Karp Capital Management Focus

2nd Quarter Report

Written by Peter Karp
July, 2014

Balancing Act

World Economic Pitfalls

After last year’s blockbuster market, the first half of 2014 was erratic even though it continues to hover at all-time highs. Investors’ appetite for risk has declined. Geopolitical risks abound but financial markets were resilient thanks to the mostly dovish tone struck by a meeting of the Federal Open Market Committee (FOMC). We believe with market complacency running high, both investors and the Fed should pay more attention to inflation. The latest GDP report was a sobering reminder of just how much trouble the economy found itself in earlier this year, though investors have been rewarded year to date. The pace of economic recovery in the developed world and the stability of emerging markets, particularly China, are of lingering concern. While stocks still appear more attractive than bonds and cash, investors should be cognizant that U.S. equities are no longer cheap and might be vulnerable to unexpected news, such as a deterioration of events in Iraq. Investors so far have paid little attention to the fighting in Iraq, the Ukrainian political and military crisis and higher oil prices. In this installment of Karp Capital Focus we will address how we are positioning portfolios for the second half of 2014 and action items to prepare for retirement.

In This Issue:

Balancing Act

Market Performance

Federal Reserve

Recovered?

The Markets

Inflation

Time to Retire

Show Me the Money

The Play Book

History Lesson

Gold

Civil War and Why it Matters

Real Estate –Playing to Win

Taking a Vacation?

Safe Deposite Box – Abandoned Accounts

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Market Performance

Here are the performance numbers for the major indices as of 6/30/2014:

Latest
1 Month

Latest
3 Months
2014
% Change
The
Close
Dow Jones Industrials
0.65%
2.24%
1.51%
16,826.60
Standard & Poor’s 500
1.91%
4.69%
6.05%
1,960.23
NASDAQ Composite
3.90%
4.98%
5.54%
4,408.18
Russell 2000
5.15%
1.70%
2.52%
1,192.96
MSCI EAFE
0.79%
2.95%
2.95%
1,972.12
Long Term Treasury Bonds
-0.20%
4.87%
12.64%
Gold
5.16%
1.80%
9.45%
The joke on Wall Street was that the only fear was the fear of not being in the market and losing out on potential gains. The S&P 500 posted a respectable 1.91% return in June, outperforming long term treasuries -.2%. The S&P 500 posted eight new closing highs in June, bringing the YTD count of closing highs to 22. June was the sixth consecutive quarterly gain for the S&P 500 an event that had not been seen since 1998. Investors took on risk with low quality rated companies (B or worse) +4.8% vs. B+ rated companies up +2.4%. The worst performing sectors for the quarter were Telecom 2.5% and Financials 1.84%, the best performing sectors were Energy 11.45 and Technology 6.05%. The day to day market has continued to be slow, with volume for June 18% lower than recent monthly averages.
Sources : Thomson Reuters; WSJ Market Data Group, Dow Jones & Co., BTN Research, BofA ML.
Absolute price return. Stock market indices do not include reinvested dividends.



Federal Reserve

The results of the FOMC meeting weren't terribly exciting or wildly different from expectations. The Committee voted 10-0 to keep short-term interest rates unchanged. The Federal Reserve is continuing to reduce its quantitative easing program with purchases likely to conclude before the end of the year. Attention is now turning to what the next normalization step should be. Some members believe they need to let the balance sheet of assets decline before embarking on rate hikes, while others take the opposite approach. At this point, no decision appears imminent and the conditions in the economy will likely determine how and when the next step will be taken. Credit demand reported by the major banks show loan growth is anemic. Low rates are not enticing consumers to borrow for home purchases. Hands are tied and so the decision has been made that there will be no big changes in the U.S. Federal Reserve’s stance on interest rates or policy. The Fed's lack of attention to excesses it created (pushing up asset prices) is starting to bleed into the economy. The real danger is that we will end up with another asset bubble before there is true improvement in the living standards of the average worker.

Recovered?

Economy At LastThe question remains… is the recovery still intact? The numbers have been inconsistent. Car sales rose to levels not seen since early 2007, but the domestic labor force did not reap the rewards. On a positive note, it was reported that new home sales hit their strongest annual pace in six years. It’s important to remember that the stock market has already factored bullish news into share prices. If the markets continue to rise on low volume, complacency and rising inflation, investors could be hurt as the market slides toward fair value. We can’t be certain when the markets will turn, but market history provides strong reason to believe that intervening gains will be lost by most investors. Many investors seem to forget that markets move in cycles and not a perpetual diagonal line. We continue to invest in our focus sectors (e.g. energy, tech) where fundamentals are attractive on a risk reward basis.

The Markets

Interest Rate KnockoutThere has been no discernible trend for 2014 from the major market averages. In May and June we did see strength in a couple of investment sectors which support our Q1 investment themes. Concern of a market correction is foremost in investors’ minds. Given the alternatives we maintain a cautious overweight in U.S. equities. We still want to look at areas that benefit from growth in a slowing economy and areas that are less vulnerable to a rise in interest rates. Tech, energy and utilities stand out in this environment. Seeing opportunities is half of the long-term investment story; the other half is avoiding risk. U.S. stocks should continue to move higher although activity may remain sluggish through the summer. Technology stocks are on a tear, trading at a notable premium to valuations, while energy, basic materials, and financial services sectors are fairly valued. There are pockets of value for patient investors. We are in the late stages of a bull market and bull markets do not turn on a dime, but are typically vulnerable as a result of a political or monetary policy misstep.

Inflation

In the last couple of months, for the first time in this recovery, both core consumer price inflation and wage inflation are accelerating at the same time. Making the case that inflation is one of the biggest economic concerns right now is easy to do as meat prices rose 7.7% this year, dairy is up 4.2%, car insurance is up 5% and tuition and public transportation are up more than 3%. Another inflation factor at work is shelter. With rental vacancy rates hovering near 13-year lows and new home sales soaring by 18.6 percent we can expect a continued rise in housing costs for the rest of the year and possibly into early 2015. There is bound to be some real wage gains over the next year, as employers search for more productive workers. One of the hallmarks of a bubble economy is when asset prices rise faster than wages. We are likely to see inflationary pressures continuing to play out in the economy. It is clear that we have now passed the days of deflation and have entered a period of inflation.

Time to Retire

The number one question for people thinking about retirement is… will I have enough money to live the life to which I have grown accustomed? Ensuring that your savings last the rest of your life is a challenge. While saving as much as possible during your working years is important, so are the decisions you make in retirement. Fortunately, there are steps you can take to improve your odds of financial success click here. The challenge facing you now is moving from accumulating assets to generating income. In retirement, your savings ARE your income and a key goal is determining an appropriate budget. Establishing a reasonable average spending level without too much year-to-year volatility will maximize your savings. Give us a call to start the discussion.

Show Me the Money

When should a retiree start taking Social Security benefits? Initial Social Security benefits increase by about 8% (plus inflation) for every year a recipient delays their benefit from age 62 to 70. By delaying your Social Security benefit you receive a guaranteed return as well as a hedge against interest rate fluctuations. When you compare it to bond rates or an inflation-adjusted annuity, it’s the best fixed income return you can get. Delaying claim of Social Security benefits is an excellent retirement planning strategy.

The Play Book

In the U.S. the governing body of professional football is the NFL. In the world of finance NFL stands for No Free Lunch. We are often asked how portfolios are managed given the strong returns of 2013 and current market risk. We hedge when we can, not when we have to. Hedging is like buying flood insurance during a drought. When markets are uncertain the cost of hedging is often prohibitive. When an investor is comfortable and satisfied with their allocation and performance, it’s usually a good time to consider the possibility of a market correction. A few minor events can start a major market move. Many investors view the markets from a traditional long-term buy and hold strategy. In the short-term, anything can happen, and it is vital to keep this in mind. This becomes a real concern as you get closer to retirement; you do not have time on your side to make up portfolio losses. Concern is one thing, but worry can be the doom of reaching your financial goals. Understanding how your portfolio is constructed allows acceptance of uncertainty and peace of mind at times of chaos in the market. Today’s quiet markets are the perfect environment to develop a plan for the next financial storm. Call us to find out what strategies are in play to hedge against the unknowns of tomorrow.

History Lesson

The Bull is BackThe Dow Jones Transportation Index dates back to 1884. It is comprised of bellwether transportation stocks in trucking, domestic airlines, and railroads. Strong gains in the index are a good sign for the U.S. economy, especially in periods when energy prices are high or increasing. The biggest risk to strong gains is a pullback in consumer spending, negatively affecting shipping. Consumer confidence, manufacturing activity, and strong corporate earnings are factors that will tell us whether or not the gains in transportation related stocks are sustainable. The airline sector is up strongly this year, increasing approximately 34% due to recent airline mergers and restructurings as well as increased passenger traffic. The railroad component is up nearly 10% YTD. The Transportation index is also one of the underpinnings of the Dow Theory of stock price movement. Part of the theory states that a major trend in the stock market can be confirmed by the simultaneous movement of the Dow Jones Industrial Average and the Dow Jones Transportation Average to new highs or lows. The Dow Theory is intact and confirms the current stock market rally and the future health of the markets.

Gold

Gold is a barometer of the market's expectations for the U.S. dollar and a proxy for global trade and inflation. When you talk about the price of gold, what you're really talking about is the strength of the U.S. dollar in relation to other currencies. When the global market starts to lose confidence in the buying power of the dollar it is reflected in the rising price of gold. Investors choose to use the commodity as a hedge against the deflating currency to maintain the value of their hard earned wealth. With rising domestic inflation and rising global oil prices, the dollar isn’t buying as much as it was. The price of gold has turned the corner and will continue to climb. We are currently adding gold to our clients’ portfolios through the Gold Exchange Traded Fund (GLD) and select gold mining stocks.

Civil War and Why It Matters

The Winds of WarRecent developments in the Middle East deserve our attention. Beyond the human tragedy, religious factions have access to pools of money and supporters like never before. Countries are torn apart economically and the populous is left without basic necessities. Governments and humanitarian agencies around the world are overwhelmed. The situation in the Middle East has an economic effect around the world. Iraq is the world’s seventh largest oil producer. Predictably, oil markets rallied as the gravity of the situation unfolds. Concerns over supply bottlenecks lead to volatility in the markets and a spike in gold prices. Our position in oil is based on a worst case scenario; the conflict escalates, engulfing southern Iraq and neighboring countries. While the situation is bleak, it is by no means as bad as it can get. As militias in the south are mobilized and Iran and the U.S. engage, violence can spread. This could threaten the region’s stability, particularly as neighboring countries will likely get dragged in. Iraq was slated as one of the key sources of production growth over the next decade. We expect some volatility in oil prices for the rest of 2014 and see oil and energy related stocks as a growth component for our portfolios through 2015. With lagging production in Iraq, sanctions on Russia and new domestic drilling in the mid-west we will add to our position in the sector during price pullbacks.

Real Estate – Playing to Win

The belief that the domestic housing market has hit the wall two years into a recovery after a 6 year decline is nothing more than a consolidation within a longer-term improvement. We think improvements in employment and the increased cost of renting is what’s driving the market, not low cost mortgages. The biggest headwind to home ownership is a shortage of attractive inventory. Higher prices are leading to a modest increase in listing activity. This would be a favorable trend since real estate markets feed off higher volume, not higher home prices. Sales volume is essential for the sector to be a significant contributor to overall economic activity. Single family and multifamily real estate is in transition. We will be adding to our real estate holdings during any market pullback.

Taking a Vacation?

Vacation LibertySummer is in full swing. The travel industry in the United States is enormous, with over $887 billion spent every year on lodging, transportation, food and amusement. $209 billion goes to restaurants and other foodservice entities nationwide. Hotels and retail stores also capture a generous portion of traveler’s dollars. Even with the draw of the World Cup and other tourist destinations around the globe the U.S. is still a prime travel destination. Foreign travelers find the Unites States a safe and easy country to visit. This is a boon to the economy and employment trends. In 2013, the U.S. had nearly 70 million international arrivals at airports and seaports. The U.S. Travel Association calculates that a foreign visitor spends $4,500 during their stay. The travel industry generates over $2 trillion in economic activity. Nearly 15 million jobs are supported by the industry, producing over $200 billion a year in wages earned by U.S. workers.

Safe Deposit Box – Abandoned Accounts

Do you or a family member have a bank account that you don't actively use or a safe deposit box that you have not checked on for a while? If so, you might want to see if the government has claimed your money or raided your safe deposit box. The state controller's office sends out unclaimed property notices annually. Often those notices don’t reach the property owner (e.g. no forwarding address or deceased). The Unclaimed Property Law provides the state an opportunity to return your money (or that of a deceased relative) and provides you with a single source to check for unclaimed property. The State of California is currently in possession of more than $6.9 billion in unclaimed property belonging to approximately 24.9 million individuals and organizations. To find out if any of this property belongs to you, visit the state controller’s website at sco.ca.gov. It’s not only bank accounts and safe deposit boxes that are covered by California law. There is a vast array of unclaimed property that’s covered (e.g. cashier's checks, money orders, CDs, matured or terminated insurance policies, mineral interests, royalty payments, trust funds, and escrow accounts). Protect yourself and know the rules that govern your safe deposit box and other properties.

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All of us at Karp Capital Management thank you for your continued support. 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, 8th Floor
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.