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Don’t Celebrate the New Market High!

by Ted Schwartz

As we near new “all-time highs” for the Dow Jones average, the financial services community seems about to throw a party. I say leave the champagne on ice! I don’t want to be a curmudgeon, but…..

The very lowest bar for any investor is the rate of inflation. If your investments don’t at least keep up with the rate of inflation, you have lost money in terms of real buying power. There is no reason to save if you do not at least keep your current buying power.

So, the Dow all time high was reached in October of 2007. The website has a calculator that computes the inflation from then through January of 2013 at over 10%. So, if we hit a “new high” it will mean that market losses over the past five plus years are all the way down to 10% in real terms! The clock will continue ticking on inflation, so who knows when you will finally really break even in this market. Hardly seems like a reason to celebrate to me.

Election Distortion

By Ted Schwartz

If you tune in to politics recently, you are encouraged to take sides in a false dichotomy. You are asked to choose between the people who believe in the free market and the people who believe in government (AKA “Socialism”). This is an absurd choice as both paths would lead to total destruction. Unfettered free markets are not in place to deal with long term societal issues. The government is not in place to deliver optional goods and services to people in an efficient manner. So, fortunately, we have a hybrid system that attempts to carve out a middle ground that allows us to muddle through. So, the real question for this and every election is, what is the optimal mix going forward of government and capitalism.

Free market capitalism seems to be the optimal system to provide goods and services to people. As its focus is primarily on profitability, a layer of regulation is necessary to protect the health and welfare of the public. Too much regulation can harm the market system and too little leads to toxic excesses (see 2008!).

The government’s main role is to look after society’s best interests now and in the future. That includes many complex and unprofitable tasks (how do we protect people from fire, workplace safety, what goods and services should we provide to poor children, how do we protect the earth for future generations, what infrastructure is needed to support the private sector).  These big picture items are beyond the scope of the market economy. Some tasks offer no hope of profit ever and some offer no current profit so will be shirked by the market economy.

Both the government and the private sector have a tendency towards waste and excess if left to their own devices. We, the voters and taxpayers, are charged with closely monitoring these systems, serving as a check and balance to unfettered power, and ultimately choosing where we should set the mix of government and private enterprise to maximize outcomes. It is a very tough and very important decision that we face, but it is not the decision bandied about on television and in the media.

Give Bill Gross an F in Financial Physics!

By Ted Schwartz and Kevin Starkey


Bill Gross has always been one of the few voices that we at Capstone believe is worth listening to. The world’s largest fixed income manager got that way through solid performance over decades. His thinking is usually lucid and his worldview often intriguing. As other financial industry talking heads are peddling something and Bill sells fixed income, could he be selling something new?

That said, he seemed to fall off of a turnip truck this week. He forecasted anemic real GDP growth of 1.5% per year for the US for the next decade. We are not forecasters, so will not take issue with this gloomy forecast.  However, he went on to say that “if real GDP grows at 1.5%, then a diversified portfolio of stocks and bonds would probably grow at 1.5% as well.”

While GDP growth would certainly be correlated to expected stock returns, the 1:1 correlation that Mr. Gross throws in to the equation has been pulled from thin air. The long term growth rate of GDP is rather consistently around 3% per year. The long terms real return of stock is around 6.5% per year. In other words, stocks have historically grown at a rate far higher than GDP.

Why would this be true? Well, financial physics is about the basics of return on equity. As companies are already earning money every day as we enter Mr. Gross’ 1.5% decade, the companies have earning that are considerable to add to their bottom lines before we consider growth. Companies can 1) distribute money they earn through dividends; 2) they can use it for share buybacks that should increase stock prices; 3) they can use it for expansion, acquisitions, and debt reduction which should increase net earnings. All of these choices should yield shareholder returns well in excess of Mr. Gross prediction of GDP growth. So, even with his dire prediction, we may hope for returns that are rather paltry but well above Mr. Gross’ calculations. Stay tuned for the pitch!

Is this year going according to form?

By Kevin Starkey and Ted Schwartz

Sell in May and go away for the summer this year? Maybe not, according to data compiled by our research partner Hidden Levers. In a recent study they conducted of Election Year markets, this year has gone amazingly well to the script for election years. Hidden Levers studied election years from 1926 thru 2011 and found the first 3 months of the year had positive average returns in the S&P 500 Index for each month. Check mark for 2012! The next two months have had negative average returns historically. Check mark for again for 2012! June has had a positive average return historically. You guessed it, check mark for 2012!


So, what does history tell us about the balance of the year? Historically, July and August are the two best months of election year returns.  Then, they are followed by a small negative in September and a small positive in October. Then, the certainty of Election Day sets in and we have a positive return in November and December.


This year has played to form perfectly so far. Can that continue through the balance of the year? It seems odd when this year and period seems so different from the norm, yet it has been so predictable year to date that we would not bet against returns continuing to approximate the norm over coming months.