We received an email recently from a client requesting that we wire $85,000 to an overseas account. What was intriguing about the email was that it was very authentic at first glance. The email was sent from our client’s Gmail account. It was not the beginning of a new dialogue, but rather a reply to an email we sent previously.
We became suspicious because we were pretty sure our client did not want to send over eighty grand to someone named Abdul in Dubai. It turns out that a criminal had hacked our client’s Gmail account and was sending emails as our client. He or she had combed through the emails, learning a lot about our client, even ending correspondence with initials, just like our client does.
Suspecting a ruse, we sent a document for our client to sign and return to us. We protected the document using our client’s social security number as a password, but the hacker knew our client’s SS number and opened it. He returned the signed document with a signature SIMILAR to our client’s so we could execute the transfer.
Fortunately we smelled fraud and prevented the transfer of funds. However, I think it is important to note how easily this happened. If this criminal manages to be successful just once a month, that’s an annual income of close to $1,000,000. And no punishment when he or she is unsuccessful.
Here’s an important lesson. Change your email password often. If your password is “password” or “123456” or something equally stupid as those, expect to have your email account hacked. It’s not a matter of if…
This is typically the time of year when we comb through portfolios looking for security holdings that have declined in value. If possible, we usually sell those devalued stocks prior to December 31st, thereby realizing the loss for our client. The loss can then be deducted on a tax return, reducing the tax amount owed.
The bad news is that this is one of those years when investors have very few investments trading at a price below what they paid. That is also the good news. 2013 has been a boring year of stock market increases almost every month. June and August were the ONLY months that registered negative returns… very tiny negative returns at that. Through November 30th, the S&P 500 index increased 29.11%. And it is up 192% since March 6, 2009!
Which brings us to other points. Is this stock market overvalued? If it is, what should we do? If not, at what point will it be overvalued?
There is no question we witnessed an impressive rally this past year… even the past five years. In the graph below I point out that since the market bottom at the end of February 2009, the S&P 500 has increased 23.3% per year for almost five years.
However, that is a bit misleading and doesn’t take into account the “lost decade” prior to this recent rally. If you go back to the end of the previous millennium, the S&P 500 increased ONLY 3.43% per year.
However, that is ALSO a bit misleading and doesn’t take into account the famous 18-year bull market from the end of 1982 that took us to the end of the millennium. If you include that period, the S&P 500 has increased 11.36% per year.
So which of those periods determines whether stocks are overvalued or undervalued? The answer is none of them. (Although I have to confess one would be naïve to look at the sharp incline at the far right in the graph and be surprised that the market declined in 2014.)
What should determine the price of stocks is earnings. Using that scale, we feel that stocks are not horribly expensive. However, it is clearly obvious that they are not very cheap either.
Although we are not exiting the stock market entirely, the graph makes it easy for us to take profits, sell covered call options and decrease our allocation to equity (stocks).
The economy continues to plug along. Growth is positive, albeit sluggish. Unemployment continues to decline (very slowly) and it officially hit the magic 7% mark last Friday. I say magic because that is the level at which most people feel the Fed will begin to unwind or “taper” its stimulus program.
The Fed has been purchasing approximately $85 billion each month in government securities including mortgages for a long time now. The effect has held down interest rates, especially mortgage rates. The thinking was that injecting all that liquidity into the economy and holding down interest rates would keep the patient (our economy) alive long enough until it could function on its own. Common knowledge is that the Fed would begin to cease such activities when it became apparent that the economy could function on its own.
With unemployment at 7% and falling, it is highly likely that the Fed’s activities in the open market will begin declining. This is not a secret, but rather long anticipated. We don’t think it will have a material impact on interest rates or on the economy. We think the Fed may be getting way too much credit for an economy that would have plugged along on its own.
At Boyer & Corporon Wealth Management, we still have a larger allocation of municipal bonds than we would typically expect to have. Not just municipal bonds, but “zero coupon” municipal bonds, the kind that fluctuate in value more than your typical municipal bond.
You can see in the chart below, that for many years, 20-year zero coupon municipal bonds (the blue line) were bouncing around with an interest rate similar to the U.S. Treasury 20-year zero coupon bonds (the red line). In 2008, the prices of municipal bonds collapsed. The chart is a bit confusing because when something collapses, the line spikes upward, the opposite of what you would expect. In 2008, the blue line spiked upward (to an interest rate of 6%) while the red line (treasuries) fell downward (to an interest rate of 3%). That means that zero coupon municipal bonds became very cheap relative to treasury bonds.
In the 2008 economic crisis, investors became very scared. In a massive “flight to safety,” they sold their municipal bonds (along with everything else!) and bought treasury bonds driving UP the price of treasury bonds and driving down interest rates. As the prices of municipal bonds plummeted, the interest rate on municipal bonds spiked.
A similar pattern occurred in 2010 when a prominent Wall Street analyst predicted the demise of municipalities across America (see October Commentary R.I.P. Joe Granville). Prices plummeted and interest rates shot back up to 6% again.
Although we didn’t take advantage of the cheap prices in 2008, we stepped up to the plate in 2010. As interest rates on zero coupon municipal bonds decreased over the next year to below 4.5%, we took some profits. At the time, we figured that was an aberration and that we would not get a chance like that again for a long time. But we were wrong. As you can see above, 2013 looks like a mini-repeat of 2008 and 2010.
So we find ourselves with a “larger than normal” allocation to zero coupon municipal bonds again. Not because we have an affinity for zero coupon municipal bonds. We try to be rather agnostic when it comes to investments. But when a particular investment appears to be relatively cheap, we can’t help ourselves. And in today’s investing environment, it is difficult to find anything that appears relatively cheap.
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.