnatural, and control your emotions. A lifetime of learning how to respond to uncomfortable feelings or situations needs to be unlearned to succeed in the long term. Responses that are appropriate in personal situations are sure to cause losses when investing in the financial markets. You expect to make a profit over time, but in the short term, even a diligent investment process is bound to have losing investments. That's just the nature of probability theory. How do you control perfectly natural emotional responses? Investing is not about who you are or your financial goals. It is about executing a process that performs over time on a risk adjusted basis. What makes this business very difficult is sometimes hard work and a process does not payoff in the short term. That's hard to accept for most people because it means that being successful (profitable) in the short term to some extent is just a matter of the odds randomly working in your favor. There is logic behind this randomness. We use this as a back drop in our investment process to our advantage to reduce risk and increase returns, that’s the alpha that Karp Capital brings to the relationship. Recognizing that odds are part of our risk management strategy takes some of the emotion out of it. Additionally understanding your investment time horizon versus your investment return helps you cope with the inevitable draw downs in principal.

Attention Retirement Plan Sponsors

The Supreme Court’s decision in U.S. vs Windsor declared that the Defense of Marriage Act (DOMA) defining marriage as a union between one man and one woman was unconstitutional. The effect of the Windsor decision is that state law determines whether a person is married for purposes of deciding his or her eligibility to receive federal benefits and those afforded to spouses in employee benefit plans. One of the key unresolved questions following the Windsor decision was whether marital status would be determined by the laws of the state in which a couple was married (i.e., state of celebration) or by the laws of the state in which they reside. In the recently released IRS Revenue Ruling 2013-17, the IRS clarified that for tax code purposes the status of a marriage will be determined by the laws of the state of celebration. We expect that many 401(k) plan sponsors will be relieved to have clarity on this issue. There are pending legislative proposals in other states, as well, so it is incumbent on plan administrators to track this issue in states where they have plan participants. The IRS rule does not extend to people in legal non-marriage relationships, such as civil unions or domestic partnerships, so the rules have not changed in terms of how 401(k) plans choose to deal with people in those relationships. Ruling 2013-17 addresses the definition of marriage for tax code purposes only and does not govern the definition for purposes of Department of Labor (DOL) or other rules. We will keep you apprised of any guidance from the DOL when it becomes available. If you have any questions please call your Third Party Plan Administrator or ERISA Attorney.

Family Values

The family dynamic that you had a hand in creating will survive you, impacting your children and grandchildren. Although many of the events that went into forming your family as it now exists have already occurred, your family dynamics are not set in stone. How you live your life from this point forward and how you structure your estate are new opportunities to reinforce the healthy aspects of your family, correct past wrongs, and leave a lasting legacy of fairness, compassion and love. How can you control your assets and build your family’s legacy? Have you stopped to consider how a trust may help you pass on your legacy and avoid making critical estate planning mistakes? In addition to the transmission of wealth, your estate plan communicates many things to those we leave behind. We believe protecting wealth for future generations should be one of your top priorities. There are many types of trusts available; each designed to help achieve specific goals. The estate planning benefits of a trust begins with documentation carefully drafted by a qualified attorney with knowledge of your specific situation and goals. Without the appropriate documentation, your beneficiaries may not reap the benefits of a trust. Ideally, you should articulate your wishes and document relationships in detail. By carefully and thoughtfully planning your estate, you can protect your most important legacy. (Click here – Why Have a Trust?)

America's Cup

At Karp Capital Management we have rallied around the America’s Cup race, sponsoring events for our clients to learn and experience the thrill of international racing. We congratulate Oracle Team USA in their capping an unprecedented and improbable comeback, defeating New Zealand to win the America’s Cup on September 25th. Despite New Zealand’s massive 8-1 lead and needing just one more victory to capture the Cup, Oracle roared back with win after win. The America’s Cup is the oldest trophy in international sports. This never give up spirit captures how we feel about our clients and the work we perform on your behalf. It is our pleasure to work for you.

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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.